McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved. Chapter 10 Federal Deficits, Surpluses, and the National Debt

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved. Chapter Outline Surpluses, Deficits, and the Debt: Definition and History How Economists See the Debt Who Owns the Debt A Balanced Budget Amendment Projections of the Future

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved. Surpluses, Deficits, and the Debt: Definitions Budget Deficit: the amount by which expenditures exceed revenues Budget Surplus: the amount by which revenues exceed expenditures National Debt: the total amount owed by the federal government

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved. Off vs. On Budget Off-budget: parts of the budget designated by Congress as separate from the normal budget. Programs that operate with their own revenue sources and have trust funds; Social Security, Medicare, and the Post Office are examples. On-budget: parts of the budget that rely entirely or mostly on general revenue.

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved. History of Deficits, Surpluses, and the National Debt Revolutionary War debt $75 million Closest budget to balance (no deficit or surplus) was $3800 in 1835 There were more years of surplus than deficit between 1791 and 1836 resulting in a national debt of only $37,000 Civil War debt reached $2 billion From 1865 to 1930 the debt reached $50 billion By 1946 (the end of WWII) the debt was $250 billion By 2000 the debt was $5.6 trillion

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved. Accounting for Inflation All figures for deficits, surpluses, and the national debt must be adjusted for inflation. The Real Deficit or Real Surplus measures the deficit or surplus in constant dollars

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved. Real Deficit/Surplus

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved. Debt and the Ability to Pay It Economists insist that the absolute magnitude of the debt is less important than a nation’s ability to pay it. The measure that does this is the Deficit/GDP ratio

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved. Deficit/GDP

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved. Surpluses of the late 1990s Surpluses were generated over the late 1990s as a result of –High GDP growth that resulted in high tax revenues –Peace Dividend: money that was freed up for other spending priorities when the Cold War was over –Rapid increases in capital gains tax revenue from a booming stock market

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved. How Economists See the Deficit and Debt Separating the Operating and Capital Budgets –Operating Budget: part of the federal budget devoted to spending on goods and services that will be used in the current year –Capital Budget: part of the federal budget devoted to spending on goods that will last several years Separating Cyclical and Structural Deficits –Cyclical Deficit: That part of the deficit attributable to the economy’s not being at full employment –Structural Deficit: That part of the deficit that would remain even if the economy were at full employment

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved. The Debt as a Percentage of GDP

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved. International Comparisons Debt as a % of GDP CanadaUSUKGermanyItalyJapan

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved. Generational Accounting A method of analysis that computes a net tax rate that accounts for the taxes that each generation will pay compared to the services and transfers they will receive If government runs a deficit in one generation to finance a project where the benefits accrue to a later generation that is paying the interest on that debt then the net tax rate does not change.

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved. Who Owns The Debt Public –US investors –Foreign investors Trust Funds –Social Security –Medicare Federal Reserve –The Fed buys Federal Debt as a means of getting new money into the money supply.

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved. Who Holds Federal Debt

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved. A Balance Budget Amendment Proponents argue that a BBA is necessary to keep a current generation from borrowing more than is optimal. A majority of economists do not favor such an amendment because it would be Procyclical –good times would be even better and bad times even worse

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved. Figure 5 Built-In Stabilizers RGDP AS Price Level AD 1 RGDP AS Price Level AD 1 AD 3 AD 2 AD 3

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved. Projections for the Future The Office of Management and Budget (in the White House) and the Congressional Budget Office each produce a projection of the 10 year budget picture using assumptions of economic growth. These projections are rarely accurate beyond the near term because –They often are based on the assumption that Congress will not change current law. –They are quite sensitive to small changes in the performance of the economy.