1. CHAPTER 20 Deficit Finance Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

2. 20-2 How Big Is the Deficit? Deficit Surplus On-budget deficit Off-budget deficit

3. 20-3 How Big Is the Deficit? Source: Congressional Budget Office [2009a]

4. 20-4 How Big Is the Debt? National (Public) Debt Stocks vs. Flows

5. 20-5 How Big Is the Debt? Source: Congressional Budget Office [2009a]

6. 20-6 Interpreting Deficit, Surplus, and Debt Numbers Government Debt held by the Federal Reserve Bank State and Local Government Effects of Inflation –Inflation tax Capital versus Current Accounting Tangible Assets Implicit Obligations Summing Up

7. 20-7 The Burden of the Debt Statutory versus Economic Incidence Lerner’s View –Internal Debt –External Debt

8. 20-8 Overlapping Generations Model The Period 2010-2030 YoungMiddle-AgedOld (1) Income$12,000 12,000 (2) Government Borrowing-6,000 (3) Government- provided consumption4,000 The Year 2030 YoungMiddle-AgedOld (4) Government raises taxes to pay back debt -4,000 (5) Government pays back debt+6,000

9. 20-9 Generational Accounting Computation of Net Tax –PV of transfers received – PV of taxes paid

10. 20-10 Neoclassical Model Crowding Out Hypothesis Empirical testing of the hypothesis

11. 20-11 The Ricardian Model Intergenerational transfers Form of Finance is irrelevant Empirical evidence

12. 20-12 To Tax or To Borrow Benefits-Received Principle Intergenerational Equity Efficiency Considerations –χ = ½εLt 2 Macroeconomic Considerations –Functional finance Moral and Political Considerations

13. 20-13 Present Value of Tax Payments Under Alternative Taxing/Borrowing Decisions PolicyYear 1 Year 2 All Future Years PV @ 10% interest rate Spend an additional $100 in year 110000 Financing Options Balanced budget: raise 100 in taxes in year 1 10000 Deficit Finance I: borrow 100 in year 1 and pay back debt plus interest in year 2 by raising taxes 01100100 Deficit Finance II: borrow 100 in year 1 and pay interest on debt in all subsequent years always rolling over debt principle 010 100

14. 20-14 To Tax or To Borrow Tax rate Excess Burden t2t χ2χ2 χ1χ1