Chapter 12 Federal Deficits, Surpluses, and the National Debt McGraw-Hill/Irwin Copyright © 2012 by 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 ©2012 The McGraw-Hill Companies, All Rights Reserved 12-2 1-2 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 ©2012 The McGraw-Hill Companies, All Rights Reserved 12-3 1-3 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 ©2012 The McGraw-Hill Companies, All Rights Reserved 12-4 1-4 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 2009 the debt was $13 trillion McGraw-Hill/Irwin ©2012 The McGraw-Hill Companies, All Rights Reserved 12-5 1-5 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 ©2012 The McGraw-Hill Companies, All Rights Reserved 12-6 1-6 Real Deficit/Surplus McGraw-Hill/Irwin ©2012 The McGraw-Hill Companies, All Rights Reserved 12-7 1-7 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 ©2012 The McGraw-Hill Companies, All Rights Reserved 12-8 1-8 Deficit/GDP McGraw-Hill/Irwin ©2012 The McGraw-Hill Companies, All Rights Reserved 12-9 1-9 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 ©2012 The McGraw-Hill Companies, All Rights Reserved 12-10 1-10 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 • Functional Finance: that part of the deficit attributable to the “stimulus package” useful and label it functional finance McGraw-Hill/Irwin ©2012 The McGraw-Hill Companies, All Rights Reserved 12-11 1-11 The Debt as a Percentage of GDP McGraw-Hill/Irwin ©2012 The McGraw-Hill Companies, All Rights Reserved 12-12 1-12 International Comparisons Debt as a % of GDP Canad a US UK Germa ny Italy Japan 1970 54.1 44.5 78.0 17.5 38.0 10.6 1975 44.9 42.8 62.1 23.1 57.4 20.2 1980 45.6 39.8 54.5 30.2 58.0 47.9 1985 66.3 53.5 59.4 41.6 82.1 64.2 1990 73.5 60.9 39.1 42.0 103.7 61.4 1995 99.2 68.3 58.9 59.1 123.1 76.0 2000 81.8 57.9 41.2 60.4 123.9 142.3 2005 70.3 62.4 46.5 71.1 120.5 177.3 2010 84.4 92.8 81.3 79.9 131.3 198.4 McGraw-Hill/Irwin ©2012 The McGraw-Hill Companies, All Rights Reserved 12-13 1-13 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 ©2012 The McGraw-Hill Companies, All Rights Reserved 12-14 1-14 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 ©2012 The McGraw-Hill Companies, All Rights Reserved 12-15 1-15 Who Holds Federal Debt McGraw-Hill/Irwin ©2012 The McGraw-Hill Companies, All Rights Reserved 12-16 1-16 Externally Held Debt McGraw-Hill/Irwin ©2012 The McGraw-Hill Companies, All Rights Reserved 12-17 1-17 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 not favor such an amendment because it would be Procyclical • good times would be even better and bad times even worse McGraw-Hill/Irwin ©2012 The McGraw-Hill Companies, All Rights Reserved 12-18 1-18 Figure Built-In Stabilizers Price Level Price Level AS AS AD1 AD2 AD3 AD2 AD1 AD3 RGD P McGraw-Hill/Irwin RGD P ©2012 The McGraw-Hill Companies, All Rights Reserved 12-19 1-19 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 McGraw-Hill/Irwin ©2012 The McGraw-Hill Companies, All Rights Reserved 12-20 1-20 CBO Projections McGraw-Hill/Irwin ©2012 The McGraw-Hill Companies, All Rights Reserved 12-21 1-21 ... 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... billion • By 1946 (the end of WWII) the debt was $250 billion • By 2009 the debt was $13 trillion McGraw-Hill/Irwin ©2012 The McGraw-Hill Companies, All Rights Reserved 12-5 1-5 Accounting for Inflation... 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 ©2012