copyright © 2002 by thomson learning, inc. chapter 12 budget balance and government debt copyright...

Copyright © 2002 by Thomson Learning, Inc.

Chapter 12

Budget Balance and Government Debt

Copyright © 2002 Thomson Learning, Inc. Thomson Learning™ is a trademark used herein under license.

ALL RIGHTS RESERVED. Instructors of classes adopting PUBLIC FINANCE: A CONTEMPORARY APPLICATION OF THEORY TO POLICY, Seventh Edition by David N. Hyman as an assigned textbook may reproduce material from this publication for classroom

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systems—without the written permission of the publisher. Printed in the United States of America

ISBN 0-03-033652-X


I- DefinitionsII- Economic EffectsIII- Public Debt


Budget Terms

A Budget Surplus exists when Tax Revenues are greater than Expenditures and is the difference between the two.

A Budget Deficit exists when Expenditures are

greater than Tax Revenues and is the difference between the two.

The National Debt is the sum of deficits minus the

sum of all surpluses since 1776.


Figure 12.1A Federal Budget Outlays, Receipts, Deficits, and Surpluses, 1950-1999

Bill

ion

s o

f D

olla

rs

Year

1,500 1,400 1,300 1,200

1,000

800

600

400

200

0

Outlays Receipts

Surplus

Deficit

1950 1955 1960 1965 1970 1975 1980 1985 1990

1,700 1,800

1,600

1995 1999

Deficit Surplus


Déficit Public, Liban

0

2,000

4,000

6,000

8,000

10,000

12,000

1993

1995

1997

1999

2001

2003

2005

LB

P m

illi

ard

s

recettestotales

dépensestotales


Figure 12.1 B Federal Budget Outlays, Receipts, Deficits and Surpluses, 1950-1999F

ed

era

l D

efi

cit

as

a P

erc

en

t o

f G

DP

, 1

96

0 –

19

97

8

6

4

2

0

-2

19

60

19

62

19

64

19

66

19

68

19

70

19

72

19

74

19

76

19

78

19

80

19

82

19

84

19

86

19

88

19

90

19

92

Surplus

Deficit

19

94

19

96

19

98


Surpluses, Deficits and the Debt as a Percentage of GDP

Nominal figures are less important than their relationship to the size of the economy.

Economists tend to look at these figures as a percentage of GDP.


Controversies Over What To Do With the Current Surpluses Options Pay off portions of the national debt Cut taxes Increase spending on programs Set surpluses aside to make Social

Security and Medicare more solvent


High-Employment Deficit or Surplus

The budget balance is altered significantly by the state of the economy.

If GDP is rising quickly, then fewer people are drawing on the welfare state and more are paying taxes.

The high-employment deficit or surplus is what the surplus would be if unemployment were low.

Economists often prefer this measure to the actual level of the deficit or surplus when advocating policy.


Measuring Budget Balance

On Budget vs Off Budget Social Security and the Post Office are run off

budget. Since 1982 Social Security has run a considerable

surplus. This money is loaned to the rest of the on budget

side of the government with the bonds issued to the Social Security Administration being the Social Security Trust Fund.


Unified Budget

The Unified Budget is the sum of the on- and off-budget deficits and surpluses.

If this is a net deficit, then the government must borrow new money from the public.

If it is a net surplus, then it is a net provider of capital to the private sector.


National Income and Product Accounts Budget

The NIPA Budget does not include any transactions that finance preexisting debts such as outlays for deposit insurance.


Real Surpluses and Deficits

Real Surpluses and Real Deficits are expressed in inflation-adjusted terms.


Economic Effects of Federal Budget Deficits

Unified budget deficits require additional borrowing.


Figure 12.2 Government Demand for Loanable Funds and the Market Rate of Interest

Inte

res

t R

ate

Loanable Funds per Year 0 L1

E'

L2

i2

i1 E

S

D1 + DG

D1


Ricardian Equivalence

Ricardian Equivalence is the view that deficits do not alter interest rates because citizens today see that deficits today will be financed with higher taxes tomorrow and citizens save in order to have the funds to pay those higher taxes.


Figure 12.3 Ricardian Equivalence: Deficits Do Not Affect Interest Rates

Inte

res

t R

ate

0 L1

E'

L2 L3

E'' i2

i1

Loanable Funds per Year

L

D1 + DG

E

S

D1

S'


Economic Effects of Federal Budget Surpluses

Unified budget surpluses allow government to provide capital to the loanable funds market.


Figure 12.4 Impact of a Budget Surplus on Credit Markets

Inte

rest

Ra

te

Loanable Funds per Year 0

L

D

E'

E I1

I2

L1 L2

S S' = S1 + L


Budget Balance, National Saving, and Economic Growth

An increase in the deficit contributes to a decrease in national savings while an increase in a surplus contributes to a increase in national savings.

Increases in national savings increases the potential for the economy to grow.


Figure 12.5 The National Savings Rate and its Components, 1959-1999 (Measured as a Ratio of

Savings to Gross National Product)*

59 5

0

5

10

15

20

Gross Saving

Corporate and Other Private Saving

Personal Saving

Gross Government Saving

25

Pe

rce

nt

61 63 65 67 69 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99

Recession


Incidence of Deficit Finance

Lower growth rates imply lower incomes for future generations.

If Ricardian Equivalence holds, then this is not the case.

Deficits may also change political equilibrium so that there are increases in government infrastructure that could lean to increased future growth.


The Government Debt

Mid-2000 Federal Debt $5.66 trillion State and Local Debt $1 trillion


Figure 12.6 Federal Debt Held by the Public as a Share of GDP (By fiscal year)

120

100

80

60

40

20

0 1940 1950

Pe

rce

nta

ge

of

GD

P

1960 1970 1980 1990 2000


0%

20%

40%

60%

80%

100%

120%

140%

160%

180%

200%

1996 1997 1998 1999 2000 2001 2002 2003 2004

Gross Public Debt

Net Public Debt


Net Federal Debt

The Net Federal Debt is the portion of the debt not held by the federal government.


Gross public Debt of the US Treasury

by Holder July 31, 2000 Holder Amount of

Debt (Billions of Dollars)

Percent of Total

U.S. Govt. AgenciesTrust Funds and Federal Reserve

2,229.5 39.4

Private Investors 3,429.3 60.6

Total 5,658.8 100.0


Net Public Debt of the U.S. Treasury by Holder (Percent Distribution) December

1999 Holder Percentage of

TotalDepositors and Institutions 7.6

Mutual Funds 10.9

Insurance Companies 4.2

Pension Funds 13.8

State and Local Governments 6.6

Foreign and International 39.2

Other Investors 17.7

Total 100


Public Sector External Debt By Type of Creditor (1)(2)

(In millions of U.S Dollars)

1999 2000 2001 2002 2003

BILATERAL 476 454 446 465 1,124

MULTILATERAL 768 880 951 1,053 1,217

COMMERCIAL BANKS 487 398 357 289 225

EUROBONDS 3,685 5,260 7,613 12,512 12,790

TOTAL 5,416 6,992 9,367 14,319 15,356


Internal and External Debt

The Internal Debt is the portion of the debt owed to our own citizens.

The External Debt is the portion of the debt owed to people other than U.S. citizens.


LBP billions 2001 2002 2003 2004 Mars, 05

Eurobonds 11,788 19,222 19,566 23,682 23,687

Loans. 2,643 2,752 3,876 3,995 3,921

Paris II related concessional loans

0 0 942 1,026 977

Bilateral and multilateral loans

2,105 2,316 2,595 2,700 2,677

Foreign private sector loans

539 436 338 270 267

Total Foreign Debt 14,431 21,974 23,442 27,677 27,608

Dette externe, Liban


Dette interne, Liban

LBPBillions

2001 2002 2003 2004March,

2005

Total Domestic

Debt28,214 25,302 26,843 26,371 25,912

Long term bonds

24,069 22,268 24,691 20,766 18,837

Short term bills

3,974 2,866 1,799 5,102 6,574

Other domestic

debt172 169 353 504 502


State and Local Borrowing

Bonds are issued by state and local governments to fund large projects.

They are rated by financial companies for their riskiness.

Similar to federal debt, much of it is held externally.


General Obligation vs Revenue Bonds

General Obligation Bonds are backed by the state or local government’s ability to tax.

Revenue Bonds are backed by the revenue that a state or local enterprise would generate.


Social Security and the Deficit

Social Security Surpluses are used to purchase federal government debt.

This will happen until benefits exceed revenues (estimated to be 2023).

Thereafter it will run deficits and will be forced to sell off those bonds.

Whether Social Security is on- or off-budget and whether or not there is a trust fund has no effect on the net national debt.


Burden of the Debt

Impact on future generations: People have to pay increased taxes to pay interest

on that debt. Some may inherit the original bonds. Growth rates are reduced because of higher

interest rates. These impacts can be offset by the increased

private savings of the generation that does the borrowing, or by returns that come from programs that were funded by the borrowing.


European Union

Entry into the EU required that members have inflation rates no more than 1.5 percentage point

more than that of the three lowest inflation countries.

interest rates on government debt be no more than 3 points higher than that of the three lowest interest countries.

government deficit as a percentage of GDP be no greater than 3% and debt no more than 60% of GDP.


EU Deficit and Debt FiguresNation Surplus/Deficit as a

percentage of GDP 1998

Debt as a percentage of GDP 1998

Belgium –0.9 118.2

Germany –2.0 61.1

France –2.9 58.8

Italy –2.7 118.7

Sweden 1.9 74.2

United Kingdom 0.5 48.7


What Should be Done With Surpluses?

Social Security and Medicare solvency Tax Cuts Other Spending Programs Reduce National Debt

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