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Isues in economics today 6th by guell chapter12

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

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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

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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.

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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
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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
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Real Deficit/Surplus

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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

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Deficit/GDP

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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

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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.
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The Debt as a Percentage of GDP

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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

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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.
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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.

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Who Holds Federal Debt

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Externally Held Debt

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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

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Figure 5 Built-In Stabilizers
Price Level

Price Level
AS

AS

AD1

AD2
AD3
AD2

AD1

AD3

RGD
P
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RGD
P

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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.
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CBO Projections

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