chapter 5 -- the federal budget zbudget = tax revenues - government expenditure (over a given...
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Chapter 5 -- The Federal Budget
Budget = Tax Revenues - Government Expenditure (over a given period)
Budget = Tax Revenues - (Government purchases of goods and services + Transfer Payments + Interest on the National Debt)
Budget Definitions
Budget < 0 -- Budget DeficitBudget > 0 -- Budget SurplusBudget = 0 -- Balanced Budget
Realistic Goal -- Balanced Budget when Y = YN.
The Federal Budget: 2006 (Billions of Dollars)
Government Receipts = $2495.8Government Expenditure = $2715.8Budget = -$220.0
Source: Economic Indicators, February 2008
Breakdown of Government Receipts
Personal Income Taxes = $1053.2Corporate Profits Taxes = $373.1Taxes on Production and Imports
= $98.6Contributions for
Social Insurance = $901.6Miscellaneous = $69.3
Breakdown of Government ExpenditureConsumption Expenditures (G)
= $812.8Transfer Payments = $1576.1Net Interest Paid = $277.5Miscellaneous = $49.4
The Budget: In Our Notation
Recall variable definitions:
-- T = net taxes
= tax revenues
- (transfer payments
+ interest on the
national debt)
-- G = government purchases of
goods and services
The National Debt
The National Debt -- The total accumulated stock of debt owed by the government to its lenders.
Debt2011 = Debt2010 + Deficit2011
National Debt -- Realistic Goal
Realistic Goal -- consider the Debt-Income Ratio =
(National Debt)/(GDP).
For US in 2007 = ($5035.1)/($13843.8) = 0.364
Decomposition of Deficit
Purpose -- break up deficit for more precise analysis of causes.
Consider the deficit, with the income tax function for net taxes.
Deficit = G - (T0 + tY*)
Add and subtract the term tYN
Deficit = [G - (T0 + tYN)]
+ t(YN - Y*)
The Cyclical Deficit
The Cyclical Deficit = t(YN - Y*) -- the deficit that arises when the economy is not at its natural level.
Sluggish economy (Y* < YN) positive cyclical deficit.
Economy with accelerating inflation (Y* > YN) negative cyclical deficit.
More on the Cyclical Deficit
Connected with Automatic Stabilization -- net tax revenues change automatically in directions that work to stabilize the economy.
Cyclical deficit -- not considered a special problem. It’s resolved when Y = YN.
The Structural Deficit
The Structural Deficit =
[G - (T0 + tYN)].
Interpretation -- the deficit that remains after Y* = YN.
Constitutes a problem, with a need for special deficit policy.
Realistic Goal (Budget)
-- zero structural deficit.
•Analyzing the Deficit -- A Numerical Example
Year Structural + Cyclical = Total
1979 100 -50 50
(Y* > YN)
1982 100 50 150
(Y* < YN)
1995 100 0 100
(Y* = YN)
Main Results From Example
Overstimulated economy can mask a deficit problem.
Sluggish economies tend to have larger deficits.
Two step strategy -- deficits
(1) Get Y* = YN.
(2) Take steps to reduce deficit
that remains.
Why are the Debt and Deficits a Problem?
Hampers the use of fiscal policy.Getting the benefits without
considering the costs.Crowding Out Effect -- higher
deficits may increase interest rates, reducing investment and possibly net exports.
The Crowding Out Effect
Consider “magic equation”:
S + (T - G) + -NX = I.Less government saving (T - G) , more
reliance on foreign borrowing (NX) or lower investment (I).
Particularly damaging if investment decreases (more later).
The Increased Debt: Burden on Future Generations
In general, older generations enjoy benefits from the debt. But younger generations have to sacrifice in the future to repay the debt, maintain interest payments, or be deprived of new initiatives.
The Crowding Out Effect:A More Sober Implication
Crowding Out Effect – Expansion of Federal Deficit and Debt increases interest rates, lowers investment (and possibly consumption)
Lower investment retards development of the capital stock, the economy’s productive capacity for future generations.
Maybe Effects of Deficits and Debt Aren’t so Bad
Riccardian Equivalence -- Given an increased deficit, older people correspondingly increase their saving.
Older generations provide the means to pay debt and interest.
Riccardian Equivalence -- No Crowding Out Effect
Within the macro identity:
S + (T - G) + -NX = I.Riccardian Equivalence when (T
- G), S simultaneously interest rates and therefore Investment are unaffected.
Another Reason Why Debt May Not Be Overly Harmful
The government (in reality) as producer as well as spender.
Some G is in fact government investment (e.g. buildings)
Some investment government can do better than the private sector (infrastructure).
Reducing a Structural Deficit = [G - (T0 + tYN)]
Increase Taxes (income or consumption-based)
Advantages: smaller multiplier, can focus on higher incomes, undesirable behavior.
Disadvantages: implicit permission for government to be inefficient in its spending.
Reducing a Structural Deficit = [G - (T0 + tYN)]
Decrease Transfer Payments.Advantages: smaller multiplier,
largest component of government expenditure, holds the line on taxes.
Disadvantages: very painful to the groups affected (often vulnerable).
Reducing a Structural Deficit = [G - (T0 + tYN)]
Decrease Government Purchases of Goods and Services
Advantages: permanence, gives discipline to government, encourages (often more efficient) private sector to replace government programs.
Disadvantages: largest multiplier, most painful way.
Reducing a Structural Deficit = [G - (T0 + tYN)]
All three are contractionary measures, will reduce Y*.
-- shifts EP curve downward
-- shifts IS curve leftwardHopefully, i* will decrease (IS-LM), I,
with its associated benefits.One more possibility -- can we make
YN? -- Discussed later.
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