Download How Do Future Budget Deficits and the National Debt Affect Future

Application 2
How Do Budget Deficits
and the National Debt
Affect Future Generations
Slides to Accompany “Economics: Public and Private Choice 9th ed.”
James Gwartney, Richard Stroup, and Russell Sobel
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1. Budget Deficits
and the National Debt
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Budget Deficits
and the National Debt

A budget deficit is a fiscal year where
expenditures (e.g. government spending)
exceed revenues (e.g. taxes).


A budget surplus is when receipts
exceed revenues.
The national debt is the sum of the
outstanding bonds of the U.S. Treasury.
It is increased by budget deficits and
reduced by budget surpluses.
The national debt reflects the cumulative
effect of prior budget deficits & surpluses.


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Budget Deficits and the National Debt
Federal Deficit
as a % of GDP
3
2
1
0
–1
–2
–3
–4
–5
–6
1950
Surplus
Deficit
1955
1960
1965
1970
1975
1980
1985
1990
1995
2000
(a) Federal Budget Deficit or Surplus as a % of GDP
% of GDP
80
National debt
as a % of GDP
65%
60
40
20
39%
Privately held
Federal debt
as a % of GDP
Other federal debt a
0
1950
1955
1960
1965
1970
1975
1980
1985
1990
1995
2000
(b) Gross and Net Federal Debt as a % of GDP




Throughout most of the 1950s and 1960s, federal budget deficits were small
as a % of GDP, and occasionally the government ran a surplus.
During this period, the national debt declined as a % of GDP.
During 1974-1995, budget deficits were quite large, causing the national
debt to increase as a % of GDP.
During the last few years, the national debt has fallen as a % of the economy.
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2. Who Owns
the National Debt?
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Who Owns the National Debt
U.S. Government
Agencies 31.7%
Federal
Investors 37.5%
Federal Reserve
Banks 8.3%
Private
Investors 60%
Domestic
Investors 62.5%
(a) National debt = $5.548 trillion
(b) Privately held federal debt = $3.331 trillion
Source: Federal Reserve Bulletin, January 1999.


Of the $5.548 trillion national debt, 40% is held by
government agencies (primarily the social security trust fund),
and Federal Reserve banks. The other 60% is held privately
(by both private domestic and foreign investors).
 Only the privately held debt imposes a net interest obligation
on the Federal Government.
Of the $3.331 trillion privately held federal debt, 62.5 percent
is held by domestic investors and 37.5 percent by foreigners.
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3. Concerns About
the National Debt
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Concerns about
the National Debt

How does debt financing influence
future generations?


For domestically held debt (62.5% of total
privately held debt), the future generations that
pay the tax liability accompanying the debt
will also receive the interest income.
The opportunity cost of resources used by
the government is incurred during the
current period regardless of how the
government activity is financed.
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Concerns about
the National Debt

Budget deficits affect future generations
through their impact on capital formation.
There are two views about their effects:


The traditional view is that budget deficits
reduce future capital stock by increasing
current consumption, pushing up real interest
rates, and retarding private investment.
The new classical theory argues that people
will increase their savings in anticipation of
the higher future taxes implied by additional
debt, leaving interest rates, consumption, and
investment unaffected.
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Concerns about
the National Debt

The empirical evidence on the impact of
the deficit is mixed.



Empirical studies have found little, if any,
relationship between year-to-year changes in
the budget deficit and real interest rates —
providing support of the new classical theory.
Consistent with the traditional view, however,
when budget deficits rose sharply during the
‘80s, American’s current consumption
expenditures rose while domestically financed
capital formation fell, and net foreign
investment rose while net exports fell.
At this point, the bulk of the evidence appears
to be consistent with the traditional view.
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Concerns about
the National Debt

Dependence on foreign investors:



The inflow of foreign capital leads to lower
interest rates and a higher level of investment
than would take place in its absence, increasing
the productivity & wages of U.S. workers.
Wisely invested funds will generate returns
(future income) that will offset the future
income claims of foreigners; but poorly
invested funds will not.
If foreigners suddenly tried to sell their assets
here, falling prices would create bargains for
domestic investors; domestic investors would
gain and foreign investors would lose.
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Concerns about
the National Debt

Dependence on foreign investors (cont.):


The vulnerability accompanying foreign
investment lies mainly with the foreign
investor, because the investment is a
hostage to the domestic policies of the
recipient country.
A major reason why investment in the
United States is attractive to foreigners is
their confidence that the U.S. government
will not confiscate investment properties.
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4. Debt Financing
in Other Countries
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Government Debt of Industrial Countries
Net Interest on
Government Debt,
1998
1.0
1.2
3.1
Net Public Debt as a % of GDP, 1998
a
16
Australia
Japan
30
United States
39
2.9 United Kingdom
3.4
France
4.0
Germany
1.5
Spain
4.8
Canada
7.6
Italy
7.3
Belgium
41
44
47
51
61
107
115
0
50
100
150
Source: OECD Economic Outlook (December 1998), Annex Tables 30 and 35.


A large national debt relative to the size of
an economy leads to a large tax burden just
to pay the interest on the debt.
Several countries have government debt to
GDP ratios greater than the United States.
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5. How Does the
Social Security System
Influence the
National Debt?
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How Does the Social Security
System Influence the National Debt?


Including social security in the unified budget
of the federal government makes the deficit
appear smaller or the surplus appear larger
than would otherwise be the case.
Social security surpluses are intended to
increase the national saving rate and stimulate
additional investment helping to finance
baby-boomer retirement benefits.



Using these funds to finance current government
expenditures undermines this strategy.
Many economists argue that the federal budget,
exclusive of the social security system, should be
balanced.
In the decade ahead, projections indicate that the
social security system will run a large surplus
while the operating budget will be (approximately)
in balance.
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6. Political Economy,
Demographics, and
Debt Financing
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Political Economy,
Demographics,
and Debt Financing



Sustained economic growth and
favorable demographic factors moved
the federal budget to surplus in 1998.
Sizable budget surpluses are likely to
occur in the decade ahead.
However, as the baby-boom generation
moves into the retirement phase of their
life beginning in 2015, large budget
deficits are likely to re-emerge.
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Questions for Thought:
1. “The national debt is a mortgage against the future
of our children and grandchildren. We are forcing
them to pay for our current consumption of goods
and services.” Evaluate this statement.
2. When government bonds are held by foreigners, the
interest income from the bonds goes to foreigners
rather than to Americans. Would Americans be better
off if we prohibited the sale of bonds to foreigners?
3. How is the social security system currently
influencing the size of the budget deficit? If it is
not reformed, how will social security influence the
budget deficit in the years following 2020? Is this
a cause for concern? Why or why not?
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End
Application 2
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