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The Government Budget: Prospects and Implications Andrew B. Abel March 8, 1999 National Saving and Wealth • Income Statement Concepts • Output: Y = C + I + G + NX • National Saving: S = Y - C - G = I + NX • Balance Sheet Concept • National Wealth = domestic capital stock + net foreign assets The Government Budget: Prospects and Implications, Professor Andrew Abel 2 Link Between Balance Sheet and Income Statement • National Saving = Growth of National Wealth • S = I + NX • I = growth of domestic capital stock • NX = growth of net foreign assets The Government Budget: Prospects and Implications, Professor Andrew Abel 3 Capital Gains and Saving • Capital gain for an individual • Increases current income • If not spent: • Increases current saving • Increases wealth at end of year • Capital gain can increase current and/or future consumption of individual The Government Budget: Prospects and Implications, Professor Andrew Abel 4 Capital Gain in Closed Economy: National Perspective • S=I • If add capital gain to national output, Y • S would increase • Would have to add capital gain to I • But I is intended to measure gross capital formation, which affects capacity to produce and consume in future The Government Budget: Prospects and Implications, Professor Andrew Abel 5 Source of Capital Gains Dividend Asset price bubble rg • Increase in dividend, current or future • Reflects increase in current or future output • Decrease in r • Does not reflect increased current or future output • Bubble • Unrelated to current or future output The Government Budget: Prospects and Implications, Professor Andrew Abel 6 Capital Gains: Individual vs. National • Increase ability of individual to consume • May not affect ability of nation to consume • Example: Stock market bubble • Increases wealth of individual owners • Does not increase ability of nation as a whole to consume The Government Budget: Prospects and Implications, Professor Andrew Abel 7 U.S. National Saving, 1998-III 1998-III Gross Private Saving Personal Business Gross Government Saving Federal saving State and local saving $billions % of GDP 1078.7 12.6 12.6 0.1 1066.1 12.5 $/person 3991 47 3944 395.7 161.6 234.1 4.6 1.9 2.7 1464 598 866 Total National Saving 1474.5 17.3 5455 Investment Private Federal State and local Current Account Balance Investment + Current Account Balance 1604.2 1364.4 60.8 179.0 -231.6 1372.6 18.8 16.0 0.7 2.1 -2.7 16.1 5935 5048 225 662 -857 5078 Statistical Discrepancy -102.0 -1.2 -377 The Government Budget: Prospects and Implications, Professor Andrew Abel 8 Gross Government Saving 1998-III 1998-III Gross Government Saving Federal saving Receipts Current expenditures Current surplus Consumption of fixed capital State and local saving Receipts Current expenditures Current surplus Consumption of fixed capital $billions 395.7 161.6 1858.8 1766.7 92.0 69.6 234.1 1152.3 1003.6 148.7 85.4 The Government Budget: Prospects and Implications, Professor Andrew Abel 9 Budget Outlook under Current Policies Source: CBO, The Economic and Budget Outlook: Fiscal Years 2000-2009, Table 2-1, p. The Government Budget: Prospects and Implications, Professor Andrew Abel 10 Deficits and Debt in Europe (percent of GDP) General Gross Country Government Government Deficit Debt 1996 1997 1996 1997 Germany 3.8 3.3 60.3 61.5 France 4.1 3.3 56.3 57.8 Italy 6.8 3.3 123.0 121.5 UK 4.4 3.1 49.3 49.4 Spain 4.4 3.2 69.5 69.0 Netherlands 2.3 2.2 78.8 76.1 Belgium 3.4 2.9 130.0 127.1 Sweden 2.5 0.8 78.6 76.6 General Gross Country Government Government Deficit Debt 1996 1997 1996 1997 Austria 3.9 2.5 69.8 68.1 Denmark 1.6 0.1 69.9 67.3 Finland 2.6 1.9 58.0 58.7 Greece 7.6 5.1 110.7 107.7 Portugal 4.0 2.9 70.8 69.2 Ireland 1.0 1.6 76.4 72.3 Luxembourg 0.1 0.1 5.9 5.7 Maastricht 3.0 60.0 criteria Source: World Economic Outlook, International Monetary Fund, May 1997, Table 5, p. 27. The Government Budget: Prospects and Implications, Professor Andrew Abel 11 Revenues as a Share of GDP (fiscal year) Source: CBO, The Economic and Budget Outlook: Fiscal Years 2000-2009, Figure 3-2, p. 45. The Government Budget: Prospects and Implications, Professor Andrew Abel 12 Revenues by Source (fiscal year) Source: CBO, The Economic and Budget Outlook: Fiscal Years 2000-2009, Figure 3-3, p. 47 The Government Budget: Prospects and Implications, Professor Andrew Abel 13 Outlays • Discretionary spending • Annual appropriation • Defense, education, transportation, ... • Mandatory spending (Entitlements) • Eligibility rules and benefit formulas • Offsetting receipts • e.g., drilling leases for Outer Continental Shelf • Net interest The Government Budget: Prospects and Implications, Professor Andrew Abel 14 Outlays Discretionary Spending Source: CBO, The Economic and Budget Outlook: Fiscal Years 2000-2009, Figure 4-1, p. 63. The Government Budget: Prospects and Implications, Professor Andrew Abel 15 Outlays Entitlements and Other Mandatory Spending Source: CBO, The Economic and Budget Outlook: Fiscal Years 2000-2009, Figure 4-1, p. 63. The Government Budget: Prospects and Implications, Professor Andrew Abel 16 Outlays Net Interest Source: CBO, The Economic and Budget Outlook: Fiscal Years 2000-2009, Figure 4-1, p. 63. The Government Budget: Prospects and Implications, Professor Andrew Abel 17 CBO Budget Projections Source: CBO, The Economic and Budget Outlook: Fiscal Years 2000-2009, Summary Table 3, p. xviii. The Government Budget: Prospects and Implications, Professor Andrew Abel 18 CBO Budget Projections Source: CBO, The Economic and Budget Outlook: Fiscal Years 2000-2009, Summary Table 3, p. xviii. The Government Budget: Prospects and Implications, Professor Andrew Abel 19 Measures of Fiscal Policy Source: CBO, The Economic and Budget Outlook: Fiscal Years 2000-2009, Table 1-3, p. 16. The Government Budget: Prospects and Implications, Professor Andrew Abel 20 Measures of Fiscal Policy Source: CBO, The Economic and Budget Outlook: Fiscal Years 2000-2009, Table 1-3, p. 16. The Government Budget: Prospects and Implications, Professor Andrew Abel 21 Projections of Federal Debt Source: CBO, The Economic and Budget Outlook: Fiscal Years 2000-2009, Table 2-3, p. 38. The Government Budget: Prospects and Implications, Professor Andrew Abel 22 Trust Fund Surpluses (fiscal year, billions of dollars) Source: CBO, The Economic and Budget Outlook: Fiscal Years 2000-2009, Table 2-4, p. 41. The Government Budget: Prospects and Implications, Professor Andrew Abel 23 Burden of the Debt Gross Federal Debt Debt Subject to Limit Debt Held by the Public billions of dollars 5479 5439 3720 dollars per capita 20,271 20,123 13,763 • Debt ceiling • raised to $5500 billion in March 1996 • raised to $5950 billion in Balanced Budget Act of 1997 The Government Budget: Prospects and Implications, Professor Andrew Abel 24 Two Views of Burden of Debt • “We Owe it to Ourselves” ==> No Burden • $1759 billion held by gov’t is no burden • $3720 billion held by public is owed to public • but foreigners own some of this debt • Burden, even if U.S. citizens owned all of debt • Crowds out capital stock • Reduces long-run wages and output per person The Government Budget: Prospects and Implications, Professor Andrew Abel 25 Federal Interest Outlays (Fiscal year, billions) Source: CBO, The Economic and Budget Outlook: Fiscal Years 2000-2009, Table 4-8, p. 79. The Government Budget: Prospects and Implications, Professor Andrew Abel 26 Debt-GDP Ratio in the U.S. 1.4 Ratio to GDP 1.2 1 0.8 0.6 0.4 0.2 0 1860 1880 1900 1920 1940 1960 1980 The Government Budget: Prospects and Implications, Professor Andrew Abel 2000 27 Changes in Debt-GDP Ratio • Debt-GDP Ratio: B GDP • Growth of numerator: deficit • Primary deficit + net interest • Growth of denominator: nominal GDP growth The Government Budget: Prospects and Implications, Professor Andrew Abel 28 Factors Causing Debt-GDP Ratio to Rise • Large Primary Deficits (deficit minus interest) • Wars • Great Depression • 1980s and first half of 1990s • High (Real) Interest Rates • Low GDP growth • Great Depression The Government Budget: Prospects and Implications, Professor Andrew Abel 29 Effect on Deficit of 1 Percentage Point Reduction in Measured CPI (fiscal years, billions of dollars) D Revenues D Outlays Social Security Debt Service Other D Total Outlays D Deficit 1998 1.9 2000 10.5 2007 44.2 -2.8 -0.2 -0.9 -3.9 -5.8 -10.7 -2.0 -4.5 -17.2 -27.7 -44.6 -32.0 -19.3 -95.9 -140.1 Source: Congressional Budget Office, The Economic and Budget Outlook: Fiscal Years 1998-2007, January 1997, p. 41. The Government Budget: Prospects and Implications, Professor Andrew Abel 30 Long-Run Deficit Projections (Calendar year, percentage of GDP) Source: CBO, The Economic and Budget Outlook: Fiscal Years 2000-2009, Table 2-5, p. 43. The Government Budget: Prospects and Implications, Professor Andrew Abel 31 Long-Run Debt Projections (Debt held by public, calendar year, percentage of GDP) Source: CBO, The Economic and Budget Outlook: Fiscal Years 2000-2009, Figure 2-2, p. 44. The Government Budget: Prospects and Implications, Professor Andrew Abel 32 Will Federal Debt Be Eliminated? • Debt held by public • Projected to be zero in 2012 • Why might this projection prove incorrect? • Projected surpluses might not occur • Policies to cut taxes/increase spending • Recessions • Social Security Trust Fund may sell bonds to public in exchange for equity The Government Budget: Prospects and Implications, Professor Andrew Abel 33 Social Security: Demographic Time Bomb Beneficiaries per 100 Covered Workers 80 70 60 Intermediate 50 Low Cost 40 High Cost 30 20 1995 2005 2015 2025 2035 2045 2055 2065 2075 Source: 1998 OASDI Trustees Report, Table II.F.19 The Government Budget: Prospects and Implications, Professor Andrew Abel 34 OASDI Trust Fund Ratio 600 500 400 Intermediate Low Cost 300 High Cost 200 100 0 1995 2005 2015 2025 2035 2045 2055 2065 2075 Source: 1998 OASDI Trustees Report, Table II.F.20 The Government Budget: Prospects and Implications, Professor Andrew Abel 35 Possible Solutions • Increase Contributions by Workers • Increase retirement age • Reduce Benefits Paid to Retirees • Increase retirement age • Tax Social Security benefits • Earn Higher Return on Assets in Trust Fund • Invest in equities • Privatize Social Security • Individuals control allocation of assets • Transitional problems The Government Budget: Prospects and Implications, Professor Andrew Abel 36 Clinton Plan: Use of Projected Surpluses, 15 Years Transfer to Social Security Transfer to Medicare Transfer to USA Accounts Military, education, research % 62 15 11 11 The Government Budget: Prospects and Implications, Professor Andrew Abel 37 Surpluses, Deficits, and Debts* • SS Surp. + On-Budget Surp. = Unified Surp. • SS Def. + On-Budget Def. = Unified Def. • DSSTF = SS Surp. = - SS Def. • DGross Debt = On-Budget Def. = - On-Budget Surp. • DDebt Held by Public = Unified Def. = - Unified Surp. • -DSSTF + DGross Debt = DDebt Held by Public • DGross Debt = DDebt Held by Public + DSSTF *Ignores other off-budget items and trust funds The Government Budget: Prospects and Implications, Professor Andrew Abel 38 Double Counting? • Unified surplus results from SS surplus • SS surplus increases SSTF anyway • Transfer 62% of projected unified surplus to Social Security • DSSTF = SS Surplus + Transfer • DGross Debt = Unified Deficit + Transfer • Unified deficit and debt held by public unchanged The Government Budget: Prospects and Implications, Professor Andrew Abel 39 Illustration of Transfer to Social Security Year Transfer ? SS Surplus On-budget surplus Unified surplus Transfer to SSTF DSSTF DDebt held by public DGross debt 2000 No 138 -7 131 0 138 -131 7 Yes 138 -7 131 81 219 -131 88 2009 No 217 164 381 0 217 -381 -164 The Government Budget: Prospects and Implications, Professor Andrew Abel Yes 217 164 381 236 453 -381 72 40