Download Government Budget

The Government Budget
What are the sources of government revenue?
How does the government allocate its revenue?
What is the difference between deficit and debt?
Why does running a deficit matter?
Remember:
• The objective of macroeconomics is three-fold:
– Price stability (control inflation)
– Low unemployment
– Economic growth
• In 2.4 and 2.5 we will investigate alternative
government policies to affect AD/AS
– Fiscal and monetary policy
– The difference between demand- and supply-side
policies
Demand-side policy
• Demand-side or demand management policies
are meant to change aggregate demand to
achieve macroecon. goals
– Based on idea that short-term business cycle flux is
due to consumers and producers causing
inflation/deflationary gaps
• This is also known as discretionary policy, as
it’s at the discretion (choice) of the gov’t
– Two types: fiscal and monetary
• D-S policies try to counteract
inflation/deflationary gaps, bring AD to full
employment level of real GDP (potential GDP)
Government Budget
• To influence AD, gov’t
must have a plan of
revenues and
expenditures
• The gov’t budget is
exactly that: an outline or
proposal of all gov’t
spending, transfer
payments, and tax
revenues for the coming
fiscal year—a chosen
time period for this
economic activity to occur
(in the US, Oct. 1-Sept.
30)
• The composition and
amount of spending is
politically motivated,
rather than what may be
needed
• The budget is often
considered part of a
political agenda, as it
reflects the goals of the
dominant party in power
Sources of Revenue
Expenditures
TAXES!-direct and indirect
Defense
Social Security (not usually
budgeted in US)
Infrastructure
Education
Public Works
Healthcare
Profits from state-owned
businesses (Amtrak,
electricity/utilities…)
Social welfare program
contributions
Sales of state-owned
businesses (privatization)
Government expenditure (G)
• Current expenditures—day-to-day items
(consumables) such as wages, supplies
and equipment, social services
• Capital expenditures—investment in
roads, bridges, infrastructure
• Transfer payments—payments to
vulnerable groups for income distribution
purposes (welfare, pension, social
security)
Debt and deficit
• Balanced budget—when (tax) revenues
are equal to expenditures in a fiscal year
• Deficit—when expenditures are larger
than (tax) revenues in a fiscal year
• Surplus—when expenditures are smaller
than (tax) revenues in a fiscal year
• Debt—accumulation of deficits (minus
surpluses) over time
debt clock
Points to remember
In a balanced economy . . .
• Withdrawls = injections or S+T+M = I+G+X
Types of deficits:
• Trade deficit M > X
• Spending deficit G > T
Where do T and G come from?
T=taxes
G=government
spending
Growth of National Debt as
Percentage of GDP
Where does money come from
when G>T?
Types of gov’t issued debt:
•
•
•
•
T-Bills
Treasury Notes
Bonds
US Savings Bonds
To whom is the money owed?
Who Owns the National Debt?
June 2009
Federal Reserve and
Intragovernmental Holdings
Depository institutions
U.S. savings bonds
Private: Pension Funds
Private: State and local
governments
Insurance companies
Mutual funds
State and local governments
Foreign and international
Other investors
Foreign Holders of the National
Debt
Historic National Debt adjusted
for inflation
National Debt as a percentage of
GDP, 2009
Impact of the Debt
Short-run impact, 5 years
• With excess capacity (full
employment), less noticeable
impact
•
In the short run, deficits can
have two potentially damaging
effects on the economy:
•
If the economy is at full
employment, a government
deficit is inflationary, because the
excess of government spending
over government revenues adds
to aggregate demand pressures
in the economy.
•
To the extent that federal deficits
raise interest rates, they can
retard growth in investment and
housing activities, which are
interest-sensitive.
Intermediate run, 5 - 15 years
• G>T and growing
• Baby boomers retirement
means increased demand on
medicare and social security
• Less tax revenue, as
boomers no longer working
• Falling savings rate
• Boomers are drawing down
on their savings in 401k and
other investment plans
• Falling Investment rate
• Deficits = increased
borrowing = increased
interest rates. This is called
Crowding Out (next slide)
“Crowding out” effect
•
•
Crowding out: increased public sector
spending (gov’t) replaces, or drives
down, private sector spending
Government must finance its spending
with taxes and/or with deficit spending,
leaving businesses with less money
and effectively "crowding them out"
•
One explanation: because the
government borrows such large
amounts of capital, its activities can
increase interest rates.
•
Higher interest rates discourages
individuals/firms from borrowing
money reduces spending and
investment activities
Examples:
1. higher taxes required for government
to fund social welfare programs leaves
less discretionary income for
individuals and businesses to make
charitable donations.
2. When government funds certain
activities there is little incentive for
businesses and individuals to spend
on those same things.
3. Increased government spending on
Medicaid, which has been linked to
decreased availability of private health
insurance.
Impact of the Debt
Long run, More than 15 years
• As debt grows, more interest
is owed relative to debt
principle
• National savings rate will fall
as more money goes to pay off
interest, and less towards
principle
• In the long run, deficits can be
harmful if they add to the debt
burden:
• Persistent deficits mean a
rising national debt. If the
national debt rises fast than
GDP/GNP, then this can have
serious negative ramifications
for the future growth potential
of the U.S.
• Moreover, if a large portion of
the debt is held by other
countries, then this means that
foreigners have a large claim
on U.S. resources.
Big Ideas
1. Deficits can rise not only because policy
makers raise spending or lower taxes, but
also when the economy is in a recession.
2. During recessions, unemployment
benefits and welfare payments rise
automatically while tax receipts drop.
a. One way to separate the cyclical and
structural components of the deficit is to
estimate what the deficit would be if the
economy were operating at full employment.
Big Ideas
3. Government budgets should not necessarily be
balanced at all times. Specifically, in a recession,
balancing the budget means cutting spending and/or
raising taxes—both of which have a contractionary
effect on GDP/GNP.
a. Nevertheless, in the long run the structural deficit (as measured
by the full-employment deficit, for example) should be close to
zero
4. It is important to distinguish between balancing the
budget and reducing the size of the government. A large
government can have a balanced budget while a small
government can run a large deficit.
Sources:
http://www.learner.org/series/econusa/unit24
https://sites.google.com/a/bvsd.org/paarogers/ib-economics
http://mysite.cherokee.k12.ga.us/personal/s
ean_sharrock/site/ECON%20WORKSHEE
TS/1/Fixing%20an%20Economy%20Fiscal
%20and%20Monetary%20Worksheet.pdf