# The Government Budget The Federal Budget Deficit by mikeholy

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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 Deficit
Budget > 0 -- Budget Surplus
Budget = 0 -- Balanced Budget

Realistic Goal -- Balanced Budget
when Y = YN.
The Federal Budget: 2001
(Billions of Dollars)

Tax Revenues =          \$1991.0
Government Expenditure =
                       \$1863.9
Budget =                 \$127.1

Source: Economic Indicators,
April 2002
Breakdown of
Tax Revenues

Personal Income Taxes = \$1010.1
Corporate Profits Taxes = \$186.5
Contributions for
Social Insurance = \$720.6
Breakdown of
Government Expenditure
Consumption Expenditures (G)
= \$514.1
Transfer Payments      = \$831.7
Grants-in-aid to State
and Local Governments = \$274.2
Net Interest Paid      = \$236.4
Net Subsidies of
Gov’t Enterprises      = \$52.4
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 Budget and
The Size of the Deficit

Budget = T - G
Size of Deficit = G - T
The National Debt

The National Debt -- The total
accumulated stock of debt owed
by the government to its lenders.
Expanded by deficits, reduced by
surpluses
National Debt --
Realistic Goal

Realistic Goal -- consider the
Debt-Income Ratio =
(National Debt)/(GDP).

For US in 2001 =
(\$3320.0)/(\$10208.1) = 0.325
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
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 macro identity:
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
Older generations enjoy benefits
from the debt. But younger
generations have to sacrifice in the
future to repay the debt or at least
maintain the interest payments.
Lower investment retards
development of the capital stock,
the economy’s productive capacity
for future generations.
Maybe Effects of Deficits

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)
can focus on higher incomes,
undesirable behavior.
permission for government to be
inefficient in its spending.
Reducing a Structural
Deficit = [G - (T0 + tYN)]

Decrease Transfer Payments.
largest component of government
expenditure, holds the line on
taxes.
groups affected (often vulnerable).
Reducing a Structural
Deficit = [G - (T0 + tYN)]
Decrease Government Purchases
of Goods and Services
discipline to government,
encourages (often more efficient)
private sector to replace
government programs.
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 leftward
Hopefully, i* will decrease (IS-LM),
 I, with its associated benefits.
One more possibility -- can we
make YN? -- Discussed later.

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