| 1. |
The budget deficit of the Federal
government is the amount by which its expenditures exceed its revenues in any year
and
the public debt at any time is the sum of the Federal government’s previous annual
deficits (less any annual surpluses).
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| 2. |
If the Federal government uses fiscal policy to
combat recession and inflation
its budget is not likely to be balanced in any particular
year. Three budget philosophies may be adopted by the government; the adoption of any of
these philosophies will affect employment
real output
and the price level of the
economy.
- Proponents of an annually balanced budget would
have government expenditures and tax revenues equal in every year. Such a budget is pro-
rather than countercyclical; but conservative economists favor it to prevent the expansion
of the public sector (and the contraction of the private sector) of the economy without
the increased payment of taxes by the public.
- Those who advocate a cyclically balanced budget
propose matching surpluses (in years of prosperity) with deficits (in depression years) to
stabilize the economy
but there is no assurance that the surpluses will equal the
deficits over the years.
- Advocates of functional finance contend that
deficits
surpluses
and the size of the debt are of minor importance and that the goal of
full employment without inflation should be achieved regardless of the effects of the
necessary fiscal policies on the budget and the size of the public debt.
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| 3. |
Any government deficit increases the size of
the public debt. The public debt has grown substantially since 1929.
- There are four basic causes of the debt:
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- wars require increased Federal borrowing to
finance the war effort;
- recessions result in budget deficits because of
the built-in stability of the economy (tax revenues fall and domestic spending rises);
- cuts in tax rates without offsetting reductions
in expenditures contribute to budget deficits
as occurred during the early 1980s; and
- a lack of political will to control expenditures
for popular entitlement programs or raise taxes to pay for them adds to budget deficits.
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- The public debt in 1997 was $5.4 trillion.
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- The size of the debt as a percentage of the
economy’s GDP did not grow as rapidly as the absolute size of the debt between 1940
and 1997
but relative to the GDP
it has increased significantly since the early 1980s.
- Other industrial nations have relative public
debts similar to or greater than the United States.
- Since the 1970s the interest payments on the debt
(because of increases in the size of the debt and higher interest rates in the economy)
have also increased significantly
and interest payments as a percentage of the
economy’s GDP have grown dramatically.
- More than one-third (37%) of the public debt is
owed to government agencies and the Federal Reserve Banks. Less than two-thirds (63%) is
owed to others
including 23% owed to foreign citizens
firms
and governments.
- Because the accounting system the Federal
government uses records its debts but not its assets
the public debt is not a true
picture of its financial position. Adjusting for inflation further decreases the size of
budget deficits and the public debt.
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| 4. |
The contentions that a large debt will
eventually bankrupt the government and that borrowing to finance expenditures passes the
cost on to future generations are false.
- The debt cannot bankrupt the government because
the government
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- need not retire (reduce) the debt and can refund
(or refinance) it
- has the constitutional authority to levy and
collect taxes
and
- can always print (or create) money to pay both
the principal and the interest on it.
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- The debt cannot shift the burden of the debt to
future generations because the debt is largely internally held
and repayment of any
portion of the principal and the payment of interest on it does not reduce the wealth or
purchasing power of U.S. citizens.
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| 5. |
The public debt does create real and potential
problems in the economy.
- The payment of interest on the debt probably
increases the extent of income inequality.
- The payment of taxes to finance these interest
payments may reduce the incentives to bear risks
to innovate
to invest
and to save
and
therefore they slow economic growth in the economy.
- The portion of the debt that is externally held
(by foreign citizens and institutions) requires the repayment of principal and the payment
of interest to foreign citizens and institutions. This transfers a part of the real output
of the U.S. economy to them.
- It creates political problems for the use of
fiscal policy as an antirecessionary measure because increasing government expenditures or
cutting taxes during a recession adds to the public debt.
- An increase in government spending may or may not
impose a burden on future generations.
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- If the increase in government spending is
financed by increased personal taxes
the burden of the increased spending is on the
present generation whose consumption is reduced
but if it is financed by an increased
public debt
the increased borrowing of the Federal government will raise interest rates
and crowd out investment spending
and future generations will inherit a smaller stock of
capital goods.
- The burden imposed on future generations is
lessened if the increase in government expenditures is for real or human capital or if the
economy were initially operating at less than full employment (and it stimulates an
increase in investment demand).
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| 6. |
Federal budget deficits during the past two
decades have been the focus of national interest for many economic reasons.
- The absolute size of the annual Federal budget
deficit grew enormously during the 1980s and 1990s.
- Recent budget deficits may be understated because
surpluses from social security are being used to offset current government spending.
- Interest costs of the debt have risen.
- The deficits have taken place in an economy
operating close to full employment
which means there is great potential for the crowding
out of real private investment and for demand-pull inflation.
- Large budget deficits make it difficult for a
nation to achieve a balance in its international trade.
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| 7. |
These large Federal budget deficits produced a
cause-and-effect chain of events with the balance of trade deficits.
- They increased interest rates
which crowded out
real private investment and increased foreign financial investment in the United States.
The greater foreign investment increased the international value of the dollar
which in
turn reduced U.S. exports and increased U.S. imports
resulting in trade deficits.
- There are three loose ends to the complex chain
of events as described in a:
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- The inflow of foreign funds helped keep interest
rates lower than would otherwise be the case and diminished the size of the crowding-out
effect.
- High interest rates in the United States
resulting from large deficits placed an increased burden on developing countries
thereby
contributing to the world debt problem and banking problems in the United States.
- The unfavorable trade balance meant that the
United States had to borrow heavily from other nations and to sell assets to foreign
investors
thereby affecting the course of economic growth in the future.
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| 8. |
Several policy responses have lessened the
effect of the large Federal budget deficits and the expanding public debt.
- Deficit reduction legislation has been passed in
recent years
including the Deficit Reduction Act of 1993 and a 1996 tax and spending
package designed to reduce the deficit to zero by 2002.
- In 1995 Congress gave the president authority to
veto individual spending items.
- Congress has considered an amendment to the U.S.
Constitution that would require Congress to balance the Federal budget each year.
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| 9. |
Private and public debt play a positive role in
the economy. As an economy grows
saving increases. This saving is borrowed and spent by
consumers and businesses
and private debt is created. If
however
consumers and
businesses do not borrow sufficient amounts
the public debt will need to be increased to
absorb some saving so that the economy can maintain full employment and achieve its growth
potential. |
