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4.1 Government Budgeting

4.2 Measuring the Budgetary Position of the Government: Alternative Approaches

4.3 Do Current Debts and Deficits Mean Anything? A Long-Run Perspective

4.4 Why Do We Care About the Government’s Fiscal Position?

4.5 Conclusion

Budget Analysis and Deficit Financing 4

Heather Luea and Dan Sacks

P R E P A R E D B Y

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Beth (ecr) - Update copyright year, edition, and looks like pagination needs an update, too.

C H A P T E R 4 ■ B U D G E T A N A L Y S I S A N D D E F I C I T F I N A N C I N G

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Excerpts from Inaugural Speeches and

the U.S. Deficit

4.1

“We will continue along the path toward a balanced budget in a balanced economy.” President Lyndon Johnson

Deficit in first year in office (1964): 0.9% of GDP

Deficit in last year in office (1968): 2.9% of GDP

“We must balance our federal budget so that American families will have a better chance to balance their family budgets.” President Richard Nixon

Deficit in first year in office (1969): –0.3% of GDP (surplus)

Deficit in last year in office (1974): 0.4% of GDP

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Excerpts from Inaugural Speeches and

the U.S. Deficit

4.1

“We can achieve a balanced budget by 1979 if we have the courage and the wisdom to continue to reduce the growth of federal spending.” President Gerald Ford

Deficit in first year in office (1975): 3.4% of GDP

Deficit in last year in office (1976): 4.2% of GDP

“With careful planning, efficient management, and proper restraint on spending, we can move rapidly toward a balanced budget, and we will.” President Jimmy Carter

Deficit in first year in office (1977): 2.7% of GDP

Deficit in last year in office (1980): 2.7% of GDP

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Excerpts from Inaugural Speeches and

the U.S. Deficit

4.1

“[This budget plan] will ensure a steady decline in deficits, aiming toward a balanced budget by the end of the decade.”

President Ronald Reagan

Deficit in first year in office (1981): 2.6% of GDP

Deficit in last year in office (1988): 3.1% of GDP

“[This budget plan] brings the deficit down further and balances the budget by 1993.” President George H. W. Bush, Deficit in first year in office (1989): 2.8% of GDP

Deficit in last year in office (1992): 4.7% of GDP

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Excerpts from Inaugural Speeches and

the U.S. Deficit

4.1

“[This budget plan] puts in place one of the biggest deficit reductions . . . in the history of this country.” President William Clinton

Deficit in first year in office (1993): 3.9% of GDP

Deficit in last year in office (2000): –2.4% of GDP (surplus)

“Unrestrained government spending is a dangerous road to deficits, so we must take a different path.” President George W. Bush

Deficit in first year in office (2001): –1.3% of GDP (surplus)

Deficit in last year in office (2008): 3.2% of GDP

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Excerpts from Inaugural Speeches and

the U.S. Deficit

4.1

“This budget builds on these reforms . . . it’s a step we must take if we hope to bring down our deficit in the years to come.” President Barack Obama

Deficit in first year in office (2009): 9.8% of GDP

Deficit in most recent year in office (2015, projected): 3.2% of GDP

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Government Budgeting

4.1

Debt: The amount that a government owes to those who have loaned it money.

Deficit: The amount by which a government’s spending exceeds its revenues in a given year.

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The Budget Deficit in Recent Years

4.1

Federal government spending rose fairly steadily from 1965 through the mid-1980s, but tax revenues did not keep pace, leading to a large deficit. This deficit was eroded and turned to a surplus in the 1990s, but by 2001 the United States was back in deficit again.

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4.1

The budget process distinguishes between two types of federal spending:

Entitlement spending: Mandatory funds for programs for which funding levels are automatically set by the number of eligible recipients, not the discretion of Congress.

Discretionary spending: Optional spending set by appropriation levels each year, at Congress’s discretion.

The Budget Process

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4.1

Controlling the budget is a difficult process.

The Balanced Budget and Emergency Control Act (also known as the Gramm-Rudman-Hollings Deficit Reduction Act, or GRH).

Passed in 1985 in an attempt to control the budget.

Initiated automatic spending cuts once the budget deficit started missing specified targets.

The cuts were avoided by gimmicks, such as changing the targets.

Application: Efforts to Control the Deficit

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4.1

Failure to meet GRH deficit targets led to the 1990 adoption of the Budget Enforcement Act (BEA):

Rather than trying to target a deficit level, the BEA aimed to restrain government growth.

It created the pay-as-you-go process (PAYGO), which prohibited any policy from increasing the estimated deficit in the next six-year period.

If deficits increase, the President must issue a sequestration requirement, which reduces direct spending by a fixed percentage.

Apparently successful in reducing spending.

Application: Efforts to Control the Deficit

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4.1

PAYGO expired on September 30, 2002, and has not been renewed.

President Bush proposed renewing PAYGO in 2004…

… but not before passing a budget that cut taxes and increased spending.

President Obama has publicly supported PAYGO legislation…

… but his proposed budget would increase deficits to almost $2 trillion in the near term.

Application: Efforts to Control the Deficit

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Budget Policies and Deficits at the State Level

4.1

One tool for balancing budgets is a balanced budget requirement, used by many states.

Balanced budget requirement (BBR): A law forcing a given government to balance its budget each year (spending = revenue).

Ex post BBR: A law forcing a given government to balance its budget by the end of each fiscal year.

Forces revenues and expenditures at the end of each year to actually balance.

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Budget Policies and Deficits at the State Level

4.1

Ex ante BBR: A law forcing either the governor to submit a balanced budget or the legislature to pass a balanced budget at the start of each fiscal year, or both.

Less effective than ex post BBR because rosy projections of revenues can make a budget appear to be balanced when at the end of the year, it is revealed to actually be unbalanced due to unrealistic expectations.

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Measuring the Budgetary Position of the Government: Alternative Approaches

Real vs. Nominal

4.2

Real prices: Prices stated in some constant year’s dollars. Using real prices allows analysts to assess how any value has changed over time, relative to the overall price level.

Nominal prices: Prices stated in today’s dollars.

Consumer Price Index (CPI): An index that captures the change over time in the cost of purchasing a “typical” bundle of goods.

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The Standardized Deficit

4.2

Because revenue (taxes) and spending (insurance) depend on the economy, the deficit changes even when policy does not.

Automatic stabilizers: Automatic reductions in revenues and increases in outlays when the economy shrinks relative to its potential.

Cyclically adjusted budget deficit: A measure of the government’s fiscal position if the economy were operating at full potential GDP.

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Budget Deficit, Accounting and Not Accounting for Automatic Stabilizers

4.2

As expected, this figure shows that in periods of economic expansion, the cyclically adjusted deficit is actually higher than the reported deficit. When the economy is underperforming, the cyclically adjusted deficit is significantly lower than the reported deficit.

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Cash vs. Capital Accounting

4.2

Government investments in assets can worsen the budget deficit.

Cash accounting: A method of measuring the government’s fiscal position as the difference between current spending and current revenues.

Capital accounting: A method of measuring the government’s fiscal position that accounts for changes in the value of the government’s net asset holdings.

Cash accounting treats a birthday party and an office building as identical, but capital accounting does not.

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Problems with Capital Budgeting

4.2

Capital budgeting seems conceptually appealing, but

It is very hard to say when spending has increased the government’s assets. Does buying a missile count as an investment?

The difficulties might make it easier for politicians to misstate the government’s budgetary position with a capital budget than without one.

Some U.S. states and foreign countries use capital budgets with mixed results.

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Static vs. Dynamic Scoring

4.2

When policy changes, household behavior also changes, potentially affecting the budget deficit.

How to account for this?

Static scoring: A method used by budget modelers that assumes that government policy changes only the distribution of total resources, not the amount of total resources.

Dynamic scoring: A method used by budget modelers that attempts to model the effect of government policy on both the distribution of total resources and the amount of total resources.

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Static vs. Dynamic Scoring: Scoring the Stimulus

4.2

How does “stimulus spending” affect the budget deficit?

This government spending can be very large and is explicitly intended to grow the economy; static scoring would suggest that it is very expensive.

Dynamic scoring by the CBO suggested that the stimulus increased GDP by 0.1–1.9% in 2012–2013.

But in the long run, the stimulus may slightly decrease growth.

Overall, it is difficult to assess the impact of policy on the aggregate economy.

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Do Current Debts and Deficits Mean Anything? A Long-Run Perspective

4.3

Many government programs create future expenses, even if they are not explicitly in law.

Implicit obligation: Financial obligations that the government has in the future that are not recognized in the annual budgetary process.

Example: Social Security payments are promised into the far future.

Deciding to spend $1 this year or next affects the current deficit by $1 but has very little impact on the government’s financial position.

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Background: Present Discounted Value

4.3

How much do future obligations or payments cost today?

Present discounted value (PDV): The value of each period’s dollar amount in today’s terms.

Mathematically, if the interest rate is r, and the payments in each future period are F1, F2, . . . and so on, then the PDV is computed as:

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Background: Present Discounted Value

4.3

Example: Pitcher Max Scherzer was offered a seven year, $210 million contract. A provision of the contract stated, however, he would receive $15 million installments over 14 years. The present value of his contact was “only” $166 million.

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Measuring Long-Run Government Budgets: Intertemporal Budget Constraint

4.3

One way to account for current and future expenditures and revenue is the intertemporal budget constraint.

Intertemporal budget constraint: An equation relating the present discounted value of the government’s obligations to the present discounted value of its revenues.

Using this approach, the Trustees of the Medicare and Social Security Funds released data in 2012 on the long-run fiscal imbalance of the Social Security and Medicare programs. The results are stunning: from the perspective of 2012, the fiscal imbalance of these two programs is $63.2 trillion.

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Measuring Long-Run Government Budgets: Intertemporal Budget Constraint

4.3

There are limitations to this approach.

Fiscal imbalance calculations assume an interest rate of 2.9%.

These calculations require potentially heroic assumptions about interest rates, costs, and incomes in the very distant future.

They assume that government policy remains unchanged.

They only consider the pattern over time of transfer programs and not of other investments and government policies.

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Generational Accounting

4.3

Generational accounting is an influential approach to dynamic budget constraints.

Assesses the implications of the government’s policies for different generations of taxpayers.

How much does each generation of taxpayers (those born in different years) benefit, on net, from the government’s spending and tax policies, assuming that the budget is eventually brought into long-run balance?

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Generational Accounting

4.3

Generational accounting answers the question by first rewriting the government’s intertemporal budget constraint:

PDV of remaining tax payments of existing generations

PDV of tax payments of future generations

PDV of all future gov’t consumption

Current gov’t debt

Generational accounting then asks: How much (net) tax on future generations is required to balance the budget?

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4.3

The Composition of U.S. Generational Accounts

Age in 1998	Net Tax Payment (PDV, $1,000s)
	Male		Female
0	$249.7	$109.6
40	241.4	37.9
80	–56.3	–99.2
Future generations	361.8	158.8
Lifetime net tax rate on future generations		32.3%
Lifetime net tax rate on newborns		22.8%
Generational imbalance		41.7%

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4.3

Alternative Ways to Achieve Generational Balance

in 22 Countries

Country	Cut in Transfers	Country	Cut in Transfers
Argentina	11.0%	Italy	13.3%
Australia	9.1	Japan	25.3
Austria	20.5	Netherlands	22.3
Belgium	4.6	New Zealand	–0.6
Brazil	17.9	Norway	8.1
Canada	0.1	Portugal	7.5
Denmark	4.5	Spain	17.0
Finland	9.2	Sweden	18.9
France	9.8	Thailand	–114.2
Germany	14.1	United Kingdom	9.5
Ireland	–4.4	United States	21.9

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Long-Run Fiscal Imbalance

4.3

Central question for policy makers: If the government continues with today’s policies, how much more will the government spend than it will collect in taxes over the entire future?

The long-run fiscal imbalance of the Social Security and Medicare programs. The fiscal imbalance of these two programs is $63.2 trillion.

To achieve intertemporal budget balance would require a tax increase of about 11% of payroll. This would mean almost doubling the existing payroll tax that finances the government’s social insurance programs.

Generational accounting doesn’t really address this.

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Problems with These Measures

4.3

The fiscal imbalance calculations are fairly tenuous.

Depend on a wide variety of assumptions about the distant future:

Future growth rates in costs and incomes

Interest rate used to discount future taxes and spending

The long-run imbalance measures only consider the pattern over time of transfer programs, and not of other investments and government policies.

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4.3

What Does the U.S. Government Do?

The current U.S. budgeting approach scores policies on a 10-year window.

Replaces 1- and 5-year windows used before 1996, incorporating some long-run concerns.

Avoids imposing assumptions about revenue and expenditure in the very distance future.

Nonetheless, difficult to forecast over even a 5-year period:

Actual and projected deficit can differ by more than $500 billion.

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4.3

Projected vs. Actual Surplus/Deficit

CBO projections of the budget surplus/deficit five years ahead have deviated significantly from the actual surplus/deficit, particularly during the high deficit years of the early 1990s and the high surplus years of the late 1990s and early twenty-first century.

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4.3

The tax reduction enacted in June 2001 was one of the largest tax cuts in our nation’s history.

The tax cut consisted of a convoluted set of phase-ins and phase-outs of various tax cuts to comply with a congressional budget plan limiting the 11-year cost to $1.35 trillion.

Included a sunset provision: All of the tax cuts disappear on December 31, 2010, reducing the 2011 cost of the tax cut to zero.

APPLICATION: The Financial Shenanigans of 2001

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4.3

The bill itself contained numerous tax cuts operating on erratic schedules.

Many of the cuts would phase in over periods longer than in any prior American legislation, backloading most of the fiscal impact toward 2010.

Convoluted scheduling allowed legislators to claim action had been taken on a wide range of issues, while delaying the fiscal consequences associated with these actions.

APPLICATION: The Financial Shenanigans of 2001

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4.4

Why Care About the Deficit?

The government’s budget deficit has implications for both efficiency and (intergenerational) equality.

Budget deficits can affect the amount of savings and growth in the economy.

Today’s deficits are tomorrow’s taxes, so high deficits imply redistribution from future to current generations.

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4.4

Short-Run vs. Long-Run Effects of the Government on the Macroeconomy

Short-run stabilization issues: The role of the government in combating the peaks and troughs of the business cycle.

Automatic stabilization: Policies that automatically alter taxes or spending in response to economic fluctuations in order to offset changes in household consumption levels.

Discretionary stabilization: Policy actions taken by the government in response to particular instances of an underperforming or overperforming economy.

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4.4

Background: Savings and Economic Growth

More capital, more growth: Capital accumulation is a key part of economic growth.

As there is more capital in an economy:

Each worker is more productive, and total social product rises.

A larger capital stock means more total output for any level of labor supply. Thus, growth in the capital stock drives (per capita) growth.

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4.4

What determines the amount of capital accumulated?

Interest rate: The rate of return in the second period of investments made in the first period.

The higher is the interest rate, the more people want to save (demand), but the more it costs firms to invest (supply).

In a competitive capital market, equilibrium is determined by the intersection of these demand-for-savings and supply-of-investment curves.

More Savings, More Capital

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Capital Market Equilibrium

Price of capital (Interest rate), r

Quantity of capital, K

Supply of savings, S1

Demand for capital, D1

4.4

Adding government borrowing into the capital market reduces the supply of saved funds available to the private capital market.

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4.4

The Federal Budget, Interest Rates, and Economic Growth

The simple supply and demand framework is complicated by introducing the federal government into the market.

What if there is a federal deficit and the government must borrow to finance the difference between its revenues and its expenditures?

The key concern about federal deficits is that the federal government’s borrowing might compete with the borrowing of private firms.

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Suppose a fixed supply of savings is used to finance both the capital of private firms and the borrowing of the government.

Government’s borrowing reduces the supply of savings.

This increases interest rates and crowd outs the borrowing of the private sector, leading to a lower level of capital accumulation.

In reality, there are a number of complications of how government financing affects interest rates and growth.

The Federal Budget, Interest Rates, and Economic Growth

4.4

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4.4

International Capital Markets

If capital markets are internationally integrated, then the amount of savings is very large relative to government spending.

This might mitigate crowding out.

Evidence: While integration is present (and perhaps growing), it is far from perfect.

The supply of capital to the United States may not be perfectly elastic, and government deficits could crowd out private savings.

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4.4

Ricardian Equivalence

Much of the savings in the United States is accumulated to finance bequests, inheritances left behind for the next generation.

If the government borrows from future generations to increase benefits to the current generation, people will simply save the extra money, leaving a larger bequest.

This implies that government debt has no impact on the economy. This is called Ricardian equivalence.

This model has received very little empirical support in the economics literature.

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4.4

Expectations

There are both short-term (e.g., 30-day) and long-term (e.g., 10-year) interest rates.

Because businesses tend to make long-standing capital investments, they focus more on the longer-term rates. As a result, the entire future path of government surpluses and deficits matters for capital accumulation, not just the surplus or deficit today.

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4.4

Evidence

Theory, therefore, tells us that higher deficits lead to higher interest rates and less capital investment, but it does not tell us how much higher and how much less.

The existing empirical literature on this question is somewhat inconclusive, although recent evidence suggests that projected long-term deficits do appear to be reflected to some extent in long-term interest rates.

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4.4

Intergenerational Equity

Intergenerational equity: The treatment of future generations relative to current generations.

Budget deficits mean more benefits for the current generation relative to future generations.

But, because of economic growth, future generations have better standards of living than previous ones.

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4.5

Conclusion

The deficit has been a constant source of policy interest and political debate over the last decade.

The existing deficit is quite large, but the long-run implicit debt that is owed to the nation’s seniors through the Social Security and Medicare programs is even larger.

This could have major long-term negative effects on both economic efficiency and intergenerational equity.

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Presentations

General Guidelines for Presentations

You have to prepare one presentation for this class. You can base your presentation on any of the chapters that we have covered in class. You can use the textbook as the main source, but you are also welcome to incorporate material from other textbooks or academic papers. If you are going to use a journal article, I suggest that you use a specialized search engine like Google Scholar (scholar.google.com). This article or articles may not be accessible from your home. You will need to download the article(s) for any FIU campus. Alternatively, you may have to use a VPN. FIU uses AnyConnect. You can find it here (Links to an external site.)Links to an external site..

Preparing the presentation

Once you have chosen the chapter and/or paper(s) you can start preparing your presentation. These are some guidelines that can help you improve your presentation:

Your presentation should contain at least 20/25 slides.

Only include two or three bullets per slide, four at most.

First, develop a script for the presentation where you can have all the relevant details. Then, create the presentation using the script as your source. You only have to submit the presentation, but you are welcome to submit the script as well.

Use an attractive template. You can use any of the templates that come with Microsoft PowerPoint. You can find more templates here (Links to an external site.)Links to an external site..

There are several web sites that will teach you how to prepare a successful presentation. They include, but are not limited to:

https://prezi.com/

This link contains additional resources to prepare a professional presentation

https://www.google.com/search?client=firefox-b-1-ab&q=websites+to+learn+how+to+make+presentations&spell=1&sa=X&ved=0ahUKEwiJ4OPhkPLcAhUI0lMKHY3DDTMQBQgmKAA&biw=1680&bih=908 (Links to an external site.)Links to an external site.

Choose the one that works best for you.

If you use a presentation program other than Microsoft PowerPoing (e.g., Google Slide, Keynote, etc.) make sure to save your work in .ppt, pptx or .pdf format.

Content

If you choose to use an academic paper to be the basis or a supplement to your presentation, bare in mind that the paper(s) you are going to use are peer-reviewed scientific papers published in reputable journals. They are divided into several sections. The first part typically contains an introduction with the basic intuition, the idea that the author wants to present and prove. There are going to be several sections in the middle that are highly technical in nature, and there will be a final section with the conclusion. If the technical part is too much for you, concentrate on the first and last one. You only need to communicate the topic of the paper and the conclusion(s) that the author(s) arrived at.

Final thoughts

Why Presentations? Most of the students in this course will graduate soon. Whether you go to Graduate School or the corporate world, you will be required to prepare presentations either for your professors or for clients, coworkers, regulators, etc. This course is a safe way for students to develop their presentation skills.

This document contains essential guidelines. I hope I have covered all the important points. If you need additional help, please let me know. We can discuss your specific needs via email or Canvas messages.

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