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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.

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Chapter 5 the federal budget
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 Definitions Budget

  • Budget < 0 -- Budget Deficit

  • Budget > 0 -- Budget Surplus

  • Budget = 0 -- Balanced Budget

  • Realistic Goal -- Balanced Budget when Y = YN.


The federal budget 2006 billions of dollars
The Federal Budget: 2006 (Billions of Dollars) Budget

  • Government Receipts = $2495.8

  • Government Expenditure

    = $2715.8

  • Budget = -$220.0

  • Source: Economic Indicators, February 2008


Breakdown of government receipts
Breakdown of Government Receipts Budget

  • Personal Income Taxes = $1053.2

  • Corporate Profits Taxes = $373.1

  • Taxes on Production and Imports

    = $98.6

  • Contributions for

    Social Insurance = $901.6

  • Miscellaneous = $69.3


Breakdown of government expenditure
Breakdown of Government Expenditure Budget

  • Consumption Expenditures (G)

    = $812.8

  • Transfer Payments = $1576.1

  • Net Interest Paid = $277.5

  • Miscellaneous = $49.4


The budget in our notation
The Budget: In Our Notation Budget

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
The Budget and The Size of the Deficit Budget

  • Budget = T - G

  • Size of Deficit = G - T


The national debt
The National Debt Budget

  • The National Debt -- The total accumulated stock of debt owed by the government to its lenders.

    Debt2011 = Debt2010 + Deficit2011


National debt realistic goal
National Debt -- Realistic Goal Budget

  • Realistic Goal -- consider the Debt-Income Ratio=

    (National Debt)/(GDP).

  • For US in 2007 =

    ($5035.1)/($13843.8) = 0.364


Decomposition of deficit
Decomposition of Deficit Budget

  • 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 Budget

  • 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
More on the Cyclical Deficit Budget

  • 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 Budget

  • 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
Analyzing the Deficit -- A Numerical Example Budget

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
Main Results From Example Budget

  • Overstimulated economy can mask a deficit problem.

  • 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
Why are the Debt and Deficits a Problem? Budget

  • 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
The Crowding Out Effect Budget

  • Consider “magic equation”:

    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
The Increased Debt: Burden on Future Generations Budget

  • In general, older generations enjoy benefits from the debt. But younger generations have to sacrifice in the future to repay the debt, maintain interest payments, or be deprived of new initiatives.


The crowding out effect a more sober implication
The Crowding Out Effect: BudgetA More Sober Implication

  • Crowding Out Effect – Expansion of Federal Deficit and Debt increases interest rates, lowers investment (and possibly consumption)

  • Lower investment retards development of the capital stock, the economy’s productive capacity for future generations.


Maybe effects of deficits and debt aren t so bad
Maybe Effects of Deficits and Debt Aren’t so Bad Budget

  • 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
Riccardian Equivalence -- No Crowding Out Effect Budget

  • 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
Another Reason Why Debt May Not Be Overly Harmful Budget

  • 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 t 0 ty n
Reducing a Structural Deficit = Budget[G - (T0 + tYN)]

  • Increase Taxes (income or consumption-based)

  • Advantages: smaller multiplier, can focus on higher incomes, undesirable behavior.

  • Disadvantages: implicit permission for government to be inefficient in its spending.


Reducing a structural deficit g t 0 ty n1
Reducing a Structural Deficit = Budget[G - (T0 + tYN)]

  • Decrease Transfer Payments.

  • Advantages: smaller multiplier, largest component of government expenditure, holds the line on taxes.

  • Disadvantages: very painful to the groups affected (often vulnerable).


Reducing a structural deficit g t 0 ty n2
Reducing a Structural Deficit = Budget[G - (T0 + tYN)]

  • Decrease Government Purchases of Goods and Services

  • Advantages: permanence, gives discipline to government, encourages (often more efficient) private sector to replace government programs.

  • Disadvantages: largest multiplier, most painful way.


Reducing a structural deficit g t 0 ty n3
Reducing a Structural Deficit = Budget[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.


The clinton surpluses what happened
The Clinton Surpluses: What Happened? Budget

  • Marginal tax rate increases on higher incomes, sales tax increases in 1993.

  • Holding the line on transfer payments, government purchases.

  • Unusually large growth in the natural level of real GDP (YN).


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