Chapter 17 Budget Deficits

  I. Three Budget Philosophies
II. Federal Tax Receipts are Complicated
III. Relative Size of Federal Debt
IV. Should the Federal Debt be Paid
V. Should America Be Unhappy With Her Federal Debt?
VI. The Future of Social Security
VII. Latest Data

Return to Economics Interactive Course Notes

I. Three budget philosophies
   A. A government defect occurs when cash out is greater than cash in
   B. Deficit spending became large with WWII. See graph
C. Three Budget Philosophies
        1. Annually balanced budgets (classical economists)
            a. The problem with this type is it reinforces the business cycle
                 1. Governments spend less during a recession as tax revenues decline. 
                 2. Governments increase
spending during expansion as revenues increase.
            b.  Many disagree with this philosophy as it is counter cyclical especially in recession.
        2. Cyclically balanced budgets (Keynesian)
             a. Balance over the business cycle with deficits during recessions
                 and a surplus during expansions. 
             b. Problem is getting politicians not to spend revenue increases
                 which occur during expansions. 
        3. Functional finance
             a. A balanced budget is not important.
             b. Deficits are expansionary and somewhat self-liquidation.
             c. Money can be printed and taxes increased.
             d. The interest burden of the debt is falling.  Interest on the debt as a percent
                 of GDP was projected to be down to 2.5% in 1999
                 from 3.0% in 1992.
             e. See 
Functional Finance and Full Employment: Lessons from Lerner for Today  

        D. Experience of the 1990's
   1. The deficit turned into a surplus  in the early 1990's
 2. Causes
                 a. Refinancing to short-term bonds lowered interest costs
                 b. A strong economy increase  payroll taxes receipts
A 1993 tax bill increased revenue
By the year 2000, the Treasury was retiring debt which
             3. In November of 2001, the Treasury decided to stop issuing 30-year bonds.
                1. Long-term Treasury bonds carry a higher interest rate because inflation
                     risk increases with time.
                2. Issuing shorter-term Treasury bonds should lower the interest paid on the
                    federal debt.
                3. People who want 30-year bonds will now buy 10-year bonds pushing their
                    rate down. 
                    a) Since 10-year bond rates are used to set mortgage rates, the resulting
                        mortgage refinancing would provide consumers with the ability to increase
                    b) Low mortgage lowers the risk of recession.
               4. Sundry
                    a) The government spends less of its income on interest than most businesses
                         and individuals
Democratic Capitalism
vs. a Capitalistic Democracy explores running
                         government as business
         E. Readings
1. A Tale of Two Debts Japan vs. Greece
is an interesting read for understanding
                why some are not bothered by U.S. recent debt build-up.
            2. CBO 2015-2025 Budget Projection Note: Ten-year budgets are notoriously poor












Seven new federal debt data series  from FRED,
data service of the St. Louis Fed. 1/11/12
You can get in Excel with FRED pluginsat :

 II. Federal Tax Receipts are Complicated
A. Tax expenditures the loss in tax revenue from items that lower taxable income
          have a substantial affect what is paid by tax entities.
          1. Tax deductions and Tax Credits affect the bottom line the same as traditional expenditures.
          2. They are designed to benefit select groups with political clout

3. Politicians have made increased tax expenditures dramatically since 1986 because they hide
              political maneuvering from all but experts. See graph.







     B. See
Big money tax breaks
 2. Distribution Tax Expenditures CBO


The U.S. Treasury building in 1804. 
This building was
by the British on August 25, 1814.

III. Relative Size of Federal Debt
 A. Many countries have more Debt

Federal Debt Hit 18 Billion 2015

CBPP debt to GDP ratio

Household Net Worth Hit 81 Billion in 2013


IV. Should the Federal Debt be Paid

     A. Pay it
         1. The external debt (owned by foreigners) has gone up from
5% in 1960 to 13% in 1988, 22% in 1999 and 43% in 2005.
         2. The crowding-out effect slows growth as Federal dissaving  
             causes high interest rates lowering private investment.
         3. Paying $230 billion in annual interest causes incentive 
             problems as this money could be used to solve many 
         4. Recently foreigners have been willing to invest their export
             earnings in America helping to minimize the effect of the  
             high federal deficits on interest rates.
             a. If foreigners decided not
to make these investments, 
                 interest rates would increase, slowing economic growth. 
             b. Interestingly one of the reasons the Federal Reserve 
                 was unable to lower long interest rates quickly during
                 the 1990-91 recession and its recovery may have been
                 the Japanese decision to dramatically curtail their U.S. 
         5. Annual interest on the federal debt increased 50% (from
to 3.3%) during the 1980's. By 1999 it was down
             to 2.5%.

   B. Don't Pay It
       1. The debt was caused by wars and recessions.
       2. We are not going bankrupt, the debt is about 100 % of one
            year's GDP. Editor's Note: This is not as true today because
            of the Great Recession and projections will force reductions
            in entitlements unless the economy really takes off.
            Entitlements are not contracts. What congress gives congress
            can take away
           a. First-time homeowners go a few salary years into debt.
           b. Much of the annual deficit goes into capital expenditures
and because the U.S. does not have a capital budget, 
                these items are all expensed in the year of purchase. 
                During periods of growth, the result is an over

                statement of the deficit.
       3. Paying it would overtax the average American.
       4. Most Americans would rather spend tax money to 
           solve problems rather than lower the deficit.
           a. This attitude changed substantially in the early 1990's. 
           b. By the end of the 1990's, projection had the debt paid
               off in 10 years. By November of 2001, the impending 
               recession and events of September 11 cast a shadow
               on this 10-year projection
   C. Balance the budget allows participants to balance the budget.

Editors Note: Revolutionary War debt that had piled up by both state and federal governments. Secretary of the Treasury Alexander Hamilton orchestrated the first federal tax on imports in 1789 to pay federal and state debt It was our largest federal debt related to GDP until 1933 when the Great Depression crashed revenue collections revenue which caused deep-do-do (d-cubed).

Secretary of the Treasury Alexander Hamilton began the practice of increasing taxes to pay for war but he only paid interest as principle was refinanced. This practice continued for over 200 years and but changed when Bush II reversed  the logic and cut taxes and not pay for wars in Afghanistan and Iraq plus Medicare Part D. 

Hamilton also began the practices of the federal government paying state bills. Today many states take the money and show their appreciation by telling the federal government to stay out of state and local business.

Individuals also follow the practice of taking and saying stay out of my business. 
Retires and poor people don't want the FEDS involved with their lives even though much of our debt is caused by the big four of Social Security, Medicaid, Medicare and Defense.

State and Local Governments can't print moneys so they can't have deficits. They must use unfunded liabilities to cover excess spending. Unfunded state and local employee and retiree benefits would head list of major contributors to state and local liabilities.

I don't like the term entitlement programs financed by individuals paying into a fund. This is especially true since there is not a contract so what the government t gives it can take away so the word entitlements is a sham.

Governments spend so much more than is taken in that balancing the budget is futile. Living at such a peaceful and prosperous time should limit cuts in the gravy train. Source

V. Should America Be Unhappy With Her Federal Debt?

Few Pay More Income Taxes

Inflation To Date Has Paid Much of the Bill

But some were hurt by government financing with debt and inflation.

1. Revolutionary War  veterans were paid in worthless currency which
    they sold at a large discount to wealth people who were then helped
    by Hamilton's decision to redeem at full value.

2. Some states had paid their revolutionary war debt and were not helped
     by Hamilton's decision to assume al war debts.

3. Financial stress caused by financial excesses were substantial during
    the 19th century and early 20th century..

4. Inflation during the 1970's hurt fixed income and fixed asset people.

5. Recent financial crisis's have been moderated by government action.



VI. The Future of Social Security
     A. "In 1980, my friend Mr. Average lamented his Social Security pension would be small. He
            wished the government would take more out of his pay and increase his expected pension.
           This would be difficult as Social Security was having  financial problems to be solved by a
           bipartisan commission. It recommended, Congress passed, and the President signed
           a social security tax increase, an increase in the wages subject to Social Security, and
           a delay in the normal retirement age. My normal retirement age increased from 65 to
           sixty-six. What have these changes accomplished over the past 25 years.

    B. What Is the Outlook for Short-Term Trust Fund Adequacy?
2013 Trustees Report  measure short-range adequacy of OASI, DI, and HI Trust Funds by
         comparing  fund asset reserves to projected costs for the ensuing year (the “trust fund ratio”).
         A trust fund ratio of 100 percent or more—that is, asset reserves at least equal to projected
         cost for the next year—is a good indicator of a fund’s short-range adequacy. That level of
         projected reserves for any year suggests that even if cost exceeds income, the trust fund
         reserves, combined with annual tax revenues, would be sufficient to pay full benefits for
         several years.

        By this measure, the OASI Trust Fund is financially adequate throughout the 2013-22 period,
        but the DI Trust Fund fails the short-range test because its trust fund ratio was 85 percent at
        the beginning of 2013, with projected depletion of all reserves in 2016.  The HI Trust Fund also
        does not meet the short-range test of financial adequacy; its trust fund ratio was 81 percent at
        the beginning of 2013 based on the year’s anticipated expenditures, and the projected ratio
        does not rise to 100 percent within five years. Projected HI Trust Fund asset reserves become
        fully depleted in 2026. Chart E shows the trust fund ratios through 2040 under the intermediate
The 2013 report explores cost relative to GDP, the value of what we
        produce. Editors Note: What do you spend money on that is more important than
        retirement and health care? Current consumption, highway accidents, mental health
        of children, education, military safety , death and carnage from terrorism,
        death and carnage from lighting strikes?

        C. White House delaying Social Security trustee report to factor in Health reform

click on graph for underlying data

What to do! Options include increasing the wage base being taxed, the tax rate, and delaying the maximum benefit date. All were done in 1981. Ignoring the problem and borrowing the cash will be difficult as borrowing much more than we already have will push interest rates higher on Treasuries and lower the value of the dollar. So they will  increase from $90,000 base soon because it is politically easier although Republicans won't be happy. Then a bipartisan commission will be formed to increase rates, wages subject to Social Security taxes, and the normal retirement age. A commission shares the political burden. 
All have been done before. What bothers me is a new option.

Indexing Social Security to wages has caused Social Security pensions to increase. Wages go up because of inflation and productivity. A plan indexing  pensions to inflation lowers pensions and a Presidential/Congressional cash crisis is avoided for a while. The Center for Retirement Research at Boston College  analyzed this change. My friend Mr. Average just retired at 65 and receives $14,689. Had we indexed to inflation in 1951, the average Social Security pension would be lowered by $2,131 to $12,558.  To be candid, my friend Mr. Average needs this additional income. Let us move ahead to 2025. Under the current system, Mr. Average will receive $16,205 in 2005 dollars, a $1,516 increase.  If indexing to inflation passes Congress and is approved by the President, Mr. Average will receive only $14,689 in 2005 dollars. No real increase because he would not share in productivity increases. His pension would be larger in 2025 because it was but he could only buy the same amount of goods and services as in 2005.

The Real Story  

The Center for Retirement at Boston College also reports the entire mess can be solved by increasing the normal retirement age from 67 to 70 over a period of years for people under 45 or people under 55 could receive a benefit cut of 20%. Becoming Oldest-Old: Evidence from Historical US Data from MIT shows we are living longer. Since Social Security was adopted in 1935, life expectancy for someone 65 has increase by almost 5 years to almost 17 years. Since these numbers are going up, my friend Mr. Average is making out very well. My normal retirement age is 66 years. Hopefully I will pay for one more year and collect for 4 more years. Not bad! Boston College has more on Social Security.

Read Historical Development of Social Security (In Adobe PDF format)
A section from SSA's publication, "Social Security Programs in the United States." (7 pages)

Not All Debt is Created Equal.


VII. Latest Data



X. From the net      
      1. State Budget Deficits for Fiscal Year 2004 are Huge and Growing ...
      2.  Institute of Economic Analysis for a liberal view of budget deficits and much more.
How Much Deficit Reduction Is Appropriate  CBO 12/21/13.
      4. Effects on economic growth of federal investment and reductions in federal deficits and debt CBO 6/20/14
Last Chapter  Next Chapter 
Chapter 15 Class Discussion Questions Economics Interactive Course Notes
Chapter 15 Homework Questions Economics Internet Library

VI. Many industrial countries have debt.  

Country 2003 Central Government Debt as a percent of GDP
All are higher in 2015.

Japan 155% and stagnate population makes problem
more difficult to solve.
Italy 106% and tendency toward socialism
makes problem more difficult to solve.
Canada 77% and tendency toward socialism makes problem
 more difficult to solve.
Germany 64% and tendency toward socialism
makes problem more difficult to solve though a major decrease in the social safety net should help
United States 62%
Great Britain 51%
Source: 2004 World Fact Book of  CIA

VIII. Foreign Holdings of U.S. debt as of Dec. 2004

Foreign Holdings of U.S. debt as of Dec. 2004

Holder Debt held
Japan $711.8 billion
China $193.8 billion
United Kingdom $163.7 billion
Caribbean Banking $69.4 billion
Korea $69 billion
Analysis: Most of this debt is held by foreign central banks that have a vested interest in the economic well being of the Unites States Economy.