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Chapter 17 Budget Deficits

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I. Introduction
    A. A budget deficit results when expenditures are greater than revenues
         for an accounting period.
    B. Debt is an accumulation of deficits.
    C.
History of the Debt from the St Louis Federal Reserve Nov/Dec 2012
    D. Federla Debt overview from
Library of Economic Liberty
II. Three budget philosophies
     A. Annually balanced budgets (classical economists)
         1. The problem with this is it reinforces the business cycle as
             a. Governments spend less during a recession as tax revenues
                  decline. 
             b. Governments increase
spending during expansion as revenues
                  increase.
         4. Many disagree with this philosophy as it is counter cyclical
             especially in recession.
    B. Cyclically balanced budgets (Keynesian)
        1. Balance over the business cycle with deficits during recessions
          
 and a surplus during expansions. 
        2. Problem is getting politicians not to spend revenue increases
            which occur during expansions. 
   C. Functional finance
        1. A balanced budget is not important.
        2. Deficits are expansionary and somewhat self-liquidation.
        3. Money can be printed and taxes increased.
        4. 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.
        5
Functional Finance and Full Employment: Lessons from Lerner for Today  

           b. Much of this decrease was caused by refinancing old debt as
               it came due at lower rates.
           c. By the year 2000, the Treasury was retiring debt which, if
               continued, will lower the burden even more.
           d. In November of 2001, the Treasury decided to stop issuing
               30-year bonds.
               1. Long-term Treasury bonds carry a higher interest rate
                   because they have higher inflation risk.
               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 consumption.
                   b) This could help the U.S. pull out of the impending recession.
              e.  The government spends much less of its income on interest than
                   most businesses and individuals though the great recession and
                   an increase in interest rates could change the situation.
               5.
Democratic Capitalism
vs. a Capitalistic Democracy


III. Federal Tax Receipts are complicated
   
 
A. Tax expenditure are up

   
 B.
Big money tax breaks
     C. Distribution Tax Expenditures CBO

 

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


 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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 :
http://research.stlouisfed.org/fred-addin/install_windows.html

CBPP debt to GDP ratioEditor Note:

The U.S. is on a cash budget. This means asset are not accumulated, so you can't subtract assets-liabilities to calculate net worth. Value of our land, buildings, military, human capital investment is not calculated.

IV. Gross national saving rate (as a % of GNP)

Year

Gross National  Saving Rate =

Household Saving +

Business Saving +

Federal  Saving +

State and Local Saving

1952-71

15.9

4.8

11.7

-0.5

-.1

1972-81

16.9

5.4

12.4

-1.9

1.0

1982-89

13.4

3.3

12.9

-4.1

1.3

Analysis: Savings of governments are under stated because they do not include asset accumulation. Savings of individuals are understated because asset accumulation in homes and the stock market are not part of the calculation. Businesses are not in the business of saving. Our economy is very dependent on low interest rates and cheap oil. Any dramatic change in either will cause a sever recession, but to expect participants to hoard cash for such a situation is asking too much. General Motors has all kinds of cash but is using it quickly to downsize in hopes of staying in business.

U.S. Department of Commerce as published in Jan. 1992 issue 1, Vol. 27, p. 37 of Business Economics
"Low U.S. Savings: Increase It By Reducing the Federal Deficit" by Dennis K. Hoover
.

V. 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 
            problems.
        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. 
                investments. 
        5. Annual interest on the federal debt increased 50% (from
            1.9%
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 less than 59% of one
            year's GDP.
           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. Budget Hero allows participants to balance the budget.

 

VI. Others in the United States have debts. 

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People Are Earning More But No One Pays More Taxes

 

VII. Many industrial countries have debt.  

Country 2003 Central Government Debt as a percent of GDP

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.
United States 62%
Great Britain 51%
Source: 2004 World Fact Book of  CIA

 

VII. Social Security Recollections Lead To Follow The Cash
 
     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
        assumptions."  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 carnahe from terrorism,
        death and carnage from ighting 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 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.

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 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.

My liberal side is bothered by the fact that this has even been proposed and the average pension  is so low.
My conservative side reminds me, "If we send it, they will spend it."
My cynical side realizes the excess is spent to buy votes from constituents.

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)

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

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

 

from Debt, Taxes And Politics: A Perspective On Federal Tax History by Doug Short

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.
IX. From the net 
      1. View Budget Deficits and Debt: Issues and Options, A symposium sponsored 
           by the Federal Reserve Bank of Kansas City.
      2. View State Budget Deficits for Fiscal Year 2004 are Huge and Growing ...
      3.  View Institute of Economic Analysis for a liberal view of budget deficits.
      4. The Intelligent Guess blog has done the following analysis U.S. deficits and savings.
      5.
How Much Deficit Reduction Is Appropriate  CBO 12/21/13.
Part I Relationship between Fiscal Deficit and Savings rate ( since 1981 )
Part 2 Relationship between GDP and Savings rate ( Quarterly data since 1985 )
Part 3 Relationship between Total Debt ( data from 1929) and External debt as a % of the GDP (data from 1995) 
Part 4 Manner in which the Deficit has been financed since 1995 (Savings viz External Debt)
Part 5 Relationships between Fed Rate and Savings Rate (Data from 1954)
Source: U.S. Treasury Dept.
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