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
How Can the US Afford a $17 Trillion Debt?
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I. Three Budget Philosophies
A. A government defect occurs when expenses are
           greater than revenue.
      B. Peacetime deficit spending became continuous
           after WWII as we were forced save for their future
           with Social Security and Medicare. Source
      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.

Recent US Deficits


         2. Cyclically balanced budgets Keynesian
              a. Balance over the business cycle with deficits
                 during recessions and a surplus during
              b. Problem is getting politicians not to spend
                  revenue increases which occur during
         3. Functional finance
              a. A balanced budget is not important.
              b. Deficits are expansionary and somewhat self-
              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. The Great Recession lowered tax collections
                  while federal spending increased taming the
                  recession and now increased economic activity
                  has brought spending back to normal. See
                  Financial Crisis Lessons ... It's extensive.
                  Editor's Note: I'm sure one could find a
                  conservative economic analysis attributing the
                  success of taming the Great Recession to non-
                  governmental factors.

Total Government Debt
 in 20th Century









Government debt began the 20th century at less than 20 percent of GDP. It jerked above 45 percent as a result of World War I creating a New Normal. Debt went above 70 percent in the depths of the Great Depression then returned to normal. Debt has breached 100 percent of GDP because of World War II and returned to normal. The Crash of 2008 caused a big spike but much debt was intergovernmental which has no interest expense.

U.S. Federal Government Spending
Quickly Returned to Normal

NET Deficit Low

          4. Readings
              a. Functional Finance and Full Employment: Lessons from Lerner for Today
          b. U.S. Federal-Debt Basics

      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
               c.  A 1993 Omnibus Budget Act
  increased revenue
d. By the year 2000, the Treasury was retiring debt which
           3. In November of 2001, the Treasury decided to stop issuing 30-year bonds.
               a. Long-term Treasury bonds carry a higher interest rate because inflation
                   risk increases with time.
               b. Issuing shorter-term Treasury bonds should lower the interest paid on the
                   federal debt.
               c. People who want 30-year bonds will now buy 10-year bonds pushing their
rate down. 
                  1. Since 10-year bond rates are used to set mortgage rates, the resulting
                      mortgage refinancing would provide consumers with the ability to increase
                  2. 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 projections 
               are notoriously inaccurate
          3. The Incredible Shrinking Budget Deficit
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.
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.


      B. See Distribution Tax Expenditures CBO


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

III. Relative Size of Federal Debt

Federal Debt as % of GDP


Federal Debt in Trillion

Federal Debt
Debt Held by
Public (not FRS)
Debt held by
gov. accounts
Debt Held by
Federal Reserve
2014 $17.8 $10.3 $5.0 $2.5

Editors Note: Because federal assets are not accounted for there is no way to calculate federal worth.

Household Net Worth Hit 81 Trillion 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 dur-
             ing 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 1.9% to 3.3%)
             during the 1980's. By 1999 it was down
             to 2.5%.
How To Tell Debt Facts From Political Hype

   B. Don't Pay It 
       1. The debt was caused by wars and
       2. We are not going bankrupt, the debt is
           about 100 % 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
       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 11/01
               the impending recession and events of
               September 11 cast a shadow
               on this 10-year projection
What is the Federal Debt: a primer for
The Big Lie
        6. 2 concerns U. S governments debt
Balance the budget is a simulation that allows
    participants to make changes and balance
    the budget.



Editor's Note:
The Debt to GDP ration headed up with Ronald Reagan, dropped with Clinton, then headed up again with Bush 2 and finally leveled off during Obama's second term projections   could force reductions in entitlements unless the economy really takes off. The effect of Obamacare are not known. Entitlements are not contracts. What congress gives it can
take away.


Projection probably include an increase in current low rates.

Editors Note: Revolutionary War debt had been 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 . This debt was our largest federal debt related to GDP until 1933 when the Great Depression crushed revenue collections which caused deep- do-do (d-cubed).

Secretary of the Treasury Alexander Hamilton began the practice of increasing taxes to pay for war expenses. Printing money causing inflation usually helped. 

This practice continued for over 150 years. Then both Hover and Roosevelt borrowed not for war but to help people survive the Great Depression. Then Bush II reversed over 200 years of logic as he cut taxes during good times so as not to pay for wars in Afghanistan and Iraq plus he created entitlement Medicare Part D. 

Hamilton's paying state war debts began federal government practice. 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 use unfunded pension and health liabilities to cover future 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 when they are financed by individuals paying into a fund. This is especially true since there is not a contract so what the government 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 allow cuts in the gravy train but Greed, Guns, God, and Government get in the way.  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.

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. This could happen again as debt is bought by the wealth on margin on borrowed money at low Federal Reserve sponsored interest rates.

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

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

Inflation during the 1970's hurt fixed income often retired older residents and fixed asset people. SS was not indexed to inflation until early 1980's.

BUT, recent financial crisis's have been moderated by government
action and the debt has been much larger.


Continental currency depreciated 
badly during the war, giving rise to
the famous phrase "not worth a continental".


VI. The Future of Social Security

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 to increase his expected pension. This would be difficult as Social Security was having  financial problems soon to be solved by a bipartisan commission chaired by a man named Greenspan. 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 friends normal retirement age increased from 65 to sixty-six. What have these changes accomplished over the past 25 years.


Outlook for Short-Term SS 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?

click on graph for underlying data

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


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



  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.
Effects on economic growth of federal investment, 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.


What makes 2015 difficult is the large contingent liability
for SS, Medicare, and Federal Retirement. Unless US has
a real prosperous decade or two
similar to after WW 2
she will have Inflation,
a substantial change in benefits
unless Obama Care works! Net Debt looks a little better.