Lecture Thirty One

Measuring the Deficit

(Economics 100b; Spring 1996)
Professor of Economics J. Bradford DeLong
601 Evans, University of California at Berkeley
Berkeley, CA 94720
(510) 643-4027 phone (510) 642-6615 fax
delong@econ.berkeley.edu
http://www.j-bradford-delong.net

April 22, 1996

Administration
Review
The "Unified" Deficit
The "On Budget" Deficit
The Inflation-Adjusted Deficit
The Capital-Budget Deficit
Conclusion

Administration

Review

Let me briefly review last Friday's lecture. The U.S. has had--for a number of years--
persistent, peacetime, structural deficits leading to a relatively high value of the national
debt as a share of GDP--a higher value than had been seen in the U.S. since the 1950s.

However, the U.S. is far from being alone in having a substantial national debt:
Why worry about the national debt? Because it is a drag on U.S. productivity through
higher tax rates... 60% of GDP x 2.5% real interest rate means that 1.5% of U.S. real
GDP is taxed just to be transferred.
 Say, an elasticity of labor and capital supply of -0.5--would mean that we are now
poorer by about 0.75% of GDP as a result of the fact that we have a large
accumulated national debt to service than if we were, say, debt-free.
 In one sense, it is as if we had an unemployment rate 0.75% higher forever; in
another sense not--distributional impact is very, very different

Our experience of peacetime structural deficits very new. In the old days, little debt. In
fact, in the old days, little federal government. Debt-to-GDP ratio up to perhaps 30% of
National Product in a war, but little outside of a war.
Pattern of spending. Post-Civil War return of spending to a very low level. Run your
national debt/GDP ratio down to zero after a war. Andrew Jackson paid off the national
debt in the 1830s. Post-Civil War debt. Veterans' bonus programs. 1913 debt of 3% of
GDP; 1930 debt of 20% of GDP; 1975 debt of 25% of GDP.

With the Great Depression, the movement of the federal government into infrastructure
spending in a big way for the first time, and so forth (Social Security system) civilian
spending bounced up to nearly ten percent of GDP. And then came World War II, the
Korean War, and the postwar military-industrial buildup associated with the Cold War.
Taxes kept pace--and the underlying growth of the American economy steadily reduced
the outstanding national debt as a share of GDP. (Expand on this: D/Y down from 112%
at the end of WWII to perhaps 25% in the mid-1970s.)

But since the end of the 1970s things have turned very strange: doubling of debt-to-GDP;
first-time emergence of large persistent peacetime budget deficits.

Three reasons for post-1980 deficits:

 The post-1973 productivity slowdown

 The Reagan tax cuts (the Laffer Curve; too small by a factor of three or more; not
to say that there aren't lots of times and places where Laffer Curve effects are
important)
 Loss of political immunity against budget deficits as a result of "Keynesian"
expenditure policies. Cyclical deficit--good; structural deficit--bad seems just a
little bit too hard a lesson for American politics to keep in its small collective
brain.

One non-reason (that you will find if you look at, say, the Wall Street Journal editorial
page)

 Legislative changes in 1974 that established the current congressional budgeting

office, and (they claim) created a persistent bias toward spending and excessive
deficits.

I have never been able to make any sense out of this argument at all; in the 1980s (and so
far in the 1990s as well), actual budget outturns have always shown a smaller deficit than
original presidential submissions; and congressional legislation has always shown a
smaller deficit than the presidential submission. Spending priorities have been changed--
yes (in the 1980s toward less defense and more social programs than Reagan asked for; in
the 1990s the reverse. But overall legislation tracks the presidential submission.

The "Unified" Deficit

Start with the actual federal budget deficit as a share of GDP. Worry is the effect on
national saving and investment. Thus a "cyclical" deficit is not a worry: a "cyclical"
deficit is not a crowder-out of saving and investment--to first order--but is a boost to
GDP (and possibly belief that cyclical deficits will be permitted in the future is a boost to
saving and investment now.

So start by moving from the "actual" to the "high employment" deficit to GDP concept.

It doesn't change the picture that much. It makes the sharp deterioration in the early
1980s a little sharper; it makes the deterioration in the early 1990s an almost entirely
cyclical event...

The "On Budget" Deficit

But there's more. The social security surplus: should it be counted as part of the "budget
deficit"? Well, to the extent that people view their social security contributions as taxes,
yes. To the extent that people view their social security contributions as substitutes for
savings, no...

The Inflation-Adjusted Deficit

And there is the adjustment for the inflation component of the debt...

The Capital-Budget Deficit

And there are all of the "capital budgeting" issues. Federal borrowing to finance public
investment is not a crowder out of capital...
Conclusion

Make all the adjustments you should make, and the federal budget today is in rough
balance...
 Now it is projected to go out of balance in the future...
 It has not been in balance in the past...
 And, given that the U.S. has a low savings rate, perhaps we should be aiming for
something better than balance...