Chapter 12

Budget Balance and

Government Debt
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 Budget Terms
 A Budget Surplus exists when Tax Revenues are
greater than Expenditures and is the difference
between the two.
 
 A Budget Deficit exists when Expenditures are
greater than Tax Revenues and is the difference
between the two.
 
 The National Debt is the sum of deficits minus the
sum of all surpluses since 1776.

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 Figure 12.1A Federal Budget Outlays, Receipts,
Deficits, and Surpluses, 1950-1999
1,800
1,700 Surplus
1,600
1,500
Billions of Dollars

1,400
1,300
1,200

1,000 Deficit

800
Outlays Receipts
600

400

200 Surplus
Deficit
0
1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 1999

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 Figure 12.1 B Federal Budget Outlays, Receipts,
Deficits and Surpluses, 1950-1999
Federal Deficit as a Percent
of GDP, 1960 – 1997

2 Deficit
0
Surplus
-2
1960
1962
1964
1966
1968
1970
1972
1974
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
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 Surpluses, Deficits and the
Debt as a Percentage of GDP

 Nominal figures are less important than

their relationship to the size of the
economy.
 Economists tend to look at these figures
as a percentage of GDP.

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 Controversies Over What To Do
With the Current Surpluses
Options
 Pay off portions of the national debt
 Cut taxes
 Increase spending on programs
 Set surpluses aside to make Social
Security and Medicare more solvent

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 High-Employment Deficit or
Surplus
 The budget balance is altered significantly by
the state of the economy.
 If GDP is rising quickly, then fewer people are
drawing on the welfare state and more are
paying taxes.
 The high-employment deficit or surplus is what
the surplus would be if unemployment were low.
 Economists often prefer this measure to the
actual level of the deficit or surplus when
advocating policy.

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 Measuring Budget Balance
 On Budget vs Off Budget
 Social Security and the Post Office are run off
budget.
 Since 1982 Social Security has run a considerable
surplus.
 This money is loaned to the rest of the on budget
side of the government with the bonds issued to
the Social Security Administration being the Social
Security Trust Fund.
 

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 Unified Budget
 The Unified Budget is the sum of the
on- and off-budget deficits and
surpluses.
 If this is a net deficit, then the
government must borrow new money
from the public.
 If it is a net surplus, then it is a net
provider of capital to the private sector.

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 National Income and Product
Accounts Budget

 The NIPA Budget does not include any

transactions that finance preexisting
debts such as outlays for deposit
insurance.

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 Real Surpluses and Deficits
 Real Surpluses and Real Deficits are
expressed in inflation-adjusted terms.

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 Economic Effects of Federal
Budget Deficits

 Unified budget deficits require additional

borrowing.

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 Figure 12.2 Government Demand for Loanable
Funds and the Market Rate of Interest
S
Interest Rate

i2 E'
i1 E

D1 + DG
D1

0 L1 L2
Loanable Funds per Year
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 Ricardian Equivalence
 Ricardian Equivalence is the view that
deficits do not alter interest rates
because citizens today see that deficits
today will be financed with higher taxes
tomorrow and citizens save in order to
have the funds to pay those higher
taxes.

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 Figure 12.3 Ricardian Equivalence: Deficits Do Not
Affect Interest Rates
S
Interest Rate S'

i2 E'
i1 E E''

D1 + DG
D1
L

0 L1 L 2 L 3
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Loanable Funds per Year
 Economic Effects of Federal
Budget Surpluses

 Unified budget surpluses allow

government to provide capital to the
loanable funds market.

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 Figure 12.4 Impact of a Budget Surplus on
Credit Markets

S
S' = S1 + L
E
Interest Rate

I1 E'
I2

L
0 L1 L 2
Loanable Funds per Year
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 Budget Balance, National
Saving, and Economic Growth
 An increase in the deficit contributes to
a decrease in national savings while an
increase in a surplus contributes to a
increase in national savings.
 Increases in national savings increases
the potential for the economy to grow.
 

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 Figure 12.5 The National Savings Rate and its
Components, 1959-1999 (Measured as a Ratio of
Savings to Gross National Product)*

Recession

25
20
15
Percent

10
5
0
5
59 61 63 65 67 69 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99

Corporate and Other Private Saving Gross Government Saving

Gross Saving Personal Saving
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 Incidence of Deficit Finance
 Lower growth rates imply lower incomes for
future generations.
 If Ricardian Equivalence holds, then this is
not the case.
 Deficits may also change political equilibrium
so that there are increases in government
infrastructure that could lean to increased
future growth.
 

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 The Government Debt

 Mid-2000
 Federal Debt $5.66 trillion
 State and Local Debt $1 trillion

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 Figure 12.6 Federal Debt Held by the Public as a
Share of GDP (By fiscal year)

120
Percentage of GDP

100

80

60

40

20

0
1940 1950 1960 1970 1980 1990 2000
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 Net Federal Debt
 The Net Federal Debt is the portion of
the debt not held by the federal
government.

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 Gross public Debt of the US Treasury
by Holder July 31, 2000
Holder Amount of Percent of
Debt (Billions Total
of Dollars)
U.S. Govt. Agencies 2,229.5 39.4
Trust Funds and
Federal Reserve
Private Investors 3,429.3 60.6

Total 5,658.8 100.0

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 Net Public Debt of the U.S. Treasury by
Holder (Percent Distribution) December
1999
Holder Percentage of
Total
Depositors and Institutions 7.6
Mutual Funds 10.9
Insurance Companies 4.2
Pension Funds 13.8
State and Local Governments 6.6
Foreign and International 39.2
Other Investors 17.7
Total 100

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 Internal and External Debt
 The Internal Debt is the portion of the
debt owed to our own citizens.

 The External Debt is the portion of the

debt owed to people other than U.S.
citizens.

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 State and Local Borrowing
 Bonds are issued by state and local
governments to fund large projects.
 They are rated by financial companies
for their riskiness.
 Similar to federal debt, much of it is held
externally.
 

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 General Obligation vs Revenue
Bonds
 General Obligation Bonds are backed
by the state or local government’s ability
to tax.
 Revenue Bonds are backed by the
revenue that a state or local enterprise
would generate.

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 Social Security and the Deficit
 Social Security Surpluses are used to
purchase federal government debt.
 This will happen until benefits exceed
revenues (estimated to be 2023).
 Thereafter it will run deficits and will be forced
to sell off those bonds.
 Whether Social Security is on- or off-budget
and whether or not there is a trust fund has
no effect on the net national debt.

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 Burden of the Debt
 Impact on future generations:
 People have to pay increased taxes to pay interest
on that debt.
 Some may inherit the original bonds.
 Growth rates are reduced because of higher
interest rates.
 These impacts can be offset by the increased
private savings of the generation that does
the borrowing, or by returns that come from
programs that were funded by the borrowing.

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 European Union
 Entry into the EU required that members have
 inflation rates no more than 1.5 percentage point
more than that of the three lowest inflation
countries.
 interest rates on government debt be no more
than 3 points higher than that of the three lowest
interest countries.
 government deficit as a percentage of GDP be no
greater than 3% and debt no more than 60% of
GDP.

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 EU Deficit and Debt Figures
Nation Surplus/Deficit as a Debt as a
percentage of GDP percentage of
1998 GDP 1998
Belgium –0.9 118.2
Germany –2.0 61.1
France –2.9 58.8
Italy –2.7 118.7
Sweden 1.9 74.2
United Kingdom 0.5 48.7

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 What Should be Done With
Surpluses?
 Social Security and Medicare solvency
 Tax Cuts
 Other Spending Programs
 Reduce National Debt

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