deficit finance chapter 20. how big is the deficit? deficit surplus on-budget deficit off-budget...
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DEFICIT FINANCE Chapter 20
How Big Is the Deficit?
• Deficit• Surplus• On-budget deficit• Off-budget deficit
20-2
How Big Is the Deficit?
Source: Congressional Budget Office [2012b]
20-3
How Big Is the Debt?
• National (Public) Debt• Stocks vs. Flows
20-4
How Big Is the Debt?
Source: Congressional Budget Office [2012b]
20-5
Interpreting Deficit, Surplus, and Debt Numbers
• Government Debt held by the Federal Reserve Bank• State and Local Government• Effects of Inflation– Inflation tax
• Capital versus Current Accounting• Tangible Assets• Implicit Obligations• Summing Up
20-6
The Burden of the Debt
• Statutory versus Economic Incidence• One Hand Borrows from the Other– Internal Debt– External Debt
20-7
Overlapping Generations ModelThe Period 2010-2030
Young Middle-Aged Old
(1) Income $12,000 $12,000 12,000
(2) Government Borrowing -6,000 -6,000
(3) Government- provided consumption 4,000 4,000 4,000
The Year 2030
Young Middle-Aged Old
(4) Government raises taxes to pay back debt
-4,000 -4,000 -4,000
(5) Government pays back debt +6,000 +6,000
20-8
Overlapping Generations Model
• Generational Accounting– Computation of Net Tax• PV of transfers received – PV of taxes paid
20-9
Other Models
• Neoclassical Model – Crowding Out Hypothesis– Empirical testing of the hypothesis
• Ricardian Model– Intergenerational transfers– Form of Finance is irrelevant– Empirical evidence
20-10
To Tax or To Borrow
• Benefits-Received Principle• Intergenerational Equity• Efficiency Considerations– χ = ½εLt2
• Deficits and Functional Finance– Functional finance
• Moral and Political Considerations– Federal Debt and the Risk of a Fiscal Crisis
• Controlling the Deficit
20-11
Present Value of Tax Payments Under Alternative Taxing/Borrowing Decisions
Policy Year 1
Year 2
All Future Years
PV @ 10% interest rate
Spend an additional $100 in year 1 100 0 0 100
Financing OptionsBalanced budget: raise 100 in taxes in year
1100 0 0 100
Deficit Finance I: borrow 100 in year 1 and pay back debt plus interest in year 2 by
raising taxes
0 110 0 100
Deficit Finance II: borrow 100 in year 1 and pay interest on debt in all subsequent
years always rolling over debt principle
0 10 10 100
20-12
To Tax or To Borrow
Tax rate
ExcessBurden
t 2t
χ2
χ1
20-13
Chapter 20 Summary• When government spending > revenues, it must borrow
money: debt is the sum of past deficits & surpluses• Economic research centers on whether future
generations carry the burden of government debt• Several factors influence whether government should
finance expenditures through taxes or debt– From an efficiency point of view, the excess burden of tax
vs. debt financing should be considered• Options for controlling the deficit include changing
budget-making processes and a constitutional amendment
20-14
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