The Government Budget:Prospects and Implications

Andrew B. Abel

March 13, 2000

The Government Budget: Prospects and Implications, Professor Andrew Abel

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National Saving and Wealth

• Income Statement Concepts• Output: Y = C + I + G + NX• National Saving: S = Y - C - G = I + NX

• Balance Sheet Concept• National Wealth = domestic capital stock + net

foreign assets

The Government Budget: Prospects and Implications, Professor Andrew Abel

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Link Between Balance Sheet and Income Statement

• National Saving = Growth of National Wealth

• S = I + NX• I = growth of domestic capital stock

• NX = growth of net foreign assets

The Government Budget: Prospects and Implications, Professor Andrew Abel

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Capital Gains and Saving

• Capital gain for an individual• Increases current income• If not spent:

• Increases current saving

• Increases wealth at end of year

• Capital gain can increase current and/or future consumption of individual

The Government Budget: Prospects and Implications, Professor Andrew Abel

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Capital Gain in Closed Economy:National Perspective

• S = I

• If add capital gain to national output, Y• S would increase• Would have to add capital gain to I

• But I is intended to measure gross capital formation, which affects capacity to produce and consume in future

The Government Budget: Prospects and Implications, Professor Andrew Abel

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Source of Capital Gains

• Increase in dividend, current or future• Reflects increase in current or future output

• Decrease in r• Does not reflect increased current or future

output

• Bubble • Unrelated to current or future output

bubblegr

DividendpriceAsset

The Government Budget: Prospects and Implications, Professor Andrew Abel

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Capital Gains:Individual vs. National

• Increase ability of individual to consume

• May not affect ability of nation to consume

• Example: Stock market bubble• Increases wealth of individual owners• Does not increase ability of nation as a whole to

consume

The Government Budget: Prospects and Implications, Professor Andrew Abel

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U.S. National Saving, 1999-III1999-III $billions % of GDP $/personGross Private Saving 1355.7 14.6 5003 Personal 139.5 1.5 515 Business 1216.1 13.1 4487

Gross Government Saving 379.9 4.1 1402 Federal saving 225.1 2.4 831 State and local saving 154.8 1.7 571

Total National Saving 1735.6 18.7 6404

Investment 1930.7 20.8 7124 Private 1635.0 17.6 6033 Federal - defense 53.4 0.6 197 Federal - nondefense 41.5 0.4 153 State and local 200.8 2.2 741Current Account Balance -336.3 -3.6 -1241Investment + Current Account Balance 1594.4 17.1 5883

Statistical Discrepancy -141.2 -1.5 -521Source: Survey of Current Business, February 2000.

The Government Budget: Prospects and Implications, Professor Andrew Abel

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Gross Government Saving1999-III

1999-III $billionsGross Government Saving 379.9 Federal saving 225.0 Receipts 1883.1 Current expenditures 1749.3 Current surplus 133.8 Consumption of fixed capital 91.2 State and local saving 154.9 Receipts 1148.0 Current expenditures 1099.1 Current surplus 48.9 Consumption of fixed capital 106.0

Source: Survey of Current Business, February 2000.

The Government Budget: Prospects and Implications, Professor Andrew Abel

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Discretionary Outlays under Alternative Versions of Baseline

Source: CBO, The Economic and Budget Outlook: Fiscal Years 2001-2010, Figure 4-3, p. 80.

The Government Budget: Prospects and Implications, Professor Andrew Abel

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Budget Outlook under Current Policies

Source: CBO, The Economic and Budget Outlook: Fiscal Years 2001-2010, Summary Table 1, p. xiv.

The Government Budget: Prospects and Implications, Professor Andrew Abel

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International Comparison of Fiscal Balances: I

Percent of GDP. Source: World Economic Outlook, International Monetary Fund, October 1999, Table 14, p. 188.

The Government Budget: Prospects and Implications, Professor Andrew Abel

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International Comparison of Fiscal Balances: II

Percent of GDP. Source: World Economic Outlook, International Monetary Fund, October 1999, Table 15, p. 190.

The Government Budget: Prospects and Implications, Professor Andrew Abel

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Gross Government Debt in Europe(percent of GDP)

Source: World Economic Outlook, International Monetary Fund, May 1997, Table 5. P. 27.

1996 1997Belgium 130.0 127.1Italy 123.0 121.5Greece 110.7 107.7Sweden 78.6 76.6Netherlands 78.8 76.1Ireland 76.4 72.3Portugal 70.8 69.2Spain 69.5 69.0Austria 69.8 68.1Denmark 69.9 67.3Germany 60.3 61.5Finland 58.0 58.7France 56.3 57.8UK 49.3 49.4Luxembourg 5.9 5.7

The Government Budget: Prospects and Implications, Professor Andrew Abel

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Revenues as a Share of GDP

Source: CBO, The Economic and Budget Outlook: Fiscal Years 2001-2010, Figure 3-2, p. 51.

The Government Budget: Prospects and Implications, Professor Andrew Abel

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Revenues by Source

Source: CBO, The Economic and Budget Outlook: Fiscal Years 2001-2010, Figure 3-3, p. 53

The Government Budget: Prospects and Implications, Professor Andrew Abel

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Outlays

• Discretionary spending• Annual appropriation• Defense, education, transportation, ...

• Mandatory spending (Entitlements)• Eligibility rules and benefit formulas

• Offsetting receipts• e.g., drilling leases for Outer Continental Shelf

• Net interest

The Government Budget: Prospects and Implications, Professor Andrew Abel

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Source: CBO, The Economic and Budget Outlook: Fiscal Years 2001-2010, Table E-9, p. 143.

Federal Outlays, 1962-1999

-2

0

2

4

6

8

10

12

14

1962 1967 1972 1977 1982 1987 1992 1997

Perc

ent o

f GD

P

Discretionary

Entitlements and other mandatory

Net interest

Offsetting receipts

The Government Budget: Prospects and Implications, Professor Andrew Abel

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The Peace Dividend

Source: CBO, The Economic and Budget Outlook: Fiscal Years 2001-2010, Table 4-3, p. 75.

The Government Budget: Prospects and Implications, Professor Andrew Abel

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Nondefense Discretionary Spending

Source: CBO, The Economic and Budget Outlook: Fiscal Years 2001-2010, Figure 4-2, p. 78.

The Government Budget: Prospects and Implications, Professor Andrew Abel

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Source: CBO, The Economic and Budget Outlook: Fiscal Years 2001-2010, Summary Table 2, p. xvi.

The Government Budget: Prospects and Implications, Professor Andrew Abel

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Source: CBO, The Economic and Budget Outlook: Fiscal Years 2001-2010, Summary Table 2, p. xvi.

(percent of GDP)

The Government Budget: Prospects and Implications, Professor Andrew Abel

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Source: CBO, The Economic and Budget Outlook: Fiscal Years 2001-2010, Summary Table 3, p. xvii.

The Government Budget: Prospects and Implications, Professor Andrew Abel

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Source: CBO, The Economic and Budget Outlook: Fiscal Years 2001-2010, Summary Table 4, p. xviii.

The Government Budget: Prospects and Implications, Professor Andrew Abel

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Alternative Measure of Fiscal Balance

Source: CBO, The Economic and Budget Outlook: Fiscal Years 2000-2009, Table E-1, p. 135. Standardized budget excludes deposit insurance, receipts from auctions of electromagnetic spectrum, timing adjustments, and constributions from allied nations for Operation Desert Storm.

Actual and Standard Federal Budget Balances1960-1999

-7

-6

-5

-4-3

-2-1

01

2

1960 1965 1970 1975 1980 1985 1990 1995

Per

cent

of G

DP

Actual

Standardized

The Government Budget: Prospects and Implications, Professor Andrew Abel

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Projections of Federal Debt: I

Source: CBO, The Economic and Budget Outlook: Fiscal Years 2001-2010, Table 1-5, p. 20.

The Government Budget: Prospects and Implications, Professor Andrew Abel

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Projections of Federal Debt: II

Source: CBO, The Economic and Budget Outlook: Fiscal Years 2001-2010, Table 1-5, p. 20.

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Projections of Federal Debt: III

Source: CBO, The Economic and Budget Outlook: Fiscal Years 2001-2010, Table 1-5, p. 20.

The Government Budget: Prospects and Implications, Professor Andrew Abel

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Trust Fund Surpluses

Source: CBO, The Economic and Budget Outlook: Fiscal Years 2001-2010, Table 1-6, p. 23.

The Government Budget: Prospects and Implications, Professor Andrew Abel

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Burden of the Debt(end of FY99, billions of dollars)

• Debt ceiling • raised to $5500 billion in March 1996• raised to $5950 billion in Balanced Budget Act of 1997

Gross Federal Debt Held by public 3633 Held by government 1973 Social Security 855 Other government accounts 1118Total Gross Federal Debt 5606Debt Subject to Limit 5568

The Government Budget: Prospects and Implications, Professor Andrew Abel

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Two Views of Burden of Debt

• “We Owe it to Ourselves” ==> No Burden• $1973 billion held by gov’t is no burden• $3633 billion held by public is owed to public

• but foreigners own some of this debt

• Burden, even if U.S. citizens owned all of debt• Crowds out capital stock

• Reduces long-run wages and output per person

The Government Budget: Prospects and Implications, Professor Andrew Abel

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Federal Interest Outlays

Source: CBO, The Economic and Budget Outlook: Fiscal Years 2001-2010, Table 4-10, p. 94.

The Government Budget: Prospects and Implications, Professor Andrew Abel

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Debt/GDP Ratio in the United States

0

0.2

0.4

0.6

0.8

1

1.2

1.4

1869 1879 1889 1899 1909 1919 1929 1939 1949 1959 1969 1979 1989 1999

Gross Debt/GDP

Net Debt/GDP

The Government Budget: Prospects and Implications, Professor Andrew Abel

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Changes in Debt-GDP Ratio

• Debt-GDP Ratio:

• Growth of numerator: deficit• Primary deficit + net interest

• Growth of denominator: nominal GDP growth

GDP

B

The Government Budget: Prospects and Implications, Professor Andrew Abel

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Factors Causing Debt-GDP Ratio to Rise

• Large Primary Deficits (deficit minus interest)

• Wars• Great Depression• 1980s and first half of 1990s

• High (Real) Interest Rates

• Low GDP growth• Great Depression

The Government Budget: Prospects and Implications, Professor Andrew Abel

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Effect on Deficit of 1 Percentage Point Reduction in Measured CPI

(fiscal years, billions of dollars)

Source: Congressional Budget Office, The Economic and Budget Outlook: Fiscal Years 1998-2007, January 1997, p. 41.

1998 2000 2007 Revenues 1.9 10.5 44.2 Outlays Social Security -2.8 -10.7 -44.6 Debt Service -0.2 -2.0 -32.0 Other -0.9 -4.5 -19.3Total Outlays -3.9 -17.2 -95.9 Deficit -5.8 -27.7 -140.1

The Government Budget: Prospects and Implications, Professor Andrew Abel

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Long-Run Deficit Projections(Calendar year, percentage of GDP)

Source: CBO, The Economic and Budget Outlook: Fiscal Years 2000-2009, Table 2-5, p. 43.

The Government Budget: Prospects and Implications, Professor Andrew Abel

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Long-Run Debt Projections(Debt held by public, calendar year, percentage of GDP)

Source: CBO, The Economic and Budget Outlook: Fiscal Years 2000-2009, Figure 2-2, p. 44.

The Government Budget: Prospects and Implications, Professor Andrew Abel

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Social Security:Demographic Time Bomb

Source: 1999 OASDI Trustees Report, Table II.F.19

Beneficiaries per 100 Covered Workers

0

10

20

30

40

50

60

70

80

1999 2009 2019 2029 2039 2049 2059 2069

Intermediate

Low Cost

High Cost

The Government Budget: Prospects and Implications, Professor Andrew Abel

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OASDI Trust Fund Ratio

0

100

200

300

400

500

600

1999 2009 2019 2029 2039 2049 2059 2069

Intermediate

High Cost

Low Cost

Source: 1999 OASDI Trustees Report, Table II.F.20

The Government Budget: Prospects and Implications, Professor Andrew Abel

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Possible Solutions• Increase Contributions by Workers

• Increase retirement age

• Reduce Benefits Paid to Retirees• Increase retirement age• Tax Social Security benefits

• Earn Higher Return on Assets in Trust Fund• Invest in equities

• Privatize Social Security• Individuals control allocation of assets• Transitional problems