The Government Budget: Prospects and Implications

The Government Budget:Prospects and Implications

Andrew B. Abel

March 8, 1999

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, 1998-III1998-III $billions % of GDP $/personGross Private Saving 1078.7 12.6 3991 Personal 12.6 0.1 47 Business 1066.1 12.5 3944

Gross Government Saving 395.7 4.6 1464 Federal saving 161.6 1.9 598 State and local saving 234.1 2.7 866

Total National Saving 1474.5 17.3 5455

Investment 1604.2 18.8 5935 Private 1364.4 16.0 5048 Federal 60.8 0.7 225 State and local 179.0 2.1 662Current Account Balance -231.6 -2.7 -857Investment + Current Account Balance 1372.6 16.1 5078

Statistical Discrepancy -102.0 -1.2 -377

The Government Budget: Prospects and Implications, Professor Andrew Abel

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Gross Government Saving1998-III

1998-III $billionsGross Government Saving 395.7 Federal saving 161.6 Receipts 1858.8 Current expenditures 1766.7 Current surplus 92.0 Consumption of fixed capital 69.6 State and local saving 234.1 Receipts 1152.3 Current expenditures 1003.6 Current surplus 148.7 Consumption of fixed capital 85.4

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 2000-2009, Table 2-1, p.

The Government Budget: Prospects and Implications, Professor Andrew Abel

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Deficits and Debt in Europe(percent of GDP)

CountryGeneral

GovernmentDeficit

GrossGovernment

DebtCountry

GeneralGovernment

Deficit

GrossGovernment

Debt1996 1997 1996 1997 1996 1997 1996 1997

Germany 3.8 3.3 60.3 61.5 Austria 3.9 2.5 69.8 68.1France 4.1 3.3 56.3 57.8 Denmark 1.6 0.1 69.9 67.3Italy 6.8 3.3 123.0 121.5 Finland 2.6 1.9 58.0 58.7UK 4.4 3.1 49.3 49.4 Greece 7.6 5.1 110.7 107.7Spain 4.4 3.2 69.5 69.0 Portugal 4.0 2.9 70.8 69.2Netherlands 2.3 2.2 78.8 76.1 Ireland 1.0 1.6 76.4 72.3Belgium 3.4 2.9 130.0 127.1 Luxembourg 0.1 0.1 5.9 5.7Sweden 2.5 0.8 78.6 76.6 Maastricht

criteria3.0 60.0

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

The Government Budget: Prospects and Implications, Professor Andrew Abel

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Revenues as a Share of GDP(fiscal year)

Source: CBO, The Economic and Budget Outlook: Fiscal Years 2000-2009, Figure 3-2, p. 45.

The Government Budget: Prospects and Implications, Professor Andrew Abel

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Revenues by Source(fiscal year)

Source: CBO, The Economic and Budget Outlook: Fiscal Years 2000-2009, Figure 3-3, p. 47

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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OutlaysDiscretionary Spending

Source: CBO, The Economic and Budget Outlook: Fiscal Years 2000-2009, Figure 4-1, p. 63.

The Government Budget: Prospects and Implications, Professor Andrew Abel

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OutlaysEntitlements and Other Mandatory Spending

Source: CBO, The Economic and Budget Outlook: Fiscal Years 2000-2009, Figure 4-1, p. 63.

The Government Budget: Prospects and Implications, Professor Andrew Abel

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OutlaysNet Interest

Source: CBO, The Economic and Budget Outlook: Fiscal Years 2000-2009, Figure 4-1, p. 63.

The Government Budget: Prospects and Implications, Professor Andrew Abel

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CBO Budget Projections

Source: CBO, The Economic and Budget Outlook: Fiscal Years 2000-2009, Summary Table 3, p. xviii.

The Government Budget: Prospects and Implications, Professor Andrew Abel

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CBO Budget Projections

Source: CBO, The Economic and Budget Outlook: Fiscal Years 2000-2009, Summary Table 3, p. xviii.

The Government Budget: Prospects and Implications, Professor Andrew Abel

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Measures of Fiscal Policy

Source: CBO, The Economic and Budget Outlook: Fiscal Years 2000-2009, Table 1-3, p. 16.

The Government Budget: Prospects and Implications, Professor Andrew Abel

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Measures of Fiscal Policy

Source: CBO, The Economic and Budget Outlook: Fiscal Years 2000-2009, Table 1-3, p. 16.

The Government Budget: Prospects and Implications, Professor Andrew Abel

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Projections of Federal Debt

Source: CBO, The Economic and Budget Outlook: Fiscal Years 2000-2009, Table 2-3, p. 38.

The Government Budget: Prospects and Implications, Professor Andrew Abel

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Trust Fund Surpluses(fiscal year, billions of dollars)

Source: CBO, The Economic and Budget Outlook: Fiscal Years 2000-2009, Table 2-4, p. 41.

The Government Budget: Prospects and Implications, Professor Andrew Abel

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Burden of the Debt

• Debt ceiling

• raised to $5500 billion in March 1996

• raised to $5950 billion in Balanced Budget Act of 1997

billions dollars perof dollars capita

Gross Federal Debt 5479 20,271Debt Subject to Limit 5439 20,123Debt Held by the Public 3720 13,763

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• $1759 billion held by gov’t is no burden• $3720 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(Fiscal year, billions)

Source: CBO, The Economic and Budget Outlook: Fiscal Years 2000-2009, Table 4-8, p. 79.

The Government Budget: Prospects and Implications, Professor Andrew Abel

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0

0.2

0.4

0.6

0.8

1

1.2

1.4

1860 1880 1900 1920 1940 1960 1980 2000

Ra

tio

to

GD

PDebt-GDP Ratio in the U.S.

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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Will Federal Debt Be Eliminated?

• Debt held by public• Projected to be zero in 2012

• Why might this projection prove incorrect?• Projected surpluses might not occur

• Policies to cut taxes/increase spending

• Recessions

• Social Security Trust Fund may sell bonds to public in exchange for equity

The Government Budget: Prospects and Implications, Professor Andrew Abel

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Social Security:Demographic Time Bomb

Source: 1998 OASDI Trustees Report, Table II.F.19

Beneficiaries per 100 Covered Workers

20

30

40

50

60

70

80

1995 2005 2015 2025 2035 2045 2055 2065 2075

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

1995 2005 2015 2025 2035 2045 2055 2065 2075

Intermediate

Low Cost

High Cost

Source: 1998 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

The Government Budget: Prospects and Implications, Professor Andrew Abel

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Clinton Plan: Use of Projected Surpluses, 15 Years

%Transfer to Social Security 62Transfer to Medicare 15Transfer to USA Accounts 11Military, education, research 11

The Government Budget: Prospects and Implications, Professor Andrew Abel

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Surpluses, Deficits, and Debts*

• SS Surp. + On-Budget Surp. = Unified Surp.• SS Def. + On-Budget Def. = Unified Def.• SSTF = SS Surp. = - SS Def.

• Gross Debt = On-Budget Def. = - On-Budget Surp.

• Debt Held by Public = Unified Def. = - Unified Surp.

• -SSTF + Gross Debt = Debt Held by Public• Gross Debt = Debt Held by Public + SSTF *Ignores other off-budget items and trust funds

The Government Budget: Prospects and Implications, Professor Andrew Abel

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Double Counting?

• Unified surplus results from SS surplus• SS surplus increases SSTF anyway

• Transfer 62% of projected unified surplus to Social Security• SSTF = SS Surplus + Transfer• Gross Debt = Unified Deficit + Transfer• Unified deficit and debt held by public unchanged

The Government Budget: Prospects and Implications, Professor Andrew Abel

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Illustration of Transferto Social Security

YearTransfer ? No Yes No YesSS Surplus 138 138 217 217On-budget surplus -7 -7 164 164Unified surplus 131 131 381 381Transfer to SSTF 0 81 0 236SSTF 138 219 217 453Debt held by public -131 -131 -381 -381Gross debt 7 88 -164 72

2000 2009