Federal Budget Deficit

General Information

Definition: The opposite of a budget surplus, a deficit is when the government spends more money than it takes in. Essentially government expenditures and transfer payments are greater than the revenue from taxes. This is assuming that taxes are the main form of revenue.

G>T = A budget deficit

G= federal, state, and local government spending on currently produced goods and services

T= federal, state and local tax revenue

Stabilization Policy

-In terms of stabilization policy, the budget has three variables that affect macroeconomic goals:

• Government purchases of goods and services
• Government transfer payments
• Government tax reciepts

-How does the government budget deficit work as an automatic stabilizer for economic activity?

-As GDP increases then taxes increase as well. The revenue from taxes in higher so the deficit is smaller in times economic prosperity. As this happens, fiscal policy becomes more resrictive and this in turn dampens the expansion.

-A shock the causes economic activity to fall means that the deficit will increase because tax revenues are smaller then before. In addition, in times of low economic activity, unemployment is high and so are government transfer payments like unemployment compensation, and thus government expenditures rise. This cushions the fall in national income.

-Are government budget deficits good or bad?

• This can depend on what the excesses expenditures are being used for.
• For example: if the government borrows to deal with a recession, to fund self-defense, or for public investment it is not a bad thing.
• Obviously wasteful expenditures would be bad

-Ways to deal with the federal budget deficits:

• revenue from taxes
• government bonds: leads to open market operations
• money creation: leads to sustained inflation

-In the US, the government is not allowed to issue new currency to pay off bills.

• Must fix deficit with an increase in taxes or by issuing bonds to the public

(Frederic S. Mishkin, The Economics of Money, Banking, and Financial Markets (Boston, Pearson Addison Wesley, 2004), 642-55)

(Richard T. Froyen, Macroeconomics: Theories and Policies (Upper Saddle River, Pearson Prentice Hall, 2005) 406-22)

Types of Deficits

-In 1989, President Reagan called for a constitutional amendment that would mandate a balanced federal budget.

-In 1995, congress voted against the amdendment

-Kenynesians are the main opponents of a balanced budget. They argue that deficits stabilize the economy and are actually required.

• The tax transfer system acts as an automatic fiscal stabilizer and a deficit or surplus is neccesary at the appropriate time in the business cycle.

Cyclical Vs. Sctructural Deficits

-Federal budget deficit depends in part on the level of economic activity.

-Cyclical Deficits: are the portion of the federal budget deficit that results from the economy being at a low level of economic activity.

-Structural Deficits: are the portion of the federal budget deficit that would exist even if the economy were at its potential output.

-Keynesians believe that cyclical deficits show that automatic stabilizers are working as desired.

-On the other hand, strucutral deficits are not directly attributable to the behavior of the economy.

• Structural deficits are the direct result of policymakers' decisions. For example: tax rates, level of government spending and benefit levels for transfer programs.

-Keynesians believe that large structural deficits reflect a mistaken mix of fiscal and monetary policies.

• Perhaps these deficts are the result of overly expantionary fiscal policy.

(Frederic S. Mishkin, The Economics of Money, Banking, and Financial Markets (Boston, Pearson Addison Wesley, 2004), 642-55)

(Richard T. Froyen, Macroeconomics: Theories and Policies (Upper Saddle River, Pearson Prentice Hall, 2005) 406-22)

Current State of the Federal Budget Deficit

-The federal deficit fell to a four year low recently. The deficit for the budget year that ended September 30th was 22.3 percent lower than the $318.7 billion imbalance for 2005. The deficit for 2006 was $247.7 billion dollars.

-President Bush attributes the decline to his tax cuts.

-In 2004, Bush pledged that he would cut the budget deficit in half by the year 2009. Now this seems to have been achieved three years ahead of schedule.

-Democrats critical of Bush believe that this decline is only temporary and that the deficit will increase again soon

"Only a president with such a historically bad economic record would be this excited about a $248 billion deficit," said Rep. Carolyn Maloney, D-N.Y. "Under his watch ... record surpluses turned into record deficits as far as the eye can see." (FOXNews)

-In 2006, tax revenues grew by 11.7 percent while government expenditures only grew by 7.3 percent.

-Originally the predict deficits was more then 423 billion.

"Republicans said the big improvement showed that Bush's economic policies were working to stimulate growth and boost tax revenues. But Democrats said the narrowing of the deficit would be temporary as the pending retirement of 78 million baby boomers will send costs of the government's big benefit programs soaring." (Fox)

• Here we can see how the government transfers expenditure aspect of the deficit is believe to increase in the future, causing the deficit to increase.

(http://www.foxnews.com)

(http://cnnmoney.com)

History

-For most of the Nation's history, deficits were the result of either wars or recessions. Wars necessitated major increases in military spending, while recessions reduced Federal tax receipts from businesses and individuals.

-The Government incurred its first deficit in 1792, and it generated 70 annual deficits between 1900 and 1997. The Government generated deficits during the War of 1812, the recession of 1837, the Civil War, the depression of the 1890s, and World War I. Once the war ended or the economy began to grow, the Government followed its deficits with budget surpluses, with which it paid down the debt.

-Deficits returned in 1931 and remained for the rest of the decade—due to the Great Depression and the spending associated with President Roosevelt's New Deal. Then, World War II forced the Nation to spend unprecedented amounts on defense and to incur corresponding unprecedented deficits.

-Since then, with Democratic and Republican Presidents, Democratic and Republican Congresses, the Government has balanced its books only 11 times, most recently last year. During the 1970s, large budget deficits emerged as the economy was disrupted by oil shocks and inflation. In the 1980s, this trend increased. By 1992, the deficit reached $290 billion. Budget deficits have gradually declined since that high point, returning to balance in 1998. In 2000, the budget surplus was $236 billion.

-The main reason we have been able to move from a deficit to balance is due to a strong economic growth has increased tax receipts faster than the growth in Federal spending. Also, the end of the Cold War allowed the growth in defense spending to slow. Since the 1960’s, receipts have stayed relatively constant, at around 17 to 20 percent of GDP. However, strong economic growth since the mid-1990s has increased receipts to nearly 21 percent of GDP, the highest level since World War II. In that same time, outlays grew from about 17 percent of GDP in 1965 to nearly 24 percent in 1983 before falling to 18 percent in 2000.

-Since 1983, spending has grown dramatically across a wide variety of programs. Total spending in 2000 is 37 percent higher than in 1983 in constant dollars. Medicare and Medicaid, combined, are 175 percent higher and Social Security is 48 percent higher. Similarly, spending for net interest is 60 percent higher in 2000 than in 1983. In total, discretionary spending is six percent higher. But non-defense discretionary spending is 30 percent higher while national defense discretionary spending is 11 percent lower than in 1983.

-In recent years the growth in discretionary spending has accelerated, especially since 1997. Between 1997 and 2000, total discretionary spending has increased five percent, with non-defense discretionary spending increasing more than eight percent during this three-year period.

(http://www.whitehouse.gov/infocus/budget/2007/index.html)

What can we expect in the Future?

As we have discussed, a Federal budget deficit can have a positive and negative impact on the economy. A deficit can stimulate the economy which results in higher levels of business activity and profitability. Also, a deficit can help to create business and investor optimism because of more employment opportunities. Conversely, a deficit that is too large can lead to a rise in inflation. Deficit spending may also create a rise in unemployment, but lower the inflation rate, however the main objective is to maintain a level of balance.

With a current national debt of roughly $8.5 trillion, many questions and concerns have been raised about the future plans for the Federal Budget. The budget deficit for the 2006 fiscal year was $248 billion, which is down from the $319 billion deficit in 2005. President Bush has implemented numerous pro-growth policies that have generated historic revenue growth, resulting in a deficit reduction. In fact, over the past three years the budget deficit has been more than cut in half.

2007 The White House website explains what has caused the deficit decline and continued policies that will only further the pro-growth mentality. "In 2007, the President proposes to continue the successful pro-growth policies that have encouraged robust economic growth and job creation. A strong economy, together with spending restraint, is critical to reducing the deficit. The FY 2007 Budget builds on last year’s successful spending restraint by again holding the growth of overall discretionary spending below inflation, proposing to reduce non-security discretionary spending below the previous year’s level, and calling for the elimination or reduction of programs not getting results or not fulfilling essential priorities. Like last year, the budget proposes savings and reforms to mandatory spending programs, whose unsustainable growth poses the real long-term danger to our fiscal health."

Continued Expansion The Bush Aministration will be possible for several reasons. The tax relief plan, implemented in 2003, has created almost five million new jobs and productivity is increasing at 3% annually. The deficit decrease in largely dependent upon the level of Federal reciepts. In 2005, receipts grew 14.5% and the 2006 number is projected at a 6.1% increase from 2005. One of the many procedures enacted by the administration in creation of falling deficits has been the result of a budget cut of non-productive programs. The current plan terminates or reduces 141 programs that are not getting results or not fulfilling essential priorities, for a proposed savings of $14.7 billion. Projections show the deficit will decline from its projected 2004 peak of 4.5 percent of GDP ($521 billion) down to 1.4 percent ($208 billion) in 2009, more than in half and well below the 40-year historical average deficit of 2.3 percent.

Long Term Danger? The greatest threat to the United States fiscal well-being over the long-term comes from unsustainable growth in entitlement programs such as Social Security, Medicare, and Medicaid. As the baby boomers retire, funding for these programs will increase rapidly due to their retirement entitlement packages. Alan Greenspan was quoted last January as saying, "The looming retirement of 78 million baby boomers will put massive strains on the country’s finances." In 2008, the oldest of the boomers will reach 62, the earliest age at which they can tap Social Security retirement benefits. Three years after that, in 2011, they will reach 65 and become eligible for Medicare. The President is currently seeking ways to reform the structure of Social Security that will affect future generations.

Current National Budget Issues The Budget focuses taxpayer resources on National priorities like the War on Terrorism, health care, energy research and strengthening our global competitiveness through improved math and science education and research.

War on Terror "To give our troops the resources they need to fight terror and protect our Nation, the Budget increases defense spending by nearly 7 percent. This funding will maintain a high level of military readiness, develop and procure new weapon systems to ensure U.S. battlefield superiority, and support our service members and their families."

Homeland Security "Government-wide, non-defense homeland security funding, including fee-funded activities, increases by more than 8 percent. The Budget also provides resources to strengthen our borders with funding for 1,500 new border patrol agents, 6,000 new detention beds, 560 detention and removal personnel, and 257 attorneys to expedite removal of illegal immigrants."

Health Care "The Budget makes health care more affordable and available with improvements to Health Savings Accounts, health information technology, and medical liability reform."

Reducing our Addiction to Foreign Oil "The Advanced Energy Initiative provides a 22-percent increase in research funding for cleaner, cheaper, more reliable energy: solar, wind, nuclear, zero-emission coal, batteries for hybrid and electric cars, hydrogen, and biomass – with the goal of replacing 75 percent of oil imports from the Middle East by 2025."

Strengthening our Competitiveness through Education The American Competitiveness Initiative commits $5.9 billion in FY2007, and more than $136 billion over 10 years, to increase investments in research and development, recruit new math and science teachers, encourage American innovation, and strengthen our nation’s ability to compete in the global economy."

Promoting Compassion and Strengthening Families "The Budget continues to advance compassionate programs that are effective in addressing social concerns, including $322 million in targeted Faith-based and Community initiatives. These efforts fund the Helping America’s Youth initiative, as well as other priority programs."

The Bush Aministration is seeking ways to reduce deficits by controlling spending and researching potential other outlets to utilize taxpayer dollars.

Different Economist's Perspectives

Paul Krugman