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 Model
The Period 2010-2030
Young
Middle-Aged
Old
$12,000
$12,000
12,000
(2) Government Borrowing
-6,000
-6,000
(3) Government- provided consumption
4,000
4,000
(1) Income
4,000
The Year 2030
(4) Government raises taxes to pay back
debt
(5) Government pays back debt
Young
Middle-Aged
Old
-4,000
-4,000
-4,000
+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
0
0
100
110
0
100
10
10
100
Financing Options
Balanced budget: raise 100 in taxes in year 100
1
Deficit Finance I: borrow 100 in year 1 and
0
pay back debt plus interest in year 2 by
raising taxes
Deficit Finance II: borrow 100 in year 1
and pay interest on debt in all subsequent
years always rolling over debt principle
0
20-12
To Tax or To Borrow
Excess
Burden
χ2
χ1
t
2t
Tax rate
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