CHAPTER 20 Deficit Finance McGraw-Hill/Irwin Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved. How Big Is the Deficit? • • • • Deficit Surplus On-budget deficit Off-budget deficit 20-2 How Big Is the Deficit? Source: Congressional Budget Office [2009a] 20-3 How Big Is the Debt? • National (Public) Debt • Stocks vs. Flows 20-4 How Big Is the Debt? Source: Congressional Budget Office [2009a] 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 • Lerner’s View – 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 Generational Accounting • Computation of Net Tax – PV of transfers received – PV of taxes paid 20-9 Neoclassical Model • Crowding Out Hypothesis • Empirical testing of the hypothesis 20-10 The Ricardian Model • Intergenerational transfers • Form of Finance is irrelevant • Empirical evidence 20-11 To Tax or To Borrow • Benefits-Received Principle • Intergenerational Equity • Efficiency Considerations – χ = ½εLt2 • Macroeconomic Considerations – Functional finance • Moral and Political Considerations 20-12 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 Options Balanced budget: raise 100 in taxes in year 1 Deficit Finance I: borrow 100 in year 1 and pay back debt plus interest in year 2 by raising taxes 100 0 0 100 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 20-13 To Tax or To Borrow Excess Burden χ2 χ1 t 2t Tax rate 20-14
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