Chapter 18

Deficits, Surpluses, and the Public Debt

Definitions of Deficit, Surplus, and Debt

• Budget Deficit – The amount by which government’s expenditures exceed its revenues during a particular year.

• In contrast, a surplus is the amount by which its revenues exceed expenditures.

Definitions of Deficit, Surplus, and Debt

• In 2002 there was a Federal deficit of $158 billion

• In 2000 there was a surplus of $236 billion• The national or public debt is the total

accumulation of the Federal government’s total deficits and surpluses that have occurred through time.

Definitions of Deficit, Surplus, and Debt

• State and local governments historically have a collective budget surplus

Three Budget Philosophies

• Annually Balanced Budget – Was the goal until the 1930s Depression, but this ruled out using fiscal policy as a countercyclical, stabilizing force and even makes recession or depression worse

• The balanced budget is not neutral, but is procyclical – it worsens the business cycle

• In a recession, the government would have to arise taxes and lower spending to balance the budget as tax revenues fell with recessionary income levels – This policy would worsen recessions

Annually Balanced Budget

• In an inflationary boom period, a balanced budget would intensify the inflation - As tax revenues increased, the government would need to cut taxes or increase spending to avoid budget surplus. This strategy would make the inflation worse.

• Those who argue for the annually balanced budget want to limit the growth of government.

Three Budget Philosophies

• Cyclically balanced budget – Allows for some government stabilization policy over the length of the business cycle. Deficit spending is allowed during a recession, and surpluses during an inflationary period.

• Over the business cycle, deficits would be offset by surpluses.

• But in reality, surpluses and deficits do not offset each other.

Three Budget Philosophies

• Functional Finance – Advocate contend that deficits, surpluses, and the size of the debt are of minor importance

• The primary purpose of Federal finance is to achieve noninflationary full employment.

• Government should do what is necessary to achieve this goal regardless of the deficit or surplus in the budget.

The Public debt

• Any government deficit increases the size of the public debt.

• The public debt has grown substantially since 1940

Three causes of the debt:

• Wars require increased Federal borrowing to finance the war effort

• Recessions result in budget deficits because of the built-in stability of the economy (tax revenues fall and domestic spending rises).

• Lack of fiscal discipline, such as a cut in tax rates without offsetting reductions in expenditures or a lack of control over increased spending, will contribute to deficits.

The Social Security Trust Fund

• Currently generates more revenue than expenditures for the federal government. This situation decreases budget deficits and increased budget surpluses.

• If we do nothing to Social Security program right now, Social Security can pay every cent it owes to 2036. after 2036, can only pay about 70% (2010)