Chap_16_-_Fiscal_Policy_part_1_[1] - Fiscal Policy Before...

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Unformatted text preview: Fiscal Policy Before we get to the government’s role in stabilizing the economy, we need to talk a bit about how the government works. The government takes in revenue, mainly through taxes, and then the government spends money. When the government spends its money, it is called government outlays. The government spends its money mainly in two ways. Sometimes it just gives the money to individuals and organizations. These are called government transfers. Some examples of government transfers are the earned income tax credit, Social Security, and Medicare. Sometimes the government buys stuff with its money. This is called government expenditures (G). Examples of government expenditures would be aircraft carriers and office supplies. As we can see to the right, the largest chunk of the Federal Government’s tax revenue, 45% comes from individual income taxes. Social Security taxes, 36% are the next largest part of Federal Government revenues, and then come corporate income taxes at 12%. The rest of all the other taxes combined only make up 7% of Federal government revenues. Federal Tax Revenue, 2008 Individual Income Taxes; 45% Social Insurance Taxes; 36% Misc Taxes; 7% Corporate Income Taxes; 12% When the government turns around and spends money, there are two sorts of outlay that it makes. There are outlays that are mandated my law. These are Federal Government Outlays, called mandatory outlays. And 2008 there are outlays that are not mandated by law. These are called Net discretionary outlays. The three interest; largest and most famous Other; 8% Defense 12% mandatory outlays are Social Spending; Security, Medicare, and Medicaid. 21% Together they made up 43% of Domestic Federal Outlays. Net interest, or Discretionary Spending; the interest the government has to Social 16% Medicare pay on its debt is another 8% of Security; & Federal outlays. After that another 21% Medicaid; 11% of Federal outlays are legally 22% mandated. This means that in 2008, a full 62% of how the Federal Government spent its money was mandated by law. This left only 38% for © K. A. Kramer, 2009 1 discretionary spending. Of the funds available for discretionary spending over half was spent on defense. So only 16% of the Federal budget last year went to domestic discretionary spending. When tax revenues are greater than government outlays, we say that we have a budget surplus. When tax revenues are less than government outlays we say that we have a budget deficit. If tax revenues are equal to government outlays, we say we have a balanced budget. To calculate the size of the budget surplus or deficit we subtract government outlays from tax revenues. If the number is positive, we have a surplus, if it is negative there is a deficit: budget surplus (+) / budget deficit (-) = tax revenues – government outlays In 2008, government revenues were $2,523.6 billion while government outlays were $2,978.5 billion. This made our budget deficit $454.8 billion: $2,523.6 billion - $2,978.5 billion = -$454.8 billion From 1950 until 1970 our Federal Government on average had a balanced budget. But you can see below that we have tended to run a deficit since then, and that in general, these deficits have been increasing: Real Federal Budget Deficit or Surplus 500 400 300 Billions (2008$) 200 100 0 1960 -100 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 -200 -300 -400 -500 So why should we care about Federal Budget deficits? When we looked at the market for loanable funds we saw that government budget deficits can crowd out investment spending. However, in general this effect is not large. So when deficits are temporary, they are not particularly worrisome. Most economists think that the budget only needs to © K. A. Kramer, 2009 2 be balanced on average over the years. In fact, as we will see later on, temporary deficits during recessions can be quite useful. However, when deficits are permanent, the effects are more troubling. Persistent deficits are caused by the structure of Federal Government. Either tax revenues are permanently too low, outlays are permanently too high, or both. We call persistent deficits structural deficits. Structural deficits have two consequences that can cause concern. The first is the national debt. The national debt is that total amount of debt that is outstanding from all previous deficits. To calculate the current level or debt you talk the level of debt from the previous year, and add the current years deficit or surplus. So: Debt at end of 2008 = Debt at end of 2007 + Budget deficit in 2008 = $5,035.1 billion + $454.8 billion = $5,489.9 billion If there had been a budget surplus, we would have subtracted that from the debt: Debt at end of 1999 = Debt at end of 1998 - Budget surplus in 1999 = $3,721.1 billion – $125.6 billion = $3,595.5 billion Small amounts of debt are not a big deal. But when a country’s debt begins to accumulate two things happen. The first is that lenders start worrying about whether or not the country will be able to pay back its loans. So they stop lending to the country at low rates of interest. Since by this point it is unlikely that the country will stop borrowing, they will now be borrowing at higher and higher rates of interest. This means that they will have give over more and more of their revenues to paying the interest on the debt, and won’t be able to use those revenues to help its citizens. If this cycle keeps going, sooner or later the country won’t even have the money to keep paying interest on the debt. At this point a number of things can happen. The country can start printing money to pay its debts. This often causes hyperinflation. Or it can stop paying its debts and go into default on its loans. This normally causes numerous economic and political problems. As of 2008, the United States had $5,802.9 billion in debt held by the public, a little more than 40% of GDP, and we had to use 8% of our Federal budget outlays to service that debt. We have certainly had higher levels of debt, during WWII our debt climbed to higher that 100% of GDP, and as recently as 1995 our debt was almost 50% or GDP, though the Clinton surpluses decreased it a bit. What is so worrying about our debt right now is not its size, but the fact that it seems likely to keep growing which could easily get it to a size that was worrisome. © K. A. Kramer, 2009 3 Federal Debt as Percent of GDP 60 Percent of GDP 50 40 30 June 17, 2008 20 LONG-TERM FISCAL OUTLOOK ty Integrity Reliability ghts 10 Long-Term Federal Fiscal Challenge Driven Primarily by Health Care 0 1960 2T, a testimony to ce, U.S. Senate his Study rovide its rm fiscal ment addresses the federal erm fiscal of utmost allenge is driven care cost of health care is areas also need uires a on; and (4) the faces s yet a f opportunity ed adjustments. of the federal erm fiscal ed with the mediate tinue to g-term outlook is update ’s analysis of f state and local nstrates that the ing all levels of ed and should trategic and s published ulations of to federal els under 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 Social Security, Medicare, Medicaid, and the Federal Debt What GAO Found Long-term fiscal simulations by GAO, the Congressional Budget Office (CBO), and others all show that despite a decline in Social Security, Medicare, and Medicaid arethe federal government’s This means that if entitlement programs. unified budget deficit between fiscal years 2003 and 2007, it still faces large and you fit certain characteristics the Federal Government is legallycosts and to pay you growing structural deficits driven primarily by rising health care obligated mknown demographic programs. Since thesefederal government is onrapidly, the oney through these trends. Simply put, the programs are growing an government is legally obligated to uselthoughand more of its revenues each year to fund unsustainable long-term fiscal path. A more Social Security is important because of its Combined, these programs care spending is the principal these programs.size, over the long term health are expected to more than double in size over d next seventy years Medicaid are both arge and theriver—Medicare and as a percentage oflGDP. projected to continue growing rapidly in the future. Social Security, Medicare, and Medicaid Spending as a Percentage of GDP 25 20 15 10 5 0 2008 2020 2030 2040 2050 2060 2070 2080 Fiscal year Medicare Medicaid Social Security Source: GAO analysis. Rapidly rising health care costs are not simply a federal budget problem. Growth in health-related spending is the primary driver of the fiscal hallenges facing state ©cK. A. Kramer, 2009 and local governments as well. Unsustainable growth in health care spending also threatens to erode the ability of employers to provide coverage to their workers and undercuts their ability to compete in a global marketplace. Public and private health care spending continues to rise because of several key factors: (1) increased utilization of new and existing 4 Since the government is obligated to use more and more of its revenues each year to fund these programs, it has less and less money left over to use for discretionary spending on things like roads, public health, and education. So it is left with a dilemma. It can cut more and more of these services, it can raise taxes, or it can borrow more money. In general, the government tends to decide to borrow more money. This then raises the amount of net interest the government has to pay on its debt, which leaves less money for discretionary spending, which causes the government to borrow more money, and so on. As I described before, this can lead the government to either print money or default on its loan, either or which has awful consequences. Figure 2: Potential Fiscal Outcomes under GAO’s Alternative Simulation: Revenues and Composition of Spending as Shares of GDP Percent of GDP 50 40 30 Revenue 20 10 0 2008 2018 2030 2040 Fiscal year All other spending Medicare & Medicaid Social Security Net interest Source: GAO’s April 2008 analysis. Notes: Discretionary spending grows with GDP after 2008. The Alternative Minimum Tax (AMT) exemption amount is retained at the 2007 level through 2018 and expiring tax provisions are extended. After 2018, revenue as a share of GDP returns to its historical level of 18.3 percent plus expected revenues from deferred taxes (i.e., taxes on withdrawals from retirement accounts). Medicare spending is based on the Trustees’ 2008 projections adjusted for the Centers for Medicare and Medicaid Services’ alternative assumption that physician payments are not reduced as specified under current law. Rapidly rising health care costs are not simply a federal budget problem; they are a problem for other levels of government and other sectors. As shown in figure 3, GAO’s fiscal model demonstrates that state and local governments—absent policy changes—will also face large and growing © K. A. Kramer, 2009 5 Figure 4: Debt Held by the Public under GAO’s Alternative Simulation Percent of GDP 300 250 Alternative Simulation 200 150 Historical high 109 percent in 1946 100 50 0 2000 2010 2020 2030 2040 2050 Fiscal year Source: GAO’s April 2008 analysis. Note: Assumes currently scheduled Social Security and Medicare Part A benefits are paid in full throughout the simulation period. There are a lot of good strategies for fixing Social Security. For example, when social security was created, the average life expectancy was about 65 years. And that was also B q this is only part of the story. full federal government the qualifying theutualifying age that was set for The benefits. Currently, for years has age is being been borrowing the surpluses in the Social Security trust funds and other raised to 67, but we could easily raise it higher than that. Also, only the first $97,000 of a similar funds and using them to finance federal government costs. When person’s yearly income is taxed for Social Security, and we could increase or remove that such borrowings occur, the Department of the Treasury issues federal cap. And we could increase the years of covered employmentfull faith and securities to these government funds that are backed by the from 35 to 40. Whether or not we will doU.S. government. Although borrowingsolutions outof the if we have the credit of the this remains to be seen, but there are by one part there political will to implement another does not have the same economic and federal government from them. financial implications as borrowing from the public, it represents a claim Uon future resources andand Medburden on future taxpayers and the future nfortunately, Medicare hence a icaid make up the bulk of the increase in entitlement spending. Since much of their risingby those funds areby the rising cost or health care in economy. If federal securities held costs are driving included, the federal general in the Uniteddebt is much higher—about $9 trillion as of the end of government’s total States, there is no way to reform them without reforming our fiscal year 2007. As shown T figure 5, total federal reform is so important right now. national health care system. in his is why health caredebt increased over each of the last 4 fiscal years. Without it the health of the Federal government itself is at stake. Implicit Liabilities Debt held by the public is government debt held by individuals and institutions outside the government. However, the Federal government also issues loans to itself. These are called implicit liabilities. For example, right now Social Security takes in more in revenue than it pays out. However, this will change in 2011 when baby boomers begin to retire in large numbers. Then Social Security will pay out more than it takes in, and it will start running a deficit. The people who run social security have known that this would happen for a long time, so they created something called the social security trust fund. The Social Security trust fund is basically just a big account where Social Security Page G stored6all of its extra revenue, so that it would still have money to AO-08-912T fits even pay out bene when it was running a deficit. However, other parts of the government has borrowed most of this money to fund spending. When people talk about the government raiding © K. A. Kramer, 2009 6 Social Security, this is what they are talking about. If you add in implicit liabilities into the size of the debt, the size of the debt about doubles. So is it appropriate to add implicit liabilities into the size of the debt. There is a lot of debate about this. Since implicit liabilities represent a debt the government holds to itself, it is less worrying than a debt held to the public. But sooner or later Social Security is going to need to take the Treasury bonds that are in its trust fund right now and turn them into money so that they can pay claimants. In which case either the Federal government will need to pay Social Security money directly, or Social Security will sell those bonds to the public. In either case the implicit liability will become an explicit one. © K. A. Kramer, 2009 7 ...
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