BudgetDeficitsLecture

BudgetDeficitsLecture - Budget Deficits and the Federal...

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1 Budget Deficits and the Federal Budget Process Federal budget deficits The Lerner model The overlapping generations (OLG) model Consequences of deficits The theory of strategic deficits Federal budget rules and the “common pool” problem Generational accounting
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2 US Federal Deficits Traditionally, the US Federal govt did not run deficits, except in wartime Since the 1970’s, however, it has almost always run a deficit The only exception is during the boom of the late 1990’s In the last few years, deficits have returned, and are predicted to persist
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Government Budgeting The Budget Deficit in Recent Years
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6 Taxes v. Debt? Deficits occur when the govt borrows rather than taxes to finance current spending But, the govt must satisfy its intertemporal budget constraint in the long run: PV of spending = PV of taxes
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7 Debt as a Deferred Tax Thus, borrowing can only defer , not avoid, the imposition of taxes Who bears the burden of govt debt? This is a question of tax incidence i.e. who bears the future tax required to pay for the spending financed by current borrowing?
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8 The Lerner Model Assume there are 2 periods: Period 1: Generation A is alive (and dies at the end of the period) Period 2: Generation B is alive (and dies at the end of the period) Each generation consists of 100 individuals Each individual earns an exogenous wage of $10
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9 The Lerner Model Suppose that in period 1, the govt wants to raise $100 of revenue, in order to provide a transfer of $1 to each member of generation A Why? This is just a simple way to capture the idea that the govt wants to spend money on public goods etc that benefit members of A The govt can either tax or borrow
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10 The Lerner Model If the govt taxes generation A, then each member of each generation consumes $10 Govt Policy Generation A Generation B Wage Tax Transfer Bond Cons Wage Tax Transfer Int. Cons Tax 10 1 1 0 10 10 0 0 0 10
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11 The Lerner Model What if the govt borrows? e.g. imagine it sells each member of generation A a $1 bond that pays $1 in period 2 Assume interest rate = 0 Period 2: the govt must repay the bonds issued in period 1. The people who bought them are dead, but assume each member of B is a descendant of A, and has inherited a bond
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12 The Lerner Model Govt Policy Generation A Generation B Wage Tax Transfer Bond Cons Wage Tax Transfer Int. Cons Tax 10 1 1 0 10 10 0 0 0 10 Debt 10 0 1 1 10 10 1 0 1 10 Under these assumptions, govt debt is neutral: It does not affect the distribution of consumption across gen’s The use of debt has identical effects to the use of taxes
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The Lerner Model: Caveats Govt Policy Generation A Generation B Wage Tax Transfer Bond Cons Wage Tax Transfer Int. Cons Tax 10 1 1 0 10 10 0 0 0 10 Debt 10 0 1 0 11 10 1 0 0 9 What if the period-1 bonds were sold to foreigners? However, this assumes that individual behavior
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BudgetDeficitsLecture - Budget Deficits and the Federal...

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