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McGraw-Hill/Irwin Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. CHAPTER 20 DEFICIT FINANCE.

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Presentation on theme: "McGraw-Hill/Irwin Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. CHAPTER 20 DEFICIT FINANCE."— Presentation transcript:

1 McGraw-Hill/Irwin Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. CHAPTER 20 DEFICIT FINANCE

2 20-2 How Big is the Deficit?  Deficit  Surplus  On-budget deficit  Off-budget deficit

3 20-3 How Big is the Deficit?

4 20-4 How Big is the Debt?  National (Public) Debt  Stocks v Flows

5 20-5 How Big is the Debt?

6 20-6 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

7 20-7 The Burden of the Debt  Statutory versus Economic Incidence  Lerner’s View Internal Debt External Debt

8 20-8 Overlapping Generations Model The Period 2007-2027 YoungMiddle-AgedOld (1) Income$12,000 12,000 (2) Government Borrowing-6,000 (3) Government- provided consumption4,000 The Year 2027 YoungMiddle-AgedOld (4) Government raises taxes to pay back debt -4,000 (5) Government pays back debt+6,000

9 20-9 Generational Accounting  Computation of Net Tax PV of transfers received – PV of taxes paid

10 20-10 Neoclassical Model  Crowding Out Hypothesis  Empirical testing of the hypothesis

11 20-11 The Ricardian Model  Intergenerational transfers  Form of Finance is irrelevant  Empirical evidence

12 20-12 To Tax or to Borrow  Benefits-Received Principle  Intergenerational Equity  Efficiency Considerations Efficiency Considerations χ = ½εLt 2 χ = ½εLt 2  Macroeconomic Considerations Functional finance  Moral and Political Considerations

13 20-13 Present Value of Tax Payments Under Alternative Taxing/Borrowing Decisions PolicyYear 1 Year 2 All Future Years PV @ 10% interest rate Spend an additional $100 in year 110000 Financing Options Balanced budget: raise 100 in taxes in year 1 10000 Deficit Finance I: borrow 100 in year 1 and pay back debt plus interest in year 2 by raising taxes 01100100 Deficit Finance II: borrow 100 in year 1 and pay interest on debt in all subsequent years always rolling over debt principle 010 100

14 20-14 To Tax or To Borrow Tax rate Excess Burden t2t χ2χ2 χ1χ1


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