CHAPTER 15 Government Debt slide 0 Econ 101: Intermediate Macroeconomic Theory Larry Hu Lecture 9: Government Debt

CHAPTER 15 Government Debt slide 1 The U.S. Government Debt-GDP ratio Revolutionary War Civil War World War I World War II

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CHAPTER 15 Government Debt slide 4  The number of people receiving Social Security, Medicare is growing faster than the number working, paying taxes  Congressional Budget Office projections: yeardebt-GDP ratio % % % The Fiscal Future

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CHAPTER 15 Government Debt slide 7 An Overview of Health Care in the United States

CHAPTER 15 Government Debt slide 8 An Overview of Health Care in the United States  Medicare  Every citizen who has worked for ten years in Medicare-covered employment (and their spouse) is eligible for Medicare at age 65.

CHAPTER 15 Government Debt slide 9  Medicaid  Medicaid A federal and state program that provides health care for the poor.  Medicaid benefits are targeted at several groups:  Those who qualify for cash welfare programs.  Most low-income children in the United States.  Most low-income pregnant women.  The low-income elderly and disabled.

CHAPTER 15 Government Debt slide 10 Health Reform Starting from July 1 Health care expenditures in the United States are currently about 18 percent of GDP 2 will reach 34% of GDP at tremendous variation across states in Medicare spending per enrollee, suggest that up to 30 percent of health care costs could be saved

CHAPTER 15 Government Debt slide 11 Health Care Cost per person US $ 6714 France $ 3449 UK $ 2760 Canada $3678

CHAPTER 15 Government Debt slide 12 A central point : create a government-sponsored health insurance program that would be an option for all Americans Just like Medicare How to pay for it? Republican don’t like the plan, they want tax break for private insurance A lot of debate!

CHAPTER 15 Government Debt slide 13 Economics of Health Care Reform Adverse selection  Individuals know more about their risk than does the insurer  Those most likely to have the adverse outcome to select insurance  Leading insurers to lost money if they offer insurance

CHAPTER 15 Government Debt slide 14  Program Details  How Is Social Security Financed?  Almost all workers in the United States pay the Federal Insurance Contributions Act (FICA) tax on their earnings.  Who Is Eligible to Receive Social Security?  A person must have worked and paid this payroll tax for 40 quarters (10 years) over their lifetime, and must be age 62 or older. What Is Social Security and How Does It Work?

CHAPTER 15 Government Debt slide 15 Social Security Outlays and Expenditure

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CHAPTER 15 Government Debt slide 18 Problems Measuring the Deficit 1. Capital assets 2. Uncounted liabilities 3. The business cycle

CHAPTER 15 Government Debt slide 19 Measurement problem 1: Capital Assets  Currently: deficit = change in debt  Better: Capital budgeting deficit = (change in debt)  (change in assets)  EX: Suppose govt sells an office building and uses the proceeds to pay down the debt. –Under current system, deficit would fall –Under capital budgeting, deficit unchanged, because fall in debt is offset by a fall in assets

CHAPTER 15 Government Debt slide 20 Measurement problem 2: Uncounted liabilities Current measure of deficit omits important liabilities of the government:  future pension payments owed to current govt workers such social Security payments

CHAPTER 15 Government Debt slide 21 Measurement problem 3: The business cycle  The deficit varies over the business cycle due to automatic stabilizers (unemployment insurance, the income tax system).  These are not measurement errors, but do make it harder to judge fiscal policy stance. EX: Is an observed increase in deficit due to a downturn or expansionary shift in fiscal policy?

CHAPTER 15 Government Debt slide 22 Is the govt debt really a problem? Two viewpoints: 1. Traditional view 2. Ricardian view

CHAPTER 15 Government Debt slide 23 The traditional view of a tax cut & corresponding increase in govt debt  Short run:  Y,  u(unemployment)  Long run: –Y and u back at their natural rates –closed economy:  r,  I –open economy:  ,  NX

CHAPTER 15 Government Debt slide 24 The Ricardian View  due to David Ricardo (1820)  According to Ricardian equivalence, a debt-financed tax cut has no effect on consumption, national saving, the real interest rate, investment, net exports, or real GDP, even in the short run.

CHAPTER 15 Government Debt slide 25 The logic of Ricardian Equivalence  Consumers are forward-looking, know that a debt-financed tax cut today implies an increase in future taxes that is equal---in present value---to the tax cut.  Thus, the tax cut does not make consumers better off, so they do not raise consumption.  They save the full tax cut in order to repay the future tax liability.  Result: Private saving rises by the amount public saving falls, leaving national saving unchanged.

CHAPTER 15 Government Debt slide 26 Problems with Ricardian Equivalence  Myopia: Not all consumers think that far ahead, so they see the tax cut as a windfall.  Borrowing constraints: Some consumers are not able to borrow enough to achieve their optimal consumption, and would therefore spend a tax cut.  Future generations: If consumers expect that the burden of repaying a tax cut will fall on future generations, then a tax cut now makes them feel better off, so they increase spending.

CHAPTER 15 Government Debt slide 27 Evidence against Ricardian Equivalence?  Early 1980s: Huge Reagan tax cuts caused deficit to rise. National saving fell, the real interest rate rose, the exchange rate appreciated, and NX fell.  1992: President George H.W. Bush reduced income tax withholding to stimulate economy. This merely delayed taxes but didn’t make consumers better off. Yet, almost half of consumers used part of this extra take-home pay for consumption.