1. Copyright © 2010 Worth Publishers

2. Budget Analysis and Deficit Financing 4
4.1 Government Budgeting
4.2 Measuring the Budgetary Position of the Government: Alternative Approaches
4.3 Do Current Debts and Deficits Mean Anything? A Long-Run Perspective
4.4 Why Do We Care About the Government’s Fiscal Position?
4.5 Conclusion
P R E P A R E D B Y
Heather Luea and Dan Sacks

4. Excerpts from Inaugural Speeches and the U.S. Deficit
4.1
Excerpts from Inaugural Speeches and
the U.S. Deficit
“We will continue along the path toward a balanced budget in a balanced economy.” President Lyndon Johnson
Deficit in first year in office (1964): 0.9% of GDP
Deficit in last year in office (1968): 2.9% of GDP
“We must balance our federal budget so that American families will have a better chance to balance their family budgets.” President Richard Nixon
Deficit in first year in office (1969): –0.3% of GDP (surplus)
Deficit in last year in office (1974): 0.4% of GDP

5. Excerpts from Inaugural Speeches and the U.S. Deficit
4.1
Excerpts from Inaugural Speeches and
the U.S. Deficit
“We can achieve a balanced budget by 1979 if we have the courage and the wisdom to continue to reduce the growth of federal spending.” President Gerald Ford
Deficit in first year in office (1975): 3.4% of GDP
Deficit in last year in office (1976): 4.2% of GDP
“With careful planning, efficient management, and proper restraint on spending, we can move rapidly toward a balanced budget, and we will.” President Jimmy Carter
Deficit in first year in office (1977): 2.7% of GDP
Deficit in last year in office (1980): 2.7% of GDP

6. Excerpts from Inaugural Speeches and the U.S. Deficit
4.1
Excerpts from Inaugural Speeches and
the U.S. Deficit
“[This budget plan] will ensure a steady decline in deficits, aiming toward a balanced budget by the end of the decade.”
President Ronald Reagan
Deficit in first year in office (1981): 2.6% of GDP
Deficit in last year in office (1988): 3.1% of GDP
“[This budget plan] brings the deficit down further and balances the budget by 1993.” President George H. W. Bush, Deficit in first year in office (1989): 2.8% of GDP
Deficit in last year in office (1992): 4.7% of GDP

7. Excerpts from Inaugural Speeches and the U.S. Deficit
4.1
Excerpts from Inaugural Speeches and
the U.S. Deficit
“[This budget plan] puts in place one of the biggest deficit reductions in the history of this country.” President William Clinton
Deficit in first year in office (1993): 3.9% of GDP
Deficit in last year in office (2000): –2.4% of GDP (surplus)
“Unrestrained government spending is a dangerous road to deficits, so we must take a different path.” President George W. Bush
Deficit in first year in office (2001): –1.3% of GDP (surplus)
Deficit in last year in office (2008): 3.2% of GDP

8. Excerpts from Inaugural Speeches and
4.1
Excerpts from Inaugural Speeches and
the U.S. Deficit
“This budget builds on these reforms it’s a step we must take if we hope to bring down our deficit in the years to come.” President Barack Obama
Deficit in first year in office (2009): 9.8% of GDP
Deficit in most recent year in office (2015, projected): 3.2% of GDP

9. 4.1
Government Budgeting
Debt: The amount that a government owes to those who have loaned it money.
Deficit: The amount by which a government’s spending exceeds its revenues in a given year.

10. The Budget Deficit in Recent Years
4.1
The Budget Deficit in Recent Years
Federal government spending rose fairly steadily from 1965 through the mid-1980s, but tax revenues did not keep pace, leading to a large deficit. This deficit was eroded and turned to a surplus in the 1990s, but by 2001 the United States was back in deficit again.

11. 4.1
The Budget Process
The budget process distinguishes between two types of federal spending:
Entitlement spending: Mandatory funds for programs for which funding levels are automatically set by the number of eligible recipients, not the discretion of Congress.
Discretionary spending: Optional spending set by appropriation levels each year, at Congress’s discretion.

12. Nominal prices: Prices stated in today’s dollars.
4.2
Measuring the Budgetary Position of the Government: Alternative Approaches
Real vs. Nominal
Real prices: Prices stated in some constant year’s dollars. Using real prices allows analysts to assess how any value has changed over time, relative to the overall price level.
Nominal prices: Prices stated in today’s dollars.
Consumer Price Index (CPI): An index that captures the change over time in the cost of purchasing a “typical” bundle of goods.

13. The Standardized Deficit
4.2
The Standardized Deficit
Because revenue (taxes) and spending (insurance) depend on the economy, the deficit changes even when policy does not.
Automatic stabilizers: Automatic reductions in revenues and increases in outlays when the economy shrinks relative to its potential.
Cyclically adjusted budget deficit: A measure of the government’s fiscal position if the economy were operating at full potential GDP.

14. 4.2
Budget Deficit, Accounting and Not Accounting for Automatic Stabilizers
As expected, this figure shows that in periods of economic expansion, the cyclically adjusted deficit is actually higher than the reported deficit. When the economy is underperforming, the cyclically adjusted deficit is significantly lower than the reported deficit.

15. Cash vs. Capital Accounting
4.2
Cash vs. Capital Accounting
Government investments in assets can worsen the budget deficit.
Cash accounting: A method of measuring the government’s fiscal position as the difference between current spending and current revenues.
Capital accounting: A method of measuring the government’s fiscal position that accounts for changes in the value of the government’s net asset holdings.
Cash accounting treats a birthday party and an office building as identical, but capital accounting does not.

16. Problems with Capital Budgeting
4.2
Problems with Capital Budgeting
Capital budgeting seems conceptually appealing, but
It is very hard to say when spending has increased the government’s assets. Does buying a missile count as an investment?
The difficulties might make it easier for politicians to misstate the government’s budgetary position with a capital budget than without one.
Some U.S. states and foreign countries use capital budgets with mixed results.

17. Static vs. Dynamic Scoring
4.2
Static vs. Dynamic Scoring
When policy changes, household behavior also changes, potentially affecting the budget deficit.
How to account for this?
Static scoring: A method used by budget modelers that assumes that government policy changes only the distribution of total resources, not the amount of total resources.
Dynamic scoring: A method used by budget modelers that attempts to model the effect of government policy on both the distribution of total resources and the amount of total resources.

18. Static vs. Dynamic Scoring: Scoring the Stimulus
4.2
Static vs. Dynamic Scoring: Scoring the Stimulus
How does “stimulus spending” affect the budget deficit?
This government spending can be very large and is explicitly intended to grow the economy; static scoring would suggest that it is very expensive.
Dynamic scoring by the CBO suggested that the stimulus increased GDP by 0.1–1.9% in 2012–2013.
But in the long run, the stimulus may slightly decrease growth.
Overall, it is difficult to assess the impact of policy on the aggregate economy.

19. Background: Present Discounted Value
4.3
Background: Present Discounted Value
How much do future obligations or payments cost today?
Present discounted value (PDV): The value of each period’s dollar amount in today’s terms.
Mathematically, if the interest rate is r, and the payments in each future period are F1, F2, and so on, then the PDV is computed as:
𝑃𝐷𝑉= 𝐹 1 (1+𝑟) + 𝐹 𝑟 𝐹 𝑟 3 +…

20. Background: Present Discounted Value
4.3
Background: Present Discounted Value
Example: Pitcher Max Scherzer was offered a seven year, $210 million contract. A provision of the contract stated, however, he would receive $15 million installments over 14 years. The present value of his contact was “only” $166 million.
𝑃𝐷𝑉= $15𝑀 1 ( ) + $15𝑀 … $15𝑀 =$166M

21. Generational Accounting
4.3
Generational Accounting
Generational accounting is an influential approach to dynamic budget constraints.
Assesses the implications of the government’s policies for different generations of taxpayers.
How much does each generation of taxpayers (those born in different years) benefit, on net, from the government’s spending and tax policies, assuming that the budget is eventually brought into long-run balance?

22. Generational Accounting
4.3
Generational Accounting
Generational accounting answers the question by first rewriting the government’s intertemporal budget constraint:
PDV of remaining tax payments of existing generations +
PDV of tax payments of future generations =
PDV of all future gov’t consumption
Current gov’t debt
Generational accounting then asks: How much (net) tax on future generations is required to balance the budget?

23. Net Tax Payment (PDV, $1,000s) Male Female 41.7%
4.3
The Composition of U.S. Generational Accounts
Age in 1998
Net Tax Payment
(PDV, $1,000s)
Male
Female
$249.7
$109.6 40
241.4
37.9 80
–56.3
–99.2
Future generations
361.8
158.8
Lifetime net tax rate on future generations
32.3%
Lifetime net tax rate on newborns
22.8%
Generational imbalance
41.7%

24. Long-Run Fiscal Imbalance
4.3
Long-Run Fiscal Imbalance
Central question for policy makers: If the government continues with today’s policies, how much more will the government spend than it will collect in taxes over the entire future?
The long-run fiscal imbalance of the Social Security and Medicare programs. The fiscal imbalance of these two programs is $63.2 trillion.
To achieve intertemporal budget balance would require a tax increase of about 11% of payroll. This would mean almost doubling the existing payroll tax that finances the government’s social insurance programs.
Generational accounting doesn’t really address this.

25. Problems with These Measures
4.3
Problems with These Measures
The fiscal imbalance calculations are fairly tenuous.
Depend on a wide variety of assumptions about the distant future:
Future growth rates in costs and incomes
Interest rate used to discount future taxes and spending
The long-run imbalance measures only consider the pattern over time of transfer programs, and not of other investments and government policies.

26. What Does the U.S. Government Do?
4.3
What Does the U.S. Government Do?
The current U.S. budgeting approach scores policies on a 10-year window.
Replaces 1- and 5-year windows used before 1996, incorporating some long-run concerns.
Avoids imposing assumptions about revenue and expenditure in the very distance future.
Nonetheless, difficult to forecast over even a 5-year period:
Actual and projected deficit can differ by more than $500 billion.

27. Projected vs. Actual Surplus/Deficit
4.3
Projected vs. Actual Surplus/Deficit
CBO projections of the budget surplus/deficit five years ahead have deviated significantly from the actual surplus/deficit, particularly during the high deficit years of the early 1990s and the high surplus years of the late 1990s and early twenty-first century.

28. Why Care About the Deficit?
4.4
Why Care About the Deficit?
The government’s budget deficit has implications for both efficiency and (intergenerational) equality.
Budget deficits can affect the amount of savings and growth in the economy.
Today’s deficits are tomorrow’s taxes, so high deficits imply redistribution from future to current generations.

29. 4.5
Conclusion
The deficit has been a constant source of policy interest and political debate over the last decade.
The existing deficit is quite large, but the long-run implicit debt that is owed to the nation’s seniors through the Social Security and Medicare programs is even larger.
This could have major long-term negative effects on both economic efficiency and intergenerational equity.