Budget Deficit

2 Key excerpts on "Budget Deficit"

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  eBook - ePub

  How Real is the Federal Deficit?

  • Robert Eisner(Author)
  • 2010(Publication Date)
  • Free Press

    (Publisher)

  7

  Deficits and the Economy:The Theory, Part II

  WE HAVE SO FAR CONCENTRATED on a world in which full employment is assured—or assumed. This is a world where all who want to work are working, and are working as much as they want. It is a world where all that we can produce is produced. There is no problem of being able to sell our output. The way to increase production—and income—is therefore to increase our ability to produce, that is, to increase supply. And we have explored potential effects of deficits on supply—finding them somewhat more enigmatic than many chose to believe.

  But every businessman knows that getting the goods is only half the problem, if that much. What is critical is being able to sell what you can produce. For any single firm that is a problem of the demand for its products. For the economy as a whole it is a problem of total, or aggregate demand.

  It is here that we will find major effects of federal Budget Deficits and federal debt. They can have a significant impact on aggregate demand. This impact can be good or bad, depending on the situation of our changing, dynamic economy, and depending on just how large the deficits and debt really are. The latter issue brings to the fore some of the critical questions of measurement we have been discussing. But the first essential question is, however large the deficit or debt, what difference does it make? Why should the deficit—the difference between government expenditures and government tax revenues—matter?

  To answer this, we must build upon a body of theory and analysis well known to most economists, and indeed to a generation or two of survivors of freshman economics courses. We also have to be familiar with some of the recent reservations and objections to this theory and analysis. If we are convinced beforehand that the reservations and objections have been sufficient to negate the analysis, we have in effect decided that deficits do not matter. Those so convinced have perhaps read too far already, and might well pursue a more promising pastime. Those still concerned may want to plunge on with us into the theory.

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  eBook - ePub

  Macroeconomic Theory

  A Dynamic General Equilibrium Approach - Second Edition

  • Michael Wickens(Author)
  • 2012(Publication Date)
  • Princeton University Press

    (Publisher)

  figure 5.1 , which plots government expenditures as a proportion of GDP for the United States and for the United Kingdom since 1901. Real government expenditures on goods and services and real social security benefits as a proportion of GDP have increased considerably over the last century. In 1901 they were only 2.3% of GDP for the United States and 13.5% for the United Kingdom. In most Western countries they increased from around 10–20% of GDP prior to World War I to around 40–50% after World War II. The wars themselves were the times of the greatest expansion in government expenditures. Since World War II, the shares of government expenditures in GDP have risen steadily and, apart from unemployment benefits, which vary countercyclically over the business cycle, they are not much affected by the business cycle. On average, the expenditures on goods and services and on transfers are roughly equal in size. Total government expenditures also include interest payments on government debt.

  Government revenues are primarily tax revenues: direct taxes on incomes and expenditure, social security taxes, and corporate taxes. The balance varies somewhat between countries, but for most developed countries direct taxes and social security taxes—which are in effect taxes on incomes—are about 60% of total tax revenue, consumption taxes are about 25%, and corporate taxes are about 10%. The average tax rate on incomes (including social security) is around 42%. Tax revenues tend to be more affected by the business cycle than expenditures. This is the main reason why government deficits tend to increase during a recession.

  As previously noted, governments can raise additional revenues through borrowing from the public or borrowing from the central bank, i.e., by printing money. The government simply extends its overdraft on its account with the central bank, which cashes checks issued to the public by the government.

  It is common in macroeconomics without microfoundations, such as Keynesian macroeconomics, to treat government expenditures as having no welfare benefits. They are included simply to allow fiscal policy to be included in the analysis and to allow the size of the fiscal multiplier to be calculated. In the standard Keynesian model this is the effect on GDP of a discretionary change in government expenditures. As this is tantamount to buying goods and services and then throwing them away—or, as Keynes himself noted, burying them— this is not a satisfactory formulation of fiscal policy. In our analysis we start by including government expenditures in the household’s utility function. We then discuss the issue of the optimal level of government expenditures. This is followed by an analysis of public finances: how best to pay for government expenditures and satisfy the government budget constraint. We also examine optimal tax policy, optimal debt, and the sustainability of fiscal deficits (the fiscal stance) in the longer term. At the end of the chapter we summarize our findings on the best way to manage fiscal policy.

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