Federal Budgets and Public Policy

•The federal budget process• Problems with the process

•Rationale for deficits•The historical records•The national debt•Interest on the national debt•Who does the federal government owe?•The ‘crowding out’ view•The intergenerational view

Revenue and appropriations bills start in the House Ways and

Means Committee. The federal fiscal year runs from October 1

to September 30.

Problems with the budget process

1. Continuing resolutions2. Uncontrollable budget items such as

entitlements and interest on the national debt.

3. No separate capital budget

About three-fourths of federal spending in each fiscal year is determined by existing

law

• Defense’s share of federal outlays declined since 1960 and redistribution increased

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Federal outlays since 1960

What is a federal deficit?

If federal outlays exceed (net) tax receipts in a fiscal year,

then we have a federal deficit

Real GDP

G

NT

Federal deficits have a stimulatory effect on the economy

Remember that government expenditures are an injection and net taxes are a leakage

Many economists believe the federal government budget should be

roughly balanced when the economy is a full-employment.

G

NT

Real GDP

Budget is structurally-balanced at full-employment

YFY

Deficit

G, NT

0

The Congressional Budget Office Now Projects the Federal Deficit for fiscal year 2008 at $475 billion.

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After decades of federal budget deficits, surpluses appeared from 1998 to 2001, but deficits are back

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During the 1990s, federal outlays declined relative to GDP and revenues increased, turning deficits into surpluses, but not for long

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Government outlays as a percentage of GDP declined between 1994 and 2007 in most major economies

In the case of a federal deficit, the Treasury must borrow. The national debt

is the accumulated borrowing of thefederal government in all previous

fiscal years, minus what has been repaid

For updated information, check the National Debt Clock

Is a large national debt a bad thing?

Arguments against a large national debt include:

•The “burden on future generations” argument.

•A large national debt means that a significant share of federal spending must be allocated for interest payments—leaving less for other priorities.

•A large national debt makes the U.S. too dependent on foreign financial inflows.

•Federal borrowing “crowds out” private sector borrowing units—i.e., firms and households.

“[W]e (the U.S.) owe $5.7 trillion in debt and if we don’t pay it off, our children and our grandchildren are going to have to.”

Congressman Marion Berry, in a speech to the Jonesboro Lions Club on April 16, 2001.

19651968

19711974

19771980

19831986

19891992

19951998

20012004

0

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4

6

8

10

12

14

16

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Year

Percent

Interest payments as a Percent of Federal Expenditures (Annual)

www.economagic.com

As long as the debt grows by the same percentage as nominal GDP, the ratios of debt to GDP will remain constant. In this case, the government can continue to pay interest on its rising debt without increasing the average tax rate in the economy.

National Debt Graph (2007 Budget data) Click image below to enlarge.

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Relative to GDP, US net public debt in 2007 was about average for major economies

Who Owns the National Debt?

Source: Federal Reserve

3342 / 48%

463 / 7%

1271 / 18%

1814 / 26%

Privately Owned

Fed. Reserve Banks

Foreign Investors

Agencies and Trusts

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Largest foreign holders of US treasury securities as of June 2007 (in billions and as percent of foreign held)