The Federal Budget and Tax Policy

Lecture by Robert M. Coen

Emeritus Professor of Economics

Northwestern University

September 29, 2009

120

140

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260

55 60 65 70 75 80 85 90 95 00 05

Debt of Domestic Nonfinancial Sectors, 1952Q1-2009Q2

Government + Households + Business

Per

cent

of

GD

P

Year

Source: Federal Reserve Flow of Funds

20

30

40

50

60

70

55 60 65 70 75 80 85 90 95 00 05

Federal Government Debt, 1952Q1-2009Q2

Per

cent

of

GD

P

Year

Source: Federal Reserve Flow of Funds

6

8

10

12

14

16

18

55 60 65 70 75 80 85 90 95 00 05

State-Local Government Debt, 1952Q1-2009Q2

Per

cent

of

GD

P

Year

Source: Federal Reserve Flow of Funds

20

30

40

50

60

70

80

90

100

55 60 65 70 75 80 85 90 95 00 05

Household Debt, 1952Q1-2009Q2

Per

cent

of

GD

P

Year

Source: Federal Reserve Flow of Funds

20

30

40

50

60

70

80

55 60 65 70 75 80 85 90 95 00 05

Nonfinancial Business Debt, 1952Q1-2009Q2

Per

cent

of

GD

P

Year

Source: Federal Reserve Flow of Funds

-10

-8

-6

-4

-2

0

2

4

6

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Federal Budget Surplus, 1947Q1-2009Q2

Per

cent

of

GD

P

Year

Source: BEA, National Income Accounts

-0.8

-0.4

0.0

0.4

0.8

1.2

1.6

2.0

50 55 60 65 70 75 80 85 90 95 00 05

State-Local Budget Surplus, 1947Q1-2009Q2

Per

cent

of

GD

P

Year

Source: BEA, National Income Acounts

Federal Receipts and Expenditures(Billions of dollars)

Quarter Receipts Expenditures Surplus

2000Q1 2,032.9 1,827.7 205.2

2009Q2 2,214.7 3,509.6 -1,294.9

Change +181.8 +1,681.9 -1,500.1

Estimated Federal Budget Surplus for 2009-12(Billions of dollars per year)

Jan. 2001 est. +846

Early 2000s downturn -291Bush policies -673

(tax cuts, Iraq, drug ins.)Current recession -479Bailouts -185Continuing policies (e.g., war, AMT adj.) -232Obama stimulus -145Other Obama programs -56

Current estimate -1,215

Source: David Leonhardt, New York Times, June 10, 2009

CBO: Baseline Federal Budget Projection

2010-14 2010-19Total deficit $3,988 $7,137($ billions)

2010 2014 2019Deficit/GDP 9.6 3.2 3.4(Percent)

Debt/GDP 61.4 66.0 67.8(Percent)

Total Public Debt as Percent of GDP, 2008

France 68

Germany 64

Japan 173

Sweden 37

UK 52

US 61

Source: CIA World Fact Book

CBO: Baseline Federal Expenditures Projection

Change in annual expenditures, 2009 to 2019 (billions of dollars)

Total +1,294Mandatory +506Discretionary +243Interest +545

Social security +418Medicare +444Medicaid +174

CBO: Effects of Alternative Policies on Deficit

(Billions of dollars)

2010-14 2010-19Baseline deficit $3,988 $7,137

30,000 troop reduction by 2013 -374 -1,074Freeze discretionary spending -203 -950

Extend expiring tax cuts +1,640 +4,090Index AMT for inflation +177 +448

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Yield on 10-Year U.S. Treasuries, 1953M4-2009M8

PercentP

erce

nt

Year

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25

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35

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Federal Interest Payments, 1947Q1-2009Q2

Percent of Tax Receipts (excl. Social Insurance Taxes)

Per

cent

Year

http://research.stlouisfed.org/fred2/graph/?s%5B1%5D%5Bid%5D=TWEXB

What Is Sound Budget Policy?

False analogies to private debt

Balance the budget?Balance current budget, borrow for capital

expenditures?Balance the budget over business cycle?Keep debt/GDP ratio at “safe” level?Functional finance?

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Total Federal State-local

Government Receipts, 1947Q1-2009Q2Percent of GDP

Pe

rce

nt

Year

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8

9

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12

13

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Federal Personal Income Taxes, 1947Q1-2009Q2 Percent of Personal Income

Per

cen

t

Year

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50

60

70

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Federal Corporate Profits Taxes, 1947Q1-2009Q2 Percent of Corporate Profits

Per

cen

t

Year

0.5

1.0

1.5

2.0

2.5

3.0

3.5

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Federal Indirect Taxes, 1947Q1-2009Q2 Percent of GDP

Per

cen

t

Year

1

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7

8

9

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Federal Social Insurance Taxes, 1947Q1-2009Q2 Percent of Personal Income

Per

cen

t

Year

Key Comparative Ratios2006

Taxes Income tax Consumptionto GDP to total tax* to GDP

France 44 49 55Germany 36 52 57Japan 28 66 56Sweden 49 60 46UK 37 58 62US 28 74 70

* Excluding property and social insurance taxesSource: OECD

How We Could Impair the Economic Well-being of Future Generations

Bequeathing less capital

Bequeathing a less educated, less healthy workforce

Bequeathing less scientific, engineering, and managerial knowledge

Bequeathing fewer natural resources

Accumulating foreign debt to finance current consumption or unprofitable investment