Chapter 14 Deficit spending and the public debt

1. The national debt clock: your family’s share $87,639. In terms of looking at government spending, economists will categorize a tax cut or tax break of any kind as a tax expenditure. In other words, the government spends money by not collecting it. Tax expenditures are typically stated as providing incentives for businesses and individuals to change their behavior in a manner that is beneficial to society. For example: R&D tax breaks are expenditures to encourage businesses to develop new technologies that can increase potential GDP. Chapter 14 Deficit spending and the public debt

2. Tax expenditures over the last 30 years have primarily gone to the wealthier households and businesses with the supply-side theory that this would increase investment and therefore GDP. Over the same period, inflation was raising the tax rates of those at lower income levels. Supply-side theory: More money in the hands of investors means more investment and a higher GDP. Demand-side theory: More money in the hands of investors without a significant increase in demand means that we will see more hoarding (trillions sitting in cash) and speculation (bubbles, booms and busts in the asset markets). 30 years of tax expenditures

3. If all of the gains from tax expenditures went to the top, why should the debt it created be shared equally? The debt created by the Bush tax cuts generated more in debt for the average family than that family received in tax breaks. 30 years of tax expenditures

4. Capital gains is the income generated from buying low and selling high. It is the income generated from market speculation. Capital gains are taxed at a lower rate than regular income. True investments generate profits, interest, and rents, all of which are taxed as regular income. Under supply-side economic theory, lower capital gains tax rates will help the economy by generating more investments. Under Keynesian economic theory, this form of tax expenditure actually incentivizes speculation. Capital gains taxes

5. Roughly 1946 to 1981 saw relatively balanced budgets with National debt remaining much the same but becoming a smaller percentage of GDP as the economy grew. Shift in economic paradigms from Keynesian to Washington Consensus sees deficits growing unchecked after 1981 with the exception of three years of surpluses under Bill Clinton. “The most recent projections, granted their tentativeness, nonetheless make clear that the highly desirable goal of paying off the federal debt is in reach before the end of the decade. This is in marked contrast to the perspective of a year ago when the elimination of the debt did not appear likely until the next decade.” Alan Greenspan, January 25, 2001.

6. Who holds national debt is relevant as it affects policy options available to balance a budget and invest in an economy. Third world nations who have been bailed out by the IMF and the World Bank are forced to accept structural adjustment programs (SAPs) or Washington Consensus economic policies that routinely make the problems worse. National debt

8. Under Keynesian-style progressive tax codes deficits were substantially lower as a % of GDP. Tax expenditures meant to stimulate the economy through increased investment had little effect other than to substantially increase the deficit and the debt. Historic deficits

9. Tax revenues as a % of GDP puts the US on a par with Chile, Mexico, and Turkey. These are countries whose economies we do not want to emulate. Supply-side economists would argue that the government is spending too much money, that tax revenues are a leakage from the economy. Demand-side economists would argue that the tax expenditures benefiting the well-to-do and corporations, who have hoarded trillions of dollars, are actually the leakage from the economy that is having a detrimental effect. Deficit as % of GDP

10. Throughout the accumulation of the net public debt, we have seen tax expenditures that go predominantly to high income levels and corporations being paid for through increases in the tax rates of low income households, shifting incomes from net consumers to net savers. The textbook aptly describes those time periods when the deficit and debt grew under supply-side economic policies. Debt as a % of GDP fell steadily until the 1970s (under truly progressive tax structures) then leveled off, net public debt increased through the 1980s (increase in bottom rate and decrease in top rate, as well as putting more Americans in the top rate) Dropped slightly in the 1990s (slight increase in top income tax rates and capital gains coupled with the earned income tax credit). Accumulation of the net public debt

11. Look carefully at Table 14.1. Compare the data of 1985-1995 and more recent years. For example, 1985 we had a $2.5 trillion debt whose interest payments were $210 billion. In 2005 we had a $4.5 trillion debt with $184 billion in interest. The difference between the two years is the interest rate. If interest rates increase, the debt could become an even more significant issue. • Things that could raise the interest paid by the US • Downgrading by credit agencies: 2011 S&P downgraded US as the result of difficulty in raising the debt ceiling, pointing to the dysfunctional policy-making process as the cause. 2013: Downgraded by Egan-Jones and threatened by Fitch in response to the 2013 debt-ceiling crisis. • If the US ever, for the first time in its history reneged on its debts. Net interest as a % of GDP

12. Future generations: Note that the textbook again treats all taxes as the same. $300 billion in increased taxes will displace $300 billion in private consumption. From the Keynesian perspective, $300 billion in taxes imposed on net savers (like the corporations sitting on trillions in cash) will be a direct injection into the economy displacing neither consumption nor investment. Burdens of the public debt

13. The crowding-out effect: Please note the assumptions required to make this statement true. • We are at potential GDP • Even though we are at potential GDP, the government decides to indulge in deficit spending. • It is a closed economy • Investment is more dependent on interest rates than aggregate demand Burdens of the public debt

14. “the increased level of spending by the present generation crowds out investment and reduces the growth of capital goods, leaving future generations with a smaller capital stock and thereby reducing their wealth.” Austrian argument against: Spending based on credit looks like growth, but is unsustainable when the bills come due. Keynesian argument against: The capital stock that is jointly owned by society (infrastructure like bridges, schools, roads, public utilities) are paid for by government spending. If the government does not spend to maintain and replace these public goods, infrastructure deteriorates. Burdens of the public debt

15. Paying off debt in future: Much of the federal debt is the result of ta expenditures going to the top that was supposed to trickle down. This flawed theory failed to provide the outcomes intended. Why would the debt be evenly distributed if the tax expenditure were not? If the government suddenly tried to collect taxes evenly split between households we would find ourselves in a revolution. That revolution, if it does not shift us all the way to socialism, would be likely to provide a more progressive tax structure. Burdens of the public debt

16. Who owns American debt does matter. As discussed previously, debt owed to Americans allows greater policy autonomy than debt owed to foreign investors. Burdens of the public debt

17. Textbook left out one important aspect of this issue. Those nations (not necessarily individual households) depend on exporting to the United States as a major injection into their economies. As long as the US can continue to borrow for consumption, these exporters will continue to buy up securities. Federal budget deficits in an open economy

18. Correlation is not caustion Supply-side theorists: budget deficits cause trade deficits. As foreign citizens and organizations buy up US debt they have less money to spend on US exports. Keynesian: Trade deficits cause budget deficits. As multi-national corporations (MNCs) move manufacturing overseas (outsourcing) there is downward pressure on domestic wage rates. MNCs also invest and keep their money overseas. Revenues are reduced and the needs of the social safety net are increased. Budget deficits and trade deficits

19. The textbook talks about deficit spending when the economy is at full employment. At full employment, revenues should exceed expenditures under Keynesian theory. This is the time to be running a surplus to develop a rainy day fund or pay down preexisting debt. This is dependent on having the political will to collect taxes to meet the needs of society. The exception would be those investments that will shift the LRAS curve to the right, increasing potential GDP. The development of alternative energy sources comes to mind. Short-run effects

20. We should not be operating deficits over the long run (period) Increasing taxes for everyone: ludicrous to anyone. Why should working families be taxed to pay for government tax expenditures for those who are well off? Taxing the rich: Again, this is an oversimplification of the real world. An increase in taxes at the top rates results in higher wages for workers. This has three significant effects: 1) economy is stimulated through increased consumption and GDP increases providing a larger tax base, 2) the higher wages to workers makes them less dependent on government support and reduces expenditures for welfare, food stamps, and Medicaid (among others) decreasing government expenditures, and 3) the tax expenditure of tax breaks for the wealthy is rescinded. Note that the textbook talked only about raising the rates to 45% and 100,000 households. Try 400 households. Long-run effects

22. It is called this because people are entitled to them, not because they think they are. Workers pay into Social Security and Medicare throughout their working lives. In the textbook, Social Security and Medicare are lumped in with Medicaid. Social security and Medicare are paid for through payroll taxes. They should not be included in this discussion in the manner that they are. They are a separate issue. As for the sustainability of SS and Medicare, if workers were paid in accordance with their productivity levels, these programs would be in great shape. The only relationship between Social Security and the federal debt is that the Social Security Trust Fund owns a significant portion of the federal debt. Expenditures for healthcare have been growing at double digits for private insurance as well. This is because pharmaceutical companies, insurance companies, and medical device manufacturers are unencumbered by law or regulation form leveraging life-saving products to gouge consumers. This was not a problem when we had higher tax rates at the top. entitlements

23. Basically, a horror story. The example they give of you having to pay 25% of your income in taxes is an example of a flat tax, a favorite of the supply-side theorists. The textbook also discusses deficit and debt as a % of GDP. Based on the chart to the right, is it more likely that the government has a spending problem, or lacks the political will to tax. You are there