Budget Deficits and Public Debt

Definitions and Basics

Federal Debt, from the Concise Encyclopedia of Economics

A good way of judging the size of the federal debt, and hence its likely effect on the economy, is, as for an individual, to take it as a ratio of income. The federal debt reached a peak ratio of 114 percent of GDP after World War II and declined to 26 percent by 1981, before rising again. But even with the subsequent deficits, it was still only 51 percent of GDP in 1992. True “balance” in the budget, it might be suggested, would entail not a zero deficit, but one such that the debt grows at the same percentage rate as GNP, thus keeping the debt-to-GNP ratio constant….

Federal Deficit, from the Concise Encyclopedia of Economics

Those concerned about large deficits usually argue as follows: deficits let current generations off the hook for paying the government’s bills. Therefore, current generations consume more. This reduces the amount Americans save and invest. A reduced rate of investment means less capital per worker and, therefore, lower productivity growth. When capital is scarce, its rate of return rises, causing interest rates to increase. Higher U.S. interest rates attract foreign investment to the United States….

The simple fact is that the deficit is not a well-defined economic concept. The current measure of the deficit, or any measure, is based on arbitrary choices of how to label government receipts and payments. The government can conduct any real economic policy and simultaneously report any size deficit or surplus it wants just through its choice of words. If the government labels receipts as taxes and payments as expenditures, it will report one number for the deficit. If it labels receipts as loans and payments as return of principal and interest, it will report a very different number.

Take Social Security, for example. Social Security “contributions” are called taxes, and Social Security benefits are called expenditures. If the government taxes Mr. X by $1,000 this year and pays him $1,500 in benefits ten years from now, this year’s deficit falls by $1,000 and the deficit ten years hence will be $1,500 higher. But the taxes could just as plausibly be labeled as a forced loan to the government, and the benefits could be labeled as repayment of principal plus interest. In that case there would be no impact on the deficit.

Debts, Deficits, and Spending Cuts, at Learn Liberty.

Fiscal Policy, from the Concise Encyclopedia of Economics

The state of fiscal policy is usually summarized by looking at the difference between what the government pays out and what it takes in—that is, the government deficit….

Taxation, from the Concise Encyclopedia of Economics

Economists specializing in public finance have long enumerated four objectives of tax policy: simplicity, efficiency, fairness, and revenue sufficiency. While these objectives are widely accepted, they often conflict, and different economists have different views of the appropriate balance among them….

There are two separate official agencies devoted to making estimates of the Federal budget and its effects: the Office of Management and Budget (OMB) on behalf of the President, and the Congressional Budget Office (CBO) on behalf of Congress. Why two? The checks and balances in the U.S. Constitution mean that both the President and the Congress each have a different role in preparing the Federal Budget. Differences between the two budget estimates are hashed out in Congress prior to the annual budget being signed by the President.

In the News and Examples

How to Create a Balanced Budget: It’s a Balancing Act. Lesson plan from PBS.

In the Fiscal Ship Game, students will evaluate fiscal policy objectives to learn the challenges of sustainable national budget formation. A lesson plan from EconEdLink.

Progressive Taxes, from the Concise Encyclopedia of Economics

If, as Oliver Wendell Holmes once said, taxes are the price we pay for civilized society, then the progressivity of taxes largely determines how that price varies among individuals. A progressive tax structure is one in which an individual or family’s tax liability as a fraction of income rises with income. If, for example, taxes for a family with an income of $20,000 are 20 percent of income and taxes for a family with an income of $200,000 are 30 percent of income, then the tax structure over that range of incomes is progressive. One tax structure is more progressive than another if its average tax rate rises more rapidly with income….

A Little History: Primary Sources and References

The debates over debt, at Marginal Revolution University

Taxes Paid by the Producer, by David Ricardo. Chapter 29 in On the Principles of Political Economy and Taxation.

If Government delayed receiving the tax for one year till the manufacture of the commodity was completed, it would, perhaps, be obliged to issue an Exchequer bill bearing interest, and it would pay as much for interest as the consumer would save in price, excepting, indeed, that portion of the price which the manufacturer might be enabled in consequence of the tax, to add to his own real gains. If for the interest of the Exchequer bill, Government would have paid 5 per cent, a tax of £50 is saved by not issuing it. If the manufacturer borrowed the additional capital at 5 per cent, and charged the consumer 10 per cent, he also will have gained 5 per cent on his advance over and above his usual profits, so that the manufacturer and Government together gain, or save, precisely the sum which the consumer pays….

Advanced Resources

What Economic Research Says About Fiscal Austerity and Higher Tax Rates, by Robert P. Murphy, at Econlib, January 7, 2013.

FRED (Federal Reserve Economic Data) Get data on US federal surplus or deficit by fiscal year.

Fiscal Sustainability, from the Concise Encyclopedia of Economics

Related Topics

Economic Institutions

Roles of Government

Fiscal Policy

Aggregate Demand

Balance of Trade and Balance of Payments