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Special Topic 7
The Federal Budget and National Debt
OUTLINE
I. Deficits, Surpluses, and the National Debt
A. The national debt (the sum of the outstanding bonds of the U.S. Treasury) is increased
by budget deficits and reduced by budget surpluses.
B. The national debt reflects the cumulative effect of all prior budget deficits and
surpluses.
II. Who Owns the National Debt?
A. The national debt is held by U.S. government trust funds, the Federal Reserve, private
domestic investors, and foreign investors.
B. It is important to distinguish between (a) the total national debt and (b) privately held
government debt.
III. How Does Debt Financing Influence Future Generations?
A. Overview
1. For domestically held debt (about two-fifths of total privately held debt), the future
generations that pay the tax liability accompanying the debt will also receive the
B. How Does Debt Financing Influence Capital Formation?
1. The new classical view: people will increase their savings in anticipation of the
higher future taxes implied by additional debt, leaving interest rates, consumption,
and capital formation unaffected.
2. The traditional view: government budget deficits reduce future capital stock by
increasing current consumption, pushing up real interest rates, and retarding private
investment.
C. Borrowing from Foreigners
1. Borrowing from foreigners accounts for approximately three-fifths of the federal
debt.
2. If the foreign borrowing is used to finance productive projects, future generations
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D. Deficits 2001-2013
1. As the U.S. experienced large budget deficits from 2001 to 2013, consumption
IV. Government Debt: A Cross-Country Comparison
A. A large national debt relative to the size of an economy leads to a large tax burden just
V. Social Security, Budget Deficits, and the National Debt
A. Including Social Security in the unified budget of the federal government makes the
deficit appear smaller or the surplus appear larger than would otherwise be the case.
B. Social Security surpluses are intended to increase the national saving rate and stimulate
additional investment, and thereby help to finance the retirement benefits of the baby
boomers paying the surpluses.
1. Using these funds to finance current government expenditures completely
undermines this strategy.
VI. The Political Economy of Debt Financing
A. Spending makes it possible for politicians to provide voters with benefits now, but if
financed by taxes, current costs are also highly visible.
B. Debt financing (borrowing) can push the need for higher taxes into the future, reducing
VII. Politics, Demographics, Federal Debt, and the Dangers Ahead
A. During 2009-2010, 40% of federal expenditures were financed by borrowing.
B. The large deficits have pushed the federal debt as a share of the economy to levels not
seen since WWII.
C. The retirement of the baby boomer generation will push spending on Social Security and
Medicare upward making it more difficult to control the growth of the federal debt.
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OBJECTIVES
This special topic is designed to enhance student understanding of budget deficits and the national
debt. Several alternative views are presented. The recent teaching experience of the authors
indicates that there is a strong student interest in the topics of this application.
IMPORTANT POINTS AND TEACHING SUGGESTIONS
1.
tub), while the national debt is a
2. Go over Exhibit 1, which presents data for the 1960 2012 period for both the federal budget
deficit and the national debt as a percent of GDP. Note that when the budget deficit as a percent
of GDP is less than the growth of real output, the federal debt will decline relative to the size
of the economy and vice versa.
5. Critical Analysis questions 1, 3, 4, and 8 provide the basis for a stimulating class discussion of
the major topics of this chapter.
6. In talking abo
sizable off-budget commitments that are being made, but not yet funded, and that therefore do
not appear in the current budget.
7. Be sure to discuss the impact of the Social Security surplus on the deficit. That is, inclusion of
Social Security in the budget calculations makes the deficit appear smaller or the surplus larger
than would be true if these funds were omitted.
294 Special Topic 7/ The Federal Budget and National Debt
HINTS FOR ANSWERING CRITICAL ANALYSIS QUESTIONS