119-1Government Spending and its Financing,Part 219-2Agenda• The Government Budget: Facts and Figures• Gov’t Spending, Taxes, and the Economy• Government Deficits and Debt19-3The Government Budget: Facts & Figures• Government outlays:¾ Government purchases (G)¾ Transfer payments (TR)¾ Net interest payments (INT)¾ Also: Subsidies less surpluses of government enterprises.• Relatively small, so ignore it.19-4• Government outlays:¾ Government purchases (G)• Government consumption expenditures.– About 5/6 of total government purchases.• Government investment is purchases of capital goods.– About 1/6 of total government purchases.The Government Budget: Facts & Figures219-5• Government outlays:¾ Transfer payments (TR)• Transfers are expenditures for which the government receives no current goods or services in return.• Examples: social security benefits, pensions for government retirees, welfare paymentsThe Government Budget: Facts & Figures19-6• Government outlays:¾ Net interest payments (INT)• Interest paid to holders of government bonds less interest received by the government.The Government Budget: Facts & Figures19-7The Government Budget: Facts & Figures19-8• Government outlays:¾ U.S. government spending is a smaller percentage of GDP than almost any other OECD country.The Government Budget: Facts & Figures319-9The Government Budget: Facts & Figures19-10• Taxes:¾ Personal taxes (income taxes and property taxes)¾ Contributions for social insurance¾ Taxes on production and imports»¾ Corporate taxesThe Government Budget: Facts & Figures19-11The Government Budget: Facts & Figures19-12• The composition of outlays and taxes: ¾ To get an overall picture of government spending, combine Federal, state, and local government spending.• The composition of the Federal government budget is quite different from state and local government budgets.The Government Budget: Facts & Figures419-13The Government Budget: Facts & Figures19-14• The composition of outlays and taxes: ¾ Consumption expenditures• About 75% of state and local current expenditures are purchases of goods and services.• About 30% of Federal current expenditures are for purchases.– About 2/3 of those are for national defense.• For all government purchases of nondefense goods and services, over 80% is done by state and local governments.The Government Budget: Facts & Figures19-15• The composition of outlays and taxes: ¾ Transfer payments• The Federal government budget is more heavily weighted to transfers than state and local budgets.¾ Grants-in-aid are payments from the Federal government to state and local governments.The Government Budget: Facts & Figures19-16• The composition of outlays and taxes: ¾ Net interest paid• Net interest is significant and positive for the Federal government.• It is small and sometimes negative for state and local governments.The Government Budget: Facts & Figures519-17• Composition of taxes:¾ About 80% of Federal receipts are accounted for by personal taxes and contributions for social insurance.¾ Only about 20% of state and local government receipts are accounted for by personal taxes and contributions for social insurance.The Government Budget: Facts & Figures19-18• Composition of taxes:¾ About half of state and local government receipts are accounted for by taxes on production and imports. ¾ Only about 5% of Federal receipts are accounted for by taxes on production and imports.The Government Budget: Facts & Figures19-19• Deficits and surpluses:¾ Budget balance = outlays – tax revenues • When outlays exceed revenues, there is a deficit.• When revenues exceed outlays, there is a surplus.¾ Budget balance = outlays – tax revenues• BB = G + TR + INT – TThe Government Budget: Facts & Figures19-20• Deficits and surpluses:¾ The primary government budget balance excludes net interest payments.¾ Primary government budget balance = outlays – tax revenues – net interest • Primary BB = G + TR – T – INTThe Government Budget: Facts & Figures619-21• Deficits and surpluses:¾ The total deficit is the amount the government must borrow to cover all its expenditures.¾ The primary deficit indicates if the government’s receipts are enough to cover its current purchases and transfers.• The primary deficit ignores interest payments because those are payments for past government spending.The Government Budget: Facts & Figures19-22The Government Budget: Facts & Figures19-23• Deficits and surpluses:¾ The current deficit equals the deficit minus government investment.¾ The primary current deficit equals the primary deficit minus government investment.• Which equals the current deficit minus interest payments.The Government Budget: Facts & Figures19-24• Deficits and surpluses:¾ The current deficit and primary current deficit usually move together over time.• Large current deficits occurred in World War II, the mid-1970s, and the early 1980s.• The primary current deficit became a primary surplus in some years in the 1980s and 1990s, but large interest payments kept the overall deficit large until the late 1990s.The Government Budget: Facts & Figures719-25The Government Budget: Facts & Figures19-26Gov’t Spending, Taxes, & the Economy• Fiscal policy and aggregate demand:¾ An increase in government purchases increases aggregate demand and shifts the IS curve right.• This results in higher economic activity and a higher real interest rate.19-27Gov’t Spending, Taxes, & the Economy• Fiscal policy and aggregate demand:¾ The effect of tax changes depends:• Classical economists accept the Ricardian equivalence proposition that lump-sum tax changes have no effect on national saving or on aggregate demand.• Keynesians think a tax cut will increase consumption and decrease saving, thus increasing aggregate demand.19-28Gov’t Spending, Taxes, & the Economy• Fiscal policy and aggregate demand:¾ Classicals and Keynesians disagree about using fiscal policy to stabilize the economy.• Classicals oppose activist fiscal policy while Keynesians favor it.819-29Gov’t Spending, Taxes, & the Economy• Fiscal policy and aggregate demand:¾ Classicals and Keynesians disagree about using fiscal policy to stabilize the economy.• Keynesians admit that fiscal policy is difficult to use.– There is a lack of flexibility, because much of government spending is committed years in