Saturday, November 03, 2007

Forgotten College Education

I'm perusing my Economics book from college and re-learning some interesting points. I figured I would post some of them here for my future reference. Today I'm reading about Budget Deficits and the Public Debt. We start out with Budget Philosophies, the first of which being;
Annually Balanced Budget: (which up until the 1930s was accepted as a "desirable goal of public finance." ) It has since been noted that an annually balanced budget actually intensifies the business cycle. So that if the economy experiences high unemployment and falling incomes then tax receipts will automatically decline. To balance the budget government must either increase taxes, reduce gov't. expenditures, or a combo of both. The problem being that each of these options further dampens, rather than stimulates, aggregate demand.
An annually balanced budget will intensify inflation since money incomes rising during the course of inflation, taxes automatically increase. So, to avoid impending surplus, government must either cut taxes, increase expenditures, or a combo of both. All three of these policies will add to inflationary pressures. An annually balanced budget is "procyclical."
Some economists advocate an annually balanced budget by arguing budget deficits "are a manifestation of political irresponsibility" and allow politicians to give the public the benefits of government programs while avoiding the cost of higher taxes. There is simply less public opposition to growth financed by deficits, rather than taxes,
thereby it is used by politicians as a means of getting elected. Deficits are, therefore, "a fundamental problem of government encroachment on the private sector."

Cyclically Balanced Budget: The idea behind this philosophy being that government exerts a countercyclical influence while balancing the budget. The budget would, therefore, be balanced over the course of the business cycle (over a period of years) rather than annually. The rationale being; "to offset recession, government should lower taxes and increase spending, thereby purposely incurring a deficit. During the ensuing inflationary upswing, taxes would be raised and government spending slashed. The resulting surplus could then be used to retire the Federal debt incurred in financing the recession." The problem which may arise is that the business cycle swings may not be of equal magnitude and duration. A long slump followed by a short period of prosperity would mean "a large deficit during the slump, little or no surplus during prosperity, and therefore a cyclical deficit in the budget."
Functional Finance:
Here is where either an annual or cyclical balanced budget is secondary. The primary concern here is that economy be balanced and not the budget by providing noninflationary full employment. "The Federal budget is first and foremost an instrument for achieving and maintaining macroeconomic stability. Government should not hesitate to incur and deficits and surpluses required to achieve this goal. Those who are concerned with a large Federal debt are offered three arguments:
1). Our tax system is such that tax revenues automatically increase as the economy expands. Hence, given government expenditures, a deficit which is successful in stimulating equilibrium GDP will be partially self-liquidating.
2). Given its taxing powers and the ability to create money, the government's capacity to finance deficits is virtually unlimited.
3). Finally, it is contended that the problems of a large Federal debt are less burdensome than most people think.

The Public Debt:
The public debt is the accumulation of all past deficits, minus surpluses, of the Federal budget and has increased substantially since 1929. The reason why the U.S. has incurred large and persistent deficits is threefold:
1). Wars, and their deficit financing.
2). Recession. Incomes decline (or don't grow), so tax revenue declines.
3). Tax Cuts which decrease revenue. Especially after incurring huge expenses (i.e. bailing out a financial industry).

"One might also assert that deficits and a growing public debt are the result of a lack of political will and determination. Spending tends to gain votes; tax increases precipitate political disfavor. While opposition to deficits is widely expressed by both politicians and their constituencies, specific proposals to raise taxes or cut either domestic or defense programs typically encounter more opposition than support.

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