This file is copyright of Jens Schriver (c) It originates from the Evil House of Cheat More essays can always be found at: --- http://www.CheatHouse.com --- ... and contact can always be made to: Webmaster@cheathouse.com -------------------------------------------------------------- Essay Name : 829.txt Uploader : J. Anderson Email Address : Language : English Subject : Economics Title : Can we make ends meet? Grade : A School System : College Country : US Author Comments : Teacher Comments : Date : 11/10/96 Site found at : -------------------------------------------------------------- CAN WE MAKE ENDS MEET? Should the government balance the federal budget? One might assune assume that it would be good to balance the federal budget. However, a few economic thinkers disagree and have suggested new paradigms. For the last sixty years, the government has run budget deficits as a primary method for stimulating economies with high unemployment rates. In theory, the budget should return to balance or surplus during boom times. According to the article, "The Balanced Budget Constitutional Amendment," (Center on Budget and Policy Priorities, January 9, 1995), the Reagan administration cut taxes to such a degree that the United States would forever face high deficits, regardless of how hot the economy was. The writers of that article believe the answer is not a balanced-budget amendment because they believe it would prevent the federal government from combating recessions: Worse yet, under such an amendment, the federal government would be forced to make recessions worse. When the economy slows down, income and Social Security tax revenues drop, due to falling wages and profits. Meanwhile, costs for some programs, such as unemployment compensation, rise. These changes automatically put the federal budget into deficit, even if a balanced budget had been planned at the beginning of the fiscal year. If a constitutional amendment requires the government to balance spending and revenues at the end of the year (not just in the original plan), then the White House would be forced to cut spending or raise tax rates, thereby slowing the economy down, just at the time when it is most in need of stimulus. One argument for a balanced is as follows: Deficits force the Federal Government to borrow money on the capital markets. That Government borrowing competes with businesses borrowing to buy factories and machines that make workers more productive and raise incomes; and with families borrowing to buy new homes, cars, and other goods that provide valuable services for years. The competition for funds tends to produce higher interest rates. Also, deficits increase the national debt and, through it, the Government's obligation to pay interest. The more it must pay to service its debt, the less it has available to spend on education, law enforcement, and other important services, or the more it must collect in taxes forever after. Today, the Government must spend 40 percent of every personal income tax dollar to pay interest on the national debt Recent deficits have not financed investments. Instead, they have merely helped the Government to pay its day-to-day bills. Under those circumstances, future generations will inherit a debt for which they receive no real benefit. One difficulty with government budgets is that economic conditions are subject to change, causing receipts and outlays to be quite different from what was planned. If unemployment increases by just a small percentage, for example, the government may lose billions of dollars because of less income from tax receipts and higher outlays for welfare and unemployment benefits. Balancing the Budget Originally planned to make spending cuts in the areas that seemed to be growing at the greatest rate and comprising the largest portion of the budget. These areas were entitlement programs and the federal debt. Unfortunately, Social Security only had 3 items and Net interest only had 1 item. Health and Medicare had 22 items and Defense had 38 items. When I found that making cuts in these areas did not result in a balanced budget, I tried a new strategy. Instead, I used a highly complex and extremely scientific procedure to balance the Federal Budget. I went on an outlay cutting rampage, cutting every spending program I came across with the exception of those that would have made me feel morally uncomfortable. To my best recollection, I did not cut benefits to senior citizens or children. I wanted to cut Social Security spending by identifying fraudulent claims and other waste. I would not cut the benefits of people who have worked hard all their lives and raised families. Rather, I would cut the benefits to people who have the potential to abuse the social security and welfare system. According to "Fiscal Crossroads: Facing Up to the Budget Deficit " federal spending patterns have changed significantly over time: "At the Nation's founding, the federal government spent only on war-related costs, certain pensions, and a few other items. Gradually, however, it came to accept more and more responsibility for the health, welfare, and safety of the growing American populace, and its spending in these categories rose accordingly. Growth of Entitlement Spending: In 1962, when President Kennedy was in office, 70 cents of each dollar the federal government collected and spent was spent at the "discretion'' of Congress. Today, 64 cents of each dollar spent by the federal government is on automatic pilot-leaving only 36 cents for Congress to have discretion over. By 2003, 72 cents of each dollar the federal government spends will go for entitlement programs and interest on the debt. Only 28 cents will be available for discretionary spending. Defense and Discretionary Spending: In 1962, defense spending accounted for almost one out of every two dollars the federal government spent. Since then, defense has been cut 65 percent (as a percent of GDP) and now comprises just 18 percent of all federal spending. Domestic discretionary spending has been reduced about 50 percent (as a percent of GDP) since the 1960s and accounts for approximately 16 percent of all federal spending. Foreign Aid: Despite widespread perceptions to the contrary, spending on foreign aid has comprised a very small share of spending for each of the past 30 years. Its share fell from 5 percent in 1962 to 1.4 percent today. Foreign aid comprises less than 1 percent of federal expenditures. Where does the federal government spend our tax dollars today- and what trends lie ahead? Social Security: Social security is the single biggest federal expenditure. It accounts for 22 percent of all federal spending. The government will spend $334 billion on it this year. By the year 2000, the annual costs will increase by $100 billion to $434 billion. Defense: The second largest federal expenditure is national defense. This year it will cost the federal government $270 billion and will comprise approximately 18 percent of federal spending. This is a reduction from last year, when the government spent $282 billion on defense and it comprised nearly 20 percent of federal spending. By the year 2000, it is scheduled to decrease to 15 percent of federal spending. Interest on the Debt: Net interest payments, the result of previous budget deficits, consumed only about 7 percent of federal spending for most of the 1960s and 1970s. Today it is the third largest federal expenditure- $235 billion this year-and accounts for over 15 percent of all federal spending. By 2000, net interest on the debt will rise to $313 billion and surpass defense spending to become the second largest federal expenditure. Medicare: Medicare, which provides health care coverage for over 37 million elderly Americans, includes Part A, hospital insurance, and Part B, insurance for physicians and other services. It is the fourth largest federal expenditure. It accounts for 10 percent of all federal spending. The government will spend $178 billion on Medicare costs this year. By the year 2000, its annual cost will increase to $288 billion and represent nearly 15 percent of all federal expenditures. Medicaid: Medicaid is the health care program for the poor. The federal government shares the costs with the states, paying from 50 to 83 percent of them. Both federal and state costs are growing rapidly; Medicaid accounts for 6 percent of the federal budget. This year the federal government will spend $90 billion on Medicaid. By the year 2000, annual costs are projected to increase to $149 billion. It will rise from 5.5 percent of federal expenditures to 7.5 percent. Federal Retirement Programs: Federal civil and military retirement and disability programs comprise 5 percent of all federal expenditures. This year the federal government will spend $75 billion on these programs. In the year 2000, the projected annual cost will be $96 billion and represent the same share of federal expenditures. Aid to Families with Dependent Children (AFDC) and Food Stamps: These two programs-which together account for approximately 3 percent of federal spending-have received the most public attention and are perceived to be a much greater cost to the government than they are. The federal government will spend $44 billion on these two programs this year. In the year 2000, projected costs will increase to $54 billion, representing 2.7 percent of federal spending. These figures illustrate an important fact about the budget: a handful of programs account for the vast bulk of federal spending. Social Security accounts for 22 percent of spending, defense for 18 percent, net interest for 15 percent, Medicare for 10 percent, Medicaid for 6 percent and federal retirement programs for 5 percent. Together, these programs account for over 75 percent of all federal spending." (Source: http://www.uwsa.org/busround/8longterm.html) Economic variables affecting revenues The economic variables having the largest impact on government revenues include (un)employment, interest rates, Inflation, and population. Economic variables affecting outlays The economic variables having the largest impact on government outlays include (un)employment, interest rates, Inflation, and population. For its forecast, the Congressional Budget Office has assumed that economic variables will remain stable, almost unchanged, over the next five years. I believe this is unrealistic since the economy changes cyclically. Because economic variables are not stable, the impact on government revenues and outlays is that their forecasts and predictions are less reliable. This would affect my deficit reduction strategy as we discussed in the beginning of this paper. Changes in the economy walways affect the federal budget. Slowing of the economy can put the federal budget into deficit, even if a balanced budget had been planned at the beginning of the fiscal year. The Ultimate Question The ultimate question was whether I could balance the federal budget within the next five years? The answer is, "Yes, I can." If I remember correctly, I produced a surplus of around 65 billion dollars in the fifth year. I achieved this without raising taxes even one penny. The possible beneficial effects of my strategy are as follows. With less interest to pay on the public debt: we would not have to raise taxes. Thus, we could provide more incentives to businesses to expand and create more jobs. we would not have our nation's output transferred abroad to pay interest and principal on the portion of the debt held by foreigners. the government would no longer have to borrow to refinance (drive interest rates up). Thus, private investment spending would increase. One approach of disposing of the surplus involves the government transferring its surplus tax revenues back into the money market, causing the interest rate to fall and thereby stimulating investment and consumption. In another approach, government can realize a greater anti-inflationary impact from its budgetary surplus by allowing those funds to stand idle. we may see decreased foreign demand for American securities (due to lower interest rates). This would decrease the international value of the dollar, causing American exports to increase and imports to decrease. The resulting rebalancing of the trade deficit would exert a positive effect on our domestic economy. The possible negative effects of my strategy are as follows. With the cuts in defense spending: our economy may encounter a siege of unemployed defense workers. With falling incomes, tax receipts will automatically decline. To balance its budget, government must either 1) increase tax rates, 2) reduce spending, or 3) use a combination of both. The problem is that these policies are contradictory; each one further dampens the economy. One solution might be to use a portion of the surplus in our budget to retrain the unemployed defense workers in new growth fields. With the surplus of money put back into the economy, we may see money incomes increase during a time of inflation and therefore tax collections will increase. To avoid a further surplus from occurring, the government must either 1) cut tax rates, 2) increase expenditures, or 3) use a combination of both. All three of these policies will add to inflationary pressures. Conclusion In addition to the spending cuts discussed above some of the proposed or enacted remedies for deficits and public debt include: a proposed constitutional amendment mandating an annually balanced budget the Graham-Rudman-Hollings Act which required annual deficit reductions budget legislation of 1990 which raised taxes, cut expenditures, and forced Congress to offset new spending or tax cuts with reductions in existing spending or tax increases greater privatization of the economy by selling public assets and programs to the private sector; and giving the President line-item veto authority. --------------------------------------------------------------