In the U.S. in 2010 the Federal Government spent about $3.7 trillion dollars. But don’t forget about state and local governments – in the same year they contributed another $2.1 trillion. In total then, U.S. governments spent almost $6 trillion in a year when nominal GDP was about $14 trillion. Government expenditure is often categorized in four ways.
The first is spending on goods and services. Governments can directly buy military aircraft or paper clips for government workers. They can also purchase materials to build roads and schools. The government might buy consulting services to help with management or other decisions. This gives government a very direct means to impact AD. This is the direct counterpart to what we called “G” in the lesson on AD.
The second is spending on wages and salaries. Governments employ a part of the workforce of their countries as policemen, military personnel, teachers, bureaucrats etc. In amny countries, the government is the largest single employer in the economy. By increasing wages and salaries paid to their employees, governments can increase the consumption spending of these individuals, thus increasing AD.
The third form of government expenditure is called “transfer payments.” Transfer payments involve payments to individuals because of government programs that make them eligible for some sort of government assistance. The elderly receive social security benefits from the U.S. government. Poor persons receive welfare benefits. Other people may receive government healthcare benefits when they need medical attention. In 2003 in the U.S., these transfer payments were about twice as large as the federal government’s spending on goods and services. Economists believe that changes in government transfer payments influence people’s spending decisions. Higher transfer payments are just like receiving higher income. The recipient is expected to spend it. Since a transfer payment recipient may decide to either save or spend the amount sent by the government, there is less than a one-to-one relationship between the transfer and the spending. Nevertheless, there is a close association between changes in transfers and changes in spending and AD.
The final part of government spending is net interest payments. Most governments have debt (more is said about that below) and they must pay interest to people who hold the debt. In 2003 the U.S. government paid about $250 billion to the holders of its debt. When the government pays this money to people living within the U.S., we expect they will consider it as income and spend some of it. So just like transfer payments, changes in the interest paid by the government should influence spending and AD. When the government makes interest payments to people living abroad, some of that money might be used to buy U.S. goods and services but the link is weaker than for interest paid to people living in the U.S.
If a government is to spend, then it must tax. Recall that in countries with independent central banks the government cannot print money at will. If the U.S. national government wanted to spend $2.2 trillion in 2003, then it needed to raise nearly that amount in tax revenue. We say “nearly” because governments are usually allowed to spend more than their revenue and borrow the rest from the private sector or from people abroad. We will say more about that below. But there is only so much they can usually borrow so they must raise the revenues. In 2003, for example, the U.S. federal government raised about $1.8 trillion in taxes. About 43% of that amount came from payroll taxes associated with the social security system. Another 40% came from personal income taxes.
So you can see that more than 80% of taxes come right out of the typical person’s paycheck. Corporate income taxes contributed another 10%. The next largest category was national government sales taxes and import duties (5%).
The power to tax or to change taxes can influence spending and AD. Lowering income tax rates for households gives them more disposable income (disposable income = wage & salary income + transfer payments + net interest income – income taxes) and should increase their ability to spend and save. Of course, an increase in tax rates should have the opposite effect. For example, increasing the rate of taxation on corporate profits might reduce a corporation’s after-tax profits, cash flow, and its desire to buy new plant and equipment.
Government Deficits and Debt
A government deficit is defined as expenditures – tax revenues. Conversely, a government surplus is defined as tax revenues – expenditures.
|Whenever a government spends more than its revenue, it incurs a fiscal deficit.|
Since the U.S government in 2010 had spending of $3.7 trillion and revenue of about $1.3 trillion, this implied a fiscal deficit in the neighborhood of $1.3 trillion. That sounds like a lot of money. But sometimes these figures can be misleading. Like any deficit, what matters is the size of the shortfall relative to one’s ability to repay the debt – or relative to the size of one’s income. If nominal GDP is the size of the nation’s income, then a $400 billion deficit would be about 3.2% of the nation’s income. While $318 billion is close to the largest fiscal deficit ever for the U.S. it is not the largest as a percent of the nation’s income. It was much higher than that during World War II and it was somewhat higher in several different years of the last three decades. In 1983 it reached 6% and it exceeded 4.5% during the early 1990s.
The following link from the St. Louis Federal Reserve Bank has several interesting charts with recent data on U.S. government deficits and debt. http://research.stlouisfed.org/publications/net/page17.pdf
Two charts are reproduced below.
When a government has a deficit it borrows money by issuing debt certificates.
The value of the outstanding government debt is what people refer to as the national debt.
If a government was to have a deficit of $100 billion one year and then a surplus of $100 billion in the following year, the national debt would rise and then fall. After the two years, the debt would be unchanged. Between 1961 and 1996 there was only one small surplus – the remaining 35 years had deficits. During that time period the U.S. national debt went from $293 billion to about $5.4 trillion. The U.S. then experienced a very rare time period of 4 years of consecutive surpluses that were ended with a string of deficits starting again in 2002. The gross public debt was estimated to be about $6.8 trillion in 2003.
Since then, the debt has grown. US government deficits reached approximately 10% of GDP in 2010. These deficits had been growing larger ever since the short period of surpluses between 1998 and 2001. As a result the national debt increased from less than 60% of GDP in in 2000 to more than 90% in 2010. The debt was $13.6 trillion in 2010. Since some of the debt is held by government agencies and trusts, the debt held by the public rose from a little over 30% in 2000 to about 60% in 2010. The debt held by the public was about $9 trillion in 2010.
Much of the debt held by the public is held by the Fed. The Fed held about $1.34 trillion of federal debt in 2011. The rest of the debt is held by private investors. Of the $9.7 trillion debt held by the public in 2011, foreigners held $4.5 trillion.