1 17.ppt U.S. Fiscal Policy in the 1990s Lecture 18
FEDERAL BUDGET HISTORY 2 17.ppt Taxes have trended up largely to pay for greater entitlements (transfers) Taxes less transfers were reduced in the 1970s to prepare for baby-boom retirement The Carter (77-80) and Clinton (92-00) terms saw increased taxes to reduce inherited deficits % OF GDP 25% 20% 15% 10% 5% 0% 1947 1950 1953 FEDERAL TAXES (NIA BASIS) 1956 1959 1962 1965 1968 1971 1974 TOTAL TAXES TOTAL TAXES - TRANSFERS PERSONAL TAXES TRANSFERS 1977 1980 1983 1986 1989 1992 1995 1998 2001 2004
FEDERAL BUDGET HISTORY FEDERAL SPENDING (NIA BASIS) 3 17.ppt 30% 25% 20% Military spending is now below pre-wwii % s Transfers have surged Other categories rose in the 1960s % of GDP 15% 10% 5% 0% 1947 1949 1951 1953 1955 1957 1959 1961 1963 1965 1967 1969 1971 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2 INTEREST MILITARY TRANSFERS OTHER TOTAL Under Reagan, spending rose to a peak of 25% Military spending surged The huge deficits raised interest payments Other categories were cut
FEDERAL BUDGET HISTORY 4 17.ppt FEDERAL BUDGET % OF GDP 30% 25% 20% 15% 10% 5% Note the similar efforts to close the deficit under Carter and under Clinton, by raising taxes and cutting spending Note how unusual a surplus is 0% -5% -10% The Federal budget tended to absorb 20% of GDP, with a clear upward trend 1947 1950 1953 1956 1959 1962 1965 1968 1971 1974 1977 1980 1983 1986 1989 1992 1995 1998 2001 2004 DEFICIT (UNI) TOTAL TAXES (UNI) TOTAL SPENDING (UNI)
FEDERAL BUDGET HISTORY 5 17.ppt Taxes have trended up largely to pay for greater entitlements (transfers) Taxes less transfers were reduced in the 1970s to prepare for baby-boom retirement The Carter (77-80) and Clinton (92-00) terms saw increased taxes to reduce inherited deficits % OF GDP 25% 20% 15% 10% 5% 0% 1980 1982 FEDERAL TAXES (NIA BASIS) 1984 1986 1988 1990 1992 TOTAL TAXES TOTAL TAXES - TRANSFERS PERSONAL TAXES TRANSFERS 1994 1996 1998 2000 2002 2004
FEDERAL BUDGET HISTORY FEDERAL SPENDING (NIA BASIS) 6 17.ppt 30% 25% 20% Military spending is now below pre-wwii % s Transfers have surged Other categories rose in the 1960s % of GDP 15% 10% 5% 0% 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 INTEREST MILITARY TRANSFERS OTHER TOTAL Under Reagan, spending rose to a peak of 25% Military spending surged The huge deficits raised interest payments Other categories were cut
FEDERAL BUDGET HISTORY 7 17.ppt FEDERAL BUDGET % OF GDP 30% 25% 20% 15% 10% 5% Note the similar efforts to close the deficit under Carter and under Clinton, by raising taxes and cutting spending Note how unusual a surplus is 0% -5% -10% The Federal budget tended to absorb 20% of GDP, with a clear upward trend 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 DEFICIT (UNI) TOTAL TAXES (UNI) TOTAL SPENDING (UNI)
U.S. Fiscal Policy in the 1990s 8 17.ppt After a decade of extreme deficit spending, all three presidential candidates in 1992 promised to move toward a balanced budget in five years Ross Perot promised a blend of tax increases and budget cuts George Bush offered spending cuts but, under pressure from the Republican Party, promised new tax cuts Bill Clinton promised higher taxes and spending cuts in existing programs, but added new spending on education and infrastructure, thereby retaining a deficit Clinton, the victor, proposed his campaign program in 1993 but Congress rejected it, favoring more aggressive action to balance the budget The Democrats controlled Congress, but yielded to public opinion to reject delays in balancing the budget beyond a 5-year plan In the campaign for the 1994 Congress, the Republicans offered a strict plan they called The Contract for America This promised budget balance, welfare reform, and select new tax incentives They won control of the House and Senate and implemented the basics of their fiscal strategy
U.S. Fiscal Policy in the 1990s 9 17.ppt During this debate, research groups such as DRI analyzed the impacts The exhibits that follow were produced in late 1994 and early 1995 They reveal the expected outcomes, presenting the mainstream macro-economics position on this debate The exceptional boom of the late 1990s met and often exceeded these expectations: The actual 1995-1998 data and current forecasts through 2002 are added to a few of the slides to precisely compare results with expectations
Prospects for the Economy through 2002 Slower population growth means slower labor force growth. Productivity growth will continue to be hurt by inadequate private investment. But, Tax changes could boost labor force participation by second earners and retirees. Welfare reformed to workfare could add over a million productive employees. Gradual achievement of federal budget balance would greatly bolster private investment. Capital gains tax cuts would also boost national growth. 10
Summary of the Forecast Made in 1994, and the Results as of 1999 11 82-94 95-02Fore 95-98 Actual Unemployment Rate 6.9 5.8 5.1 Real GDP Growth (annual) 2.9 2.4 3.4 Housing Starts (million) 1.4 1.3 1.5 Consumer Price Inflation 3.8 3.4 2.4 Productivity Growth 1.3 1.4 1.6 Prime Rate 9.4 7.9 8.5
Adult Population Growth Has Fallen to Approximately 1% Per Year 12 population by age group, millions 100 90 80 70 60 50 40 30 20 10 0 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 Pop Male(20-64) Pop Retires Pop Female(20-64) Pop Teenagers
Average Growth Rates Population Growth Rates by Age and Sex 60 s 70 s 80 s 90-94 95-99 2000-05 13 Males (20 to 64) 1.1 1.9 1.4 1.0 0.9 1.0 Female (20 to 64) 1.2 1.8 1.2 0.9 1.0 1.0 Retirees (above 65) 2.6 2.4 2.0 1.6 0.8 0.9 Teenagers (16 to 19) 3.6 1.5-1.5-1.1 2.4 0.9 Total 1.6 1.9 1.2 0.9 1.0 1.0
The Labor Force Will Also Grow Only Slightly Faster Than 1% Per Year Average Growth Rates 14 3 2.5 History Forecast 2 1.5 1 0.5 0 Total Labor Force 60's 70's 80's 90-94 95-99 2000-2005
Teenage and Female Components Will Exhibit the Fastest Growth 15 (average labor force growth rates, 1995-2002) 2.5 2 1.5 1 Males Females Teenagers 0.5 0 Retirees -0.5-1
The Labor Force Is Rising at a Similar Pace Because the Big Gain From Women Becoming New Earners Appears Past Labor Force by Age-Sex Group, Millions 16 80 70 60 50 40 30 20 10 0 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 Male (20-64) Female (20-64) Retires Teenagers
Participation Rates..... for Prime-Age Women Rose to Nearly Match Those of Men..while retirees are less inclined to work. Percent of each age-sex group participating in the labor force 17 0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 Males Females Retieres Teenagers
The Recent Gains in Productivity Are Not At All Exceptional: They Reflect Normal Cyclical Boosts and Responses to Capital Formation 18 The Future Is Likely to Resemble the Recent Past Unless National Saving and Investment Improve and More People Want to Work
Key Contributors to Long-Term Growth Average Growth Rates 19 1982-1994 1995-2002 Labor Force 1.5 1.3 Capital Stock 2.8 3.1 R&D Expenditures 4.3 3.7 Potential GDP 2.35 2.44 Productivity 1.13 1.44
Productivity Growth is Always Best in the Opening Years of a Recovery (percent change) (percent change) 20 9 7 5 3 1-1 -3-5 1961 1966 1971 1976 1981 1986 1991 1996 4 3 2 1 0-1 -2 Real GDP (left scale) Productivity (right scale)
This Recovery Has Not Been Exceptional in Terms of Productivity Growth Cumulative Productivity Growth During Recoveries (Cumulative % Gain at Selected Intervals after a Recession Trough) 21 10 9 8 7 6 5 4 3 2 1 0 4 Qtrs. 8 Qtrs. 12 Qtrs. 16 Qtrs. 1991:1 Recession Trough Average of Last Three Mojor Recessions
Total Business Capital Stock Growth Has Been Low By Postwar Standards... 22 Average Growth Rates of Total Nonresidential Capital Stock 4.5 4 3.5 3 2.5 2 1.5 1 0.5 0 60's 70's 80's 90-94
...In Spite of Exceptional Growth in Computer Equipment Average Growth Rates of Capital Stock in Computers 23 30 25 20 15 10 5 0 60's 70's 80's 90-95
Growth in Other Forms of Capital Has Also been Weak in the 1990s 24 (average growth rates) 7 6 5 4 3 2 1 0 60's 70's 80's 90-94 Public Infrastructures Private R&D Capital Stock
Net Investment is Exceptionally Low Capital Spending as a % of GNP Has Been Declining and More of this Spending is on Short-Lived Equipment 25 14 Investment Relative to GDP, % 12 10 8 Gross Investment 6 4 2 Net Investment 0 1946 1951 1956 1961 1966 1971 1976 1981 1986 1991
WE CAN DO BETTER Increase capital formation through diligent pursuit of budget balance and lower capital gain taxation. 26 Motivate, not penalize, work effort through tax changes and workfare. Support education reform and training.
Budget-Balancing Need Not Be Painful Nor Partisan: Our Earlier Studies of a Concord Coalition Plan for Budget Balance by 2003 Demonstrated that as the Government Shrinks, Interest-Sensitive Sectors Will Rise (Real Spending by sector, percent change relative to baseline) 27 7 6 5 4 3 2 1 0-1 -2 1995 1996 1997 1998 1999 2000 2001 2002 2003 Capital Spending Residential Construction Imports Exports
To Update the Nonpartisan Concord Coalition Work in the Context of Current Policy Debates, DRI Has Created a Special Simulation : Our Implementation of a Balanced Budget in 2002 Includes: Elements in Common with the Republican Contract: Personal Tax Cuts (Bad Economics; Good Politics?) 50% Capital Gains Tax Cut (16.5% top rate) Welfare Reform Greater Work Incentives (Marriage Penalty Reduced and Social Security Earnings Limit Raised) Some Specified Spending Cuts and Transfers to States But not the Extra-Generous Investment Incentives or Inflation Indexation of Gains 28
DRI Has Created a Special Simulation : 29 Our Implementation of a Balanced Budget in 2002 Includes: From the Congressional Budget Office Options Menu: 1 Percentage Point Reduction in Social Security Indexation Taxation of Above-Average Employer-Paid Health Benefits A Wide Range of Other, Reasonable but Tough Options
The Simulation Reflected the Call for A Much Smaller Economic Role for the Federal Government ; The Results to Date Slightly Exceed Expectations 30 Federal Spending, Including and Excluding Interest, Relative to GDP 26% 24% 22% 20% 18% 16% 14% 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 SPECIAL SIM BASELINE DATA AS OF 1999
Tax Cuts were planned, but the booming economy and stock market raised taxes relative to GDP! Taxes Relative to Income 31 0.23 0.22 0.21 0.2 0.19 0.18 0.17 0.16 0.15 0.14 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 TAXES / GNP SPEC. SIM. DATA AS OF 1999
Fiscal Impacts, Including Responsible Economic Feedbacks 32 ($ Billions, Average change from baseline) 1996 1996-2000 2001-2005 Federal Taxes -24-15 -32 Federal Spending Defense -9-19 -28 Non-defense (excl. Interes -42-65 -102 Net Stimulus (+)/Restraint -28 69-98 Interest Savings -5-30 -106 Federal Deficit 33 99 204 Federal Debt (1995 $ per Household) -280-1803 -7475
This Budget Balancing Produces Interest Savings Equal to Program Savings by 2003 33 (Billions of dollars, changes relative to baseline) 50 0-50 -100-150 -200-250 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 Total Deficit Reduction Program & Tax Changes Interest Savings
Aggressive Federal Borrowing Forces High Bond Yields and a Balanced Budget offers a Return to better norms 10 Year Bond Yields (Percent) 34 12 10 DRI s Baseline 80 s 8 Special Sim. 70 s 2001-2005 90 s 6 1995-2000 1995-2000 4 60 s 2001-2005 2 50 s 0 0.00% 0.50% 1.00% 1.50% 2.00% 2.50% 3.00% Cyclically Adjusted Federal Deficit as a % of GDP
The 1995-1998 Bond Rate Declines Match the Expected Impacts The The line line is is the the 1959-96 1959-96 fitted fitted relationship relationship between between yields yields and and deficits deficits 35 17.ppt 16 14 1981 10-Year Government Bond Yield 12 10 8 6 4 1960 1980 1983 1979 1969 1995 1997 1993 1998 1996 2 0-3 -2-1 0 1 2 3 4 5 6 Federal Deficit as a Percent of GDP
Interest Rates and Budget Deficits: The Numbers Look Like the 50 s & 60s 36 Market Rates Federal Deficit/GDP Average 10-yr. F.Funds T-bills Actual Cyclically Adj 50 s 3.28 2.50 2.00 0.0% 0.3% 60 s 4.67 4.18 3.98 0.2% 0.7% 70 s 7.50 7.10 6.29 1.7% 1.4% 80 s 10.60 9.97 8.82 3.6% 2.8% 90-95 s 7.37 5.15 4.95 3.2% 2.4% Baseline 96-2000 7.17 5.27 4.90 2.5% 2.0% 2001-2005 7.24 5.25 4.86 2.4% 1.9% Special Sim. with Balanced Budget in 2002 96-2000 5.64 4.09 3.87 1.2% 0.7% 2001-2005 4.39 3.09 2.98 0.0% 0.4% Actual 95-98 Outcome Average 6.15 5.48 5.09 1.0% 0.9% 1998 5.26 5.35 4.78-0.8% -0.1% (Surpluses!)
Lower Interest Rates Are an Absolutely Logical Impact of Budget Balancing 37 1. Interest rates are the price of national savings; when savings are scarce, rates are high, and when savings are plentiful, rates are low. 2. Scarcity, thus rates, reflect both demand and supply. Budget balancing improves both, creating a double downward pressure on interest rates. 3. Obviously, if the federal government is borrowing less, the demand for savings is lower by definition. The drive toward a balanced budget reduces the annual borrowing (the deficit) and the accumulated borrowing (the debt). The demand for savings is lower, hence rates must be lower too. 4. If taxes have not been raised to reduce the federal deficit, then private sector saving (supply) will be unchanged, or higher to the extent that gross income is higher and thus supports more saving. 5. The Federal Reserve should be expected to expand the supply of funds, without creating any additional inflationary pressure. First, short-term credit stimulus is needed to offset fiscal restraint so as to keep unemployment from rising. Second, the investment and other genuine supply side stimulants allow the Fed to target more rapid real growth in the economy. Higher real growth in the nation s supply potential justifies greater liquidity without fear of extra inflation.
The DRI Special Simulation Assumed the Federal Reserve Added Only As Much Extra Liquidity As Was Consistent with No Change from the Baseline Inflation Rates 38 The greater liquidity added in the special simulation.. offsets the restraint from fiscal policy, and reflects the more rapid growth in the supply side of the economy. In addition, we created alternative scenarios in which the Federal Reserve took no action to boost liquidity.
Economic Performance with Alternative Federal Reserve Responses to New Spending and Tax Policy Changes Relative to Baseline Federal Funds Interest Rate Unemployment Rate CPI Inflation Rate 2002 96-2002 2002 96-2002 2002 96-2002 39 If Federal Reserve Does Not Boost Bank Reserves If Fed. Reserve adds Bank Reserves, Targeting Baseline Inflation Rate -.69 -.44 0.4 0.4-0.5-0.2-1.70-1.20-0.4-0.1 0.1 0.1
Once Again, the Analysis Confirms This Budget- Balancing Need Not Be Painful: As the Government Shrinks, Interest-Sensitive Sectors Will Rise (Real Spending by sector, percent change relative to baseline) 40 9 8 7 6 5 4 3 2 1 0-1 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 Capital Spending Residential Construction Imports Exports
Summary of Sectoral Impacts (% Difference from Baseline) 41 GDP and Sectors 1996 1996-2000 2001-2005 ------- ------------- -------------- Real GDP -0.1 0.5 2.2 Consumer Goods 0.0-0.1 0.1 Capital Spending 0.1 3.1 7.1 Residential Construction 1.8 5.1 6.7 Federal Purchases -4.1-6.5-7.8 Exports 0.1 1.6 5.2
The Estimated Potential For More Workers and Higher National Income 42 Impact of the Labor Force Expansion Assumptions on Economic Performance (comparing the special sim with labor force changes to the special sim without) 1996 2000 2005 Assumed Gain in Full-Time Equivalent Workers due to: Welfare Reform 150,000 1 million 1.5 million Lower Marriage Penalty 200,000 400,000 500,000 Higher Earnings Limit 200,000 300,000 400,000 Total 550,000 1.7 million 2.4 million Economic Feedback of More Workers and Hours Real GDP Gain ($Billion, 1987 Prices) $6 $27 $75 Cumulative Percentage Gain 0.1% 0.5% 1.1%
Estimated Supply-Side Benefits of Our Implementation of Balanced Budget in 2002 43 Average Annual Growth Rates Baseline Budget Proposals Improvements 95-2000 2000-05 95-2000 2000-05 95-2000 2000-05 Labor Force 1.39 1.25 1.64 1.33 0.25 0.08 Fixed Investment 4.62 4.13 5.6 4.52 0.99 0.39 Bus Cap Stk 3.15 2.67 3.55 3.37 0.40 0.70 Ind R&D Spend 4.49 2.76 5.84 2.98 1.35 0.22 R&D Capital Stock 2.58 2.52 2.92 2.92 0.34 0.40 Potential GDP 2.48 2.25 2.73 2.55 0.25 0.30 Output per Hour 1.49 1.28 1.51 1.5 0.01 0.22
Achieved Benefits of the Implementation of a Balanced Budget by 1997 44 Private Investment Gains When the Federal Deficit Shrinks 14% 12% 10% GDP % 8% 6% 4% 2% Federal Deficit Plant & Equipment Housing 0% -2% -4% -6% 1993 1994 1995 1996 1997 1998 1999
WE CAN DO BETTER Diligent pursuit of budget balance can boost real growth rates significantly, adding 2% to national output by 2002. 45 Eliminating the deficit need not cause a recession if the Federal Reserve provides moderately greater liquidity. A virtuous cycle of lower interest rates and lower federal debts ease the challenge of balancing the budget. Welfare reform and tax changes can motivate more citizens to work, contributing to their prosperity and the nation s. Education reform and training efforts can boost productivity of workers who might otherwise face stagnating living standards.