Deficits, Debt, and Crowding Out | Introduction to Business

Opening

A budget deficit and the national debt sound like the same thing, but they are not. One is a yearly shortfall; the other is the pile of all past shortfalls. This unit untangles them and shows how financing them can crowd out private investment.

The idea

When government spending exceeds tax revenue, the result is a federal budget deficit, financed by borrowing that adds to the national debt and can crowd out private investment.

Definition

federal budget deficit

The result when the government spends more for programs (social services, education, defense) than it collects in taxes.

A yearly shortfall: the government's spending outruns its tax revenue.

Deficit and debt basics

To cover a deficit, the government borrows money, just like a business or household. The accumulated total of all past deficits is the national debt. In 1998, the U.S. had a rare surplus of about $71 billion, but by 2005 the deficit exceeded $318 billion, and in fiscal year 2009 it hit an all-time high of over $1.413 trillion. By the end of 2015, the deficit had fallen to $438 billion, yet the national debt still amounted to about $19.8 trillion—about $61,072 per person—with total interest on the debt exceeding $2.5 trillion a year.

Vocabulary· 2 terms

Crowding out in everyday choices

Crowding out shows up in everyday choices. If the government spends more on public libraries, individuals buy fewer books at bookstores. More public education means less private education spending. More public transportation means less private transportation spending. In each case, government spending is crowding out private spending.

Definition

crowding out

The phenomenon that occurs when the government takes more money from business and consumers (the private sector), so government spending crowds out private spending.

Government activity displaces private activity—public libraries cut bookstore sales, public transit cuts private car use.

Pie chart titled 'Revenue' showing breakdown of revenue sources: Individual income taxes 48%, Social Security & other payroll taxes 34%, Corporate income taxes 9%, Other taxes & duties 9%. — What to see here
Look at the two largest slices: individual income taxes (48%) and payroll taxes (34%) together fund most of the budget, while corporate income taxes are only 9%.

Pie chart titled 'Expenses' showing the federal budget by category: Other expenses 39%, Social security 24%, Defense 16%, Medicare 15%, Interest on debt 6%. Other expenses covers both mandatory spending, such as veterans' benefits and administration of justice, and discretionary spending, such as education, community development, agriculture, science and commerce. — What to see here
Notice the 'Interest on debt' slice at 6%: even before new borrowing, the government must pay interest on past debt, and that interest competes with other spending.

Concerns about the national debt

The national debt raises two main concerns. First, not everyone holds the debt: if only the rich held bonds, they would receive interest payments funded by everyone's taxes, making the debt unfair to poorer citizens. That is why the Treasury created savings bonds—small denominations let more people participate. Second, the debt can crowd out private investment: to sell its bonds, the government may raise interest rates, forcing private businesses to raise rates on their corporate bonds to compete, making private investment more costly and slowing economic growth.

Easily confused

Looks like

A federal budget deficit and the national debt are the same thing.

Actually

A deficit is a single year's shortfall; the national debt is the accumulated total of all past deficits.

The deficit adds to the debt each year, but they measure different time spans—one year versus the entire history.

The difference between a deficit and the debt

Government borrowing and crowding out

The government borrows by issuing Treasury bills, Treasury notes, and Treasury bonds—federal IOUs that pay interest. These compete with corporate bonds for investors' dollars. When the government raises rates to attract buyers, private firms must raise their own rates, raising the cost of financing private investment.

Now apply the crowding-out idea to a new scenario.

Recap

Say each point to yourself, then tap it to check.