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POLITICS, DEFICITS, AND DEBT

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Title: POLITICS, DEFICITS, AND DEBT


1
POLITICS, DEFICITS, AND DEBT
  • The social security debate
  • Its the demography stupid!

2
Social Security and Lockboxes
  • Because the government uses a cash flow
    accounting system, statistics do not adequately
    describe the actual surplus.
  • Cash flow accounting system an accounting
    system entering expenses and revenues only when
    cash is received or paid out.

3
Social Security and Lockboxes
  • The Social Security System is currently running a
    large surplus in its portion of the budget.
  • Some politicians have argued that a lockbox
    should be created to use the surplus to pay down
    the debt held by the public.

4
Pay-as-You-Go System
  • The Social Security system was set up as a
    pay-as-you-go system.
  • Pay-as-you-go system payments to current
    beneficiaries are funded through current payroll
    taxes.

5
Pay-as-You-Go System
  • The Social Security system is a partially
    unfunded pension system.
  • Funded pension system the contributions plus
    interest paid by workers are used to fund those
    workers pensions.
  • Unfunded pension system payments to current
    beneficiaries are funded through payroll taxes.

6
Pay-as-You-Go System
  • An unfunded pension system works smoothly as long
    as the populations age distribution, the annual
    death rate, and the number of people working do
    not change much.

7
The Effect of the Baby Boom
  • An unfunded system presents a potential problem
    if the amount paid in differs from the amount
    paid out.
  • With a baby boom, the size of the retired
    elderly, the workers, and the very young who are
    not working, are no longer equal.

8
The Effect of the Baby Boom
  • When baby boomers retire, there will not be
    enough new entrants into the work force to pay
    their benefits.
  • Payments per beneficiary must decrease, real
    contributions per worker coming in must increase,
    or some combination of the two must occur.

9
Projection of Workers Compared to Retirees
10
Projection of Workers Compared to Retirees
11
The Social Security Trust Fund
  • In 1983 legislation was passed to aid Social
    Security.
  • It raised the age of eligibility slightly.
  • Social Security tax rates were raised.
  • Social Security payments became subject to
    taxation for some beneficiaries.

12
The Social Security Trust Fund
  • The social security system currently accounts for
    nearly all the government surplus.
  • The portion of surpluses held by Social Security
    is not available for spending it is saved for
    the Trust Fund.

13
The Social Security Trust Fund
  • Because the elderly use significantly more
    medical services than younger people, the
    Medicare program will also experience significant
    funding problems in the future.

14
The Real Problem and the Real Solution
  • The real problem and the real solution are
    different from the financial problem.
  • Even a fully funded Trust Fund will not solve the
    Social Security problem.

15
The Real Problem and the Real Solution
  • The reason is that the Trust Fund is simply a
    financial solution, not a real solution.
  • A real solution would deal with the supply and
    demand of real resources, not with nominal
    amounts.

16
The Real Problem and the Real Solution
  • When the baby boomers retire in 2030
  • Workers must produce enough goods for themselves
    and their families.
  • They must also produce enough for the retired
    baby boomers.

17
The Real Problem and the Real Solution
  • Workers will have to produce enough both for
    themselves and for the large number of retirees.
  • Real output per worker must increase but the real
    consumption of workers must not increase.

18
The Trust Fund Illusion
  • The Trust Fund is an accounting illusion.
  • It backs one government obligation with another
    government obligation.

19
The Trust Fund Illusion
  • The Trust Fund has a positive effect on the
    problem, even if it does not solve the problem
    completely.

20
Politics and Economic Policy
  • Politics affects economic policy.
  • A proposal to help the elderly with their drug
    expenses will, in 2020, make the situation worse
    for those still working.
  • Another proposal is to invest the Trust Fund in
    the stock market the argument for this is
    dubious since the market can always fall.

21
Politically Unpopular Policies
  • Politically unpopular policies may be needed.
  • The real solution is any policy that brings the
    real forces of aggregate supply and demand into
    equilibrium.
  • The real amount baby boomers spend when they
    retire must be reduced otherwise taxes on those
    still working must be increased.

22
Politically Unpopular Policies
  • There are a number of ways this can be done, none
    of them politically appetizing.
  • Increase taxes on those working in 2020.
  • (since you dont vote this is what is happening!)
  • Cut benefits once baby boomers start retiring.
  • Make Social Security means tested.
  • Increase the retirement age to 72.

23
Summary
  • A deficit is a shortfall of revenues over
    payments.
  • A surplus is an excess of revenues over payments.
  • Debt is accumulated deficits minus accumulated
    surpluses.
  • Deficits and surpluses are summary measures of a
    budget.
  • Whether a budget is a problem depends on the
    budgeting procedures that measure it.

24
Summary
  • A structural deficit is that part of a budget
    deficit that would exist even if the economy were
    at its potential income.
  • A passive deficit is the part of the deficit that
    exists because the economy is below its
    potential.
  • Structural deficit Actual deficit

    Passive deficit
  • A real deficit is a nominal deficit adjusted for
    inflation.
  • Real deficit Nominal deficit (InflationxDebt)

25
Summary
  • Government debt and individual debt differ in
    three major ways
  • Government is ongoing and never needs to repay
    its debt.
  • Government can pay off its debt by printing
    money.
  • Most of the government debt is internal owed to
    its own citizens.
  • Deficits, surpluses, and debt should be viewed
    relative to GDP because this ratio better
    measures the governments ability to handle the
    deficit and pay off the debt.

26
Summary
  • The Economic Growth and Tax Relief Reconciliation
    Act of 2001, an economic slowdown, and the war on
    terrorism contributed to a return to budget
    deficits in 2002.
  • Beginning in 2017, the Social Security system
    will run deficits.
  • The real problem is not the solvency of the
    Social Security system but the future mismatch
    between real production and real expenditures.

27
Review Question 15-1 Distinguish between a
structural deficit and a passive deficit.
A structural deficit is the part of the budget
deficit that would exist even if the economy were
at its potential level of income. A passive
deficit is the part of the deficit that exists
because the economy is below potential.
Review Question 15-2 What are some of the
possible solutions to the problem of Social
Security solvency?
Increase taxes on those working in 2020. Cut
benefits to baby boomers when they retire. Make
Social Security means tested. Increase the
retirement age to 72. Privatization will not
solve the solvency problem because Social
Security is a partially unfunded pension system.
Funds diverted to private accounts would not be
available to pay as benefits to current retirees.
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