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Research Papers in Economics

The Federal Budget: From Surplus to Deficit
THE MAGNITUDE of the Federal budget deficit
has been in the spotlight in recent discussions of
economic trends and prospects. Analyses of the Fed-
eral budget indicate the likelihood of continuing
deficits for the next several years, given the current
structure of tax rates and existing Government spend-
ing programs.1 Just a few years ago the concept of
“fiscal drag” was used to describe the tendency of the
budget toward chronic surplus.2 Why has there been
a shift in the assessment of the outlook for the Federal
budget?
The purpose of tins note is to give a brief quantita-
tive summary of the factors which have contributed
to the change in the budget position since early 1969.
These factors are divided into two primary effects:
(1) a discretionary effect relating to changes in tax
rates and expenditure programs, and (2) an economic
activity effect relating to the effect of the degree of
resource utilization on the size of the tax base and the
amount of unemployment benefits. The first half of
1969 is chosen as a base for comparison because this
period represents both a high-employment level of
economic activity and the most recent peak in the
time series of the net Federal budget position (the
excess of receipts over expenditures) .~ Since early
1969, some tax rates have been reduced, expenditures
have continued to increase, and the rate of resource
utilization has remained below the level attained in
that period. What is the contribution of each of these
factors to the deficit as it currently exists, and, given
this background, what is the outlook for the Federal
budget?
Factors Con.tributing to the Curren.t
Federal Budget Deficit
The Federal budget (national income accounts
basis) moved from a $10 billion annual rate of surplus
in the first half of calendar 1969 to an $18 billion rate
ki
-t~
tV~~
~f
of deficit in the first half of 1972. The following
tables provide estimates of the contributions of various
factors to this shift from surplus to deficit.
Table I gives the Federal budget for the first half
of 1972 if the economy had continued to operate at
high-employment levels and the expenditure and reve
nue relationships of the first half of 1969 had been
mainNined. In other words, given the schedule of tax
Table I
Conthtsortal Budget A — First Half 972
(Eslisens of Dclfori}
Receipts $2566
Expenditures 243 2
Defense 101.0
Nondefense I 42.2
Net Position $ 13.4
Hypothetical Federal budget in first half 1972, gwen actual
revenue and expenditure relationships in first half 1969
and assuming high employment
rates in carly 1969, the magnitude of Government
expenditurcs relative to the size of the economy
(measured by potential GNP in current dollars) at
that time, and the maintenance of a high-employment
level of activity, extrapolation of these relationships
into early 1972 would have yielded the budget situa
tion as summarized in Table I. A $13.4 billion rate
of surplus would have prevailed, given these hypo-
thetical conditions.
-TO
Fiscal Measures
tiSurplus; -lDrFiciT
Billions of Dollars °‘“‘~~“~ “ Billions of Dollars
20 20
5
10 10
S
0
-S
-10
-IS
-20
-25
-30
-35
-40
-45
-20
-25
-30
-40
964 1965 1966 1967 1968 1969 1970 1971 1972
Sus,s,s:USO.nth,uiC,,,,.,s,, C,,ds5E ‘5 (Ads,,,,, s,d~rd,,,iRrs,s—ss,Isf3ttnsi.
I_srI dl— ,Is”sd:3515; 5,5,, s,.Iisis,s,y
1
flecent analyses of the Federal budget are found in Charles
L. Schult-ze et al., Setting National Priorities, The 1973
Budget (Washington, D.C.: The Brookings Institution, 1972),
and David I. Ott et a!., Nixon, i%tcGovern and the Federal
Budget, Domestic Affairs Study 8, American Enterprise In-
stitute for Public Policy Research, Washington, D.C. (Sep-
tember 1972).
2
For a review of recent fiscal history, see Schultze et al.,
Setting National Priorities, chap, 12.
3
Throughout this article all time references are to calendar
years, and all budget references are on a national income
accounts basis.
Page 2FEDERAL RESERVE BANK OF ST. LOUIS NOVEMBER 1972
Table II
Conditional Budget B — First Half 1972
(Billions of Dollars)
Receipts $244.2
Expenditures 238.2
Defense 77.7
Nondefense 160.5
Net Position $ 6.0
Hypothetical }ederal budget in first half 1972. givcn actual
re’ ernie and expenditure rel&ition~hip~ in first hail 1972
and LISt umiU g lii gh ri npioyment
1 able ill gives the actual budget for the first hail
of 1972. The differences between Tables II and III
represent the effects of a change in the relative rate
of resource utilization on the budget. Expenditures
and revenues deviated from their hypothetical high-
employment values because the economy was operat-
ing below that hypothetical level of activity. The bud-
get was in deficit at an annual rate of more than $18
billion.
Table lit
Actual Federal Budget — First Half 1972
(Billions of Dollars)
Receipts $223.2
Expenditures 241 4
Defense 77.7
Nandefense 163.7
Net Position S —18.2
The iii!ormation in Tables I-Ill is combined in
Table IV to summarize the factors which contributed
to the shift from a substantial surplus to a substantial
deficit. Table IV is interpreted as follows. The surplus
was $31.6 billion less in the first half of 1972 than it
would have been if the revenue-expenditure relation-
ships of first half 1969 had been maintained along with
high employment. The slowdown of economic activity
contributed $24.2 billion ($21 + $3.2) to the $31.6
billion decline in the surplus (the shift to deficit). The
remaining $7.4 billion ($12.4 —$5.0) is attributable to
the effect of discretionary fiscal actions. Tax rate
changes — reflecting removal of the tax surcharge, the
Tax Reform Act of 1969, and the Revenue Act of 1971
Table IV
Summary of Factors Contributing to
Changes in the Federal Budget
First Half 1969 to First Half 1972
(Billion5 of Dollars)
Receipts $—33.4
Economic Activity Effect — 21.0
Discretionary Effect .. 12.4
Tax Rate Change --20.4
Overwilhholding ‘4 8.0
Expenditures ± 1.8
Economic Activity Effeci .‘ 3.2
Discretionary Effect + 5.0
Defense -4’23.3
Nondefenso — I 8.3
Net Position $ —31.6
NOTE .\ negas I’c’ sign nilinun.. I hi’ fs,,’i.,s’ ‘sis si’s at is. to sic’—
iTs. ,ssrs,la-s :nrrs.ass.sh.sslc.nc.rs..\js.,s:ti~-u’,k,r
.ss,,.ras, s Ii’s ~ac.tus’.vss’ ‘sy-s’aCs,s. Is i5ss’ss’5.~’I_hi- -ws’sslu.
shles’it,s sht’sls’lis 5
Given this hs:u-kground of recent budget experience,
what are tlse prospects for the future? Table V gives
estimates for 1975 as prepared by the American
Enterprise Institute.4 These figures are based on the
assumption that high employment will prevail in 1975
and that prices will be increasing at a 2.5 percent
annual rate. The revenue estimate is based on the
prospects for tax rates as of late August 1972. Ex-
penditure estimates represent a projection of existing
Government programs along with allowance for
pending legislation as of August 1972. Thus the $21.5
billion deficit represents only a projection of the bud-
get situation at that time and does not allow for possi-
ble expansion of Government spending programs.
Toble V
Federal Budget in Calendar 1975
(Billiont of Dollars)
Receipts $ 292.0
Expenditures 313.5
Net Position $ —21.5
itt et al., “ion, McCosem, use? the Federal Budget. The
estimates are those for the \sxs,sI Administration’s budget
which, when based on an a,essment in August 1972, is
consistent with a $250 billion estimate of expenditures In
Table II shows the Federal budget at an assumed — contributed $20.4 billion toward the decline in the
high-employment level of economic activity, but is surplus, while overwithholding of personal income
calculated by using the revenue and expenditure rela- taxes acted to increase the surplus (reduce the def-
tionships that prevailed in early 1972. The differences icit) at an annual rate of $8 billion. Discretionary
between Tables I and II then, reflect changes in tax expenditures contributed toward an increase in the
rates and expenditure changes relative to the size of surplus by $5 billion ($23.3—$18.3). This tendency
the economy. Under these high-employment condi- can be attributed solely to the slowdown of defense
tions the budget would have shown a $6 billion rate spending which more than offset the tendency-toward.
of surplus. deficit effects of nondefense expenditure increases.
Page 3FEDERAL RESERVE BANK OF ST. LOUIS
Prospects for the Future focus on the expenditure
side of the budget. They indicate a substantial budget
deficit, even under conditions of high employment, as
compared to the hypothetical surplus shown in Table
II. Gains in the budget position from reduced defense
spending, like those shown in Table IV, do not appear
to be in prospect for the future. The existing tax
structure would not be sufficient, given existing ex-
penditure programs, to bring the budget into balance,
even if the economy returns to high employment.
Stabilization Implications
What conclusions can be drawn? First, the cur-
rent budget deficit is attributable in large measure
to a slowdown in economic activity, but tax changes
and a rapid growth of nondefense expenditures have
also contributed to the situation, Defense expenditure
trends have actually worked to reduce the deficit,
mainly due to reductions in Vietnam expenditures.
fiscal 1973, Calendar 1975 is chosen for illustrative purposes
because it is far enough into the future to allow a focus on
fundamental budget trends while providing sufficient time
to actually achieve the assumed high-employment level of
activity. The American Enterprise Institute study presents
projections through 1980.
Page 4
NOVEMBER 1972
Future budget prospects raise questions about the
options available to pohcymakers in dealing with the
problem of expenditure growth m excess of receipts
First, there is the option of reducing existing expendi
ture programs Second, there is the consideration of
growth in new programs which yield an even larger
deficit than that shown in Table V other things equal
Third there is the option of raising tax rates Ghanges
in the effective rate for social security taxes are sched
uled but these are not large enough to erase the
deficit by 1975 Once the decision about expenditures
and taxes has been made any deficit that remains is
financed by the sale of Government bonds to the
private sector of the economy, at least initially How
ever the ultimate effects of the deficit depend on how
much of the Government debt is subsequently mone
tized by the Federal Reserve System ~
The alternative of raising tax rates to increase reve
nues has to be weighed against any tendency of such
an action to perpetuate existing Government pro-
grams whether or not they ‘ire justified on a cost
benefit basis Furthermore, there is the question of
whether new programs are scrutinized as carefully
when revenues are available to be spent
The alternative of financing the excess of Govern
ment expenditures over receipts by debt sales to the
private sector means other things equal a rise m
interest rates in the short rim Monetization of such
debt by the Fcderal Reserve Systcm on the other
hand reduces interest rates in the short run from what
they would otherwise be but ovei a longer horizon
can lead to more price inflation and ultimately higher
interest rates Gurtailing growth of new Government
programs and cutting back existing programs would
be a step in the direction of avoidmg higher tax rates,
htghcr interest rates and more rapid inflation Such
a course of action, however, has to be assessed against
the foregont benefits of the progiams themselves
5
All of the options ignore the feedback of these budget
alternatives on the course of the economy. Thus implicitly
there is the assumption that monetary actions can be im-
plemented in such a way as to achieve high employment
by 1975 gnen the particular budget alternative which is
followed. Comparing the consequences of the budget alterna-
tives probahly implies different courses of monetary action.
More detailed study of the impact of these various alterna-
tives would probably require the use of an econometric
model.
Federal Gavernment Expenditures
Notional scorne Accounts Budget
Qss,s,sisssssisss A,susls&s
964 i965 i966 i967
1st,,, 4.55pls,,,d. kd qss,,s,
i968 969 1970 i9Zi 1972
Iss,s.~titI,pss,,s,s,slcs,,sss,s,

The federal budget: from surplus to deficit

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The federal budget: from surplus to deficit

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