Senator John Kerry's health plan would significantly increase the government's role in financing and managing health care, according to a new Joint Economic Committee study released today by Vice Chairman Jim Saxton. The new study, An Analysis of Senator Kerry's Health Plan, evaluates the likely impact of the proposed health plan.

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    While economists have published many empirical studies on the macroeconomic effects of a large supply of U.S. Treasury debt securities (Treasuries) relative to U.S. gross domestic product (GDP), economists have only recently begun to examine its microeconomic effects.

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    When thinking about government spending, often people only consider its benefits. But government spending has costs, too, because the resources government uses have to come from somewhere and could be put to other uses. Research indicates that when these factors are taken into account, it turns out that the cost of raising an additional $1 in taxes is not $1, but closer to $1.40. On the other hand, reducing government spending by $1 can benefit the economy by $1.40, leading to higher economic growth.

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     Prior to the events of September 11, 2001, the U.S. government expected to run large recurring budget surpluses during this decade. The aftermath of the terror attacks has substantially changed the fiscal outlook. In this new economic and security environment, a bipartisan consensus has emerged that reducing federal net debt as rapidly as possible is not the exclusive objective of fiscal policy. Instead, both the Bush administration and Congress agree that additional tax reductions are needed to stimulate economic growth.

    This study evaluates the economic trade-offs between federal tax relief, and a more rapid reduction of federal net debt. This study employs the concept of opportunity cost (i.e., the highest valued alternative that must be sacrificed when choosing one option over others) to evaluate the federal debt reduction and federal tax relief options in terms of their expected effects on real GDP growth.

    Empirical studies consistently find that additional federal tax reductions, particularly of marginal federal income tax rates, would accrue large macroeconomic benefits. The marginal excess burden from federal taxation is about 40 percent. Reducing such deadweight losses through additional federal tax relief would enhance overall economic welfare and stimulate long-term real GDP growth. On the other hand, empirical studies do not indicate that a more rapid reduction of federal net debt would necessarily yield commensurate benefits. Under current circumstances and given the range of feasible fiscal policy options, the provision of federal tax relief is an appropriate objective for fiscal policy.

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     This study provides an overview of federal debt – its history, its composition, its management, its economic uses, and a discussion of recent trends.

    The Continental Congress began issuing debt securities in 1776, and the United States has had outstanding debt ever since. The first Secretary of the Treasury Alexander Hamilton established sound goals and principles for debt management that transformed U.S. government debt from highly speculative and illiquid securities into the world’s safest and most liquid investment. Because of Hamilton’s visionary leadership, Treasuries developed a unique set of characteristics – default risk-free, a seamless yield curve, high liquidity, a deeply integrated market, and extremely low bid-ask spreads – that let Treasuries perform many economic functions other than financing past federal budget deficits. For example, the Federal Reserve uses Treasuries to conduct U.S. monetary policy. Foreign central banks hold Treasuries as a store of value and a means to intervene in foreign exchange markets. Treasuries are the premier “safe haven” investment during economic turbulence. Wall Street uses the Treasury yield curve as the default risk-free pricing benchmark, while Washington indexes its loans to students and farmers to Treasury yields. Treasuries collateralize approximately four-fifths of the transactions in the $2.5 trillion a day repurchase agreement (repo) market. Portfolio managers employ Treasuries for interest rate hedging or speculation and for improving risk-return trade-off in their portfolios. As a regulatory tool, the Pension Benefit Guaranty Corporation (PBGC) utilizes the 30-year Treasury bond yield to determine the funding adequacy of private defined-benefit pension plans, the payout amount if an employee leaves an employer sponsoring a defined-benefit pension plan before the normal retirement age, and the insurance premiums that sponsoring employers pay to the PBGC.

    As of March 31, 2001, the U.S. government had a gross debt of $5.8 trillion, of which $3.4 trillion or 59.5 percent was net debt held by the public and $2.3 trillion or 40.5 percent was held in intragovernmental accounts. Economists consider net debt rather than gross debt as the proper measure for federal debt. By March 31, 2001, budget surpluses beginning in fiscal year 1998 have reduced the net debt to GDP ratio to 33.5 percent. Consequently, the gross issuance of Treasury notes and bonds fell by 54 percent from 1996 to 2000. As the supply of Treasuries shrinks, the characteristics that made Treasuries the ideal financial instruments for so many economic functions are deteriorating.

    Little research has been published to date on the economic consequences of federal net debt reduction. Yet, during the next few years, the sharp decline in the supply of Treasuries may compel the Federal Reserve System, international official entities, and market participants to find substitutes that are, by definition, inferior in some way to Treasuries. Given the importance of Treasuries to the U.S. economy, and the projected reduction in federal net debt during the next decade, the following questions face U.S. policymakers:

• What are the opportunity costs for federal debt reduction? Which provides greater benefits to the U.S. economy: a larger tax cut or a faster reduction in net debt?
• Could excessive federal debt reduction decrease the efficiency of the American financial market and increase systemic risk?
• Could excessive federal debt reduction hamper the Federal Reserve System’s execution of monetary policy? Will substituting other securities for Treasuries have unintended negative economic consequences?
  
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This analysis examines trends in congressional appropriations and finds that recent congressional budget policy has not only slowed the growth of discretionary spending, but has also significantly changed the pattern of such outlays. During the first half of the 1990s, large increases in non-defense outlays were offset by even larger reductions in defense outlays. The data reveal a reversal of this pattern during the 104th and 105th Congresses, when defense spending was held roughly constant and non-defense outlays were limited to historically low growth rates. The principal findings (in inflation-adjusted 1999 dollars) include:

Total discretionary appropriations dropped $16.5 billion between the end of the 103rd Congress and the end of the 105th Congress (fiscal years 1995-1999).

Non-defense discretionary outlays increased just 2.1 percent between 1995 and 1999. Over the two previous four-year cycles, non-defense spending grew 14 percent (1991-1995) and 12 percent (1987-1991).

Spending restraint imposed on non-defense discretionary spending produced savings equal to more than one-fourth (28 percent) of the current budget surplus, totaling $107 billion over the last four years.

Defense spending has reversed several years of steady decline, to level off during the last four years. The $0.37 billion increase in 1999 was the first real increase in defense spending in eight years.

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      The emergence of a budget surplus raises several questions: is federal fiscal behavior impacted when government revenues exceed outlays? Do surpluses one year induce spending the next year? Historically, have surpluses ever led to tax reduction? Debt reduction?

      Applying econometric analysis to federal budgetary data extending back to the George Washington administration but emphasizing the post-war era, the authors conclude:

• Over the full sweep of constitutional history, on average 37 cents of each one dollar surplus is used for increased federal spending in the following year;
• The propensity to spend out of budget surpluses has risen significantly over time, and in the postwar era at least 60 cents of each surplus dollar is spent the next year;
• Early in the Republic, a majority of surpluses were returned to taxpayers in the form of lower taxes; in the modern era, very little if any of surplus funds is used for tax reduction;
• Likewise, the persistence of surpluses has declined; before 1930, on three occasions surpluses lasted 10 or more consecutive years; more than 40 years has past since the last back-to-back surpluses; consequently, only a small portion of surpluses in the modern era typically goes for debt reduction;
• Surpluses arising right after World War II, in the mid-1950s, and in 1969 were quickly dissipated by major spending increases;
• If Social Security is excluded from the budget, the same major finding holds: budget surpluses one year induce government spending that absorbs most of that surplus during the following year;
• There is a negative relationship between federal spending as a percent of total output and economic growth; if surpluses typically induce higher spending, one economic growth strategy would be to reduce those surpluses through revenue-reducing tax reform.
  
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    This analysis examines trends in discretionary spending and concludes that recent congressional budget policy has successfully halted, at least for the time being, the long-term upward trend in discretionary spending. The principal findings (reported in inflation-adjusted 1998 dollars) include:

• Between fiscal years 1990 and 1998, congressional appropriations fell $77 billion. In the last three years alone, (1995 to 1998), discretionary outlays declined $38 billion.
• In 1996, domestic discretionary spending was cut by $9.3 billion, the largest single-year reduction in domestic outlays since 1982. Even with the increases in 1997 and 1998, appropriations for domestic discretionary spending for the current fiscal year are still $3.3 billion below the 1995 level.
• After increasing $100 billion in the previous three Congresses, domestic discretionary spending was cut by nearly $11 billion in the 104th Congress. All discretionary spending combined fell more than $72 billion in the 104th Congress.
• The 104th Congress was the first Congress on record to reduce real discretionary spending in all three spending categories (defense, international and domestic).
  
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      For the first time in a generation, the federal government and many states are faced with the possibility of budget surpluses. With this possibility, policy makers will be tempted to raise the line on government spending. Using a lesson from New Jersey, this report cautions against such policy and examines the potential economic effects of reducing taxes and restraining government expenditures.

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This staff study reviews problems with the Federal budget process that lead to excessive levels of government and describes how the excessive size and complexity of government can produce a bias toward additional special-interest spending. It makes recommendations for improving the transparency of the process and the accountability of policy makers.

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The Presidential Advisory Council on Social Security recently released the findings of its two-year study on the status of the Social Security program. The 13-member panel concluded that the Social Security program is facing serious long-run financing difficulties. This paper outlines the three reform proposals set forth by the Advisory Council and compares the impact of each on lifetime equity, the Federal budget, and national income. The paper also summarizes some of the major issues surrounding the Social Security discussions.

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    This report presents the results of a Joint Economic Committee (JEC) investigation of the Administration's planning for the debt limit/budget impasse that began in November 1995. This JEC investigation focuses on Treasury documents regarding the disinvestment of federal trust funds to circumvent the debt limit.

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    This study shows that the 1993 tax increase was devoted to federal spending increases and that the deficit decline since 1992 is accounted for by factors unrelated to tax policy. The largest single reason the deficit has declined in recent years is a continuation of the business cycle upswing underway since 1991. Special accounting factors and a reduction in discretionary defense spending explain the balance of the deficit decline since 1992.

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    This analysis concludes that failure to balance the budget will cost a typical American family $2,308 in the year 2000. It shows how continued deficit spending and debt accumulation push up interest rates and slow down economic growth. This translates into over $2,300 each year in extra expenses for an average family with one child.

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    This report presents the economic benefits of the Congressional balanced budget plan for a typical young American family. The figures are based on an economic analysis by DRI/McGraw-Hill on the implementation of the Congressional budget plan. By creating economic growth and lower interest rates, the Congressional plan would generate more than $2,300 in savings each year for an average American family.

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    President Clinton has taken credit for reducing the budget deficit for three consecutive years. This brief report updates an August 1994 JEC report entitled Whither the Budget Deficit? that showed the improved deficit picture is driven by economic and accounting factors, not the Clinton tax increases.

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    The deleterious effects of excessive government spending have been hurting our economy for several decades. The cumulative effects are felt in a myriad of ways. This paper reviews the impact of government spending on the labor force, on productivity, and on capital accumulation. Also included is a description and review of "rent seeking."

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   A Republican Congress said it would vote to give a Democratic President the line-item veto and it did. A clear and concise statement of the economic case for giving the President line-item veto authority over spending bills is given. The growth of deficit spending is discussed, and the experience of some state governors is reviewed in order to provide a perspective on the possible benefits of the line-item veto at the federal level.

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