AP Econ Module 30 Deficits Debt - Sunny Hills High School

What Happened to the Debt from World War ll?
As you can see from Fiqure 30.4, the govern- dipped slightly in the next few years, as the cause the debt-cDp ratio had ta en by more
ment paid for World War ll by borrowing on a United states ran postwar budget su rpluses, but than half. The reason? Vigorous economic
huge scale. By the war's end, the public debt the government budget went back into deficit in growth, plus mild inllation, had led to a rapid
was more than 100% of Goq and many people 1950 with the start of the Korean War. By 1962, rise in GDp The experience was a clear lesson
worried about how it could ever be paid off. the public debt was back up to $248 billlon. in the pecutiar fact that modern governments
The truth is that it never was paid off, ln 1946, But by that time nobody was worried about can run deficits forever, as long as they aren't
the public debt was $242 billion; that number the tiscal health ol the U.S. government be- too large.
government spending. This has led to a rapid rise in the debr GDt) ratio. For this
reason, some economic analysts are concerned about the long-run fiscal health of
theJapanese economy.
lmplicit Liabilities
Looking at Figure 30.4, you might be rempted ro conclude that the U.S. federal
budget is in fairly decent shape: the return to budger deficits after 2001, and largebut
temporary increases in government spending in response ro the recession that
began in 2007, caused the debt GDP rario to rise a bit, but rhar rario is still low compared
with both historical experience and some other wealrhy countries. In fact, however,
experts on long-run budget issues view the situation of rhe United States (and
other countries with high public debt, such as Japan and Greece) with alarm. The reason
is the problem of irnplicit liabilities. Implicit liabilities are spending promises
made by governments rhar are effectively a debt despite the fact rhar they are not included
in the usual debt statistics.
The largest implicit liabilities of the U.S. governmenr arise From rwo rransfer
programs that principally benefir older Americans: Social Security and Medicare.
The third-largest implicit liability, Medicaid, benefits low-income families. In each
ofthese cases, the government has promised ro provide transfer payments ro future
as well as current beneficiaries. So these programs represent a future debt that
must be honored, even though the debt does not currently show up in rhe usual
statistics. Together, these rhree programs currently accounr for almost 407o of federal
spending.
The implicit liabilities created by these transfer programs worry fiscal experts.
Figure 30.6 on the next page shows why. It shows actual spending on Social Security
and on Medicare and Medicaid as percenrages of GDP from 1962 to 2008,
with Congressional Budget Office projections of spending througl.r 2083. Ac,
cording to these projections, spending on Social Security will rise substantially
over the next few decades and spending on the rwo health care programs will
soar. Why?
In the case ofSocial Securitl the answer is demography. Social Securiry is a "pay-asyou-go"
system: current workers pay payroll taxes that fund the benefits ofcurrent retirees.
So demography-specifically, the ratio of rhe number of retirees drawing
benefits to the number ofworkers paying into Social Securiry has a major impacc on
Social Security's finances. There was a huge surge in the U,S. birth rate between 1946
and 1964, the years of the baby boom. Baby boomers are currently of working agewhich
means they are paying taxes, not collecting benefits. As the baby boomers retire,
they will stop earning income that is taxed and start collecting benefits. As a result, the
ratio ofretirees receiving benefits to workers paying inro tl.re Social Securiry sysreIll will
rise. In 2008, there were 31 retirees receiving benefits for every 100 workers paying inro
lnplicit liabilities ar€ spendinq pr0mises
made by governments ihat are efiectively a
debt desp te the fact that they are fot
inc uded n the uslaldebt statstcs.
module 30 Long-run lmplications of Fiscal Policy; Deficits and the Public Debt 303