World Bank Document

eceipts minus social security outlays) actually fell
Figure 3.2 Difference between long- and
short-term interest rates in the United States
from 23.7 percent of national income in 1965 to 23
percent in 1984. But government expenditure on
and Germany, 1965-83
goods and services (including interest payments
Percent
but not social security outlays) actually rose from
4 23.3 percent of national income in 1965, and 23.9
3 ^ percent in 1979, to 27.4 percent in 1984.
2
United States
j A/\ l \n Ptrial
Budget deficits have grown in the major induseconomies
(see Table 3.2, which gives infla-
1 \4 /A\ IT N\ S /tion-adjusted deficits of all levels of government).
-1 V 17
Only Germany and Japan managed to reduce their
\ / \t _J /inflation-adjusted deficits between 1979 and 1984.
/ \ /The biggest change was in the United States, from
-2 Germany |
v
V
-
an inflation-adjusted surplus of 3.6 percent of
national income in 1979 to a deficit of 2.7 percent in
-3 1984. Further large deficits are projected unless
1965 1970 1975 1980 1983 current policies are changed.
. . ~~~~~~~To judge whether the growth of budget deficits
Source: OECD financial statistics, yearbooks, and monthly supplements,
1965-83; IMF International Financial Statistics; and Fed- contributed to the rise in real interest rates, the
eral Reserve Board statistical releases.
analysis cannot stop with figures showing deficits
as a proportion of national income. Since world
favored capital investment. The changes resulted savings equal world investments, an increase in
in (a) the strong stock market recovery in the government deficits can be matched in either of
United States in 1983-84, and (b) the sharp rise in two ways: a decline in investment or an increase in
investment-more than usual at an early stage of domestic and foreign savings. One popular theory
the business cycle-high real interest rates not- argues that reductions in tax revenues will be offwithstanding.
As Figure 3.3 shows, the average set one for one by private savings, with no need
rate of profit taxation has indeed fallen consider- for adjustment in investment, the current account
ably. However, the 7 percent decline in the effec- of the balance of payments, or world interest rates.
tive rate of profit tax can, on current estimates of This hypothesis is not borne out by experience.
the marginal productivity of capital, explain less Private savings in the United States has been on a
than a percentage point increase in long-run inter- steady decline since the mid-1960s with an upturn
est rates. Moreover, the effects of such a tax change only since 1982 as the economy came out of the
on the return to capital might be expected to recession. A budget deficit of 2.7 percent of
decline over time, because additional investment national income is more than half the net private
in response to the increased after-tax return
should, over time, bring down the rate of return
on capital. This would point to a flattening of the Figure 3.3 Corporate income taxes as a
yield curve-that is, long rates rising less than percentage of economic profits in
short rates; the flattening did not take place. Fur- the United States, 1950-89
thermore, investment has not been particularly Percent
high by historical standards: 14.7 percent of U.S. 60
GNP in 1983 compared with a 15.5 percent average
for 1970-79. Therefore, tax changes are also likely 50 A
to account for only part of the increases in real
Baseline without
interest rates. 40 t reforms
* Budget deficits. Controversy about the role of Baseline \.
deficits starts with their definition (discussed in 3'
Box 3.3). But there is no dispute on the strong 20
pressures to increase deficits; in every industrial
country, public expenditure has been rising stead- 0
ily (see Figure 3.4), while taxes and social security 1950 1960 1970 1980 1989
contributions have risen much less. In the United
States, net government receipts (total government Source: Congressional Budget Office 1984.
35