The Congressional Budget Office’s long-term budget outlook

by Felipe Rezende and Stephanie Kelton

The Congressional Budget Office (CBO) has just released its long-term budget outlook. The dismal report warns:

“Although great uncertainty surrounds long-term fiscal projections, rising costs for health care and the aging of the U.S. population will cause federal spending to increase rapidly under any plausible scenario.” Given these large increases in projected spending, the report went on to caution that “[u]nless tax revenues increase just as rapidly, the rise in spending will produce growing budget deficits and accumulating debt.” Finally, the report asserts that the ensuing “[l]arge budget deficits would reduce national saving, leading to more borrowing from abroad and less domestic investment, which in turn would depress income growth in the United States.”
Once again, we find it necessary to point out the flawed logic of those who certainly ought to have a better understanding of things. First, taxes do not pay for government spending. It would help a great deal if those at the CBO (and elsewhere) would work through the balance sheet entries to decipher exactly how government “financing” operations work.

As Kelton and Wray have explained in earlier posts, the federal government spends by crediting bank accounts. Period. Tax payments to the government result in the destruction of money — high-powered money to be exact — as the banking system clears the checks and reserve accounts are debited. In other words, taxes don’t provide the government with “money to spend”. Tax payments destroy money. Not in theory. Not by assumption. By definition.

Second, growing budget deficits do not reduce national savings. They do just the opposite. Indeed, the private sector — households and firms taken as a whole — cannot attain a surplus position unless some other sector (the public sector or the foreign sector) takes the opposite position. Again, it is an indisputable feature of balance sheet accounting that is governed by the following identity:

Private Sector Surplus = Public Sector Deficit + Current Account Surplus

This fundamental accounting identity can be found in any decent International Economics texbook (see, e.g., Krugman and Obstfeld), and it is one of the most important macroeconomic concepts we can think of. It demonstrates the conditions under which national savings will be positive. Not in theory. Not by assumption. By definition.

Source: Levy Institute

To appreciate the interplay, consider the main sector balances in 2004. The public sector’s deficit of about 5% of GDP was just enough to offset the 5% current account deficit, leaving the private sector with no addition to its net saving (i.e. private sector savings were zero). Today, in contrast, private savings are up sharply because: (1) the public deficit is up sharply and (2) the external deficit is declining. Add today’s (rising) public deficit to today’s (falling) current account deficit and, voila, the CBO’s much-feared explosion in the government deficit has translated into an explosion in private savings.

As for the relationship between savings and investment . . . let’s tackle that accounting lesson next week.

Update: See some Wynne Godley’s pieces here, here , and here. See also Krugman’s piece here.

6 responses to “The Congressional Budget Office’s long-term budget outlook

  1. Glad this stuff is finally getting out there.Also very glad that this was written in such a simple manner – it is not that difficult to explain, but sometimes when I hear the theory it gets confusing.Noting that:Private Sector Surplus = Public Sector Deficit + Current Account SurplusIt is important to state that the current account surplus is offset by the capital account – again by definition. This leads to something I think you will get to very soon.

  2. "In other words, taxes don't provide the government with "money to spend". Tax payments destroy money. Not in theory. Not by assumption. By definition."This is utter nonsense. Assume for a moment, what would happen if the Federal government abolished taxation, but continued spending.The Fed is the government's banker. That is all.

  3. Dear AliceThe answer is you would have a good deal of inflation. Point? Your second and third paragraphs are in not any way a refutation of the quote that you consider to be "utter nonsense."Best,Scott

  4. Hi Alice, If you simply follow the logic implied by the middle paragraph of your comment, you will realize that taxes do destroy money. It seems crazy at first when you think of it in this manner. I struggled for about 6 months before I suspended my disbelief and simply attempted to think through the logic without preconception. Once I did that, it quickly became apparent that my old view (the fed monetizes Treasuries to create money) was incorrect. Without treasuries, how would the fed create money? Note that if it bought corporate debt or any private sector debt, unless this private sector entity would pay off the debt, taking the money out of circulation. Just like the U.S. govt can do with Treasuries. It follows that the important part of the debt is not that the fed buys it, as we have seen the effect when the fed buys private sector debt, but rather that the govt has deficit spent. Imagine a world without any U.S. dollars, and then have the govt spend a single dollar, then have the U.S. govt tax the population a single dollar. How many dollars are left net in circulation? None. There may be dollars in circulation, but these must net to zero

  5. The equation Private Sector Surplus = Public Sector Deficit + Current Account Surplus is not the same identity as Private Sector Balance + Public Sector Balance = Current Account Balance.In fact, it is not an identity at all but an equation that is only true for some values of its variables. Not only that, but the sign of the value for public sector deficit in the first equation is not clear. If it were negative in the first equation, it would have to have been positive in the second one, because the sign is reversed when the quantity is moved across the equal sign. That would have disproved the premise the author was trying to assert, that an increased deficit would balance out a current account surplus. What a sloppy piece of writing.

  6. Disregard Unraveller's comment, as he is unfortunately the one who has it wrong. The identity works fine either way. In fact, it can be expressed in many other different ways, namely:Private Sector Surplus or Net Saving = Government Deficit + Current Account BalanceHousehold Financial Balance + Business Financial Balance + Government Financial Balance + Foreign Financial Balance = 0etc…