Suppose the federal government cuts taxes and increases spending, raising the budget deficit to 12 percent of GDP. If nominal GDP is rising 5 percent per year,

Suppose the federal government cuts taxes and increases spending, raising the budget deficit to 12 percent of GDP. If nominal GDP is rising 5 percent per year,

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July 23, 2021
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Suppose the federal government cuts taxes and increases spending, raising the budget deficit to 12 percent of GDP. If nominal GDP is rising 5 percent per year, are such budget deficits sustainable forever? Explain. If budget deficits of this size are maintained for 20 years, what is likely to happen to your taxes and your children’s taxes in the future? Can you personally do something today to offset this future effect?

Answer and ExplanationSolution by a verified expert

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The ratio of the government's debt and the real gross domestic product (GDP) is called the debt-GDP ratio.

Explanation
No, the budget deficits cannot sustain forever raising at the rate of 12 percent of GDP, and 5 percent of nominal GDP because the rate of growth in the budget deficit is more than the rise in nominal GDP, that is, 5 percent.

The budget deficits can sustain forever as long as the rate of growth in the budget deficit is less than that of the national income of the economy. This implies that the government debt must grow at the rate less than the GDP of 5 percent. However, the debt is at 12 percent of the GDP, which implies that it is not sustainable.

If budget deficits of such large size are maintained for 20 long years, it will negatively affect individual's as well as their children's tax burden in the future. Therefore, there will be an increase in the tax rates to be levied on the future generations.

Yes, an individual can offset the excess tax burden on future generations by raising his present savings and leaving a bequest for their children. The bequest amplifies the ability of the future generations to pay-off higher future taxes.

Verified Answer
No, a rise in budget deficits to 12 percent of GDP, and the nominal GDP to 5 percent per year cannot sustain forever because the growth rate of government debt is more than the GDP, that is 5 percent per year.

If budget deficits of such large size are maintained for 20 long years, it will negatively affect individual's as well as their children's tax burden in the future. Therefore, the tax burden on future generations will increase.

Yes, an individual can offset the excess tax burden on future generations by raising his present savings and leaving a bequest for their children.

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