Explaining U.S. federal deficits: 1889-1998.

Goff, Brian L. ; Tollison, Robert D.

I. INTRODUCTION

Seater (1993) attempted to provide a common basis for assessing empirical studies of the effects of deficit spending. He concluded that evidence of the existence of appreciable effects of U.S. deficits on macroeconomic variables is questionable. In other words, the data do not allow for a confident rejection of Ricardian equivalence. In a world with no macroeconomic effects from deficit spending, full information, and no distinctions between political and economic markets, fluctuations in deficits merely reflect government financing considerations of secondary importance.

In contrast to this view of the world, deficits and surpluses are treated as an important topic in everyday affairs and discourse. Politicians talk about deficits and surpluses regularly when calling for higher or lower taxes, more or less spending, revisions in Social Security funding, and other changes in public policy. Economists and political analysts continue to debate why deficits became a regular feature of federal fiscal management from the late 1960s into the 1990s.

These debates have spurred divergent theories and conjectures, leading to different empirical hypotheses and variables of interest. Moreover, existing empirical studies of the subject have utilized diverse econometric techniques and specifications. As a result, the competing hypotheses concerning deficit spending have not been tested against one another in a systematic fashion. In this article our principal aim is to analyze the different explanations of U.S. federal deficits, jointly estimating competing hypotheses about deficit fluctuations in a generalized, reduced-form empirical model. To achieve this goal we collected and utilized a time series of data running from 1889 to 1998.

The apparent paradox between the seemingly innocuous effects of deficits and the political preoccupation with them may owe its existence to one or more reasons-limited and noisy information among voters, differences between economic and political markets, inaccuracy in the measured macroeconomic effects of deficits, or other reasons. We do not attempt an explanation of why deficits, which seemingly exhibit no or small real effects (Ricardian equivalence), could lead politicians and voters to treat deficits as if the Ricardian hypothesis were rejected. Instead, we treat explanations of deficits that stem from Ricardian premises as one of several hypotheses to be tested.

II. COMPETING HYPOTHESES

We first describe the leading explanations of deficit spending, organizing them around common theoretical principles. (1)

Tax Smoothing

The explanation of deficits which follows directly from a Ricardian equivalence theory is the tax smoothing theory developed by Barro (1979). (2) If deficits generate no real macroeconomic effects (and the influences of political institutions and politicians are ignored), then optimal public financing considerations govern the use of deficit spending. Simply put, fiscal authorities raise revenue to meet spending needs through income taxation, but both spending and income (the tax base) are subject to uncertain and temporary movements. Minimization of the deadweight costs of raising a given amount of revenue requires keeping tax rates steady in the face of purely temporary changes in income or spending. This is accomplished by running deficits when income is temporarily low or spending is temporarily high and running surpluses in the opposite case.

Imposing a binding no Ponzi game (NPG) constraint leads to similar long-term behavior of deficits as implied by optimal finance models. The NPG condition requires that the present value of taxes must equal the present value of spending plus the initial value of debt. Spending and revenue must share a long-term common trend so that (primary) deficits will be stationary over a long time series-deficits and surpluses will offset each other. The tax smoothing theory uses temporary movements in spending, income, or both to explain the origin of deficits and surpluses, whereas the NPG condition does not offer an explanation of why deficits might arise in the first place. It merely indicates that if they do arise, they will be offset over some long period by surpluses. Hakkio and Rush (1986), Hamilton and Flavin (1986), and Trehan and Walsh (1990a, b) considered deficits from this perspective, investigating the long-run stationarity of US. deficits and the cointegration of revenue and spending streams.

Political Strategy

Over the last decade a number of models have been developed in which strategic behavior on the part of incumbent politicians plays a role in deficit fluctuations. The literature in this vein most directly linked to deficit decisions by fiscal authorities includes models such as Alesina and Tabellini (1990), Persson and Svennson (1989), and several others where the time consistency or inconsistency of policy is of central importance. (3) In these models the presence of binding political constraints, such as term limits, can provide incumbents with an incentive to use deficit financing as a means of constraining the behavior of subsequent politicians. As a result, several of the empirical pieces have focused on the effects of term limits (see note 3).

A second role for deficits as a strategic tool of incumbents is to increase the likelihood of reelection. Although this literature has focused most heavily on the use of monetary and tax policy, a generalization of the same principles would include the use of deficits across the electoral cycle as a means of influencing electoral outcomes or as a tool for building credibility for certain policies. This opportunistic political motivation has been implicit in the literature on political business cycles and other models of political/bureaucratic behavior, but it has lately begun to be more explicitly treated. (4)

Although the objective functions of politicians are different in the time consistency and the political business cycle literatures, the two strategic approaches share common ground. The time-consistency literature treats a future election (or the lack of it) as a constraint that drives policy. The political business cycle literature treats the likelihood of future election as an objective that drives policy.

Interest Group/Distributional Influences

Seater (1993) identifies various reasons why the theoretical predictions of Ricardian equivalence may fail empirically. He emphasizes the specific assumptions underlying the dynamic model of representative household consumption and how distributional consequences of debt issue may arise if these assumptions do not hold. Probably the most obvious case is childless families with no other bequest motive and finite horizons. Such persons do not fit the basic model and may favor debt finance. Other distributional consequences can arise if different groups of individuals have different information regarding future income or if bondholders are not evenly spread throughout various groups. Although it is limited in scope, some empirical evidence supports the idea that these kinds of distributional differences matter across groups. Seater cites evidence that the elderly dissave more slowly than predicted by the permanent income hypothesis. And about one-fifth of families above the age of forty are childless.

Where such distributional consequences create winners and losers from deficit spending, political interests across these groups will arise regarding the use of deficit finance. Several models, including Crain (1988), Shughart and Tollison (1988), and Goff (1993), link deficit spending to narrowly defined interest groups who may gain from these types of distributional effects arising from increased use of deficit financing. One of the more commonly identified groups having a motive to support deficits because of the distributional consequences, as well as possessing the political organization and power to influence them, are the elderly. The childless are another such group, although they are not politically organized. Moreover, there is no consistent time-series data on the childless before 1980.

The composition of government spending may also influence deficits because of indirect links to interest group activity. Certain kinds of spending--for instance, spending on entitlement programs with built-in annual adjustments and well-defined and organized beneficiary groups--have long been viewed as a means of driving a wedge between the spending and revenue decisions of fiscal authorities. Alesina and Perotti (1996) supported this idea with cross-country evidence linking the inability to bring down persistent deficits to spending on social-oriented programs.

Institutional Theories

Various "institutional" explanations for deficits have received prominent attention, and this term covers a wide range of political factors--processes, laws, parties and coalitions, and the like. These analyses have ranged from purely descriptive/historical treatments to rigorous maximizing models of political choice. (5)

The political science literature in particular has devoted considerable attention to the importance of federal budgetary processes and deficit policy. Schick (1995) provides a comprehensive overview of changes in budgetary processes and the literature surrounding their effects. [6] Using state-level data, Porterba (1994) showed that deficit carryover rules and tax/expenditure limits have effects on how rapidly fiscal authorities adjust to deficits. At the federal level, although many statutory changes related to budgets have received attention--for example, the 1921 Budget Act, the 1946 Legislative Reorganization Act, and the 1985 Gramm-Rudman-Hollings Act--existing studies have focused most heavily the Budget Act of 1974 (Congressional Budget and Impoundment Control Act). The latter not only reorganized the committee process by which Congress appropriates monies but supposedly reasserted congressional power relative to the president in control over budgetary matters.

Political parties are another institution-based avenue through which deficit financing decisions may be altered. Parties provide deal-making processes and enforcement mechanisms so that when a single party controls all fiscal decisions, different policies may ensue than when cross-party deals must be struck. The influence of parties on deficits has been explored in Roubini and Sachs (1989) and Alt and Lowry (1994).

Variation in the use of deficit financing may also occur due to the differential emphasis placed on tax or spending policy from one presidential administration to the next. If a particular administration is committed to lower taxes as a primary goal, regardless of the short-term consequences for deficits or possibly as a strategy to force politicians into reducing the growth of spending, then deficits may increase more during that administration than in one where other objectives take precedence.

III. EMPIRICAL MODEL AND MEASUREMENT ISSUES

Dependent Variable

Among the many empirical methodologies present in the literature, incomparability often arises due to the use of different deficit series. We use changes in the natural log of real primary federal government debt outstanding, which yields percentage changes in real primary debt (Debt/P, hereafter). (7) Figure 1 shows the behavior of both the level and percentage changes in Debt/P over the period 1890-1998. Percentage changes in Debt/P are stationary and translate nicely to the theoretical literature where the results pertain to primary deficits (deficits net of government interest payments). (8) Also, Debt/P has the advantage of allowing for an explicit consideration of increases and decreases in the real level of federal indebtedness. If primary indebtedness in real terms increases, this measure will be positive.

We include only federal debt as our dependent variable measure, although some studies add state and local deficits and examine total government indebtedness. For certain questions this may be appropriate, but if deficit spending is viewed as a variable responding to legislative and executive oversight, then nonfederal units of government are best analyzed separately. Decisions by Congress and the president may affect and be affected by state and local revenue streams in direct and indirect ways, but state and local spending and revenue are not variables under their direct management. Though some of the theoretical models can be extended to state and local government decision making, most of the discussions pertain to the federal level. Moreover, the institutional and constitutional constraints on deficit spending differ markedly at the state and local level from those at the federal level. We later include state and local debt as an explanatory variable as discussed further below.

Tax Smoothing Variables

Empirical studies focusing on the short-term implications of tax smoothing commonly generate "temporary" government spending and income series to test for responses of deficits to these series. These efforts have been problematic. Supposed "temporary" and "permanent" series are, in effect, often little more than artificial labels. The work on persistence in economic time series initiated by Nelson and Plosser (1982) highlighted the fact that the separation of temporary and permanent components is difficult. Certainly, simplistic decompositions of trend and cyclical components by using ordinary least squares (OLS) residuals from linear trends to define "temporary" components of economic time series, for example, typically results in this kind of error. For instance, Barro (1979) uses a "temporary" spending series that exhibits greater persistence than his aggregate series, and Barro (1986) uses "temporary" spending and income series that are not stationary. (9)

There is not general agreement on the best econometric approach for decomposing a series into temporary and permanent components, but advances in time-series methods have presented more options in recent years than those available to earlier investigators. We use Kalman filter models to decompose real government spending and real GNP into our temporary government spending and income series. The Kalman filter permits updating of coefficient values and flexibility in the treatment of shocks. One key feature is that the residuals used as our temporary spending and income series are stationary with low persistence. (10)

Political Strategy Variables

The inclusion of presidential term lengths raises measurement issues. We follow the common practice in the empirical literature and create a dummy variable equal to 1 for periods in which term limits were binding and 0 otherwise. Although this strategy imposes strong assumptions by treating the likelihood of serving another term as 1.0 for incumbents who are eligible and as 0.0 for incumbents who are not eligible, the alternative measurement strategies introduce degrees of subjectivity. We discuss alternative specifications of the term limit variable in more detail below. (11)

In addition to presidential term limits and their effects on deficit strategies, we include a variable, Electoral Cycle, to control for different time periods in the electoral cycle to determine if deficits are subject to manipulation by incumbents for electoral advantage. This variable equals 1 for year of and the year prior to an election in which the incumbent is eligible to run, and 0 otherwise.

Interest Group and Distributional Variables

To account for the influence of the elderly population, we include changes in the fraction of the population age 65 and over. To account for changes in the composition of government spending, we include the ratio of nondefense federal spending to total federal spending. (12)

Political Variables

To account for the political explanations of deficits, we include the following dummy variables:

1921 Budget Act = 1 for 1921-73 and 0
 otherwise;

1974 Budget Act = 1 for years following
 the 1974 Budget
 Reconciliation Act
 and 0 otherwise:

1985 GRH Act = 1 for 1985-89 and 0
 otherwise;

1993 Deficit Act = 1 for 1993-98 and 0
 otherwise;

Split Congress = 1 for years in which the
 House and Senate were
 controlled by different
 parties and 0 otherwise;

Split Government = 1 for years in which
 either chamber of Congress or the presidency
 was controlled by
 different parties and 0
 otherwise;

Party-President = 1 for years with a
 Democratic president
 and 0 otherwise; and

Party-House = 1 for years with a
 Democratic majority in
 the House and 0
 otherwise;

Change in Fed Transfers = change in interest
 earnings transferred from
 the Federal Reserve to
 the Treasury.

The dummy variables for the two budget acts (1921 and 1974) and for the deficit reduction acts (1985 and 1993) are included to determine if empirical effects were generated by these legislative changes.

Split Congress and Split Government control for any effect cross-party control exerts in raising agreement costs and placing a wedge between spending and revenue decisions. Split Congress measures differences between control of the House and Senate, and Split Government measures differences between control of Congress and the presidency. Party-President and Party-House proxy for any party-related effects on Debt/P.

The public debt figures supplied by government do not include federal debt held by the Federal Reserve System. Fluctuations in the amount of debt held by the Fed and in the interest earnings transferred from the Fed to the Treasury are not a large amount on an annual basis but nonetheless reduce the deficit figures by different amounts from year to year. To control for this influence on measured deficits, we include Change in Fed Tansfers. Changes rather than levels are used because the series in levels was not stationary. (13)

Descriptive statistics for all continuous variables are given in the appendix.

IV. ESTIMATION

Estimation and Results

The equation below summarizes our general empirical model for 1890-1998.

(1) Deficit Measure

= [a.sub.0] + [a.sub.1] Temporary Income

+ [a.sub.2] Temporary Government Spending

+ [a.sub.3] Term Limit

+ [a.sub.4] Electoral Cycle

+ [a.sub.5] Pct 65 or over

+ [a.sub.6] Percent Non-Defense Spending

+ [a.sub.7] 1921 Budget Act

+ [a.sub.8] 1974 Budget Act

+ [a.sub.9] 1985 GRH Act

+ [a.sub.10] 1993 Deficit Act

+ [a.sub.11] Split Congress

+ [a.sub.12] Party-President

+ [a.sub.13] Party-House

+ [a.sub.14] Split Government

+ [a.sub.15] Fed Transfers.

The tax smoothing hypothesis implies [a.sub.1] < 0, [a.sub.2] > 0. The political strategy literature on term limits implies [a.sub.3] < 0 if limits are measured by likelihood of reelection and [a.sub.3] > 0 if term limits are measured by dummies when limits are binding. We can attach no a priori signs to the specific electoral cycle dummy so that [a.sub.4] is unsigned. Interest group explanations imply [a.sub.5] and [a.sub.6] > 0. [a.sub.7], [a.sub.8] > 0 if the 1921 and 1974 Budget Acts increased deficit spending, and [a.sub.9], [a.sub.10] < 0 if the deficit reduction acts actually reduced deficits. The split Congress and government control variables should have positive signs, [a.sub.11], [a.sub.14] > 0. The effects of party control, [a.sub.12] and [a.sub.13], may be positive or negative. Fed Transfers is expected to have a negative sign.

Table 1 reports the full model for percent changes in Debt/P as well as when the insignificant variables are excluded and when only the tax smoothing variables are included. We estimate the models by OLS and include the lag of percent changes in Debt/P to adjust for autocorrelation. The sample period now runs from 1896-1998 because the earlier years are lost in computing the Kalman filter residuals. Also, we checked for effects of lagged values of continuous variables. For temporary income the first lag was significant, whereas contemporaneous values were not, so we included lagged temporary income. Using Johansen cointegration tests, neither of the nonstationary regressors, Percent 65 and over or Fed Transfers, are cointegrated with the level of Debt/P. The diagnostic measures indicate uncorrelated and stable residuals.

Overall, the full model explains 83% of the variation in primary deficits. Removing the insignificant regressors lowers this to 81%. The tax smoothing variables, along with the lagged dependent variable, account for 77% of the movements in Debt/P. The residual diagnostics indicate an autocorrelation problem when the political variables are absent. We discuss the contribution of the political variables in more detail below.

The temporary income measure using the Kalman filter residuals is negative and significant below the 1% level in the three equations. Although statistically significant, the effect is not large. A two standard deviation increase in temporary income (0.12) increases real primary deficits by 0.04, or only about one-third of a one-standard-deviation change for the largest coefficient value in the three specifications.

Temporary government spending changes have a positive coefficient that is significant below the 1% level in the three equations. In contrast to temporary income, temporary spending has a large effect on primary deficits. A two-standard-deviation increase in temporary spending (about 0.07) increases real primary deficits by 0.20, or more than one and one-half times a one-standard-deviation increase. (14)

The effect of term limits as measured by our estimate of the likelihood of reelection is included in the first specification in Table 1 and is not significantly different from zero. We consider this variable further later. The electoral cycle variable does not appear at a significant level, confirming the results on opportunistic electoral cycles in Alesina et al. (1997). (15)

The interest group-related variable, Percent Non-Defense Spending, is highly significant (1% level) in both specifications in which it appears. Its effect is slightly larger than that of temporary income. It would take about six years of one-standard-deviation increases (0.02) in this variable to approach a one-standard-deviation increase in primary deficits. The other interest group variable, changes in the size of the elderly population, does not appear to matter to deficit formation.

Of the political variables listed in Table 1, separate control of the two houses of Congress exhibits a highly significant and relatively large positive influence. Separate control for two years is predicted to increase primary deficits by over one standard deviation. In contrast, split control of Congress and the presidency does not have an effect. This would imply that the cost of congressional deals in the budget process are more critical than deals between the legislative and executive branches. In other words, Congress sets the budget, not the president. Also, the party in control of the presidency or House, along with the legislative changes with respect to budgeting or deficits, do not have a measurable impact on Debt/P Finally, the Fed transfers variable is negative but insignificant at the 10% level. This is in keeping with the fact that Fed transfers have been small in relation to total spending.

Additional Specifications

The results presented above test several of the most prominent explanations of deficits. However, in some cases data limitations restrict our ability to estimate the influence of certain variables over the entire time frame. In other cases additional measurement issues arise regarding the variables we include.

Another measurement problem, mentioned earlier, pertains to presidential term limits. Using, as we did, a dummy variable equal to 1 only for the presidents for whom constitutional restrictions on another term were binding is a strong assumption. The only terms for which this measure equals 1 is Eisenhower II, Reagan II, and Clinton II. The likelihood of another term for all other presidents is assumed to be equal and given the qualitative value of 0. Yet only 2 of 12 presidents who served all or part of two terms of office chose to run again--Theodore Roosevelt and Franklin Roosevelt--and only Franklin Roosevelt ran for more than two consecutive terms. Seemingly, the tradition of two terms adopted by Washington and Jefferson served as a disincentive on seeking a third term for most future two-term presidents, although it was not a constitutionally binding constraint until after Franklin Roosevelt. (18)

We used the percentage of federal expenditures on nondefense items as a measure of interest group influence. More detailed components of spending, such as transfers, are another potential measure. However, a consistent time series on transfer spending does not exist prior to 1940. Likewise, data availability prior to 1929 also limits our ability to test the effects of levels of state and local government budget deficits on federal deficits.

To examine the effects of these variables with the available data, we added transfer spending as a percentage of total federal spending to specification (2) of Table 1 in place of nondefense spending and estimated the model for 1940-98. Unlike percent changes in nondefense spending, transfer spending is not stationary in levels over this period, so we use first differences. (16) We also added percentage changes in real state and local deficits to specification (2) of Table 1 and estimated the model for 1929-98. Both variables are insignificant. (17)

Further, as Alesina and Tabellini (1990) noted in their theoretical model of term limits and deficits, the appropriate measure is one indicating the likelihood of another term for the incumbent. Not only would such a measure capture the effects of term limits, whether constitutionally imposed or influenced by tradition, but it would also distinguish between first-term presidents who faced different likelihoods of a second term. For instance, a 1931 or 1932 estimate of the probability of Herbert Hoover returning for a second term in office would be far lower than a 1964 estimate of the probability of Lyndon Johnson returning after the 1964 election.

Based on these ideas, we constructed two alternative measures of term limits and substituted them for the binding constitutional measure in our primary deficits equation. However, like the basic constitutional term limit variable, these alternatives had small coefficients with high P-values. (19)

Presidential Administration Effects

Figure 2 presents the residuals from the second specification in Table 1 to assess whether real primary deficits were relatively high or low during specific presidential administrations. In other words, given the values for the explanatory variables, were deficits especially large during a given president's tenure?

The evidence in Figure 2 does not indicate that the residuals were consistently high for any particular administration. A few of the years during or after was fall outside the two standard error limits, but no others do. The late Reagan, Bush, and Clinton years exhibit positive residuals, but all are around the one standard error level or less.

The Role of Political Variables: The 1980s

One lingering question both in the popular press as well as the economic literature has been: Why did we have persistent deficits over the last quarter century? Much of the attention has focused on the experience of the 1980s in particular. To consider whether the model above can account for the behavior of deficits over this time frame, we reestimated the second specification from Table 1 for 1896-1970, as well as a simpler version that includes only the tax smoothing variables, temporary income and spending, and lagged deficits while excluding the political variables, the nondefense spending ratio, and split control of Congress. We then generate out-of-sample forecasts for 1971-98 using both versions. These forecasts are dynamic, using the forecasted values for lagged deficits so that errors in the forecasts are compounded. For 1896-1970, all of the variables are significant at the 1% level in both versions.(20)

The graphs of the 95 percent confidence intervals for these out-of-sample forecasts appear in Figures 3 and 4 along with the actual percentage changes in Debt/P for 1971-98. As Figure 3 shows, the upper limit of the forecast from the model without the political variables is either at or below the size of actual deficits during the 1980s; that is, it undepredicts deficits over several years in the 1980s and for at least one year in the 1990s. In contrast, Figure 4 shows that the model with the political variables over-predicts deficit growth through several years in the 1980s, with actual deficits approaching or exceeding the upper limit of the forecast only in the 1990s. These results indicate that the deficits of the 1980s might in fact have been smaller than expected. Of special note is the fact that the nonpolitical version of the model include the variables on which the deficit growth of the 1980s is usually blamed, that is, the temporary reductions in income due to recession in the early 1980s and the te mporary increases in government defense spending.

Tax Smoothing and Symmetry of Shocks

One limitation of the estimates presented in Table 1 is that the linear coefficients estimated for temporary income and government spending provided only partial information about the tax smoothing hypothesis. A linear coefficient imposes an implicit restriction of symmetry on the effects of increases and decreases in the temporary series; asymmetrical effects between increases and decreases in either temporary series are ruled out. For example, if governments respond to short-lived events requiring increased spending more so than for short-lived events requiring lower spending, a linear coefficient will not detect this effect.

To estimate a version of the model that allows for asymmetric effects of the temporary series, we first computed two new variables from the existing series. One series contains only positive values with the years of negative values equal to 0; that is, positive temporary spending and positive temporary income. The other series contains only negative values with the years of positive values equal to 0; that is, negative temporary spending and negative temporary income. We then reestimated the model (the second column) from Table 1 with these four temporary measures. The coefficients and standard errors for the temporary income and spending variables are listed in Table 2. (The coefficients for the other variables and the diagnostic measures are listed in note 21 and are nearly identical to their prior values). (21) Also listed in Table 2 are F-statistics testing the null hypotheses of equality of the positive and negative measures for each temporary series both independently and jointly. The coefficients for t he temporary income measures are negative and very similar in magnitude, whereas the coefficients for the temporary spending series are both positive, but the positive spending series has a coefficient about 1.35 times as large as the negative spending coefficient. However, none of the F-tests rejects the null of coefficient equality, indicating a high degree of symmetry between temporary increases and decreases in spending and income.

V. CONCLUSION

Our basic finding is that tax smoothing is important in explaining primary debt movements, even with symmetrical effects between debt-increasing and debt-decreasing influences. However, holding tax smoothing or Ricardian equivalence factors constant, there are pertinent political and interest group effects on U.S. deficits. In fact, our model suggests that deficits in the 1980s might have been smaller than expected; that is, the model with the significant political and interest group variables included overpredicts deficit growth in the 1980s. Finally, our results call into question the importance of time-consistency considerations in accounting for the deficits of the Bush and Clinton administrations. Deficits during the Reagan years were lower than predicted by the model but higher than predicted for the Bush and Clinton years.

APPENDIX

TABLE A1

Decriptive Statistics for Continuous Variables

Variable Mean SD Maximum Minimum

Change in log 0.048 0.13 0.76 -0.21
 (Debt/P)
Temporary 0.030 0.06 0.19 -0.16
 Income
Temporary -0.001 0.033 0.18 -0.127
 Spending
Change Pct 65 0.0008 0.00007 0.002 -0.0001
 and Over
% Non-Defense 0.519 0.14 0.786 0.066
Change in Fed 0.000 0.0003 0.0009 -0.001
 Transfers

[FIGURE 1 OMITTED]

[FIGURE 2 OMITTED]

[FIGURE 3 OMITTED]

[FIGURE 4 OMITTED]

TABLE 1

OLS Estimates for Percent Changes in Debt/P, 1896-1998

Variable Coefficient/(P-value) (a)

Tax smoothing variables
 Temporary Income (lagged) -0.30/(0.01) -0.29/(0.01)
 Temporary Govt Spending 2.94/(0.01) 2.86/(0.01)
Political strategy variables
 Term Limit 0.005/(0.83)
 Electoral Cycle 0.001/(0.66)
Interest group variables
 Percent Non-Defense 0.13/(0.01) 0.14/(0.01)
 Change % 65 or Over -0.30/(0.97)
Institutional variables
 Split Congress 0.06/(0.01) 0.07/(0.01)
 Split Government 0.001/(0.78)
 Party/President 0.006/(0.71)
 Party/House -0.006/(0.69)
 1921 Act 0.001/(0.98)
 1974 Act -0.001/(0.90)
 1985 Act 0.02/(0.44)
 1993 Act 0.03/(0.34)
 Change Fed Transfers 31.90/(0.01)
Other
 Lagged Dep. VAR 0.47/(0.01) 0.50/(0.07)
 Intercept -0.03/(0.24)
Summary measures
 [R.sup.2] 0.83 0.81
 Durbin-Watson 1.88 1.72
 Box-Pierce Q (12) 10.0/(0.60) 8.75/(0.72)
 Serial LM F (2) 0.36/(0.72) 1.39/(0.27)

Variable Coefficient/(P
 -value) (a)

Tax smoothing variables
 Temporaty Income (lagged) -0.35/(0.01)
 Temporary Govt Spending 2.78/(0.01)
Political strategy variables
 Term Limit
 Electoral Cycle
Interest group variables
 Percent Non-Defense
 Change % 65 or Over
Institutional variables
 Split Congress
 Split Government
 Party/President
 Party/House
 1921 Act
 1974 Act
 198S Act
 1993 Act
 Change Fed Transfers
Other
 Lagged Dep. VAR 0.48/(0.01)
 Intercept -0.04/(0.00)
Summary measures
 [R.sup.2] 0.77
 Durbin-Watson 1.43
 Box-Pierce Q (12) 13.74/(0.31)
 Serial LM F (2) 5.57/(0.01)

(a)P-values are the likelihood of finding a t-statistic greater than the
absolute value of the observed t under the null hypothesis of zero.
Values of 0.01 reflect rounding up from smaller numbers.
TABLE 2

Testing for Asymmetries in Temporary Spending and Income

Variable Coefficient/SE

Positive Temporary Income -0.29 0.15
Negative Temporary Income -0.25 0.22
F-statistic for Equality of 0.02
 Temporary Income (0.88)
Positive Temporary Spending 3.19 0.28
Negative Temporary Spending 2.35 0.39
F-statistic for Equality of 2.38
 Temporary Spending (0.13)
F-statistic for Equality of 1.19
 Temporary Income and (0.31)
 Spending

Notes: P-values for testing null hypotheses of equality appear in
parentheses. Model is based on specification 2 listed in Table 1.

(1.) The main attempt at evaluating different theories of deficits is Alesina and Perotti (1994). They review the leading explanations and attempt to explain cross-national differences in deficits with these explanations. Their results indicate that political parties and budgetary institutions or procedures are the most important factors. While questions of cross-national differences are important, focusing on U.S. data allows for a broader investigation of the various hypotheses, more detailed controls for U.S. idiosyncrasies (such as legislative changes), and the use of a longer time series of data.

(2.) Lucas and Stokey (1983) developed a tax smoothing model of deficits from a basic labor-leisure choice model, and Sahasakul (1986) offered evidence directly from tax rates. Several articles have extended the tax smoothing approach to include Federal Reserve policy. These include Mankiw (1987), Porterba and Rotemberg (1990), Trehan and Walsh (1990a, b), and Goff and Toma (1993).

(3.) These two models differ in various details such as attention to the composition versus the level of spending, inclusion versus exclusion of voting and open versus closed economy. Additional theoretical and empirical contributions in this area include Fisher (1980), Tabellini and Alesina (1990), Cram and Tollison (1993), and Besley and Case (1995).

(4.) Alesina et al. (1997) covered this issue extensively. Earlier contributions include Alesina and Roubini (1992), Rogoff (1990), Harrington (1993), Toma (1982), and Persson (1988).

(5.) Alesina and Perotti (1996) survey institution-based explanations.

(6.) Also see Wildavsky and Caiden (1997).

(7.) Federal Debt Outstanding to 1984 is from Office of Public Debt Accounting Web site (www.publicdebt.treas.gov). Updates to 1998 are from Table 7.1 of Historical Tables, Budget of U.S. Government FY 1988. We use gross national product (GNP) rather than gross domestic product (GDP) because of access to a series dating to 1889. Other data on GNP, Consumer Price Index (CPI), Fed transfers, percent nondefense spending, and percent over age 65 were collected from Historical Statistics of the U.S. to 1970 (through 1939; Bureau of the Census, 1975) and Economic Report of the President (various years) thereafter. The CPI is 1982-84 = 100 with conversions from Historical Statistics where 1967 = 100. A copy of the data is available on request.

(8.) Using either the augmented Dickey-Fuller (ADF) or the Phillips-Perron tests, the null of nonstationarity can be rejected at the 1% level for percentage changes in real primary debt. The same hypothesis for the level of real primary debt cannot be rejected at even the 10% level and exhibits large and positive autocorrelation at very long lags.

(9.) These statements are based on Goff (1998) as well as unpublished evidence. In his 1986 paper, Barro acknowledges the problem of permanent components in his "temporary" series and relies on a method developed by Sahasakul (1986) to derive his temporary series. Using this method, the temporary income series cannot reject the null of nonstationary at even the 10% level according to the ADF tests (four lagged difference terms), and the temporary spending series cannot reject at the 5% level. Both series show a large persistence of a 1% shock even at horizons of 20 years according to Cochrane's (1988) nonparametric procedure.

(10.) For both temporary series, the null hypothesis of nonstationary can be rejected below the 1% level using the ADF or the Phillips-Perron methods. Persistence is very low--the ADF for temporary spending is significant only at lag 1 (0.23) and falls off below 0.02 at lag 2, and temporary income is significant only at lag 1 (0.19) and falls to below 0.01 for lag 2. For government spending, we fit a time-varying coefficient model with a constant, a time trend, and a lagged spending term. The coefficients are estimated assuming some but not permanent persistence of shocks. For income (real GNP), we fit a time-varying coefficient model with a constant, where the coefficient assumes permanent shocks. In both cases, the error terms across equations are assumed to be uncorrelated for both the observation and state equations. The residuals from the one-step-ahead forecasts are used as the temporary series. All series were generated using the State Space procedures with Eviews 3.1.

(11.) Recognizing the severity of this all-or-nothing restriction, Alesina and Tabellini (1990) incorporated a probabilistic approach to reelection in their theoretical piece.

(12.) The fraction of the population over age 65 is stationary only in its first differences, and the ratio of nondefense spending to total federal spending is stationary in levels. Both the ADF and Phillips-Perron tests reject nonstationary spending at the 5% level.

(13.) The ADF and Phillips-Perron tests for levels could not reject nonstationarity at the 10% level but do reject it at 1% for changes. The "independence of the Fed" question is relevant here. If the Fed is predominantly an extension of overall revenue policy, as examined in Mankiw (1986) and the related literature, then this variable should be subtracted directly from the debt measures. If the Fed is predominantly autonomous in its decisions, this variable belongs on the right hand side. For the United States, its magnitude is small enough not to be critical regardless of where it is placed in the equation.

(14.) We also generated results using the Hodirick-Prescott filter to produce the residual income and spending series. This filter is not as flexible as the Kalman filter and tends to standardize residuals more, but it does permit a nonconstant trend. While statistically significant, these alternative residuals are not as powerful in explaining real primary debt changes. The [R.sup.2] falls from 81% using the Kalman filter to 52% using the Hodrick-Prescott filter. A copy of these results is available on request.

(15.) The empirical literature on opportunistic cycles is extensive and mixed. Tufte (1978) and others have presented evidence supporting them. However, studies that have included more extensive ceteris paribus conditions, as here, have not been as favorable as those with more limited controls.

(16.) The ADF statistic is -0.78, and the 5% critical level is -2.91.

(17.) The transfer spending coefficient was -0.14 with a P-value of 0.54. The state and local debt coefficient was 0.0004 with a P-value of 0.27. A copy of these results is available on request.

(18.) Although not a constitutional or statutory constraint, the customary limit of two terms was explicitly discussed. At the end of his second term in 1808, Thomas Jefferson openly referred to it and later praised Madison and Monroe for adhering to it. The (Republican-controlled) U.S. House adopted a resolution in 1875 calling for observance of the two-term limit in the middle of a Republican president's (Ulysses S. Grant) second term. See Palmer (2000).

(19.) The first measure equaled 1 for second-term presidents who had served at least half of the first term, except for Franklin Roosevelt, and 0 otherwise (including FDR). When substituted for the constitutional limit in the second specification of Table 1, the coefficient is 0.006 with P-value of 0.67. The second measure estimates the likelihood of reelection using the past election return for year 1 of a term, the next election return for year 4 of a first-term incumbent running for reelection, linear interpolations for years 2 and 3, and zero for years for second-term incumbents (other than FDR). The estimated coefficient is less than 0.001 with a P-value of 0.99. A copy of these results is available on request.

(20.) The (coefficients/P-values) for the 1896-1970 period are as follows: Temporary Spending (2.94/0.01), Temporary Income (0.029/0.01), Percent Non-Defense (0.15/0.01), Split Congress (0.10/0.01), Lagged Deficits (-0.49/0.01), and Constant (-0.05/0.05). The [R.sup.2] = 0.85, and the Q-statistic = 12.35 (P = 0.42). A copy of these results is available on request.

(21.) The (coefficients/P-values) for the other variables are as follows: Percent Non-Defense Spending (0.17/0.01), Split Congress (0.07/0.01), Lagged Deficits (0.47/0.01), and Constant (-0.06/0.03). The [R.sup.2] = 0.82, and the Q-statistic = 10.78 (P = 0.54). A copy of these results is available on request.

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ABBREVIATIONS

ADF: Augmented Dickey-Fuller

CPI: Consumer Price Index

GDP: Gross Domestic Product

GNP: Gross National Product

NPG: No Ponzi Game

OLS: Ordinary Least Squares

Robert D. Tollison *

* We thank Tony Caporale, Randy Krozner, and other participants in the Macro Political Economy session at the Public Choice Society meetings for comments. We also thank Mark Cram and W. F. Shughart II for comments. The comments of the referees were also extremely useful. The usual caveat applies.

Goff: Professor, Economics Department, Western Kentucky University, Bowling Green, KY 42101. Phone 1-270-745-3855, Fax 1-270.745-3190, E-mail brian.goff@wku.edu

Tollison: Robert M. Hearin Professor of Economics, Department of Economics, University of Mississippi, University, MS 38677. Phone 1-662-915-5041, Fax 1-662-915.5087, E-mail rtollison@bus.olemiss.edu