Economic Snapshot | Budget, Taxes, and Public Investment

The budget surplus and business investment

A weekly presentation of downloadable charts and short analyses designed to graphically illustrate important economic issues. Updated every Wednesday.

Snapshot for September 20, 2000

The budget surplus and business investment
The best use of the federal budget surplus has become a popular issue of debate in Washington politics over the past few years. One widely held opinion states that we need to use the surplus to reduce the government debt, so that interest rates can fall and investment can rise. In other words, government savings will help to ease potential financial market constraints for firms because households are not saving enough.

Unfortunately, the available evidence doesn’t support such a theory. Between 1991 and 1999, business investment rose from 10% of GDP to 13%, thereby recovering most of the ground lost during the 1980s. However, on average, more than 82% of the capital expenditures by U.S. corporations were paid for out of retained earnings and capital consumption (or depreciation). Other sources of savings, such as personal savings or foreign investors, played a much smaller role (see Figure 1 below). Furthermore, the government didn’t begin to accumulate a surplus until 1999, when the surplus covered 0.5% of business investment. In other words, fiscal austerity has most likely not directly contributed to the investment boom of the late 1990s.

Sources of savings relative to investment

There is, however, the claim that fiscal austerity has helped to reduce interest rates and thus contributed to the investment boom. Two facts speak against this claim. First, when government deficits were declining, real interest rates rose slightly. Second, in the face of rising interest rates, businesses began to issue more bonds to finance their investments (see Figure 2 below). In other words, business investment does not appear to be very sensitive to interest rate changes. Consequently, these changes in government borrowing seem to have no effect on investment.

Government finance and business investment

This week’s Snapshot by EPI Economist Christian E. Weller.

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