How Fracking Can Reduce the Budget Deficit

The direct way fracking can reduce the budget is by stimulating economic activity and thus tax revenues. This is obvious.

This piece is about another, less obvious, less intuitive, indirect way fracking can reduce the budget deficit. It is based on the fact that the sum of the budget deficit, the capital inflow to finance the trade deficit, and the difference between domestic saving and domestic investment equals zero. If you expand or shrink any of these three imbalances, it puts pressure on the others to expand or shrink to maintain the net zero balance.

As fracking expands domestic oil and gas production, it likely will reduce U.S. demand for energy imports and shrink our trade deficit. This reduces the net capital inflow required to finance the trade deficit. The reduced capital inflow will tend to reduce the gaps between domestic investment and saving and government expenditures and tax revenue—the deficit in question.

Let me back up and elaborate. Income minus consumption gives us saving, by definition. Income minus consumption also gives us investment, since investment represents output not consumed. Therefore, taking consumption out of the equation, total saving must equal total investment.

National saving is composed of personal saving, business saving, and government saving, i.e. an excess of tax revenue over expenditures. Personal saving, as we know, is low but positive these days. Business saving is moderately positive. However, net negative government saving (the budget deficit) overwhelms the others and make total national saving negative. Since we invest more than we save domestically, the saving deficit must be made up by importing foreign saving in the form of the capital inflow that finances the trade deficit. (See the postscript for a further explanation of this.

Therefore, I repeat, these three variables—the investment saving imbalance, the government spending-taxing imbalance and the inverse of the export-import imbalance are linked together (they total zero) and are mutually determined. Other things equal, the reduction in the trade deficit due to fracking will reduce imported capital and put pressure on investment relative to saving and government spending relative to taxing. At least some of the correction is likely to lead to a smaller budget deficit.

Got it?

P.S. In a closed economy with no government, income will adjust to make saving and investment equal in equilibrium. Introducing, government spending and taxing, the two injections into the income stream (other than consumption) will be investment and government spending while the two leakages will be saving and taxing. Therefore, the sum of the injections will equal the sum of the leakages in equilibrium, although there is no requirement for a separate balance of taxing and spending and saving and investment. Introducing foreign trade, exports become a third injection while imports become a third leakage. In equilibrium, investment plus government spending plus exports will equal saving plus taxes plus imports. In our recent past, the excess of government spending over taxes requires a net capital inflow (to finance the excess of imports over exports) to finance the excess of domestic investment over saving. If fracking reduces the excess of imports over exports the other two imbalances must adjust, thus putting downward pressure on the budget deficit.



Comments (6)

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  1. Brian Williams. says:

    Right on the mark, as ususal!

    Another idea to consider: According to the Institute for Energy Research, the federal government is sitting on $128 trillion worth of oil and gas. Why not sell off some of those assets to pay down the debt?

  2. Richard says:

    Interesting and thought-provoking post. Thanks!

  3. Paul Snickerson says:

    Yet another reason why I am in favor of fracking!

  4. Cindy says:

    Would this be true of any measure that reduces energy dependence, then, or is fracking somehow unique?

  5. Gabriel Odom says:

    Federal resources include:
    The 10.4 billion barrels of oil and 8.6 trillion cubic feet of natural gas in the Arctic National Wildlife Refuge, 86 billion barrels of oil and 420 trillion cubic feet of natural gas in the outer continental shelf of the lower 48 states, 896 million barrels of oil and 53 trillion cubic feet of natural gas in the Naval Petroleum Reserve-Alaska, 25 billion barrels of oil in the outer continental shelf of Alaska, 90 billion barrels of oil and 1,669 trillion cubic feet of natural gas in the geologic provinces north of the Arctic circle, and 982 billion barrels of oil shale in the Green River Formation in Colorado, Utah, and Wyoming.
    These technically recoverable resources total 1,194 billion barrels of oil and 2,150 trillion cubic feet of natural gas that is owned by the federal taxpayer. At $100.00 per barrel of oil and $4.00 per thousand cubic feet of natural gas, the oil resources are worth $119.4 trillion and the natural gas resources are worth $8.6 trillion for a grand total of $128 trillion, or about 8 times the U.S. national debt.

    Thanks to Brian for the link.

  6. Louise says:

    Wow. That’s eye-opening. Although it may not be that simple — energy production is an intensive process, many of these reserves are hard to get to, and the resources aren’t in their most easily usable form.

    Still worth looking into, in any case.