Fiscal Policy: What a Difference a Recession Makes
Tallman, Ellis, EconSouth
Fiscal policy is in the news again, and projections of a resurgence in federal fiscal deficits are making headlines. In contrast, detailed analyses of federal tax and spending policies--the key, active components of fiscal policy--are relegated to editorials and business sections' back pages. So what does a reprise of federal budget deficits imply about the state of fiscal policy? Budget deficits are not the problem; they are really only a symptom (that is, the excess of spending over revenues). Instead, we should think carefully about spending and tax policies that can produce deficits. More importantly, we should consider the economic incentives that tax and spending policies present taxpayers, both firms and consumers.
What happened to the surplus?
By 1999 the huge federal budget deficits of the 1980s and early 1990s were becoming a distant memory. The apparent disappearance of fiscal deficits at that time was perceived as good news in its own right. But what a difference a recession makes! The fiscal surplus in 2000 was $236 billion; for 2002 the unified deficit hovers around $159 billion. (Both of these figures include the Social Security surplus.)
The recession surely contributed to the reversal in fiscal balances, but fiscal policy actions also played a role. The currently projected federal budget deficit reflects the implementation of new fiscal initiatives (the tax cut in President Bush's 2001 legislative agenda and the Economic Recovery Act of 2002, which passed in March) along with the systematic responses from the so-called automatic stabilizers. These stabilizers, including unemployment insurance and lower tax revenues, took hold as the economy weakened.
Unfortunately, it's hard to know with much certainty how big these cyclical effects are and how long they'll last. In general, unpredictable fluctuations in the business cycle and in economic growth can generate large errors for federal deficit forecasts. …