Fiscal Policy, Growth and Budget Deficits

This graph shows how federal budgets are affected by three things: tax policy; spending and the state of the economy. We had budget surpluses in the Clinton administration. They were the result of modest tax increases, cuts in defense spending and a booming economy which also increased revenue. The Bush administration deficits were the result of huge tax cuts, increased defense spending and poor economy. The Obama deficits reflect the continuation of the Bush tax cuts and the loss of revenue from a very weak economy. The increase in federal spending is also a consequence of higher transfer payments that occur in recession and the continuation of the military buildup in the mid-east that started under Bush.

The discussions that we see in Washington today about deficits concerns many economists. In the first place, its not good to balance the federal budget in the short term during a period of high unemployment. This will exacerbate the downturn and lead to declining tax receipts and higher short term deficits. Furthermore, eliminating the Bush tax cuts which solve 50% of budget shortfall and cutting back on expenditures in the mid-east, which do little to grow the economy, could also make a big dent in the deficits. In the longer term, the high cost of government funded healthcare is the major problem that we face. Social security is less of a problem. Of course, the economy must also grow at the projected rate so that tax revenues are not reduced. I don't see any proposals that will encourage economic growth, and there is strong resistance against significant cuts in defense. We have midgets in Washington when we need giants.