Fiscal Fitness

Much is written these days concerning the federal budget, deficits, debt and fiscal prudence. The relationship of the budget to the level of economic activity is not well understood by many of the writers. I hope to subtract from the current confusions.
Once we opted for an income tax (1913) as a source of revenue, the revenue side of the budget became more sensitive to the business cycle. As the progressivity of the income tax increased, this sensitivity increased. Economic expansions and contractions moved segments of the population among the various income tax brackets and increased the sensitivity of government revenues to the ebbs and flows of economic activity. The transfer payment components of the budget, such as unemployment compensation, also behave in a countercyclical manner, increasing during recessions and declining during booms. Social Security payments are also mildly countercyclical, expenditures don’t decline during recessions or increase during booms, whereas revenues into the fund increase during booms and decrease during recessions. The same is true of Medicare. In summary, the inherent logic of the federal financing system is counter-cyclical and therefore stabilizing to the macro economy. This seems to me to be desirable. We do not want a budget structure that enhances rather than constrains the cyclical variability of our market economy.
 A balanced budget at this stage in the recovery would be counterproductive. One need only review the record on the Roosevelt Recession of 1937 to see what premature prudence (that’s about as racy as economics gets) can do to a strong recovery, let alone a slow recovery. In the post WW2 period up to 1960 the federal budget was roughly balanced, with years of deficits balanced by years of surplus. In a Keynesian world that was how it was supposed to work. He advocated cyclically balanced budgets with surpluses during booms and deficits during downturns. He underrated the ability of democratic governments to enshrine structural deficits. Since the 1960s deficits have been the rule and have become structurally embedded in the federal financial system. This has also been true in Western Europe. On the spending side we have the entitlement system with Medicare and Medicaid posing serious problems in the short-and medium term, and Social Security posing a long-term problem. Our unfunded obligations exceed $60 trillion
. On the revenue side the tax structure that emerged from the Bush Administration is inconsistent with balanced budgets or surpluses under any known economic projections and unfunded mandates were expanded. Both political parties share in this dilemma. A realistic financial solution that is politically feasible will involve revenue increase and expenditure constraint. The ugly politics involves how the pain is to be distributed.
Maybe it’s our fault. Economic growth has allowed us to postpone the date of unsustainability for a very long time, and we’ve made few demands of our legislators other than bringing home the bacon. But as Herbert Stein once observed, something that is unsustainable will not continue.
The cure  will result in a budget that generates a surplus during booms and deficits during recessions and a balanced budget in a Goldilocks economy. This behavior says nothing about the share of federal revenues and expenditures to the GDP. That is a philosophical argument dealing with the role of government in society.
 Expansive welfare states in Europe have government shares well in excess of 40% of their GDPs and they provide greater services to their constituents than we do. They are also quite prosperous and have shown the ability to grow at rates comparable to us. In the west economic performance and government size are not strongly correlated. Sorry.