Fiscal Policy (Encyclopedia of Business and Finance)
Fiscal policy is manifested in a government's policies on taxation and expenditures. To obtain funds for their operation, government units generally collect some form of taxes. The expenditure of these funds not only provides goods and services for constituents, but has a direct impact on the economy. For example, if expenditures are larger than the funds received by the government, the resulting deficit tends to stimulate the economy, as goods and services are produced for government purchase. In contrast, if a government runs a surplus by not spending all the funds it collects, economic growth will generally be curtailed, as the surplus funds are removed from circulation in the economy.
THE FEDERAL BUDGET
In the United States, the fiscal process of the federal government begins each February with the president sending to Congress a proposed federal budget for the coming fiscal year, which begins in October. Congress then develops a budget resolution, which is to be completed by April. The budget resolution contains overall revenue and spending budgets as well as the budgeted amount of discretionary and mandatory spending for each functional area, such as national defense. Mandatory spending is required by prior legislation, while discretionary spending must be approved during the current year's legislative process. The majority of all federal government spending is mandatory spending for established programs.
Using the budget resolution as a guide, bills that provide budget authority for annual discretionary spending must be completed by June each year. Legislative changes can also be made to mandatory spending or tax provisions at this time. However, any legislation that would cut taxes or increase mandatory spending must be accompanied by legislation that would raise revenue or cut spending in other areas to pay for these changes. Consequently, any new legislation in this area must be "budget-neutral."
In fiscal 1998, the federal government had receipts of $1,721 billion and expenditures of $1,651 billion, leaving a surplus of $70 billion. This was the first surplus recorded by the federal government since 1969, ending almost thirty consecutive years of deficits. During this time, the nonstop annual deficits forced the U.S. government to borrow additional money each year to make up the difference between the federal government's receipts and outlays. As a result, the outstanding federal debt reached roughly $5.5 trillion in 1998, representing more than $20,000 per citizen of the country. Paying the annual interest charges on this debt consumes a significant portion of the federal budget.
FEDERAL GOVERNMENT REVENUE
Individual income taxes have been the federal government's largest source of funds for many years. In 1998, $829 billion in individual income taxes were collected, comprising 48 percent of the federal government's receipts. Robust economic growth in the 1990s steadily increased individual income tax payments and was a large factor in turning the mushrooming deficits of the prior thirty years into a surplus in 1998, as tax collections grew faster than government spending.
Social Security taxes, which are paid by most workers in the United States, are the other major source of funds for the federal government. In 1998, payments of $540 billion were made into the Social Security system. These taxes, which are a percentage of a worker's wages, have increased substantially as a result of a growing work force in the 1990s with many workers in their peak earning years.
FEDERAL GOVERNMENT EXPENDITURES
The enormous impact of the Social Security system on the federal government's budget is demonstrated by the fact it is the largest outlay of the federal government each year. In 1998, almost 23 percent of federal government expenditures were payments of monthly benefits to families of retired and disabled workers. In 1940, in the early years of the Social Security program, there were only 222,000 beneficiaries receiving a total of $35 million a year in benefits. By 1998, the federal government was sending $379 billion to almost 45 million Social Security beneficiaries. When these payments are coupled with the burgeoning cost of Medicare, which generally provides health insurance for the same individuals who receive Social Security benefits, it means that the United States spent over 35 percent of the federal budget on this group of retired and disabled individuals in 1998. With the increased life expectancy of senior citizens and the large number of baby-boomers nearing retirement age, Social Security and Medicare will continue to consume a large part of the federal budget dollar in the foreseeable future.
Defense spending is the largest item of discretionary spending in the federal budget. In 1998, $270 billion, 16 percent of the federal budget, was spent on the armed forces of the United States. With an ever-larger portion of the federal budget being consumed by mandatory spending programs, defense spending has been the target of budget cuts since the resumption of normalized relations with the countries that constituted the former Soviet Union.
Interest on the federal government's debt is the other major federal government outlay, in 1998 requiring $243 billion in net interest payments on the federal debt, which exceeded $5 trillion. Declining interest rates and reduced federal government borrowing, however, have slowed the growth of this budget item.
IMPACT ON THE ECONOMY
As discussed previously, the federal government's policies on taxes and spending have a large impact on the economy. The economic theory of the famous English economist John Maynard Keynes advocates the use of the government's fiscal policy to offset imbalances in the economy. According to Keynes, a government should use fiscal policy to stimulate an economy slowed by a recession by running a deficit, that is, by spending more than it takes from the economy in taxes. On the other hand, to slow down an economy that is threatened by inflationary pressures, Keynes urged increasing taxes or cutting spending to create a budget surplus that would act as a drag on the economy.
Keynes thought fiscal policy could be an automatic stabilizer for the economy because it automatically responds to changes in economic activity. Government spending on items such as unemployment benefits generally increases during a recession, whereas government receipts such as income taxes will fall during a recession, moderating the extremes of the business cycle. Consequently, fiscal policy, along with monetary policy, which is dictated by the Federal Reserve, has an important influence on the health of the economy in the United States.
IMPACT ON FOREIGN COUNTRIES
The impact of fiscal policy in the United States extends far beyond the country's borders. For ex ample, top marginal income tax rates in this country have declined substantially since the late 1970s, when they were as high as 70 percent. This reduction in top rates has made it difficult for Canadian companies to attract and retain key executives because Canadian income taxes on high-income individuals are now substantially greater than in the United States. Even Canadian hockey teams have found that higher income tax rates north of the border encourage many of their players to flee to teams based in the United States, where they can retain a larger portion of their earnings. Consequently, even the balance of power in the National Hockey League is influenced by the fiscal policy of the U.S. government.
A Citizen's Guide to the Federal Budget: Budget of the United States Government, Fiscal Year 1999. (1999). Washington, DC: Executive Office of the President.
Baker, Dean. (1995). Robbing the Cradle?: A Critical Assessment of Generational Accounting. Washington, DC: Economic Policy Institute.
Bruce, Neil. (1998). Public Finance and the American Economy. Reading, MA: Addison-Wesley.