Looking forward, as one can see from the chart above, CBO projects that the cyclically-adjusted deficit will decline from a high of 7.1 percent of potential GDP in 2009 to 0.4 percent in 2015 before rising to 2.9 percent by 2018. In this business cycle, the decline in the cyclically-adjusted budget deficit since 2009 represents both specific policy changes (discretionary spending caps and tax increases) and the fading out of things like the 2009 stimulus.
Conversely, when the economy is operating at full potential, they are often inclined to reduce deficits through policy changes, like what happened in the 1990s. This is because automatic stabilizers do not count discretionary use of fiscal policy that policymakers often resort to during recessions. One thing to note about these numbers is that even when automatic stabilizers are accounted for, the remaining deficit sometimes follows the business cycle as well.
Note that for future years, these estimates use current law assumptions. The chart below shows the difference between automatic stabilizer-inclusive and automatic stabilizer-exclusive deficits since 1960. The CBO expects the output gap to remain around $1 trillion through 2014, when it will decline until it is closed by mid-2017. This is not surprising, as we have had an output gap of about $1 trillion annually since 2009, or around 6 to 7 percent of potential GDP. Examples of automatic stabilizers include income and payroll tax revenue falling as incomes fall during a recession and spending on safety net programs increasing as more people turn to them for assistance.ĬBO finds that automatic stabilizers in recent years have been higher as a percent of potential GDP - in the 2.5 to 3 percent range - than at any other time since 1960 with the exception of a few years following the early 1980s double dip recession. The report shows the effect that automatic stabilizers - features of the budget that tend to automatically push up/down spending and revenue based on cyclical economic effects - have had and what the budget would look like assuming that the economy is operating exactly at its potential. Most economists do not believe that Ricardian equivalence characterizes consumers’ response to tax changes.Last Friday, the CBO released a report showing how much the business cycle has affected budget deficits since 1960. But if consumers decide to spend some of the extra disposable income they receive from a tax cut (because they are myopic about future tax payments, for example), then Ricardian equivalence will not hold a tax cut will lower national saving and raise aggregate demand. If these economists were right, then my earlier statement that budget deficits crowd out private investment would be wrong. The extreme of this argument, known as Ricardian equivalence, holds that tax cuts will have no effect on national saving because changes in private saving will exactly offset changes in government saving.
Recognizing that a tax cut today means higher taxes in the future, the argument goes, people will simply save the value of the tax cut they receive now in order to pay those future taxes. Some economists have argued that this effect of fiscal policy on future taxes will lead consumers to change their saving.