United States: Fiscal Policy

Background:

The U.S. ran large fiscal deficits in the late 1980s and early 1990s. The deficit shrank significantly during the late 1990s and moved to a surplus during 1998-2001. Notwithstanding rising entitlement spending and the 2001-2003 tax cuts, the fiscal deficit remained low during 2002-2007 as strong economic growth boosted revenues from the corporate and financial sectors. While cyclical factors such as plunging revenues due to the recession and high stimulus spending have raised the U.S. fiscal deficit during 2009-10, the deficit also suffers from structural problems—loose fiscal policy during the boom years, delayed tax and entitlement reforms and lack of political will to tackle the deficit. With an aging population and rising debt burden, an increasing share of government expenditure will be allocated to interest payments and entitlements in the coming years, reducing government's productive investment and crowding out private investment. Once the recovery sets in sustainably, the government needs to run a primary surplus by a combination of higher taxes and spending cuts. Not tightening the fiscal policy will raise the risk of waking bond vigilantes.