Twenty Years after Humphrey-Hawkins.

• Author: LIPFORD, JODY

An Assessment of Fiscal Policy

The combination of the Great Depression and the Keynesian revolution stripped most economists and politicians of their belief in the stability of the private economy and legitimized the use of stabilization policies to counteract macroeconomic fluctuations. Such policies gained legal standing and substance with the passage of the Employment Act of 1946 and the Full Employment and Balanced Growth Act of 1978 (Humphrey-Hawkins Act), both of which commit the U.S. government to use fiscal and monetary policies to achieve the goals of full employment, price stability, and economic growth.

Yet, since the passage of those acts, many economists have questioned the efficacy of stabilization policies. The dual challenges of rational expectations theory and Ricardian equivalence, in particular, gave rise to the possibility--or the certainty, according to some economists--of policy "neutrality." Although the determination of policy effectiveness, or the lack thereof, is surely important, the emphasis on these worthy questions has been misplaced. A more important question is whether stabilization policies are even implemented in congruence with short-run macroeconomic objectives. In this article I argue that political pressures in democratic government make the "proper" implementation of stabilizing fiscal policies highly improbable.(1) Specifically, pressures to satisfy constituents will consistently result in high levels of government spending, inadequate tax revenues to fund that spending, and the appeasement of politically effective interest groups, all of which supplant fiscal policies that might genuinely attenuate the fluctuations of the business cycle.

In what follows I briefly review the Employment Act of 1946 and the Full Employment and Balanced Growth Act of 1978, highlighting their emphasis on government's commitment to full employment, and then discuss criteria for effective stabilization policy and the obstacles to such policies in a democratic political setting. Next, I investigate whether fiscal policy since 1978 has been countercyclical and examine six key pieces of fiscal legislation to determine how well they meet the criteria developed earlier.

Macroeconomic Stabilization and Fiscal Policy Legislation

In the aftermath of the Great Depression and World War II, the national government undertook an unprecedented responsibility to promote the economic good of the nation, enacting the Employment Act of 1946. The act explicitly declares that "it is the continuing policy and responsibility of the Federal Government to use all practicable means consistent with its needs and obligations and other essentials of national policy ... to promote maximum employment, production, and purchasing power." To facilitate the achievement of this goal, the act required publication of the Economic Report of the President, created the Joint Committee on the Economic Report, and established the Council of Economic Advisors, which has the responsibility (among others) "to develop and recommend to the President national economic policies ... to avoid economic fluctuations or diminish the effects thereof." Writing from a historical perspective, Bradford De Long goes so far as to say that the act provided a "signal" that "an administration that failed to achieve acceptable macroeconomic performance was a failed administration" (1996, 51).

Reacting to the high unemployment and inflation of the 1970s, the federal government recommitted itself to the goals of full employment, economic growth, and price stability with the passage of the Full Employment and Balanced Growth Act of 1978. Like its predecessor, the act places the responsibility for macroeconomic performance squarely on the national government. Unlike its predecessor, however, the 1978 act set numerical targets of no more than 4 percent unemployment and 3 percent inflation by 1983, with the inflation target to be reduced to zero by 1988. In its discussion of the president's budget, the act declares that "the expenditure and revenue elements of the President's Budget shall be developed to promote the purposes, policies, and goals of the Full Employment and Balanced Growth Act of 1978" and that the "size of the President's expenditure and revenue proposals ... shall be determined in a manner which gives consideration to the needs of the economy."

At the same time the act recognized the inadequacy of fiscal and monetary policies alone to attain full employment. To supplement those traditional policies, a number of "supplementary programs and policies" were proposed, including countercyclical employment policies, regional and structural employment policies, and youth employment policies, among others. Thus the 1978 act was larger, more complex, and more specific than its predecessor.(2)

The Criteria for and Obstacles to Stabilizing Fiscal Policy

The Criteria

For illustrative purposes, it is helpful to consider, as John Maynard Keynes apparently did, a "straw man" as policy maker. This straw man of policy is wise and benevolent, seeking to smooth economic fluctuations for the common good and completely without regard to his own interests. The illustration is further extended by assuming a citizenry of straw, a people who are unafflicted by rational ignorance of long-term policy effects and who never seek redistributive gains by means of policies with narrowly focused benefits.

For the sake of argument, I will assume the efficacy of fiscal policy for stabilization purposes, deliberately ignoring the implications of rational expectations and Ricardian equivalence theories. In this idealistic setting, fiscal policy will necessarily be conducted according to two principles. First, government budgets will exhibit a clear countercyclical pattern. In recessions, the government will raise spending or lower taxes to create a deficit that, according to standard Keynesian theory, will stimulate the economy, helping to restore full employment and economic growth. In times of growth and prosperity, especially if inflation is occurring, the government will cut spending or raise taxes, yielding a surplus that restrains growth and inflation.(3)

A second principle is that policies to change spending and taxes should be broadly based. To spend on programs that provide relatively more benefits to some than to others or to tax some more heavily than others is to introduce redistributional actions inconsistent with the more public-spirited objective of macroeconomic stabilization.

Adherence to these principles should yield appropriation and tax policies that are brief and simple. Complex spending formulas, "pork-barrel" projects, and multivolume tax codes should be alien to the policy maker and the citizen alike. The cause and (intended) effects of any fiscal policy should be easily known and understood. No citizen should ever worry about whether he (individually) will be "better off" or "worse off" under an upcoming year's fiscal regime. Spending cuts and tax increases may make citizens worse off, but in a predictable and proportionate way. Likewise, spending increases and tax cuts might improve citizens' welfare, but the improvements would be easily discerned and would yield no relative advantage to one citizen over another. Fiscal policies would simply serve the public interest by mitigating economic fluctuations.

The Obstacles

To any American who has struggled with a 1040 form (even a 1040EZ) or contemplated the impact of an "omnibus budget reconciliation bill" on his personal finances, the policy maker of straw is as easily blown down as the pig's straw house in the childhood story(4). The wisdom of the policy maker is uncertain; his benevolence is surely suspect. Moreover, citizens are not fully informed of policies and their effects, in either the short run or the long run, nor are they dispassionate participants in the political process.(5)

When policy is influenced by politics, as it must be in a democracy, its content and effects will not correspond to those that would result from a disinterested application of Keynesian policy prescriptions. James Buchanan and Richard Wagner (1977) argue forcefully that the political pressures placed on legislators and presidents yield an asymmetry in the implementation of fiscal policy: the government creates stimulative budget deficits not only in recessions, as the wise and benevolent policy maker would surely and rightly do, but also in times of prosperity. Spending increases and tax cuts yield votes regardless of the economic setting, resulting in continual deficits, an expanding public sector, and inflation.(6) In essence, political pressures preclude the possibility of countercyclical fiscal policy.(7)

George Stigler (1973) argues that countercyclical policies may not be observed because they yield little political benefit. He reasons that macroeconomic fluctuations are short-lived, that those adversely affected by recessions are relatively few and may be unlikely to vote, that some voters may benefit from a recession (for example, those who keep their jobs and enjoy lower inflation), and that recessions may have genuinely external causes. What clearly must matter, in Stigler's view, are redistributional policies that affect relatively narrow groups and interests. In those cases, benefits are focused and political rewards high.(8)

In a democracy, the problems of political motivation and influence are further compounded by the slowness with which democratic institutions act, so that even well-intended and wisely formed policies may be poorly timed. "Inside lags," the time necessary to determine macroeconomic conditions and formulate policy responses, may be long. Further, once enacted, policies affect the economy only after another time lag, the "outside lag."

On the other hand, automatic stabilization policies may circumvent political motives and time lags by requiring higher spending and lower tax...