Fiscal Policy, Past and Present

This paper begins with a review of the current fiscal situation and the causes of its recent deterioration. As a guide to possible policy actions, it provides extensive estimates of past responses of revenues and expenditures at the federal and state and local level. Estimates at the federal level suggest that policy is responsive to both economic and fiscal conditions, and that this responsiveness may have grown over time. For states, economic conditions are less important, but responses to budget gaps are swifter. Equations for federal revenues and expenditures predict tax cuts and expenditure increases given current conditions, but of a considerably smaller magnitude than those initially proposed by President Bush. However, current circumstances are difficult to evaluate because of the enormous implicit entitlement liabilities that were much less significant in the past. This difficulty is but one of the problems facing policy prediction and evaluation.