Deficits and Taxes: Federal Budget and Fiscal Policy in the 1980’s

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The economic program proposed by the Reagan administrationat its inception in 1981 was designed to reduce government spending and taxes relative to the economy's total output or grossnational product (GNP). As a first step in implementing theprogram, the administration proposed a phased reduction in taxrates over the three years from 1981 to 1983. This was to beaccompanied by reductions in the level of spending proposed bythe Carter administration for fiscal year (FY) 1982. The taxreductions were in fact adopted by Congress, and a set of spending reductions was incorporated into the First CongressionalBudget Resolution. The budget process for 1982 was never completed, however, and the 1981-82 recession intervened.

The net result of these efforts has been that tax ratesare lower now than in 1980, but not lower than rates in 1979.The reductions in aggregate federal expenditures relative toGNP, however, have not materialized. Indeed, during the firstthree years of the Reagan administration, federal spending as apercentage of GNP increased to historically high peacetimelevels. Because the decline in the rate of growth of tax revenues has not been matched by a decline in the growth of expenditures, the government's budget deficit in real terms has alsoreached unprecedented peacetime levels. The 1983 deficit wasalmost 6 percent of GNP. Projected deficits for 1985 and 1986exceed 4 percent of GNP. These levels are of the same order ofmagnitude as those reached during the Great Depression of the1930s. Without a reversal of the tax reductions or significantreal spending cuts, the projected deficits will not fall below3 percent of GNP until 1989.

The projected federal budget deficits have now become thecentral focus of economic policy. Furthermore, deficit maniahas swept Wall Street, the national media, and even the grovesof academe, where the National Bureau of Economic Research haslaunched a major project to investigate the impact of government budget deficits. The deficit issue poses three major questions: (1) Where did the deficit projections come from? (2)Where did the projected deficits come from? (3) Where will thedeficit reductions come from?[1]

Thomas S. McCaleb

Thomas S. McCaleb is associate professor of economics at Florida State University and a former senior staff economist with the Council of Economic Advisers.