U.S. Posts $3 Billion Budget Surplus for January, Essay Example

Introduction

The article addresses the topic of the United States budget surplus for the month of January 2013. The main message of the article is: The United States posted an (unexpected) surplus of approximately $3 billion in January of this year on the back of increased revenues from the expired payroll tax “holiday.”  For the purposes of discussion, there are a number of key terms that will be used: budget deficit refers to when expenditures outstrip revenues for the budget; budget surplus refers to when revenues outstrip expenditures. The discussion will primarily focus on the tension in economic theory between the short-term need to stimulate the economy on the one hand, and the long-term need to prevent “crowding out” of private sector investment.

There are two diagrams that may help in the explanation of this issue. The first is a graph that shows the (potential) role of government spending during an economic downturn.

Diagram 1: The interaction between aggregate demand and supply:

After the United States entered economic recession after the 2007-2008 financial crisis, the economy moved from point ye (output at equilibrium) to y2 (output after the economic shock).  According to Keynesian theory, a country in the throes of economic recession needs to “prime the pump” (increase government spending) as both private firms and consumers do not necessarily have the resources to undertake economic activity.

The United States took Keynes’ advice following the economic downturn increasing government spending (stimulus) in order to promote economic growth.  During the time period, the US government posted robust deficits; that is, the government borrowed money, primarily through sovereign bond offerings during a time of historically low interest rates.  Another policy which is often times lost in the debate, but brought back into focus by this article is: tax policy. The US government authorized a payroll tax “holiday” during the economic recession when individuals’ contribution to Social Security (via the payroll tax) reduced from 6.2% to 4.2%- the thinking underpinning the payroll tax holiday was: increase consumers’ disposable income that might increase spending and increase economic growth. This policy lasted for two years; however, as part of a political bargain in 2012 to raise the nation’s “debt ceiling”, the payroll tax holiday was not renewed.

All of the previous analysis points to a larger debate: the tension between running short-term deficits to stimulate the economy with long-term issues related to “crowding-out” or private investment and the inability to pay it off. From this context, the US announcement of a budget surplus in January is more of an anomaly than a representation of the country’s true fiscal condition moving forward. Indeed, although the country ran a surplus in the month of January the country still boasted an overall deficit of roughly $800 billion.

This raises the question of how much more fiscal support will be needed to support the economy, while realizing that future resources to support current action may be limited.

Indeed, continued government support of the economy, whether in the form of fiscal spending or quantitative easing, is expected over the short-term.  This is in spite of the sequestration that has led to a cut in many programs but still resulted in growth of spending overall.  Is this support sustainable?  And, if so, is it desirable?

There are two different arguments here.  First, continued funding of fiscal spending is theoretically possible, but faces limitations: Those limitations are the function of putative “bond vigilantes” who will only take so much borrowing before they will demand a higher interest rate and thus make borrowing to finance current spending less attractive. Over the short-term, however, there also may be tradeoffs: the trade-off comes in the form of public spending “crowding out” private spending”

Diagram 2 shows one potential scenario where government spending “crowds out” or impedes private spending leading to a lower level of output that is possible.  After the economy falls to point “AD1” on the graph, the government undertakes stimulus and other measures that gets the economy to “AD3”; the economy is unable to make it to the equilibrium state because the government, through excessive borrowing, may take resources that the private sector might invest to better use.  This use of resources will be inefficient and leave the economy worse off over the long-term.  Other commentators, however, that there is enough slack in the economy to allow further government expenditure because the private sector and consumers still are not at a place where they can support economic growth, at least not at their previous level.