Tuesday, November 16, 2010

What Causes Deficits, Ezra?

. Tuesday, November 16, 2010


"Basically, deficits happen when recessions happen. Anytime GDP shrinks, deficits explode. Sustained growth, by contrast, tends to bring the budget into balance. That's not to say policy doesn't matter... But policy -- and even control of the White House -- matters a lot less than the economy does."


Maybe policy matters more than Ezra thinks. Check out the pattern evident in two simple plots of tax and spending data. We all know that the two previous largest peacetime deficits came in the 1980s and the 2000s. Both seem quite related to policy. Military spending is defense department spending as a share of GDP. The two sharp against trend rises occur under Reagan and Bush. Legislated tax revenues is the estimated impact of congressional tax legislation on tax revenues* (because it measures the impact of tax legislation on tax revenues rather than actual revenue, values aren't driven by GDP growth.) Budget deficits seem to correlate strongly with congressional decisions to cut taxes and increase military expenditures. One is tempted to use the word "cause" here.

Of course, this could just be a coincidence.

<*Romer, C. and D. Romer (2008). A Narrative Analysis of Postwar Tax Changes. Berkeley, University of California, Berkeley.

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What Causes Deficits, Ezra?
 
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