Implementing fiscal policy is often easier said than done. It is frequently a complex and time-consuming process. Three disparate entities—the Senate, House, and the president—must collectively agree on specific spending and tax policies. Ideally, these decisions are made in the open with the public fully informed. The complexities of the budgeting process and its openness (not a bad thing in itself) give rise to several inherent difficulties. We will briefly consider some problems having to do with the timing of fiscal decisions and the political pressures inherent in the process, after first looking at the automatic stabilization mechanisms contained in the federal budgeting process.

There is a certain degree of stability built into the U.S. macroeconomic system. Tax revenues and transfer payments are the two principal automatic stabilizers; without any overt action by Congress or other policymakers, these two components of the federal budget expand or contract in ways that help counter movements of the business cycle.

When the economy is growing at a solid rate, tax receipts rise because individuals and firms are increasing their taxable incomes. At the same time, transfer payments decline, because fewer people require welfare or unemployment assistance. Rising tax revenues and declining transfer payments have contractionary effects, and act as a brake to slow the growth of GDP, helping to keep the economy from overheating, or keeping it from generating inflationary pressures. When the economic boom ends, and the economy goes into a downturn, the opposite happens: Tax revenues decline and transfer payments rise. These added funds being pumped into the economy help cushion the impact of the downturn, not just for the recipients of transfer payments, but for the economy as a whole.

The income tax is also a powerful stabilizer because of its progressivity. When incomes fall, tax revenues fall faster because people do not just pay taxes on smaller incomes, but they pay taxes at lower rates as their incomes fall. Disposable income, in other words, falls more slowly than aggregate income. But when the economy is booming, tax revenues rise faster than income, thereby withdrawing spending from the economy. This helps to slow the growth in income, thus reducing the threat of an inflationary spiral.

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The key point to remember here is that automatic stabilizers reduce the intensity of business fluctuations. Automatic stabilizers do not eliminate fluctuations in the business cycle, but they render business cycles smoother and less chaotic. Automatic stabilizers act on their own, whereas discretionary fiscal policy requires overt action by policymakers, and this fact alone creates difficulties.

Using discretionary fiscal policy to smooth the short-term business cycle is a challenge because of several lags associated with its implementation. First, most of the macroeconomic data that policymakers need to enact the proper fiscal policies are not available until at least one quarter (three months) after the fact. Even then, key figures often get revised for the next quarter or two. The information lag therefore creates a one- to six-month period before informed policymaking can even begin.

Even if the most recent data suggest that the economy is trending into a recession, it may take several quarters to confirm this fact. Short-term (month-to-month or quarter-to-quarter) variations in key indicators are common and sometimes represent nothing more than randomness in the data. This recognition lag is one reason why recessions and recoveries are often well under way before policymakers fully acknowledge a need for action.

Third, once policymakers recognize that the economy has trended in a certain direction, fiscal policy requires a long and often contentious legislative process, referred to as a decision lag. Not all legislators have the same goals for the economy; therefore, any new government spending must first survive an arduous trip through the political sausage machine. Once some new policy has become law, it often requires months of planning, budgeting, and implementation to set up a new program. This process, the implementation lag, rarely consumes less than 18 to 24 months.

The problem these lags pose is clear: By the time the fiscal stimulus meant to jumpstart a sputtering economy kicks in, the economy may already be on the mend. And if so, the exercise of fiscal policy can compound the effects of the business cycle by overstimulating a patient that is already recovering.

Some of these lags can be reduced by expediting spending already approved for existing programs rather than implementing new programs. This was the approach Congress and the administration wanted to take with the 2009 stimulus package. Congress allocated part of the increased spending to “shovel-ready” projects to reduce the time for this spending to have an impact on the economy. Also, the lags associated with tax changes are much shorter, given that new rates can go into withholding tables and take effect within weeks of enactment. Therefore, policymakers often include tax changes because of their shorter implementation lags.

Because of the uncertainties surrounding the economy, politicians often take their own interests into account when considering fiscal policy, if not for economic reasons then very likely for political ones. In times of recessions or slow economic recovery, those on the left tend to favor more government spending and transfer payments, while those on the right tend to favor reductions in taxes. Both policies are expansionary and lead to greater deficits, especially as tax receipts fall due to lower incomes and fewer jobs.

But in order to balance the budget over the long run, such policies generally need to be reversed in good times so that government spending is reduced and taxes raised, along with the generation of more tax receipts from higher incomes and more jobs. But politicians often are reluctant to do so. Even in good economic times, tax hikes are politically dangerous, and so are major cuts to government spending programs and transfer programs. The result is that fiscal policy is financed by deficits. Deficits persist in our system of government.

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Public choice theory involves the economic analysis of public and political decision making. James Buchanan, considered the father of public choice theory, essentially fused the disciplines of economics and political science. Buchanan contrasted Adam Smith’s description of social benefits that arise from private individuals acting in their own self-interest with the harm that frequently results from politicians doing the same thing. Competition among individuals and firms for jobs, customers, and profits creates wealth, and thus it benefits the entire society. Self-interested politicians, however, often instigate government interventions that are harmful to the larger economy.

Public choice economists such as Buchanan argue that deficit spending reduces the perceived cost of current government operations. The result is that taxpayers permit some programs to exist that they would oppose if required to pay the full cost today. But this situation, public choice economists charge, amounts to shifting the cost of government to the next generation, and has led to the steady expansion of the federal government.

Public choice analysis helps us to understand why deficits seem inevitable. Simply, we do not pay the full costs of today’s programs. In the past 50 years, the federal government has run a deficit in 45 of these years, despite significant growth of the economy over this time. The next section focuses on the role of deficits and public debt on the economy.