US Fiscal Policy and the Global Outlook

• The Policy Dilemma
• Fiscal Consolidation: Could It Be Expansionary?

US economy being a quarter of the global, had almost all economies of the world trailing it into the recession pit when the 2008 sub-prime crisis lent a severe blow to it. At that time had it not been for the fiscal stimulus packages bailing out Freddie Mac and Fennie Mac, the US would not have been able to combat the recessionary trends. (Lipsky,2011)

The case for additional stimulus can be found in the daily economic reports and dismal performance of the stock market. Growth has clearly stalled and it's hard to see what is going to get it back up to an acceptable level. Consumption normally drives growth, but that's not going to rise much as long as unemployment remains high. Businesses are not going to increase investment as long as consumption remains flat. Net exports-exports minus imports-have limited growth potential. That leaves only government, which is hobbled by political paralysis at the federal level and is being pulled down by fiscal contraction at the state and local level.

A stimulative fiscal consolidation is based on the theory given by Harvard economist Robert Barro named Ricardian equivalence in the year 1970s. His argument was based on the fact that the budget deficits of the government are not at all stimulative as many think that the higher taxes will be discounted by the necessity to pay the additional debts. Therefore, the budget deficits do have the macroeconomic effects equivalent to the higher taxes. So, the spending is reduced rather than increasing it.

What did the government do?

The Government thereafter continued its fiscal backing by announcing a slew of social security packages, by purchasing its own treasury bonds, by reducing the tax pressures on the central level with the approach focusing more on central austerity measures and tightening fiscal situation at the local level. However, the continuing fiscal expansionary policies citing the low interest rates, inflation and growth has now led the economy to about 10 percent fiscal deficit, surmounting public debt at about 62 percent of the GDP.(Rangarajan,2011)

Also, the precariously high unemployment levels and low savings rate have not been able to justify the continuance of the expansionary fiscal policies in third year of economic correction. On the contrary, the downgrading of its credit rating has given a jolt to the investor confidence in the world's economic leader. In such a scenario, US' endeavor to reduce its fiscal deficit to half the 2009 levels as promised in the G-20 Toronto summit seems bleak. This has left many of the economists wondering if lack of necessary and focused fiscal consolidation might lead US the Greece way.

What to do now?

Since US is still the global leader, it becomes all the more essential to adopt a prudent and radical approach to fiscal consolidation now. As is already known in the wake of recent presidential elections, more and more of fiscal stimulus is being promised towards unproductive sectors like medicare and other social security benefits. However, the need of the hour is to boost investment in education sector and infrastructure so as to create room for growth. This would in addition to building up human and physical capital also urge imports, thereby giving impetus to the global economy. US is still the major market for most of the developing countries. (Vietor and Weinzirl, 2012)

It is also important to check the source of Government spending. The major sources of Government spending are the taxes. It is pertinent to note that till now there is no Value Added Tax (VAT) in US, while this form of indirect taxation is playing its role in most of the major economies of the world including the rapidly growing India. Rather than increasing the taxes that directly affect the people, it is essential to identify alternate and innovative forms of taxation to reduce Government's reliance on public debt for financing public expenditure wherever necessary.(Bartlett,2010)

Now is the time when Government has to focus on phased withdrawal of its fiscal help. The US economy is at a juncture where it has to reduce the reliance of its industries on its stimulus, yet support them so as to render them competitive for the global economies. This necessitates a well chalked out fiscal consolidation plan with a concerned identification of the key areas requiring fiscal assistance.

USA cannot continue with its fiscal expansionary policies for long. It has to now plan systematic fiscal consolidation measures to check its increasing fiscal deficit, current account deficit and unemployment levels. The global economy may not be able to survive the tremors of another sub-prime or European crisis.

How will the fiscal expansion help U.S economy?

The new fiscal package in the future will include various measures that are likely to help the economy to increase the aggregate demand, although it will be unlikely that it will happen so. The increase in the extension in the various unemployment benefits will help to put the cash into the spend thrift consumers. Moreover, the extension of temporary tax breaks for the various classes of the low as well as the middle-income households will be surely bringing an increased impact on spending. Some of the other measures if implemented, the package will bring about an increase in the deficit-by about 1 percent of GDP in the fiscal year 2012 as compared to the International Monetary Fund's earlier forecast. (Lipsky, 2011)

There has been an ongoing debate on how to achieve medium-term fiscal consolidation. This has been undertaken by the National Commission on Fiscal Responsibility and Reform. The Commission has proposed that there is a need for very broad based revenue as well as spending measures as a part of the fiscal consolidation plan which points towards the expansionary fiscal policy adopted by U.S. The plan has set great targets in order to stabilize the public debt by the fiscal year of 2014. This will help the economy to return to its pre-crisis level of approximately 40 percent of GDP by the year 2035. As per the commission proposals, marginal tax will be reduced if the expenditures are scaled back. Increasing the retirement age would bring about a financial footing to the social security. The social measures such as health sectors can be cost effective; there is a need of great medium term savings and that too by 2020. Another way to increase the revenue that is suggested by the commission is by the introduction of nationwide consumption tax. This tax can be for example a value added tax. This will help in the increment of the revenue and thus consumption will boost up. Some budgetary reforms are also being suggested by the commission in order to expand the consumption. By 2013, the spending will be at par with the level of the year 2008 and from thereafter the growth will be contained to half the inflation rate that is projected. Private sector can also become positive about the fiscal developments once the fiscal target are enhanced. This will further help the U.S economy to come to the level that was at the time of pre-recession period.

State government vs Federal government

Both the state governments as well as the federal government experience a challenge in the case of fiscal consolidation. Presently, twenty percent of the gross domestic product is the amount of debt held by the state government. This is equivalent to one-third of the size of the debt held by the federal government. Thus, the state government will be too facing the recession and thus need to cater to the enhanced revenues and the increase in the tax rate.

It is mandatory for the state governments to maintain budget at the balanced levels. Such is not the case with the federal government.