Countercyclical Fiscal Policy and Multiyear Perspective on Budgeting

Abstract

This chapter offers a theoretical exploration towards a new budgetary system to cope with uncertainty and instability. It begins by examining the practice of annual balance, core of the “modern” budgetary theory, and infers that annual budget creates a mismatch between the budget cycle and the continuity of public service provision. The chapter provides multi-year perspective on budgeting as a potential solution, with counter-cyclical fiscal reserves as the means to balance the budget through and across economic cycles. The chapter suggests that states have tried a multi-year perspective by adopting budget stabilization funds (BSF) and shifting annual surpluses from the general fund into BSF. By creating BSF legislation, states institutionalize the counter-cyclical fiscal policy. Then with sufficient fiscal reserves, states can better maintain trend-level public services during recessions. Through panel data (1979–1999) analysis, the chapter provides empirical evidence that BSF did help stabilize state general expenditure in downturns by releasing reserves to fill in spending gaps. Specifically, states that had established a BSF before the three sampled recessions fared better than those that did not; states that established a BSF earlier had better weathered the recessions than those that adopted the fund late. In other words, adopting the counter-cyclical fiscal policy and BSF is a step in moving public budgeting from the annual to a longer-term perspective, which indicates progress towards building a new budgetary system for fiscal stability over the economic cycle.