Economic Significance of Fiscal Drag

Abstract

THE U. S. ECONOMY has been enjoying its longest period of continued prosperity since the World War II era. Total business activity has been rising steadily since the spring of 1961 and the recession that seemed imminent in 1962 never materialized. In the course of this period business and personal income taxes have been reduced, business depreciation guidelines liberalized and federal excises reduced or eliminated on a wide variety of goods and services. These tax cuts have been justified in terms of a theory, spelled out with growing confidence since it was first put forth in 1962, which holds that the federal budget structure automatically exerts an increasing drag on the economy as time passes unless periodic liberalizations of tax and expenditure programs are undertaken. When the economy is operating at less than full employment, therefore, there is a need to offset these potentially restrictive forces with an expansive fiscal policy in the interest of maximizing economic growth. The proponents of this approach are in the favorable position of having their views supported by the economy's strong performance during the period in which the policies they advocate have been in effect. Opponents maintain that other factors, including favorable wage/productivity relationships due in some part to the economic policies pursued prior to 1961, have been essential to the success of this new fiscal policy approach. They maintain that, while the tax cuts undertaken up to now have proved successful, continued adherence to an expansive fiscal policy involves increasing risk of price inflation and international payments difficulties. They object to the voluntary controls now being utilized to deal with these problems as inequitable and unworkable, and warn of stronger and more pervasive controls to come. In evaluating this new approach to fiscal policy, there is a need to answer the following questions: (1) what is basically new in the attitude towards the federal budget and national debt; (2) what are the new concepts; (3) how rigorous is the underlying logic and what are the loopholes; (4) what do these new policies promise for the future and what are the risks they entail.