The federal budget exhibited a $128.7 billion surplus in 2001 but moved to a deficit of $157.8 billion in 2002

Question

Some argued the deficit was opened up because of the Bush 2001 tax cuts, but others argued that the deficit grew because of the recession suffered in 2001. Evaluate the validity of the second argument.

Answer 1

Recessions increase the federal budget deficit because of automatic stabilizers in the economy. When GDP declines because of a recession, incomes and profits decline, causing tax revenues to decline. This will lower a budget surplus or increase a budget deficit. Falling GDP usually means rising unemployment, which increases government expenditures on unemployment insurance and other transfer programs. Increased government expenditures also lower a surplus or increase a deficit. Therefore, not all of the increase in the deficit was due to discretionary fiscal policy. Part of the increase in the deficit was a consequence of automatic stabilizers in the economy.