Why the Treasury's 'normal' budget isn't really normal

Taxes, spending, and deficits thus appear to be back to “normal.” If anything, fiscal policy in 2014 was slightly tighter than the average of the past four decades. But should we use the past 40 years as a benchmark for normal budget policy?

Treasury closed the financial books on fiscal 2014 last week. As my colleague Howard Gleckman noted, the top line figures all came in close to their 40-year averages. The $483 billion deficit was about 2.8 percent of gross domestic product, for example, slightly below the 3.2 percent average of the past four decades. Tax revenues clocked in at 17.5 percent of GDP, a smidgen above their 17.3 percent 40-year average. And spending was 20.3 percent, a bit below its 20.5 percent average.

Taxes, spending, and deficits thus appear to be back to “normal.” If anything, fiscal policy in 2014 was slightly tighter than the average of the past four decades.

That’s all true, as a matter of arithmetic. But should we use the past 40 years as a benchmark for normal budget policy?

It’s common to do so. The Congressional Budget Office often reports 40-year averages to help put budget figures in context. I’ve invoked 40-year averages as much as anyone.

But what has been the result of that “normal” policy? From 1975 to today, the federal debt swelled from less than 25 percent of GDP to more than 70 percent. I don’t think many people would view that as normal. Or maybe it is normal, but not in a good way.

Just before the Great Recession, the federal debt was only 35 percent of GDP. Over the previous four decades (1968 through 2007), the deficit had averaged 2.3 percent of GDP, almost a percentage point lower than today’s 40-year average.

That comparison illustrates the problem with mechanically using 40-year averages as a benchmark for normal. A few extreme years can skew the figures. In 2007, we would have said deficits around 2 percent of GDP were normal. Today, the post-Great Recession average tempts us to think of 3 percent as normal. The Great Recession has similarly skewed up average spending (from 19.9 percent to 20.5 percent) and skewed down average taxes (from 17.6 percent to 17.3 percent).

As recent years demonstrate, we don’t want a normal budget every year. When the economy is weak, it makes sense for taxes to fall and spending and deficits to rise. When the economy is strong, deficits should come down, perhaps even disappear, through a mix of higher revenues and lower spending.

Looking over the business cycle, however, it is useful to have some budget benchmarks. A mechanical calculation of 40-year averages won’t serve. Instead, we need more objective benchmarks. On Twitter, Brad Delong suggested one benchmark for deficits: the level that would keep the debt-to-GDP ratio constant. I welcome other suggestions.

The post A “Normal” Budget Isn’t Really Normal appeared first on TaxVox.