The Retirement Corporation of America

Understanding Fiscal Policy

Each year, the president sends his budget for the coming year to Congress—detailing how much money he wants to spend and how he expects to raise that money. Congress argues back and forth, adds a few new highways and subtracts a new aircraft carrier, dreams up a few new taxes and that's the budget for the new year. You get to foot the bill through the taxes you pay and all that spending by Uncle Sam helps propel the economy along.

Some years, the taxes Uncle Sam collects exceed the amount the government spends and we have a budget surplus. Some years, the amount the government spends exceeds the taxes collected and we have a budget deficit. When there is a deficit, the government must borrow the difference by selling Treasury securities. The cumulative total of all money owed by the government is the national debt. When there is a surplus, the money goes to pay down the national debt.

Lately, budget surpluses have become a matter of priority—but for decades, we ran deficits year after year. Even now, the national debt still amounts to nearly $6 trillion—which amounts to almost $21,000 for each and every American man, woman and child. Just paying the interest on the national debt costs American taxpayers about $200 billion a year. That, by the way, is more than we spend on science, the environment, housing, education and health put together.

Fiscal policy can have a powerful impact on the economy. Consider that:

•  By raising taxes, the government takes money out of your pocket and sends it to the U.S. Treasury. The money will still be spent but it won't be spent as you would have spent it. You might have bought a car. Uncle Sam is more likely to use your money to build a warship. Raising taxes changes spending patterns throughout the economy—helping some industries while hurting others.

•  By cutting taxes, the government demands less money and lets you keep it. That could mean fewer war ships but more cars built. Cutting taxes also changes spending patterns throughout the economy—again helping some industries while hurting others.

•  By changing the tax laws, the government can change many things in the economy. By making mortgage interest tax deductible, the government made it more cost-effective to buy a home than to rent. By creating tax-sheltered retirement savings plans, Uncle Sam made it much easier for all of us to save for our retirement.

Finally, fiscal policy can play a powerful role in regulating the pace of economic growth.

Cutting taxes and spending more can speed up a sluggish economy. Eventually it will create a huge budget deficit that must be covered by government borrowing. We had such deficits in the 1980s. But the spending that created those deficits helped jump-start the economy after the grim recession of 1981-82.

Raising taxes and cutting spending can slow down an over-heating economy. It's rare that Congress can be persuaded to cut spending. Mostly budget deficits melted away in the late 1990s because the strong economy and record corporate profits inflated income tax payments. The greater risk is that by keeping taxes high, Congress will keep the economy growing at a slower rate than it otherwise might grow.

Keeping Tabs on Fiscal Policy

Keeping up with fiscal policy could hardly be easier. You come into contact with the tax laws every time you file your annual tax return or make an estimated tax payment. Many of the most important decisions you make in life—from buying a house to making an investment—take the tax laws into consideration. There are millions of people who make their living explaining the tax laws to taxpayers just like you. The stores are filled with books about how to handle your taxes.

In other words, there is no reason in the world for any question you might have about taxes to go unanswered.
Federal budgets and spending plans are debated by Congress in public and thousands of reporters and correspondents are employed solely to make sure you know everything you want to know about the making of monetary policy. What you don't understand, whoever prepares your income taxes each year can clarify.

As with so much of today's economic news, you won't have to go looking for information and intelligence about fiscal policy. It will come looking for you.