Question

Explain the impact on the federal budget resulting from changes in the business cycle. How do expansions and recessions impact federal tax expenditures and revenues? Provide a detailed answer

Answer 1

Business cycle is characterised by the expansion and recession. Recession is characterised by fall in aggregate demand. Fall in aggregate demand leads to the rise in expenditure of government. Budget deficit rises during recession period. Rise in budget deficit adds aggregate demand. Rise in aggregate demand further increases output and GDP. US fiscal deficit was close to 9.5 % of GDP in 2009, period marked by recession. While in 2016, deficit came down to close to 3 %, period marked by the expansion. Hence, fiscal deficit falls in expansion phase of GDP.

In phase of expansion, government does not offer rebates and concessions, hence tax expenditure falls and revenue of government of rises. Conversely, when in phase of recession, government offers tax rebates and concession, hence tax expenditure rises and revenue also experience falls.