Budget surpluses or deficits have been treated as  inconsequential in themselves, to this point, having importance only to the  extent that they affect Aggregate Spending. After decades of successively  higher record federal deficits, a proposed constitutional amendment that the  federal budget be balanced annually receives lots of popular support, but some  serious pitfalls may be embedded in this appealing notion. Imbalance in the  federal budget may be more a symptom of economic distress than a result of  discretionary policy. For example, deficits swell during recessions because tax  revenues fall and government outlays rise. Conversely, automatic stabilizers  theoretically could create budgetary surpluses if unsustainable and  inflationary growth mushroomed.            
                        Should taxes be raised and government  spending cut during a recession to eliminate a deficit? The preceding analysis  suggests not. If inflation looms, should we cut taxes or raise spending to  eliminate a surplus? Again, Keynesians conclude that this would be unwise.  Federal deficits or surpluses are affected by the level of GDP as well as by  discretionary fiscal policy, so the appropriateness of fiscal policy is not  obvious solely from the evidence of actual deficits or surpluses. Economists  now differentiate between structural and cyclical deficits.
            A structural  deficit (or surplus) is  an estimate of the budget deficit (or surplus) that tax and spending structures  would yield if the economy achieved its potential.
            
                        During a recession, estimating the structural deficit  entails adding to the actual deficit extra tax revenues that would be collected  if full employment were achieved and deducting the outlays on unemployment  benefits and other transfer payments caused by cyclical unemployment.
            A cyclical  deficit occurs when falling income during a recession shrinks tax revenues  while increasing transfer payments. Prosperity, on the other hand, could yield  a cyclical surplus.
            Whenever  the economy deteriorates, the cyclical budget deficit worsens and vice versa.
            
                        Transfer payments can be treated as  negative taxes (negative because the  government pays people), which decline in importance as National Income rises.  Figure 5 illustrates various possible relationships between net taxes (tax revenues minus transfer  payments) and government purchases for three alternative tax structures. Note  that the tax functions are all positively sloped; net taxes rise as income  rises. We will assume that noninflationary full employment income is $7.5  trillion and that government purchases (G)  are independent of income.
            FIGURE  5  The Structural Deficit and the  Cyclical Deficit                                                        
            The  structural deficit is the deficit that would exist at a full employment, given  the existing mix of government spending and tax rate structures. The  cyclical  deficit grows when economic circumstances prevent full employment. This  figure illustrates the relationship between net taxes (taxes minus transfer  payments) and government spending for three alternative tax structures.
            
               Tax structure T0 is associated with Aggregate Expenditures AE0, and a structural surplus of $100 billion    prevents full employment, but at the equilibrium income of $7 trillion, the    spending/tax structure yields a $50 billion cyclical deficit. Budget–tax    combinations T2 and G are associated with Aggregate Spending    of AE2 and represent a    considerably more expansionary budgetary mix. At full employment, this budget–tax    mix would result in a structural deficit of    $100 billion. Tax schedule T1 is associated with Aggregate Expenditures AE1 and balances the budget at full employment ($7.5 trillion).
            Note:  Subscripts link tax structures (T)  from Panel B with the resulting Aggregate Expenditure function (AE) in Panel A.
            
                        Excessive tax rates may limit  Aggregate Spending to levels inadequate for full employment. This  "fiscal-drag" case occurs with tax structure T0 and  Aggregate Expenditure AE0, which together yield equilibrium at point  a in Panel A of Figure 5. Tax rates are high, so the structural deficit at full  employment (point b) is really a surplus to the tune of $100 billion in this  example; however, the cyclical deficit at the $7 trillion equilibrium income  (point a) is $50 billion. Thus, an excessive "structural surplus" can  create a cyclical deficit.
            
                        Contrast this with the budgetary mix  of G and tax structure T2. Simultaneous inflationary  pressures and cyclical budgetary surpluses coexist if Aggregate Spending is AE2 and the tax schedule is T2; at equilibrium point c, a cyclical surplus of $50 billion is  realized. This budget combination yields a structural deficit of $100 billion  at full employment (ignoring inflationary pressure). This structural deficit is  much more expansionary than that represented by G and T0.  Finally, a combination that balances the structural budget is represented by  tax schedule T1, which  yields Aggregate Expenditure AE1.  Cyclical deficits result below full employment, while surpluses are generated  above full employment.
            
                        Suppose low tax rates bloat  Aggregate Spending. A substantial cyclical budget surplus exists if the  Aggregate Expenditure curve is AE2  and the tax curve is T2.  If perpetually balanced budgets were legally mandated, we would cut taxes and  raise spending—bad policies certain to worsen inflationary pressure. Policies  of either raising tax rates or cutting spending may cure inflation by enlarging  any current budget surplus to dampen Aggregate Spending.
            
                        During inflation, however, proposals  that "government costs, in addition to other prices, need to be  raised," are anathema to voters. But beneficiaries of public programs,  including those whose incomes depend on government contracts, lobby against  budget cuts that threaten their standards of living. Even politicians who  constantly attack "big government" fear a backlash from voters whose  pet programs are cut. In fact, political opposition to spending cuts or tax  hikes is so intense that we need not worry about simultaneous inflation and  actual surpluses.
            
                        The reverse situation is a budget  structure with a structural surplus but a cyclical deficit because tax rates  are so high that the economy is stuck well below full employment; fiscal drag  is quite powerful. Some analysts have suggested that the sluggish American  economy of the late 1950s and of the early 1980s suffered from this malady.
            
                        The critical point is that huge  cyclical deficits do not imply an expansionary tilt to fiscal policy, nor are  large cyclical surpluses evidence of contractionary policies. Mounting federal  deficits in recent years have been a mix of (a) cyclical deficits driven by high unemployment that subsided only slowly after peaking during the  recessions of 1981–1983 and 1990-1991, and (b)  huge structural deficits, sparked in  part by large tax cuts and by unrelenting growth of government outlays. Recent  estimates place the structural deficit at nearly two-thirds of the  actual deficit and growing.[1]
            
                        In summary, the actual deficit is  determined by the fiscal mix of the federal budget and the state of the  economy. Expansionary fiscal policy creates structural deficits, and recession  triggers cyclical deficits. Deficits may arise because high tax rates produce  an anemic economy. Congress can only set tax rates; it cannot dictate the resulting[url=]tax[/url] revenues.