Cyclically Adjusted Surplus

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Definition of a Cyclically Adjusted Surplus:

A cyclically adjusted surplus is a budget surplus caused by a growing economy rather than fiscal policies such as decreasing discretionary spending or increasing the tax rates.

Detailed Explanation:

How much of a budget surplus (or deficit) results from a change in business activity, and how much of the surplus (or deficit) results from a change in fiscal policy? A cyclically adjusted surplus can indicate that the government is running a more fiscally conservative or sustainable policy, with revenues consistently exceeding expenditures, even when the economy is operating at its normal capacity.

A cyclically adjusted budget gives a clearer picture of the government’s underlying fiscal position by eliminating distortions caused by short-term economic conditions. Policymakers use the cyclically adjusted budget to evaluate the expected influence of any change in tax or spending policies on economic growth. They begin by determining what the budget surplus or deficit would be if the economy is at full-employment or long-term equilibrium. When the cyclically adjusted budget is balanced, fiscal policy is neither expansionary nor contractionary – even if the economy is running a budget surplus or deficit. The surplus or deficit results from business activity below or above the full-employment level. A fiscal policy is expansionary when there is a cyclically adjusted deficit and contractionary when there is a surplus in the cyclically adjusted budget. 

It is tempting to conclude that budget surpluses always indicate that the government is using a contractionary fiscal policy. However, this may not be the case. When fiscal policy results in a balanced cyclically adjusted budget, the policy is neutral, even if the economy is running a surplus. The surplus was caused by a growing economy rather than fiscal policy. To illustrate, assume that in Year 1, the economy is at full employment and the budget is balanced. The cyclically adjusted budget would equal zero. The economy grows in Year 2, resulting in a budget surplus. Tax revenues increase as incomes rise. Several mandatory expenses that are tied to income, such as unemployment benefits and food stamps, decrease because more people are employed. Fiscal policy is unchanged, so the cyclically adjusted budget remains balanced. The surplus was caused by economic growth rather than a change in fiscal policy. We would be wrong to conclude that the government is taking contractionary measures just because the economy is running a surplus. Now assume the economy slows in Year 3 and there is a budget deficit. Again, fiscal policy is unchanged. The cyclically adjusted budget is balanced. The deficit resulted from a slowing economy. 

Dig Deeper With These Free Lessons:

The Federal Budget and Managing The National Debt
Fiscal Policy – Managing an Economy by Taxing and Spending
Business Cycles
Monetary Policy – The Power of an Interest Rate