Does the U.S. Federal Deficit Respond More to Revenues, Expenses, or GDP Growth? A Time-Varying Coefficient Analysis

The feasibility of fiscal stimulus depends on levels of sovereign debt and future impacts on budget deficits, regardless of whether it is effective at increasing economic growth. This paper tests whether changes in revenues, expenses, GDP growth rates, private investment, and monetary stimulus affect the United States federal deficit one year after the change, taking account of fiscal multiplier effects. A state space model with time-varying coefficients from 1963 through 2019 shows that the deficit responds somewhat more to expenses, especially social insurance outlays, implying that entitlement reform may be the single best policy for fiscal solvency. For much of the time period, revenues and expenses are insignificant except in times of major upheaval and rapid change, showing the political nature of the problem and demonstrating that the solution must involve both revenues and expenses simultaneously, with careful attention to multiplier effects.