The Endless Economic Cycle

Riddle: What is it that happens on a continual basis and yet, is always ignored until it’s too late? Answer: Economic downturns. The world economy is in an endless cycle of expansion and contraction and the only thing that changes is how extreme the highs and lows reach before reversing. But somehow, no one wants to think of the lows until they are actually facing them.

Expansions are easy to deal with. As revenues increase; businesses, governments, and households find ways to spend their new found wealth. It’s the contractions that are a problem. Most businesses are able to fend off reductions in revenue by cutting costs. Payroll being the quickest, explains the run up of unemployment at every contraction. Households don’t fare as well. Most of their expenses are related to basic needs like food and shelter with the rest being debt. The problems arise when there’s not much that can be cut. In this light, government fairs the worst. They get a double whammy at every economic downturn. Revenues decrease and expenses increase - as support is given to shore up the sagging economy. But something has happened in this downturn that is shining a bright light on some real problems.

One is, government spends all the money they take in – good times or bad. Which is understandable since there is constant pressure to do as much as possible with the resources available. The flaw that becomes very evident in this downturn is that most of this spending is fixed either by law, contract, or entitlement. No one stands up and volunteers for a cut, and worse – all proposed cuts are fought tooth and nail. If spending can’t be reduced, we are faced with deficit spending, which means borrowing against future tax collections. This simply isn’t sustainable and just makes the problem worse later on. Ask any homeowner who got caught up in the equity splurge - you can’t borrow your way out of trouble.

So – wouldn't it make sense to have a balanced budget based on average tax revenue instead of projected revenue? This probably sounds easier than it is, but it sure would go a long way in smoothing out the extremes. Some form of this has been tried with things like rainy day funds, but somehow those funds always seem to get tapped even before the rain. How about trying something like, excess revenues collected during upturns are only spent on things that can be put on hold during downturns – like road repair or building improvements. Locking in an endless stream of fixed costs will always bring us back to where we are today – massive deficits and unpleasant remedies.

By. Norman LeBlanc, CPA

Tax Services Group