My previous post highlighted that the structural component of the budget deficit is relatively high. Right now, a return to economic growth will not deliver big revenue gains, in view of the reduction of cyclically-sensitive income taxes over the last decade, such that the cyclical element in the budget is measured as low.
One feature of the upcoming fiscal adjustment could be to shift the attribution of the overall deficit between structural and cyclical components. In particular, if cyclically-sensitive taxes are increased, then the cyclical component of a given deficit will increase and the structural component will decrease, since economy recovery will then ‘do more of the work’ in returning the overall fiscal balance to good health.
That is, a X percent deficit reduction package could translate into an X+Z improvement in the structural deficit and an X-Z improvement in the cyclical deficit. This is relevant, since the key target should be to reduce the structural deficit.