What Are the Four Most Important Limitations of Fiscal Policy?

Fiscal policy -- government taxing and spending -- almost always is controversial. While the government has a role in promoting economic growth, full employment and price stability, its methods for doing so frequently are subject to contentious debate. Whichever side prevails at the moment, it must deal with limitations posed by the process and past application of fiscal policy. While there are many issues with fiscal policy, some stand out above the rest.

Due to the nature of the political process, the time lapse between when a need is recognized and when the impact of the appropriate fiscal policy is felt may be considerable. First, the need for government intervention in the economy must be determined. That occurs after a rise in unemployment, for example, which is reported after a trend has already occurred. Then Congress and the President must come to terms on the appropriate legislation. If they can, only then is legislation is enacted and money appropriated. By then months may have passed, and the scope of the problem may have changed

The Congress and President are public officials, and as such they are accountable to the electorate. While the federal government has a responsibility to enact legislation to promote full employment, the drive to be reelected creates a need to bring money back to their respective constituents. Earmarks and other targeted measures create an upward bias on the amount of money the federal government spends. Spending for the home folks in order to get reelected distorts fiscal policy. Senator William Proxmire (D-Wisconsin), with his Golden Fleece Awards, was one of the first to focus on this issue. Others have followed.

While economic theory suggests that in good economic times the government should cut spending, this rarely proves to be the case. With the exception of several years in the late 1990s, government spending has exceeded tax receipts consistently. Interest on the debt amounts to over $400 billion -- and that is in a period of low interest rates. The drag that debt service imposes on the federal budget will only grow when interest rates rise. This poses a serious fiscal problem, limiting the government's ability to borrow for expansionary fiscal policies.

When the government borrows money to fund its fiscal policies, it competes directly with the business sector and consumers who also wish to borrow money. This crowding out effect can raise interest rates, forcing some borrowers out of the market. Another problem lies with fiscal policy applications, which may compete with private enterprise and even discourage private investment.