If the increase in government spending is just equal to the increase in taxes, the budget is balanced. A balanced budget with simultaneous increases in spending and taxes is not neutral but expansionary. The reason for an increase in output is that the taxes reduce both consumption and saving, and the reduction from the taxes is smaller than the increase from the additional spending. The value of the balanced budget multiplier is one.
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During most of the earlier part of this century, the various American administrations believed in balancing the budget. Any increase in spending had to be matched by an increase in tax revenue. Over that period and until 1930, the economy grew at a very healthy pace. But in the 1930's, a balanced budget with reduced spending in the recession contracted (i.e. rather than expanded) the economy further. |
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