Almost fifty years ago, in 1977, James Buchanan, who later won the Nobel Prize in Economics in 1986, and Richard Wagner published a book titled ‘Democracy in Deficit’—a critical analysis of the political legacy of Lord Keynes. Since the publication, fiscal developments have proven the accuracy of their analysis and the relevance of their warnings.
Keynesian economics has overturned the classical principle of balanced budgets and shaped the post-war conduct of budgetary policy. Before the 1930s Great Depression, government budgets were broadly balanced: when exceptional circumstances required government to issue debt (e.g., Civil War), this debt has been subsequently retired. And when capital expenditures were financed by borrowing, a sinking fund for amortization was established. Because public expenditures were expected to be funded by tax revenues, there was less incentive to use the political process to implement income transfers to constituents.
These rules guiding budgetary policy began to be gradually eroded during the 1930s. The economic disaster of the Great Depression led Keynes to challenge the assumption that the market economy is self-equilibrating and posited that policy intervention is needed to achieve high-level output and employment. During recessions, fiscal stimulus was to boost aggregated demand and restore full employment, and budgetary surpluses were to be maintained during the expansionary phase.
Keynes himself would have likely been surprised by the developments his teaching put in motion. As Buchanan and Wagner argue, his vision that fiscal policy would be conducted by “experts” shielded from political pressures ignored political reality in a democratic society. Running budget deficits in “bad times” by reducing taxes and/or increasing spending is politically easy. But running budget surpluses during good times is not.
Although it took time for the ideas of Keynesian economists to gain traction in politics, they eventually did.
The first step was the acceptance of built-in budget flexibility and “passive” deficits. Taxes and expenditures were to be arranged in a way to produce budget balance when full employment and output are achieved with deficits allowed in bad times. This broadly describes the budgetary practice of the Eisenhower administration during the 1950s. But there was still hesitancy to actively use budgets to boost output and employment. This has changed with a significant tax cut in 1964, despite the absence of recession and even though the budget was already in deficit. This procyclical fiscal stimulus resulted in higher deficits and accelerating inflation but only a temporary boost to growth.
In response, the effort was made to restore fiscal responsibility with the 1974 Budget Reform Act.
But the genie was out of the bottle, and budget deficits at all times became a norm. When budget spending was mostly financed by tax revenues, the costs of public goods provision to taxpayers/voters were obvious. The ability to finance part of budget spending by debt weakened that link: costs were less clear and more distant in time. This reduction in price of public goods led to increased demand. Voters supported politicians who were willing to meet this increased demand. The share of federal budget spending financed by borrowing rather than tax revenues has been steadily increasing since 1960s and is now about one fourth.
There is a broad agreement that this trend is not sustainable. But there is less agreement on how long it could continue and how to reverse it. Shortening of maturities and Fed’s purchases of government debt contain for now market pressures that would otherwise raise the financial and political costs of continuing deficit financing and change voters’ and politicians’ incentives. And there is always the hope that growth will accelerate enough to save the day. While not impossible, this outcome is unlikely. More likely outcome is that it would take a serious crisis—inflation, financial repression, or even the unlikely debt default—to bring down the debt to a sustainable level. But this would do serious economic damage and would not necessarily guarantee an end of fiscal incontinency.
Buchanan and Wagner argued that following the abandonment of informal fiscal discipline, only formal constitutional constraints in the form of balanced budget rule could restore the fiscal discipline. Fiscal history seems to confirm the validity of their conclusion. The recent review of experience with fiscal rules by the IMF (Staff Discussion Note 2025/4) and the World Bank (Global Economic Prospects, January 2026) shows that credible and well-designed fiscal rules could promote fiscal discipline and improve fiscal outcomes. Perhaps it’s time to start a serious debate on fiscal rules in the U.S.
Featured Author:
Jiri Jonas, is a former senior economist at the IMF with 40 years of experience in economic policy, country operations, and analytical work.
All views expressed by members are their own and not reflective of the views of the Bretton Woods Committee.