Budget Surpluses as a Fiscal Regime

Scholars of public finance have spent the last decades analyzing and explaining a “deficit bias” of representative democracies. By contrast, budget surpluses are regarded as empirically unlikely to happen and as being of minor theoretical interest. The paper challenges this focus on budget deficits. It analyzes countries with budget surpluses and asks why some of them preserved their surpluses while others returned to deficits quickly. Empirically, permanent budget surpluses became the norm in six OECD member states in the late 1990s, namely Australia, Canada, Denmark, Finland, New Zealand, and Sweden (I exclude Ireland, Luxemburg, and Norway because of the idiosyncratic nature of their surpluses). By contrast, several other countries also balanced their budgets but did not preserve surpluses. I compare the development of fiscal policy in both groups of countries and show how they differed systematically in all stages of the development of surpluses. While those cases where surpluses were lost can still be interpreted as a confirmation of models predicting a “deficit bias”, the six other cases certainly cannot. They need a different explanation. To provide such an explanation, the paper investigates how fiscal policy developed in all six countries in a largely similar sequence. They all faced a deep fiscal crisis which fundamentally questioned existing fiscal policy arrangements. It was followed by a massive and expenditure-led fiscal consolidation. The new surplus regime was finally established through a tight fiscal response to adverse macroeconomic developments. I argue that the persistence of surpluses can be explained by a shift of fiscal policy interests which is triggered by the fiscal crisis and the following expenditure-led consolidation. Support for the surplus regime is ensured by a credible commitment to use surpluses to fund tax cuts and to prevent expenditure increases. Consequentially, all six countries cut taxes substantially while they were running surpluses.