What is Fiscal Sustainability?

Fiscal sustainability is an important quality for any pattern of government spending. This term refers to the impact that the policy has on the government in the long term. If a policy is sustainable, it does not hinder the government’s policymaking ability in the future. Different analysts and commentators have different definitions of what makes a policy fiscally sustainable because sustainability depends on the permissibility of certain future government actions like raising taxes and engaging in deficit spending. Sustainability is a critical consideration for policymakers because ignoring it can lead to economic and political collapse when the government faces a debt it cannot repay.

One common explanation of fiscal sustainability is that it is met if the level of debt relative to income stays the same or declines in the long term. Some people criticize policies that create any budget deficit for being unsustainable. These policies, however, are not unsustainable if they only create debt in the short term. A government can overspend in one year, for example, and make up the deficit with a budget surplus in the following year.

Governments have leeway in their temporary debt because they have a long horizon. They, like some other institutional investors, have an infinite horizon, which means they expect to exist in perpetuity and handle finances accordingly. In contrast, individual investors have horizons that are generally limited to their own lifetimes. Longer horizons give investors more flexibility with the timing of their investments.

Although it is unreasonable to define every policy that creates a deficit as fiscally unsustainable, it is equally unreasonable to suggest that every policy is consistent with the goal of fiscal sustainability because the government can always tax people more or cut spending later to make up the deficit. While this is theoretically true, fiscal sustainability is a concept based on real behavior rather than theory. Large tax increases and budget cuts are politically infeasible. Conservative spenders protest increased taxes, while the recipients of budget funds lobby against cuts to their programs. A policy cannot be sustainable if it creates a deficit too large to be overcome using politically acceptable actions.

The basic definition of fiscal sustainability is thus vague. It depends on the political opinions of the person making the analysis. A commentator with liberal leanings, for example, might be more comfortable with the idea of high taxes than a conservative would be, so he might define a wider range of policies as fiscally sustainable.