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Balanced Budget Lunacy

posted by Adam Levitin

The House will be voting tomorrow on a proposed balanced budget amendment to the Constitution that would include a Proposition 13-like supermajority requirement for any tax increases.  It's unlikely to go anywhere, but it's worth discussing, if only because this budget lunacy is becoming half-way respectable.

On its face, what could possibly be objectionable about a balanced budget?  The words "balanced budget" have a very nice ring to them--who could possibly object to fiscal responsibility after all? We certainly don't want an imbalanced budget, do we? 

Actually, there are very good reasons why we should want some budgeting flexibility.  And there are several problems with a federal balanced budget requirement.  

1. It simply ignores or rejects basic Keynesian economics. An annual balanced budget requirement means that federal spending cannot be expanded as a counterweight to private-sector contraction absent corresponding increases in federal revenues. Raising taxes (easiest way to raise revenue) during an economic contraction, however, can exacerbate the contraction. And tax increases are likely to engender significant political opposition. So a balanced budget amendment puts us on a fast track to Hooverville.

2. An annual balanced budget requirement is simply arbitrary. We should strive for a balanced federal budget over the long-term, but if we run a deficit one year and a surplus in another, it's not a big deal.  Annual balanced budget requirements prevent the public sector's accordian flexibility that's needed to smooth out the volatility in the private sector. 

3. This amendment would require balanced budgets on a cash accounting basis (it speaks of "outlays" and "receipts").  Most states use cash accounting for their budgets.  (The federal government has a cash accounting "budget" but uses accrual accounting for the Financial Report of the US Government-see here and here.)  Both methods of accounting are very suspectible to manipulation, but cash accounting has some really obvious cheap tricks. For example, simply not paying a bill means that there is no outlay, the obligation doesn't show up in this fiscal year. Similarly, raiding off-budget trust funds (Social Security, e.g.) would count as revenue, even though it's no different from transferring money between savings to checking accounts. (See a nice history of the budget treatment of Social Security here). Both are proper treatments, however, for cash accounting. At least the bill excludes borrowed funds from treatment as "receipts".  

Fundamentally, though, cash accounting does not give a good picture of the US's finances.  The real worries with the country's finances are its long-term ability to pay things like Social Security and Medicare (particularly the new and atrociously designed prescription drug benefit). None of that shows up in a cash budget.  

4. How do you pay for a war? The increased expenses of a war would quickly bust any federal budget.  The proposed amendment has a declared war exception as well as an "imminent and serious threat to national security" exception, as recognized by a majority of the whole of both houses. Would Afghanistan or Iraq qualify? 

5. A balanced budget does not eliminate the federal deficit debt.  If you're worried about the federal government being overleveraged, that's ship's already sailed.  We could have years of balanced budgets, but we'd still have huge amounts of debt to pay down.  

6. What's the remedy for failure to comply? Who has standing to litigate? What if the President fails to submit a proposed balanced budget? And what if actual spending doesn't align with actual revenue? What's the possible judicial remedy? Order a tax increase or order spending cuts? From what programs? Farm subsidies? The military budget? Reduced social security benefits? Federal layoffs? I wish the Congressmen who sponsored this bill at least had the decency to specify that Congressional compensation would be the first item to be cut to balance a budget. That might be a useful self-disciplining mechanism. 

7. Supermajority tax increase requirement. Here's the true lunacy of the bill, it would require a 2/3s majority (by rollcall vote) in both houses for any bill to increase revenue.  Let me repeat that again:  any tax increase would have to be approved by a 2/3 majority in both houses.  That's a federal version of Proposition 13, the state Constitutional amendment that destroyed California by requiring supermajorities for tax increases.  It effectively gives a selfish minority the ability to stymie actions that benefit the whole. 

Now it might be observed that almost all the states (VT and sort-of WY excluded) have balanced budget requirements.  These requirements are a major factor in state fiscal problems:  the states have Keynesian spending obligations but don't have Keynesian borrowing power.  When there's an economic contraction, demands on states for social services rises, precisely at a time when state revenue is falling (and the market value of state pension trust funds is also likely falling).  The federal government can kick in increased transfer payments to the states, but there's no guarantee that it will.  For example the ARRA payments that helped mitigate state budget crises over the past few years are running out.  That means this fiscal year will again be rough on the states.  

This is a fundamental structural problem with US fiscal federalism. It is also, incidentally, one that state bankruptcy would be unable to address.  (I've got a forthcoming book chapter on this, but no link yet.)  

Bottom line is balanced budgets are a nice aspirational goal, but a country's budget isn't the same as a family's. A country has social welfare spending obligations that a family does not have. If a family can't meet its budget, it can look to federal welfare programs for assistance. The federal government doesn't have that luxury. That's why it needs the ability to spend more than it takes in on an annual basis. Long-term, of course, the country does need to have spending and revenue aligned, but a better way to steer the budget toward that is to impose a cap on the spending/revenue spread, ala Maastricht.  I'm not sure that I'd even endorse such a cap, but it's a much more balanced approach to budgeting than a balanced budget requirement. 

Comments

Simply put and brilliant. Even an economic nebish such as myself can understand it. Thanks for this!

You speak of cash vs. accrual accounting. How about Governmental Accounting in general? What assets are capitalized and which ones are expensed? It depends on which Fund it was purchased from not the cost. I worked as an accountant in local government for a few years. I often thought that this was part of the problem. Government needs to be speaking the same language as the private sector or at least have it translated. I never received a good answer to my question…may you can answer it for me.

Since when are household budgets always balanced? People go from deficits to surpluses all the time with their own budgets, as do all private entities. Balanced budgeting is nonsensical for everyone.

Number 5 should read: A balanced budget does not eliminate the federal ***debt.***

1. Ignoring Keynesian economics is a good thing.
2. Two thirds voting is not what wrecked California. It was profligate spending at the behest of public unions, poor fiscal management, and an unworkable government structure. But, there's no reason why government can't spend without its limits. Logically, someone tell me why the state with one of the largest populations and the third highest tax burden should not be flush with cash.

No, ignoring Austro-Chicago economics would be a good thing. Ignoring Keynes is what got us here. And there is a huge difference between a government that can issue its own, sovereign currency and one that can't.

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