Monday, July 25, 2011

Why Balanced Budgets Are Stupid, for Both Governments and Families

A few days ago, the House passed a bill that would bar any increase in the debt ceiling until Congress passes a balanced budget amendment to send to the states. Since it was obvious that this would never pass the Senate, I thought the Republicans might have given up on the matter, but apparently they haven't, since a balanced budget vote is part of the debt ceiling deal Boehner proposed today.

Because the Republicans seem keen on trying to keep this idea on life support, I thought I'd take a minute to explain why a balanced budget amendment is a terrible idea, both for the government and for a household (since Republicans [and, distressingly, Obama too, as of late] are such big fans of comparing government finances to household finances, even though the two have almost nothing in common).

Basically, a balanced budget amendment says that a government cannot spend more money than it takes in during a given period of time (usually a year). Politicians often say that people / households / families can't spend more than they make, so the government shouldn't be able to, either.

This is a ridiculous idea for several reasons, the most obvious being that people / households / families spend more than they make all the time. How do they do this? They borrow money. If they didn't borrow money to spend more than they make, almost no one would own houses or cars or go to college, since almost no one has the cash on hand to pay for those kinds of expenses out-of-pocket. I rather doubt that the Republicans would argue that people should only buy houses, cars, or college educations if they can do so without needing to borrow money. So, if people borrow money all the time, why can't the government?

Furthermore, another pernicious result of a balanced budget amendment would be to make recessions last deeper and longer, hurting more people worse than is otherwise necessary. It is a good thing if the government borrows and spends money during an economic downturn, to keep demand up and act as a counter-cyclical influence. (Note: this requires an understanding of Keynesian economics. If you don't understand or believe Keynesian economics, there's not much I can do to help you.) If the government can't do this, then the government ends up spending less during recessions (because it's taking in less money), making the recession even worse (see "procyclical"). By borrowing and spending (especially when the economy is bad), the government can smooth out overall societal consumption and lessen the pain of economic downturns.

Oh America - some things never change. Source.

The problem with the U.S. government is that it never seems to be able to save money during good times in order to have extra money (or borrowing capacity) on hand during bad times. The most recent (and perhaps most egregious) example of this was when George W. Bush was handed a surplus by Bill Clinton. Instead of saving for a rainy day as a responsible family would do (i.e. using the surplus to pay down some of the U.S.'s debt so that the U.S. would have plenty of borrowing capacity when the next downturn came), Bush instead decided to spend the surplus on decreasing taxes (especially for the wealthy) and then started two wars without paying for them - turning record surpluses into record deficits that got unimaginably huge when a recession hit at the end of his Presidency and the beginning of Obama's.

So, that's why balanced budget amendments are bad ideas for both governments and families. The problem isn't with borrowing and spending; the problem is with borrowing and spending during the good times as well as the bad times. We're currently in bad times, so the government should be borrowing and spending, especially since the government can borrow money for cheaper-than-free at the moment - but no one's talking about the sensible thing to do.

What would be preferable to a balanced budget amendment? Why, an unbalanced budget amendment, of course:

The unbalanced budget amendment is a requirement that in good times the government must run a budget surplus. The virtues of such a rule are that it allows for counter-cylical fiscal policy during a recession. Indeed, it reduces the cost of counter-cyclical fiscal policy because it guarantees a reserve fund for just such emergencies. The unBBA is thus a type of automatic stabilizer of the kind I have argued for before (e.g. here).
A simple version of the unBBA requires surpluses but more generally the rule would be a surplus or a similarly sized reduction from the previous year’s deficit. The size of the required surplus/deficit reduction would be tied to a function of current and recent GDP growth rates.
Notice that while making counter-cyclical fiscal policy easier the unBBA would tend to create budget balance as surpluses in good times were spent in bad times. Thus over a period of time the unBBA has similar results to a BBA. By requiring surpluses (and thus taxes) to be high(er) in good times,however, rather in bad times the unBBA has a lower cost and a better chance of being passed than the BBA.
 I'm sure Congress will get right to passing that.

2 comments:

  1. The overly simplistic and very partial reasoning on the family budget is way off. The average family does not increase its total debt every month, like the US government. They may buy a house or a car which puts them in debt, but the budget must be balanced over the long term or bankruptcy comes. Being out of debt is the only way to live.

    "The borrower is the slave of the lender." - Proverbs 22:7

    "If the US Government were a family & their household income was $55,000 per year, they’d actually be spending $96,500—$41,500 more than they made! That means they’re spending 175% of their annual income! So, in 2011 they’d add $41,500 of debt to their current credit card debt of $366,000!" - Dave Ramsey

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  2. Tired:

    I wasn't trying to argue that the current U.S. debt path is sustainable, which seems to be what you think I said. I don't think the current path is sustainable. I simply said that balanced budget amendments don't make any sense, either for governments or households, which is true.

    As I say in my post, the problem is that the U.S. government never saves money in good times - most recently, when the U.S. government began to run a surplus, the Republicans decided to spend the surplus (largely through tax breaks for the wealthy, and then through two unfunded wars) rather than saving it. That was dumb, and that's the kind of short-sighted thinking that has put the U.S. on its current unsustainable path.

    In fact, almost all of the short and medium term deficit problems were created by the combination of the current economic downturn and Bush-era policies: http://www.cbpp.org/cms/index.cfm?fa=view&id=3490

    (In the long run, the U.S. deficit problem is largely a function of ever-increasing health care costs, but that's not just the U.S. government's problem, and it's not terribly relevant right now.)

    Oh, and finally, I wanted to note that (again unlike a household) government debt CAN continue to grow forever - it just can't continue to grow faster than a country's overall economic growth forever. That is, if a country's economy grows at 2% a year, then government debt can continue to grow at 2% a year, forever. If you want the technical explanation behind how this works, check out this paper - http://goo.gl/OW33d (PDF warning).

    Hope this clears things up for you.

    -The Angry Bureaucrat

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