Castles in the Sky and the Balanced Budget Amendment

Jack A. Goldstone, George Mason University

There is great enthusiasm among conservatives for a balanced budget amendment.

In one sense, this is very odd, because conservatives claim to be following in the footsteps of the founding fathers and bringing the country back to their vision.  But the founding fathers did NOT put a balanced budget requirement in the constitution – that is why it requires a constitutional amendment.  So in this case conservatives are demanding a modern change to the constitution that departs from the vision of the founding fathers.  But never mind that; let’s focus on the reasons why a balanced budget amendment would be as useful, and as dangerous, and planning to live in a castle in the sky.

One argument put forward for a balanced budget amendment is that any business has to pay its bills – so shouldn’t the government have to do the same?  That is true – but private businesses also borrow money.  In fact, such borrowing is essential for businesses to buy new equipment, build their inventory, or cover their payroll until they collect their outstanding bills.  Borrowing also is crucial when a business has a down year, to tide them over until business picks up again.  Before we support a balanced budget amendment, I would like to see how many executives of Fortune 500 firms or small business owners will come forward to sign a pledge to never  borrow money to expand their business, purchase equipment, or pay their bills, and that if in any fiscal year their expenditures exceed their revenues, they will promise to declare bankruptcy rather than borrow to keep the company going until more revenues come in.

Frankly, the real world of business is not like that – of course businesses borrow and use debt.  So why shouldn’t the federal government?  What is important for both business and government is that over the medium to long term, revenues and expenditures balance closely enough that debts do not explode to a level where they can never be repaid.  As any business knows, if revenues are going up, borrowing for future growth and expansion can go up as well, because growth will pay off the debts.  It is only if expenses are going up relative to revenues for the long term (not because of a short-term dip) that borrowing has to be curtailed.

A balanced-budget amendment would not make the government act like a private business; it would PREVENT government from acting like private businesses, which rely on prudent borrowing to manage the balance of demands and revenues.  The key to a sound financial future for the US is to get government to focus on prudent borrowing, not stopping borrowing altogether.  Put another way, using a balanced budget amendment to curb the risk of excessive borrowing is like going to someone who has suffered from ‘tennis elbow’ from too much practicing and asking them to chop off their arm so that it can never be over-exercised.  You would be removing the ability to function altogether in order to prevent ill-use.

Why do I say something so drastic?  Because in wartime, a balanced budget amendment would be like chopping off an arm.  No government can pay the costs of war out of current revenues.  Buying tanks and jet-fighters, mobilizing reserves, and paying for military operations, ammunition, and supplies, requires an immediate and significant increase in spending.  If the US had a balanced budget amendment, we could never undertake any significant military operation without an immediate and commensurate increase in taxes!  Throughout history, nations have financed wars by spending a lot of money up front to fight the war and supply its fighters, borrowing the money to do so, and then raising taxes or using economic growth to pay off the loans when peace returns.

If the US should be attacked, or have to rush to the defense of an ally in danger, or wishes to upgrade its own defense capacity by building new equipment, we would have to borrow – or raise taxes so suddenly and massively that we would crush the economy.  Now you might say that of course in a war, Congress could vote supplies to an army.  Not so – the whole point of a balanced budget amendment to the constitution is that it prevents Congress from using its own authority or discretion to spend more than it takes in.  So in case of a war, we would, in effect, have our arm cut off – we would be forced to try to defend the country only using the amount of money that taxpayers would pay in a given year.

Supporters of a balanced-budget amendment might say – but of course the amendment would have an exception for war.  OK – but who would have to declare war?  The President?  Congress?  Both?   The US never declared war in formal terms in most of the operations in which it has engaged in recent years.  Worse yet, what if the Defense Department says it needs a major new investment to prevent a war – to develop a new satellite system, or cyberware or missile defense systems.  A balanced budget amendment would prevent us from investing any more new money in such defense systems in a given year than taxpayers would pay in new taxes during that year.

The same is true of a major or even minor recession.  During a recession, government revenues inevitably fall – a balanced budget amendment would also force spending to fall that same year.  That is true even it means that defense spending, or aid to states, had to be cut; the first is dangerous to our security, and the second could push states into bankruptcy.

That brings us to the other main argument used in favor of a balanced budget amendment – that nearly all the states have them, so why shouldn’t the federal government have one too?   This truly absurd argument acts as if there are no significant differences between a state government and the federal government.  Let me point out just two MAJOR differences.  First – the states do not have to defend the United States and pay for wars.  That is a Federal responsibility.  If the states had to engage in wars, they too would need to borrow much more than they do!

Second – the states are not sovereign, but part of a larger sovereign government.   That means that in case of emergencies – such as massive fires or floods, or economic recession – the states can call for Federal Assistance; most of which is paid for with money that the Federal government borrows to help the states cope with those emergencies.  What governor, faced with massive fires or floods, hurricane or earthquake – would refuse federal disaster assistance for their citizens?  If we had a balanced budget amendment that prevented the Federal government from borrowing to deal with major national disasters, the states would be on their own to deal with those massive losses.

In the great recession  that we are still facing, the states were able to balance their own budgets  ONLY with Federal money.  Rick Perry, the stalwart Republican governor of Texas, took $17 billion in federal stimulus  money to help balance the Texas state budget in 2010 (see http://www.theatlanticwire.com/politics/2011/01/stimulus-hating-gov-rick-perry-used-stimulus-to-balance-texas-budget/21369/).  In fact, 97% of Texas’ budget deficit that year was filled with Federal funds.  So it is just silly and false to say that because the states have to balance their budgets, so too should the Federal government.  In fact the only reason the states can balance their budgets in a recession is that they can call on the Federal government to fill their budget holes – again usually with money that was borrowed to cope with the  emergency.

In fact, the argument on states is worse than that, because the states ALL borrow money.  The only reason that it appears they have to balance their budgets is that they keep their capital accounts separate from general revenues.  When California or Texas builds a highway, the state government issues a bond and dedicates revenues (usually gasoline taxes) to pay the interest on the bonds.  The ‘balanced budget’ only applies to balancing  general (unrestricted) revenues and discretionary spending.  When the Federal government builds an aircraft carrier, the government issues bonds and pays it out of general taxes.  The Federal government has no separate capital account, so all federal spending in excess of current revenues shows up as a current deficit.  But in fact the Federal government is NOT doing anything different than the state governments routinely do – both issue bonds to pay for expenses that they cannot cover out of current income.  The ability of states to balance their budget is really an accounting requirement to balance  a certain part of their budget.  It is not in any way a prohibition on borrowing or on spending in excess of current revenues, a prohibition that a balanced budget amendment would in fact place on the Federal government.

In sum, a balanced-budget amendment is just a talking point.  To actually implement it would be disastrous.  If adopted, it would critically undermine our national security, end our ability to respond to natural disasters or economic recessions, and make it impossible for the Federal government to help the states fill their budget holes when they need assistance.

As a talking point, it makes certain politicians feel bold, and allows them to talk about doing something unthinkable, without doing what is really necessary – making the tough decisions on current spending and revenues to keep deficits within prudent bounds.

Prudence is a virtue that the founding fathers would have applauded; it is what we need to put our fiscal house in order.  A balanced budget amendment is the opposite of prudent; it would be performing drastic and unneeded surgery on our Constitution.  The founders would be horrified — one of the key purposes of the Constitution in 1787 was to give the federal government a sound basis for borrowing, which was lacking under the  old Articles of Confederation.  Let’s not take that power away with a balanced budget amendment; doing so would  make the founders role over in their graves.

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About jackgoldstone

Hazel Professor of Public Policy at George Mason University
This entry was posted in U.S. Politics. Bookmark the permalink.

5 Responses to Castles in the Sky and the Balanced Budget Amendment

  1. sanchk says:

    Failures and pitfalls from trying to a balanced budget amendment (BBA) go beyond wars; the legislative process to even form a budget in the presence of a BBA would be arduous. Most of the problems you mention can be overcome by balancing budgets over a period years, so for example set a 10 year window where four years of deficits totaling $6 trillion are offset by 6 years of surpluses totaling $4 trillion, so you get a balanced budget on average.

    For me, the bigger problem with a BBA is the amount of legislative work that has to go into making it happen. For starters, people will argue over the predicted costs – whether they’re overestimated, underestimated, or unfair. Measures that start off as temporary (like Bush tax cuts) may end up becoming permanent, and likewise measures that are meant to be permanent may turn out to be only temporary; yet their classification as temporary or permanent can play a huge role in the deficit. Being able to target a specific deficit or surplus, or even perfectly balanced budget, would require an ability to follow and predict prices, economic trends, and demand to a degree that’s more accurate than current forecasting tools can manage. Finally, related to your point about states, the level of coordination that would be needed between federal, state and local governments to ensure that the right amount of money is raised and disbursed would be just overwhelming.

    The worst part about a balanced budget amendment however is that it assumes a healthy or well functioning government is one that has a balanced budget. The health or functional ability of a government comes from its ability to fulfill its obligations, whether it be economic, political, diplomatic, electoral, or regulatory. Show me somebody who’s willing to sacrifice the government’s ability to fulfill one or several of those obligations for a financial budget, and I’ll find you a government that’s actually been able to manage all of those responsibilities.

  2. Hyena says:

    I think you bring up an overlooked point. Let me add another: during the crisis, a lot of states ended up borrowing against Medicaid and unemployment insurance assistance from the Federal government. The BBAs at the state level apparently exclude this form of borrowing, though it all has to be paid back, and only constrain the use of bonds. Presumably, the states could become indebted to the Federal government they just could not be directly beholden to bond holders.

    I think you’ve hit the dirty secret of state budget balance: they rely on various sorts of bailouts from the Feds in any situation where they’d otherwise borrow. I wonder if, as a consequence, the states also run higher taxes and fees than they’d otherwise need to. I can easily see how this arrangement could rapidly push the states into unsustainable territory: additional levies that provide needed revenue or just padding slowly become the new normal and so yet more must be levied later lest “important programs” are cut. The BBAs at the state level might be extremely bad.

  3. Rick Gerkin says:

    Let me propose a different version of a BBA which would instead address long-term budget shortfalls rather than short-term ones. Suppose a new 30-year security was created which paid out each year according to the level of federal debt (as a fraction of GDP) in that year. More debt/GDP means a lower payout. Sold on the open market, the price of this security would reflect the capitalized value of market expectations of debt/GDP ratios over 30 years. Now let current federal spending be constrained by amendment (with 3/5 majority override) according to the price of that security. If it falls below a certain price threshold (reflecting low expected payouts meaning high expected long-term debt/GDP ratios), then federal expenditures would automatically be cut across the board, incrementally, until the price rose above the threshold again.

  4. ChrisA says:

    Not being a US resident or citizen I have no dog in this fight, but it seems to me that the balanced budget is really an attempt to deal with an agency problem, which you really don’t address. The agents being the various arms of government (senators, representatives, civil servants). It appears that the people advocating the amendment have lost faith in the ability of the democratic processes to restrain agency issues in government and want to use regulation instead or as well. Looking at recent history, they certainly have a point. I agree with you that there will be unintended consequences of such an amendment, and probably, as with all regulation, it will be avoided in creative ways if the underlying incentives remain. So what would your suggestion be to deal with this issue instead? Or do you believe the democratic process is sufficient?

    FWIW my solution would be more Swiss style direct referendum on major social policies, combined with great decentralization in terms of delivery of social policies.

    • Chris — Do we have a problem? Yes. Did government spending get out of control? Yes. But what spending? The US military budget has risen 70% in the last decade, more than in any decade since the Korean War. As Fareed Zakaria has pointed out, the US now spends more on defense that ALL THE REST OF THE COUNTRIES IN THE WORLD COMBINED. Can we afford to do this? No. Will a Republican-dominated House of Representatives accept this? I do not know.
      But promoting a balanced budget amendment is one way for them to LOOK like they care about spending while not really doing anything about it.
      Unfortunately, where the US tried Swiss-style referendums, in the state of California, they were not used prudently, but handcuffed the government and created the fiscal crisis that was a precursor of the US Federal struggle. If you ask me what I think is the answer, it is for Democrats to engage in tough, determined negotiations, and not give into an extreme minority no matter what they threaten. The US constitution was carefully designed precisely to PREVENT any determined minority from imposing its will on the majority. But Congress has adopted a number of new rules never anticipated in the constitution — the filibuster rule on ordinary legislation, the creation of a debt cap — that artifically create crises that a minority has learned to exploit. This is the exact opposite of what was intended in the US constitution, and we should try to restore what the Founders aimed at.

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