The balanced-budget amendment: Pros and cons

Sanjay Paul
Feb 13, 1997

A version of this article appeared as Pros, Cons of Balanced Budget Amendment in Business Forum, Green Bay Press-Gazette, Feb 15, 1997.

If ordinary households can balance their budgets, say the proponents of the balanced-budget amendment, why can't the government? It sounds like a reasonable question: after all, shouldn't the government exhibit the same fiscal rectitude as the citizens they serve?

The problem with the above argument is that ordinary households do not typically balance their budgets. They spend "beyond their means" by incurring various kinds of debt -- and in most cases, such profligacy is perfectly warranted. It is through borrowing that younger folks manage to buy expensive items like cars and houses. If debt were outlawed, such luxuries would be beyond the reach of most people until they had worked for considerable periods of time and acquired the necessary savings to buy the items outright.

It is also quite common for individuals to finance another "investment" expenditure with borrowed funds -- their education. If households were determined to balance their budgets, most people would have to do without higher education. And sans higher education, prudent households realize, their prospects of advances in living standards are very dim. Accordingly, spending beyond one's means in order to go to college becomes an eminently sensible proposition.

But the question still remains: Even if prudent households do not balance their budgets, should the government balance its?

The analogy with the case of households is instructive. Just as individuals borrow to finance expenditures on items that generate returns for years to come, so too could the government incur a budget deficit in order to finance spending that increases the country's productive capacity -- things like infrastructure, education and health care.

Supporters of the balanced-budget amendment point to its salutary effect on the size of the government. By imposing this restriction, they argue, government spending will be reined in. No more wasteful government programs, no more pork. And to make matters even better, the fall in government spending may also be accompanied by a cut in taxes. What a deal! Not only do we have a less profligate government, the hated IRS gets less from us.

There is some merit to the above argument. Forcing the government to balance its budget will require cuts -- in some cases, steep cuts -- in various programs. Since some of this spending is indeed wasteful, the cuts will lead to greater efficiency in government spending. Politicians used to ladling out pork-filled projects to their constituencies will be forced to become less generous with taxpayer funds.

Another argument in favor of the balanced-budget argument is that the elimination of government borrowing will cause interest rates to fall and all household savings to flow to the private sector -- leading to greater investment and faster economic growth.

This is a powerful argument. There is indeed evidence to suggest that less government borrowing leads to lower interest rates. Since 1992, for instance, the sharp decline in the federal budget deficit has been accompanied by a fall in interest rates. Correspondingly, spending on capital goods -- houses, cars -- has increased significantly during the period. And so too has the economy's output of goods and services, or gross domestic product (GDP).

Ah, but note that this growth in prosperity occurred despite the lack of a balanced budget. This is hardly a new development -- there have been several periods in the country's history where economic growth has taken place without a balanced budget. And -- notably -- there have been periods where the lack of a balanced budget requirement has proved to be singularly beneficial.

The principal economic argument against a balanced-budget amendment is that it would hamstring the government in times of necessity. When the economy goes into a recession -- as it must sooner or later -- and people's incomes go down, tax revenues will fall. If then, as required by the balanced-budget requirement, the government is forced to cut spending or raise taxes, the recession will be greatly exacerbated. Indeed, what is required to counter a recession is a policy that would result in a larger budget deficit -- viz., an increase in government spending or a reduction in taxes.

The performance of the U.S. economy since World War II provides cogent evidence of the effectiveness of government policies in eliminating painful swings in the country's GDP. While the first half of this century is replete with episodes of severe business fluctuations -- periods of exuberant expansion followed by debilitating recessions -- the second half has been relatively benign. Since the early 1950s, the economy has grown fairly steadily; and though recessions have occurred now and then, their severity has been considerably attenuated.

What is responsible for this? Primarily, the government's (largely judicious) use of fiscal and monetary policies. By removing the fiscal controls from the government's hands, the balanced-budget amendment runs the risk of leaving the economy rudderless when they are needed the most.

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