Guest Post: Making Sense of the Balanced Budget Amendment

The guest post below is by Andrew Hanson, who blogs regularly over at Amateur Philosophy (you can also follow him on Twitter here.) Andrew is up to date on the DC pulse, and he is a wealth of knowledge about current policy developments. He always brings interesting points to the table, and best of all, he thinks like an economist! I'm thrilled that Andrew has taken the time to write today's guest post on the balanced budget amendment.

 

Greetings, Zackonomics readers! I'm Andrew Hanson. I'm a fellow 2009 Teach For America alumnus, and I blog at Amateur Philosophy on philosophy, economics, and public policy. Zack and I struggled together while teaching algebra to a quite memorable group of eighth graders. 

One of the most interesting aspects of the past five years is how hard-won economic knowledge seems to have been lost by many in the public policy realm, and zombie ideas have again gained influence. Many of these ideas are associated with the Tea Party Movement, which became particularly influential in the 2010 congressional elections. However, they've also gained influence in other conservative and libertarian circles as well. There are many examples. The so-called "Gold Buggers" have called for a return to the gold standard. The Hangover Theory has returned, suggesting that recessions are the punishment we deserve for unwarranted excesses and malinvestment during the boom. Inflation hawks have been crying out in fear of hyperinflation because of the Federal Reserve's decision to "print" more money. The most recent zombie idea is that the federal government is a family that needs to "tighten its belt" when times are tough. The Balanced Budget Amendment, a proposal that would amend the constitution to mandate that the federal government keeps the budget balanced on an annual basis. 

Let's focus on the Balanced Budget Amendment, why it's bad economics and bad policy. First, there is a long-term federal budget problem that can only be resolved by cutting health care costs and the Medicare entitlement. But balancing the budget this year and every year after that wouldn't help solve that problem; it would make it worse.  To understand why, we have to first think about why the federal government might want to run budget deficits in general. The primary reason the U.S. economy isn't growing is that there isn't enough demand for goods, services, and investments to take advantage of our productive capacity. Factories and workers are sitting idle when they could be engaging in productive activities. 

Economists know that recessions are accompanied by a fall in aggregate demand, and though it cannot prevent recessions completely, the federal government can make output and employment less volatile by adopting "automatic stabilizers", changes in fiscal policy that stimulate aggregate demand without policymakers signing any new laws or measures. The tax system, for example, collects less in taxes when output falls because taxes are tied to the level of economic activity: income, earnings, and profits. Government spending, such as unemployment insurance, can also act as an automatic stabilizer. As unemployment rises, the government spends more on unemployment insurance to make up for the lost spending in the economy. More automatic stabilizers, such as tying the payroll tax to the level of unemployment are being proposed now as well. 

A Balanced Budget Amendment would require the government to raise taxes and cut spending during a recession, which would further depress aggregate demand, and make the recession longer and far more painful. Instead, the federal government should try to balance the budget over the course of the business cycle, but even that may be asking too much. The federal government never needs to balance its budget completely; it just needs to keep the federal debt as a percentage of GDP at a reasonable level. Kenneth Rogoff and Carmen Reinhardt, economists at Harvard, have detailed exactly what levels are crisis and what countries can afford in their book "This Time It's Different". Their basic conclusion is that anything over 90% of GDP is quite dangerous, while a government could run the federal debt at 50% of GDP basically forever.