Looking Beyond the Deceptive Pleas for a Balanced Budget Amendment

Opposing a constitutional amendment to require balance in the federal budget is like opposing virtue, which is why the amendment may slide through Congress in the next few weeks. Responsible members may vote for it against their better judgment because a negative vote would be too hard to explain to voters.

The amendment sounds like a double plus--a step toward a stronger economy and more honesty in politics at the same time. In fact, it is a double fraud that could both weaken the economy and exacerbate hypocrisy in public life.

Hardly anyone would disagree with the apparent objective of the amendment: eliminating large, persistent deficits in the federal budget. For the last 10 years, the U.S. government has lived way beyond its means, piling up debt in good times and bad. Huge government borrowing has absorbed a large fraction of the nation’s inadequate supply of savings, keeping real interest rates higher than necessary, discouraging private investment especially in long-run projects and making American industry heavily dependent on foreigners for capital. Interest on the mounting federal debt has become a fast-growth item in the federal budget, crowding out more productive uses of tax revenue.

Getting rid of the persistent deficits in the federal budget is arguably the most important element of a strategy to brighten America’s economic future.

So why is a balanced budget amendment not a good idea?

The essential difficulty is that while large, continuing deficits are pernicious, smaller temporary deviations from balance are inevitable and often beneficial. Attempts to avoid temporary fluctuations can do more harm than good.

For the long-run health of the economy, it would be wise to balance the federal budget on the average over the business cycle or even run a surplus. But it would be counterproductive to try to keep the deficit zero (or any other number) every year, regardless of what is happening in the world or in the economy.

Federal tax revenue drops sharply in a recession, and some spending, such as unemployment compensation, rises. The resulting deficit helps stabilize the economy. If complying with the Constitution made it necessary to slash federal spending or raise taxes steeply in recessions, the up and down swings of the business cycle would be exacerbated. The current recession was clearly worsened by layoffs and tax increases at the state level necessitated by balanced budget rules. (States ought to build up “rainy day funds” to cushion budget cuts in recessions.) Eliminating the counter-cyclical balance-wheel of the much larger federal budget could turn a recession into a deep depression.

Moreover, while the crisis in the savings and loan industry should have been prevented or contained, once it occurred the federal government had to honor its obligations to insured depositors. Borrowing was a far more appropriate way to finance the federal acquisition and resolution of the failed thrifts than either a massive tax increase or drastic cuts in unrelated spending. Sales of assets of the failed thrifts will eventually return a significant share of the funds to the Treasury.

If the country is going to rely on procedural rules, rather than common sense, to constrain budget policy, the rules must meet the demanding “Goldilocks test”--not too tight, not too loose, but just right. They must be designed to hold down the permanent ongoing deficit while allowing temporary fluctuations.

The draft amendments under discussion attempt to meet the Goldilocks test by providing escape clauses for specified emergencies and a general provision that 60% of the Congress can unbalance the budget for any reason. Presumably, the current combination of recession plus thrift crisis, which accounts for about half the more than $400-billion deficit, would have prompted an override if an amendment were already in place. Once the lid was off, the 60% super majority would then likely have added to the permanent deficit by enacting additional spending programs and middle-class tax cuts.

The existing Budget Enforcement Act of 1990, by contrast, is keeping rigid caps on discretionary spending and enforcing pay-as-you-go rules on taxes and entitlements, even though the deficit is rising for temporary reasons. The BEA meets the Goldilocks test far better than any language that could be put in the Constitution. Trading the complex but effective BEA for a balanced budget amendment with no known enforcement mechanism would be a step back from fiscal responsibility.

BEA needs to be strengthened and extended beyond 1995. Caps should be applied to total spending (including entitlements) and the rules should be tightened to move the underlying structural deficit to zero by the end of the decade. Passage of a balanced budget amendment would greatly reduce the chances of Congress and the newly elected president taking such strong action. It would be too easy to rest on the symbolic laurels of the amendment vote, wait for action in state legislatures and let the underlying deficit drift up again.

Another danger is that Constitutional budget balance would encourage the federal government to mandate spending by states, localities and businesses as a substitute for direct federal action. Focus on year-by-year balance would also provide excuses for budget gimmickry, such as moving pay days from one fiscal year to the next or selling earning assets to raise immediate cash--gimmicks that flourished under the better designed year-by-year procedures of Gramm-Rudman-Hollings and are less tempting under BEA.

But the main problem is that the amendment is itself a gimmick (the Mother of All Budget Gimmicks?) that would likely delay a return to budget balance by substituting a purely symbolic action for practical steps that would actually get the deficit down.