Home > Deficit Commission, Fiscal Cliff, Fiscal Policy, Government, Government Deficit, Taxation > The Wisdom of a Balanced-Budget Amendment

The Wisdom of a Balanced-Budget Amendment

I read in the local newspaper today that there is some discussion going on in the Michigan state legislature regarding the federal government deficit. Specifically, there is a coalition of states that has begun to form that would force the federal government to convene a constitutional convention only concerned with the adoption of a balanced-budget requirement imposed on the federal government. Michigan is apparently discussing whether the state should be a part of that coalition. This development is a very good one for reasons that I will sketch below.

By allowing government deficits to exist, there has been a perversion of government policy that may well destroy our country in the future. It is all too often observed that government programs exist mainly to line the pockets of politically-connected groups, thereby enhancing the reelection prospects of the politicians handing out the subsidies. There is an enormous list of these programs. The Export-Import Bank, farm subsidies, ethanol programs, and many more (see a previous post for others) do nothing for the welfare of the country but the recipients of these programs benefit mightily. As the late Milton Friedman said many years ago, the benefits of these programs benefit a few who lobby furiously to get them, but the costs are diffuse, spreading across many people. And so the cost to each person is small and may not even be recognized by the individual bearing these costs. As a result, it is all too easy for the government to borrow to finance yet another vote-buying scheme. All it has to do is borrow to finance any new such spending program since raising tax rates may anger taxpayers.

The problem is that the United States is heading for an explosion of its entitlement costs that has been noted many times by economists (I wrote on this previously here). No economist that I know thinks that the U.S. can finance several trillion dollars in deficits and so, when these occur in the future, what is to be done?

To keep the game going, the federal government could pressure the Federal Reserve to buy the bonds that it must issue to finance this enormous deficit. This is what is often described as “printing money” but that is not actually quite right.  What would happen is that banks would be awash in new reserves (their bank accounts at the Federal Reserve) which they could lend out, thus increasing the money stock enormously. The risk is that this lending could create a hyperinflation whose consequence are well-known to economists. Simply put, there would be a collapse in economic activity with enormous losses of economic welfare.

The other possibility is that the federal government would simply run out of tax revenue and need to shut down, barring an enormous increase in marginal tax rates. Think Greece. The U.S. is too big to be bailed out by anybody. It is hard to believe that politicians would have the spine to raise tax rates by large amounts so the government would be faced with shutting down many of its programs. The risk, and one that concerned the founding fathers of this country, is that the U.S. could be turned into a country of warring factions struggling to preserve their government handouts. It is not a stretch to say that the country could break apart in such a situation.

Economists have often dismissed balanced-budget amendments on the grounds that they would worsen the business cycle. The reason is simple; in recessions, governments see tax revenue fall and would either need to reduce spending and/or raise tax rates, making recessions worse. But there is a counterargument to this criticism offered by public choice economists. Governments will never be serious about spending restraint if they are not required to raise tax rates, risking the ire of taxpayers, to pay for another spending scheme. Thus they would need to defend their new programs, convincing the taxpayers of the need for a new program. This seems to me to be a prescription for responsible government.

The U.S. Congress will never endorse a balanced-budget amendment because it is not in the reelection interests of most politicians to do so. Such an amendment must be imposed by the states and I hope that Michigan will sign on to the coalition. The future of the U.S. is at stake.

 

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  1. Jason Reed
    December 4, 2015 at 11:21 AM

    I feel that this post is a bit misleading. A balanced budget amendment would hurt the American people much more than the system currently in place. Austerity is a very difficult pill to swallow and is shown to be generally ineffective at spurring growth in an economy. The issue with your prescription is that politicians will not raise taxes due to the pressure from the party to hold a political majority (as you suggested). This feels like a systemic issue with how politics has evolved not with poor economic reasoning.

    What I believe should be driving your post is a call to overhaul a systemic issue with the American political system. A balanced budget amendment wouldn’t fix the political problems you’re describing but actually taking steps to abolish the political pocket-lining should be a number one priority.

  2. John Seater
    December 4, 2015 at 7:50 PM

    If I understand the proposal for a constitutional convention, it is to limit the convention to the consideration of a balanced budget amendment. I believe that kind of restriction is impossible. Once convened, a constitutional convention can do whatever it wants. Indeed, that’s what the only constitutional convention we’ve had so far did, back in 1787, which is why we have the U.S. Constitution instead of a revised Articles of Confederacy. It might not turn out that well the next time we try it, so this proposal is something not to be treated lightly.

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