If you oppose increases in the minimum wage (not to mention if one questions
the existence of a minimum wage), you must be anti-labor despite evidence which
suggests that increases in the minimum wage cause reductions in employment. If
you oppose increases in total spending in our public schools while preferring
an examination of the current allocation of spending, you must be
anti-education. Along the same lines, if you question the optimality of the
current market structure of public education while supporting policies that
give parents more choice about where to send their children to school, you must
be an elitist.
An understanding of the basics of economics, as Herbert Stein suggests, would
provide individuals with an opportunity to participate in and improve the quality of public policy
debates. Increased economic literacy would also allow individuals to
distinguish between substantive claims and hyperbole. Such is the case with a
proposed amendment to the Constitution requiring a balanced budget.
On Thursday, the Senate Judiciary Committee voted to send such an amendment to
the full Senate. It would become law after passage by both Senate and House and
ratification by 38 of the 50 state legislatures.
For years, a clear consensus among economists has existed about any policy that
mandates a balanced federal budget. While a balanced budget amendment may be
supported by a majority of Americans and elected officials, any former student
of introductory macroeconomics knows that a balanced budget amendment is bad
economics.
How would a balanced budget amendment work? To illustrate thc key criticism of
it, suppose for simplicity that the budget is initially balanced. Now assume
that the economy enters a recession. As economic activity declines, two events
will occur, causing the budget to go into deficit:
- First, as aggregate income falls, tax revenues automatically fall; consequently, expenditures now exceed revenues by the reduction in tax revenue.
- Second, certain types of government expenditures, such as unemployment compensation, will automatically rise as the recession occurs. This increase in government expenditures will cause the deficit to increase even further.
By the way, while these automatic reductions in taxes and increases in spending
will not prevent the recession from occurring, they will limit the drop in
total output and, therefore, serve as an automatic stabilizer for the
economy.
Now, if a balanced budget amendment were in place, policy makers would have to
initiate some combination of spending cuts and tax increases to make Up for the
budget shortfall. Any combination of these actions would cause a reduction in
the demand for goods and services and, therefore, exacerbate the recession. In
short, a balanced budget amendment would make recessions deeper and, more
generally, act to destabilize the economy. It is for this simple reason that
economists oppose any rule that requires a balanced budget.
Supporters of this amendment have argued that such a rule would include some
type of "escape clause" that would prevent the destabilizing effects described
above. Presumably, politicians would raise taxes or cut spending only after the
recession is over. Or, similarly, the amendment would allow for deficit
spending if a majority of Congress approves it. It is the likely case, however,
that this escape clause or any vote by Congress would occur well after the
recession had begun.
Supporters of a balanced budget amendment also argue that, since households
"live within their means," the government must balance its own budget. While
this argument may on the surface make sense, it is seriously flawed.
Individuals who have ever borrowed funds to buy a car, purchase a home or
finance their education have incurred "deficit spending." Furthermore,
businesses also deficit spend whenever they borrow to expand or to buy
equipment. Are supporters of a balanced budget amendment also in favor of
preventing individuals and firms from borrowing to finance these and other
productive activities?
The message here is not that budget deficits are always good for the economy or
that opponents of this amendment are more economically literate than the
supporters of it. To the contrary, budget deficits may have long-run negative
effects on the economy. Furthermore, one of the criticisms of the amendment
often cited suggests that some politicians who oppose the amendment are just as
economically illiterate as their peers.
For example, former Labor Secretary Robert Reich had previously argued that we
need fiscal flexibility to allow policy makers to respond to changing
economic conditions, flexibility that would be eliminated with a
balanced budget amendment. Reich correctly notes that fiscal policy in theory
can be used to stabilize the economy. In practice, however, the agonizingly slow pace of the
budget process combined with other policy lags all but prevent fiscal policy
from being used as an effective stabilization tool.
If the problems of a balanced budget amendment are so obvious to former
students of introductory economics, why do so many politicians support it?
One interpretation is that the debate on the balanced budget amendment has
become a smokescreen for a debate over the size of government. Supporters of
the amendment view it as a vehicle to reduce the size of government. Opponents,
often citing the draconian measures that would occur as a result of the
amendment, fear that such a rule would reduce the size of government. It is,
therefore, not a coincidence that Republicans generally support the amendment
while Democrats generally oppose it.
Is a balanced budget amendment a substitute for responsible decision making?
Hardly. Put simply, a balanced budget amendment would destabilize the
macroeconomy. It would also create uncertainty about future tax and spending
policy, which would impose additional costs on the economy.
During his first term, President Clinton, with the support of former Presidents
Jimmy Carter, Gerald Ford, Ronald Reagan and George Bush, successfully promoted
the benefits of free trade (i.e., NAFTA), an issue, by the way, on which a
consensus within the economics profession also exists. With the exception of
some post-election waffling on the balanced budget amendment, the president has
generally voiced his opposition to it. Let's hope that he will again use the
tools of the presidency to explain to voters why a balanced budget amendment
would be harmful to the economy.
If we listen carefully to the arguments, we might actually learn something
about policy, about how the economy works, and about economics. And who knows?
We might find that a little economic literacy might do us some good.