Thursday, Aug. 04, 2011

Alex Tabarrok: The Virtues of an Unbalanced-Budget Amendment

One thing is certain about the deal reached to raise the debt limit: deficits aren't going away. Even if the deal is fully implemented, it will not balance the U.S. budget. Deficits will continue to increase, as will spending. Before the deal, the Congressional Budget Office was projecting federal-government spending of $46.06 trillion over the next 10 years. With the deal, spending falls only to $43.66 trillion, and that is assuming that future politicians follow through on the promised cuts.

The public is tired of repeated failures to put the U.S. financial house in order. A recent CNN poll showed that nearly 3 out of 4 Americans supported a constitutional amendment to balance the budget. If the politicians won't be virtuous then, so the thinking goes, we must substitute law for virtue.

The problem is that a recession is not the best time to raise taxes or cut spending, which is what we would be required to do every time we hit an economic rough patch if we had a balanced-budget amendment. Keynesian economists believe that spending during a recession can stimulate the economy. But even if one is skeptical of this argument, its clear that taxes fall during a recession and spending needs rise, as more people need unemployment insurance and Medicaid. What's the point of unemployment insurance if it must be cut during a recession?

So instead of a balanced-budget amendment, I propose that a better idea might be an unbalanced-budget amendment (unBBA). It would allow the government to run a deficit during a recession. But unlike now, the amendment would require the government to run a budget surplus in good times. So although an unBBA would allow for deficit spending on things like unemployment and food stamps during a recession, it would have similar effects to a balanced-budget amendment over time, because surpluses in good times would be spent in bad times. The surpluses, however, would come when we can most afford them — during a boom — and the deficits would come when we most need them — during a recession.

The idea of an unbalanced-budget amendment is not new. Sweden's government has been required since 2000 to budget for a 1% surplus over the business cycle. Since implementing its unBBA, Sweden has successfully balanced its budget and created a surplus.

Even more ancient sources are supportive of an unBBA. In the Bible, Joseph doesn't advise the Pharaoh to balance the budget; instead, he tells the Pharaoh to save during the seven fat years so he will be prepared for the seven lean. An unbalanced-budget amendment reflects this simple and ancient wisdom.

Alex Tabarrok is an economics professor at George Mason University and a research director for the Independent Institute, a think tank. He is also a co-author of the popular blog Marginal Revolution.