Rethinking a Balanced Budget

With the pressure mounting from Republicans for a balanced-budget amendment which would make significant cuts in spending I thought I'd take a look into it. While their arguments make for good campaigning and political discussion, their demand for a balanced budget amendment is out of touch with common sense and good governance. Mitt Romney has the most sensible plan (that doesn't make it sensible, but in comparison with other prominent Republicans it is). He would raise the debt ceiling (the level the Federal Reserve will continue to allow the federal government to borrow to honor its obligations) provided there were comparable cuts in spending. It's something that Republicans in Congress have continued to push for. In order to keep spending at a deficit the government would have to reduce that deficit by x number of dollars in order to keep the government from defaulting on its debts. Rick Santorum and Newt Gingrich both run on their records as budget-balancers, and Ron Paul says he can cut $1 trillion in the first year (mostly from defense, but other programs as well). What they all have in common is the belief that the federal government cannot continue to run deficits (spending more than you take in), much like any family.

                Here, I want to critique the necessity of a balanced-budget amendment during difficult times. Taking a look back in history reveals just how critical deficit spending has been to the United States and other countries as well. I will also critique the analogy of treating the government like an individual household. And I also propose my own solutions on how best to spend our deficits, ease the burden on the federal government, and fix the economy.

                Alexander Hamilton, as the nation's first Treasury Secretary, arguably had the hardest job of any man of his time. He had to find a way to set the nation on a firm financial footing to ensure that people trusted the new United States. One of his proposals was a national bank very much like the National Bank of England which could loan money to the federal government to invest in government projects (such as warfare). On national debt Hamilton said, "A national debt, if it is not excessive will be to us a national blessing". Clearly Hamilton was in favor of borrowing money. If the new nation could pay back its debt it would establish good credit with other nations who would be more than happy to lend to us at lower interest rates. Another advantage dealt more with precarious situation of the new government: to establish the federal government as a legitimate institution in order to convince people that it was worth keeping around. If people held a piece of government debt (bonds), and the government paid them back plus interest those people would be more willing to support the government.

                What Hamilton was getting at is the need for the government to borrow money to pay for necessary improvements and programs. If the government borrows responsibly, and pays its lenders back, then debt is a good thing. Hamilton set up a means for the federal government to set aside money purely to pay back its debts. Hamilton got a special tax on whiskey then used the revenue collected from the tax to pay off loans. The system worked so well that without it the United States was reeling from financial woes (War of 1812, Panic of 1837, Black Friday, 1869).

                In 1936 a new way of looking at the role of the federal government came into play. John Maynard Keynes was a British economist who challenged the old notions of a self-regulated market. Previously, classical economists taught that the balance between supply and demand would work out in such a way that maximum employment was obtained. The trouble was that supply and demand are unstable (subject to change at any moment based on uncertainty), and the balance may work out at a point where certain people that could be employed wouldn't be simply because, from a business standpoint, it would be inefficient to employ them.

                Keynes proposed that the federal government should spend more than it took in when tough times were likely. The reason for this is because consumers who are worried about the future tend to save their money. Businesses lose money and lay off workers as a result. But if the government invested some money to keep people employed working on public works like roads and bridges then they would spend some of the money they earned. Eventually the system would pick back up again. In Keynesian theory the government can analyze the economy and release funds where they are most needed in order to ease pressure on the whole system; this is something no private market analyst can do.

                Keynes witnessed the great nations of Britain, France, and the United States slide into economic trouble after World War 1. And it was because of his influence that Franklin Roosevelt launched the New Deal. The plan was to dump money into the economy not in the form of stimulus (think Obama here), but by hiring people to build roads, power lines, dams, bridges, conservation camps, and a whole host of other important projects for an industrial nation. And the economy did begin to show signs of improvement. In 1933 the unemployment rate had risen to roughly 25%, almost 40% of banks had failed in 3 years which cost depositors $2 billion, and gross net produce had fallen by 21.1% (1929-1932). By 1937 GNP had risen 34.9% since 1933 and unemployment was down to 14.3%.

                However, the United States was not the first nation to recover from the depression (it would not do so until 1939 with the outbreak of World War 2). Roosevelt steered clear of the kinds of deficit spending that Keynes recommended. By contrast, Sweden bounced back out of the depression by 1934 thanks to Keynesian-level spending. Germany under Adolf Hitler grew out of the depression by 1936 though this is largely because it spent at levels that would have eventually bankrupted it if not for the outbreak of World War 2. Then Britain, in preparation for war, began to revive and by 1938 was out of the depression as well. If the U.S. had a balanced-budget amendment during this time it would have severely hampered FDR's ability to get us out of the mess we were in.

                And this is why it's such a mistake to push for a balanced-budget amendment now. The federal government is not subject to the same kinds of restrictions an individual household is. Families save during tough times, the federal government is wise not to. Government money eases pressure on businesses, provides jobs, promotes growth, and can even spur private investment. As the government lends to businesses so will investors who notice that this money will be used in smart ways such as developing new products. As an example consider the $2 billion that Chevy got to develop the Volt. That money was matched by outside investors who realized that this company was changing its line of products to reflect both government efficiency standards and the demands of the market for more fuel efficiency. Detroit is now rebounding out of its slump.

                So how would I go about fixing the federal government's budgetary woes in a smart way that promotes growth? Well, to begin, we need welfare reform badly. This is the beast that is devouring the budget, and it does not promote growth. Medicare and Social Security are for those who have already left the labor force, and Medicaid is for those who cannot afford health insurance. In the not-too-distant future these programs will have driven the budget into a pit of no return. As a brief side-note these programs are extremely useful for keeping people out of poverty, and should by no means be gotten rid of.

                While I don't claim to be able to figure out the perfect solution for reforming these programs, I do have some suggestions (though they are not entirely my own, but have been proposed by others as well). The first would be raising the retirement age to 70 starting right now. Those who are already collecting their Social Security and Medicare benefits may continue to do so, but anyone not collecting will have to wait five more years. This will keep them off these programs for those five years, and working for that same period of time. There are plenty of people capable of working until they are 70 especially in this day and age when we are living longer, and they will add their experience and knowledge for the benefit of new employees (as opposed to them retiring and the business having to hire a younger, less experienced employee in their place). For five more years, instead of draining tax dollars which could be spent elsewhere, they would continue to pay into the system, easing the pressure on politicians to work out cuts to these benefits. And someone who decides to retire early: despite their decision they wouldn't be able to collect on their benefits until they turn 70.

                I also propose a tax on fast food; at least 20% (hopefully higher). Fast food has little real value as a source of nutrition, and in fact, eating too much can lead to major health problems. Taxing the major fast food companies McDonald's, Burger King, and Wendy's would reduce consumption especially among those who consume it regularly. It would make going to the grocery store and picking out a package of hamburger more appealing as the price of a fast food hamburger is now closer to buying from the store. And the tax revenue gained from those who continue to eat at fast-food restaurants could be re-allocated to fund our healthcare system. Hopefully, society will, overtime become more healthy and the cost of supporting someone who has retired will be reduced.  I am not unaware of the opposing arguments to this. Major fast-food companies will try to show how they will be hurt by this new tax, and certainly they will be-that's the point. It may also be true that, as a result, they will have to lay off many high-school students and will no longer serve as a place where they can count on a job. Students will find work elsewhere once they realize that working a cash register at McDonalds is not the only job they can obtain.

                To spur growth the federal government, as well as state and local governments, needs to spend more in areas like research and development, education, and infrastructure. The most innovative economies are spending much more of their budgets in these areas, and the United States would do well to follow suit. These are the areas that will propel us out of this period of slow growth. There's no reason that China should experience 30 years of consistent growth above 8% a year and we cannot. In 2010 China spent 30 billion dollars on solar technology, the U.S. spent 1.5 billion. China is spending vast amounts of money on immense building projects providing people with housing and work; the U.S. is not doing that in any significant way. In order to turn the economy around our deficits should not come from welfare programs, but from pro-growth spending. Once the economy turns around we can begin to ease back on our spending and return to a balanced budget. Until then spend on growth and don't look back!         

For Further Reading

Chernow, Ron. Alexander Hamilton. Penguin Group (USA) Inc., New York (2004)

Foroohar, Rana. "Balanced-Budget Blues". TIME Inc. (August 8, 2011)