The Nature of Conventional Budgeting
Everyone knows it's good practice for
households and businesses to keep their budgets balanced,
which is to say that the amount of money taken in equals the
amount spent. Some might not understand exactly why
this is important or how the theory works, but most
adults are aware from experience—either their own or someone
else's—that failure to keep spending in line with income can
lead to severe financial difficulty at some point.
Now, given that most of us can't realistically
anticipate every penny of income or expense, this would be an
extremely difficult task, were it not for the accounting
convention of treating money saved as a liability (wealth
owed) and money borrowed as an asset (wealth owned). To
the accounting neophyte, this seems counterintuitive:
Saving money implies the privilege to reacquire money that
already belongs to us, whereas borrowing money implies an
obligation to pay back money that belongs to someone else.
But think of it this way: Money borrowed functions as a
form of (temporary) income to the borrower, whereas paying
borrowed money back to the lender is an expense for the
borrower. Now think of savings as a kind of reverse
borrowing; by saving money in a bank, we are in fact
temporarily lending our money to the bank, and the bank is
obligated to pay it back to us eventually. So, we can
view the cash flow of saving as a mirror image of the cash
flow of borrowing, since the saver acts as a lender and the
bank as a borrower.
In the final analysis, taking out a
loan or drawing money out of savings puts cash into the pocket
of the borrower or saver, and thus counts as income.
Making loan payments or depositing money into savings takes
cash out of the borrower's or saver's pocket, and thus counts
as an expense. Where accounting and budgets are
concerned, the effect of both saving and borrowing is to act
as a buffer that absorbs the moment-to-moment differences
between actual inflow and outflow of cash. Budgeting
allows us to ensure that income and expenses remain in
manageable accord, with borrowing or saving taking up the
slack between the two.
Balancing a budget is a long-term project.
From moment to moment, our income might be greater than our
expenses (on payday), or our expenses might be greater than
our income (when we buy groceries or pay bills).
Budget-balancing occurs over a period of time, typically from
payday to payday, or over the span of a year or two. The
important consideration is that overall income over some
specified period equals overall expenses over that same
period. If instead we ring up debt without regularly
paying it down, we eventually find ourselves in the dicey
situation of owing more than we own. And if the interest
and required payments on what we owe exceed our income, we're
in serious trouble. This is an unsustainable state of
affairs for any household or business, or even for a local or
state government, and declaring bankruptcy may be the only
practical way out.
Is What's Good for Households and Businesses also Good for
Government?
So, we'd expect that the rules that work for
households and businesses ought to be the same for government
as well, right? Well, yes, it's still generally a good
idea for government to aim for something fairly close to an
overall budgetary balance over a decade or two. For
example, government might run a deficit to pay for a war or
for disaster relief, and when times are better it would run a
modest surplus to pay down the earlier debt and build a
reserve for future tough times.
But government is neither a household nor a
business, in concept, design, or function. In some
respects, budgeting is very different for an entity that, by
deliberate design, operates (ideally) on behalf of all the
people and is entrusted with the unique power to create money
and to regulate its supply. Used wisely, such power is a
good thing, for it allows government the flexibility to
operate at a deficit (to spend more than it takes in) not only
when emergencies arise, but also to stimulate spending in an
economic recession; or at a surplus (to take in more than it
spends) not only to build an emergency fund, but also to curb
inflation. Without such unique powers, government would
find itself unable to deal with economic recession or
inflation, and would have to look on helplessly as they run
their destructive courses.
Economic Fluctuation
Left to themselves, naturally occurring
inflationary and recessionary eddies in the economy tend to
become not only self-sustaining but self-escalating spirals.
This owes in large part to the fact that human emotion—avarice
and apprehension—plays a prominent role in motivating markets,
whether to buy or to sell. Emotion feeds on itself, and
spreads from person to person, from group to group.
Optimism evolves from hopeful expectation into "irrational
exuberance,"1 and pessimism grows from prudent
caution into anxiety and raw panic. Emotions are
profoundly human—so much so that they're echoed in automated
market trading software, which accelerates and magnifies their
effects (producing such phenomena as the "flash crash").
Although emotion may be irrelevant in logic, its effects are
nonetheless all too real, and can do enormous economic and
social damage. Emotion and psychology must thus be
counted serious factors in the economic ebb and flow; they
cannot be simply dismissed or ruled out of the equation.
Even so, economists assure us that, in the
very long term, a free-market economy is self-regulating.
Despite fluctuations, it tends to move gradually toward
equilibrium. The problem is that the time required for a
large national economy to recover naturally from a major
fluctuation might be measured, not in months or even in years,
but in generations. But life is short, and time is
precious. Families whose jobs have been lost and whose
savings have been wiped out in a recession simply can't wait
generations to be able to afford decent food, shelter,
clothing, and education for the kids. Businesses can't
wait generations to sell accumulated inventory. Banks
can't wait for generations to have loans repaid.
Retirees can't wait generations for their pension funds and
investment accounts to recover. For an economic
system to be of reliable, practical use within human
timeframes, some form of artificial regulation must be
introduced to counteract fluctuations and to accelerate the
restoration of equilibrium. So, government needs tools
to identify and deal effectively with economic spirals, and
the ability to control the supply of money in circulation is
among the most powerful of these tools.
The Futility of a Balanced-Budget Amendment
The fundamental problem with virtually all
balanced-budget amendment proposals is that they're drawn up,
not by economists, but by politicians with little or no
understanding of macroeconomics, or even a head-full of bogus
economic ideology. Most politicians understand the
simple necessity of allowing the nation to spend more than it
takes in during an emergency—a war or a series of
disasters—and would write such provisions into an amendment
proposal. Most of them know something of basic concepts
of supply and demand in the business world. But like
most people, many politicians are mystified by the national
and global economics of inflation and recession, trading
markets, the banking system, and the Federal Reserve.
(Some even suppose that the Federal Reserve is part of a
socialist plot to cripple the free-market system and stifle
entrepreneurship.) Because they haven't bothered to
study how economics actually works, many are charmed by the
notion that balancing the budget will magically remedy all
economic ailments—a notion resulting from a confusion of cause
and effect, when in fact, a balanced budget is the effect, not
the cause, of a well-tuned economy. Indeed, it's a
matter of historical record that attempting to balance the
national budget when the economy is in recession or recovery
(as in 1937, 1960, and 2011) actually exacerbates recession and delays recovery.
Being thus severely misinformed and mystified, these misguided
politicians fail to take into consideration all the real-world
implications of a mandate to balance the federal budget.
A constitutional amendment requiring the
federal budget to be in perpetual balance
would deprive government of this stabilizing power.
Our economic system would lose the huge deficit-surplus buffer
it needs in order to cushion and counteract the enormous
cyclical tera-dollar
waves of instability that inevitably develop in a market
system free to respond to impulses of greed and panic to the
exclusion of all other concerns. Without government's
ability to put more money into circulation (by spending more
than it takes in), our economy could be locked into a
recessionary spiral lasting decades. And without
government's
ability to take money out of circulation (by taking in more
than it spends), an inflationary spiral could run out of
control, eroding the buying power of money and ultimately
making it worth less than the paper on which it's printed (as
has happened in countries that lack our system of monetary
regulation, and as has happened even in our own country when
those in charge have failed to use that system well or even
tried to dismantle it).
The Additional Matter of Inflation
Even if government could exactly balance what
it spends and what it takes in, many economists believe that
to do so would be unwise. The reason is that inflation
and government deficit spending are closely related.
Bringing the budget into long term balance would tend to drop
the inflation rate to a very low level. But wouldn't
this be a good thing? Isn't inflation always bad?
Whatever its unpleasant effects, one benefit
of a moderate rate of inflation is to encourage people to buy
sooner rather than later (because they expect prices to
increase later, so feel they can get a better deal now).
A little inflation thus tends to keep money in active
circulation, thus keep consumer demand stable, which prompts
business to maintain production and keep workers employed.
This is obviously a good thing. But inflation naturally
varies a bit, as a result of such things as day-to-day market
fluctuations, variables in the resource supply chain, and
periodic labor negotiations. So, even if we tried to peg
inflation exactly at zero, it wouldn't stay there.
Natural fluctuations would sometimes shift it slightly
positive or negative.
Now, moderately positive inflation is
tolerable. But even slightly negative
inflation—deflation—can produce disastrous effects. When
inflation turns negative, that means that prices have begun to
fall. That's good, right? It seems good to the
consumer, at least for the first few days. But falling
prices are a harbinger of economic panic in the business
world. They have a damping effect on buying psychology
opposite to the urging effect of rising prices. Once
consumers get into the habit of thinking that prices will get
even lower tomorrow, or next month, or next year (in other
words, that the buying power of their money will increase over
time), they actually stop buying virtually everything except
daily essentials. They hold onto their money, rather
than spend it, because they anticipate it'll buy more if they
wait. When this money goes out of circulation on a large
scale, consumer demand drops, production slows, profits slump,
workers get laid off. When dividends shrink and
wages are lost, the affected investors and workers get even
more cautious about spending. Consumer demand drops further, a
recessionary spiral rapidly sets in, and from there on the
outlook gets really ugly really fast.
So, if we want to avoid economic downturns,
history has shown that a slight
upward inflationary pressure turns out to be
a good thing, because it discourages hoarding and the market
stagnation that accompanies it. Still, this doesn't mean
that we can't run a moderate surplus when the economy is
booming; in fact, it's economically desirable2 to
pay down accumulated debt, and doing so in times of prosperity
can help keep that prosperity from morphing into a market
bubble or an inflationary spiral. We must just be
watchful as the rise of prices slows, adjust monetary policy
as inflation approaches zero, and alter policy if prices show
any hint of systemic decline beyond routine sales and discounts.
Realistic Goals
So, what we want to set as our long-range goal
is not a perfectly balanced national budget, but one that in
normal times gives a modest edge to deficit spending, so long
as the deficit is monitored and maintained as a percentage of
gross domestic product. Although this might be sacrilege
to the ears of balanced-budget ideologues, it's a practical,
sustainable, and even prudent stance in the real economic
world. That's why, although a balanced budget amendment
might seem a noble gesture on paper (or on a bumper sticker),
it's a shortsighted and untenable notion in practice; we'd
begin to regret it soon after it went into effect.
Moreover, as we've already pointed out, an out-of-balance
budget is merely a symptom of a problem, not the problem
itself. If we're to deal realistically with budgetary
imbalances (and at some point indeed we must), then we must
deal, not with the symptoms, but with the problems that cause
them.
There's little disagreement that imbalance in
the federal budget arises largely from government's tendency
nowadays, given even the feeblest excuse, to spend more
than it takes in, often in an effort by incumbent politicians
to channel projects and money to their home states and
districts in order to please their constituent voters. One way to address this problem would
be for government to adopt strict rules, requiring every item
of spending legislation and regulatory activity to specify not
only the benefits it's expected to produce, but also its
anticipated costs and the
revenue sources needed to initiate and support it, and to
require that taxes or fees be adjusted accordingly to provide
adequate funding. And in the not at all unlikely event
that actual costs run above or below estimates, subsequent
adjustments, either to revenue or to the program itself, would
be required in order to compensate. In other words, each
government program ought to be considered as a whole, costs
and funding
included.
We readily concede that there might be other,
better ways to address the problem of ballooning government
debt. But a balanced-budget amendment isn't one of them.
Such an amendment would set us flailing ineffectually at
symptoms while ignoring the problem, and at the same time
leave us defenseless against devastating boom-and-bust cycles.
Our proposal to require funding provisions as an integral part
of government programs, on the other hand, might serve as a
starting point for rational discussion and development of
realistic and workable solutions to the actual problems that
cause budget imbalance.
=SAJ=
NOTES
1. "Irrational exuberance" is a
term coined in the 1990s by Federal Reserve Chairman Alan
Greenspan, in reference to rapid "bubble" growth in market
prices without corresponding increases in substantive value.
2. While it's economically
advisable and responsible for government to run a surplus
during a prosperous period, nobody wants to be the one to
"rain on the party." So, most politicians tend to shy
away from budget surpluses, even though, when properly timed,
they're in everyone's long-term best interest. This is
the long-term reason that, instead of fluctuating in synch
with the economy, the national debt tends to grow almost
incessantly.