Should a Balanced Budget Amendment Also Determine the Size of Government?

The House of Representatives are set to debate and vote on introducing a Balanced Budget Amendment to the Constitution of the United States. Such a move is almost certain to fail, as it requires a super-majority in both chambers of Congress, and three-quarters of the states—38 out of 50—would need to ratify it. Coming hot on the heels of the recent spending-cap busting omnibus bill, it’s difficult not to see this as a form of Republican fiscal virtue-signalling.

As I wrote in my recent paper on fiscal rules, the best way to build support for fiscal conservatism is to deliver it. That means constructing an argument about the supply and demand for government, getting public and political buy-in for a new fiscally responsible budgeting framework, and taking the necessary steps to get to a stage where the budget is balanced, ideally though spending cuts. Neither party has shown an appetite for this so far – in fact, quite the opposite.

Rule design is an incredibly important part of acceptance, and then adherence to a rule, too, though: critics and economists have a point about some of the downsides of a pure year-on-year BBA (as proposed). Evidence from around the world suggests rules that are too inflexible to changing circumstances and recessions prove less durable.

The specific proposed bill would require budget balance every year unless three-fifths of Congress overall voted for an exception. This would be both too stringent and too lenient at the same time: creating difficult within-year budgeting conditions when outcomes deviated from plans, but also giving Congress carte blanche to abandon fiscal probity during “emergencies”. Rather than this rigid form of rule, Congress would be better served examining countries such as Switzerland, which insists on year-on-year “structural” balance, equating to absolute balance over time, and which compensates for deviations from plans and emergency spending by adjusting spending caps in future.

There’s another issue with the rule though, and one where libertarians will be divided. It tries not only to ensure balanced budgets, but also to cap the overall size of the federal government at 20 percent of GDP. This relates to a fear that conservatives such as Paul Ryan have had in the past about BBAs (he voted against one in 2011). Then he said:

My specific concern was that under this bill, a future Congress could raise spending levels without any limits and then raise taxes without any limits to meet the increased spending levels.  The result would still be a balanced budget, but without any caps on spending or taxes.  In the end, this proposal would allow Congress to continue to chase ever higher spending levels with ever higher tax rates.  Consequently, for these reasons, I could not support this Amendment.  I do; however, support a balanced budget amendment that would keep spending and tax rates in line with their historical averages.  If this version of the amendment is brought to the House floor, it would have my support.

Now all libertarians would agree with Ryan that keeping government small is desirable. And as Milton Friedman explained, it’s government spending that is the real tax burden on the private economy, so it’s spending that is what we want to reduce. The question really is then whether a pure BBA will help or hinder this goal?

Ryan’s view, shared by some of my colleagues, is that a BBA neutral between taxes and spending would make the case for tax increases easier to make. Politicians could say “we have to balance the budget, and so we must raise taxes to protect spending.”

My view is that using a BBA to try to achieve two objectives – balancing the books and determining the size of government – means there will never be a consensus for one to be introduced and endure. Democrats wouldn’t tolerate it. And that loses some key benefits of having one as a tool to encourage spending restraint.

Politicians have complete freedom to raise taxes now. They don’t. Why? One reason is surely that deficit-financed spending creates a fiscal illusion. People do not feel the effects of higher spending being linked to their pay checks or spending power. A BBA would make this link between taxes and spending explicit over time, eliminating the expectation of a free lunch. Just as in the UK when the public took deficit reduction seriously, the constant question politicians would be asked when they proposed higher spending would be “how are you going to pay for this?”

The strategy of “starving the beast” by cutting taxes first has seemingly had no discernible effect on curbing this spending, given it can be financed by borrowing. It seems highly likely that if spending and taxes tracked each other, that support for spending would be more likely to fall than rise.

Importantly, a Swiss-style debt brake would not allow Congress to raise spending without any limits and then raise taxes later. But it wouldn’t determine what the size of government should be – allowing governments to raise taxes first to facilitate higher spending. In other words, it would encourage honest and transparent budgeting.

Those who believe in smaller government should have the courage of their convictions in saying “if you want low taxes, then we need spending restraint.” Yes, there’s a risk of the opposite equilibrium developing – but right now that risk exists too as the recent spending bill showed, and there are many other downsides associated with continuing to sail into the debt abyss.