Sunday, January 27, 2013

You Can't Spell "Balanced Budget Amendment" without "A Damnable, Dumb, Decent Gent"

I agree with Arnold Kling that the Keynsian reasons for government running a deficit (IE, to stimulate the economy in a downturn) aren't very convincing.  But I strongly disagree with his conclusion that we should, therefor, adopt a balanced budget amendment.  I have five reasons for opposing a balanced budget amendment, in order from what I think is the worst to the best reason:

1.  Even if balanced budget amendment is a great idea in theory, I have some practical problems with it..  For one, the Republican party keeps wanting the balance budget amendment to cap the size of government and impose a super-majority requirement on tax increases.  I have opinions about how big government should be and about whether we should raise taxes, but I think future generations should get to make those decisions for themselves without the constitution tipping the scales.  I don't expect democrats, if they ever get around to wanting a balanced budget amendment, will be any better at keeping their other partisan goals out of it.

Secondly, I think the balanced budget requirement should be phased in.   I don't really want to see what happens if we force congress to cut a lot of spending or raise a lot of taxes over night; it's a body that works better over time.

2. I thinks sovereign debt promotes international peace.  If people invest in each others' governments, there is suddenly an international constituency for promoting stability in other countries, not going to war with them, and for promoting sounder budgetary and economic practices in your debtor nations.  If I loan a lot of money to Iran, I suddenly have strong feelings about war with Iran.  This doesn't always work to preserve peace and insure good policies, obviously, but I've got to think it has some sort of effect, and on balance I think the effect is positive (especially as the world gets more democratic, since a main negative effect is creditors propping up debtor dictatorships).  Balanced budgets means no government debt means (at the margin) more war.

3. I like the idea of a government not having to radically reform itself every time there is a downturn. Imagine we are in the great moderation and have a mild one year downturn, hurting tax revenue and increasing welfare expenditures   Is it really good to make the government  raise taxes and/or slash spending in order to keep the budget balanced?  Then come back a year later and undo their work?  That seems, to me, like 1. It would increase uncertainty a good deal, and 2. It would create a bonanza of lobbying.

Borrowing through recessions lets us keep the laws constant regardless of the business cycle.  That is probably a good thing.

4. I just don't see the harm.  The welfare state is well over a century old, but fiscal crises and default, especially in large, developed nations, are really rare.  I think Kling's article is especially telling here: his big example of why balanced budget amendments are good and not having them is bad is showing how much more indebted Canadian provinces (who can borrow) are to US states (who often can't).  This, according to Kling, makes them more likely to default.  But Canada is 146 years old.  When, exactly, are these provinces going to get around to defaulting?  When is the debt going to make something bad happen?

Don't get me wrong, countries can mismanage their debt, and healthcare costs/demographics are putting big pressures on debt to GDP ratios.  But "pressure" doesn't mean inevitable default.  Historically, countries have done a decent job of reforming and rolling back the welfare state when it starts causing major problems (See Thatcherism.  Over 25 years British government spending as a percent of GDP fell by over 15 percentage points), and there is every chance countries will rise to this challenge (see the trillions of dollars in deficit reduction over the next ten years we've already enacted, and the fact that both parties want to enact more).  

The story I think Kling wants to tell is, "for political economy reasons, welfare states that can borrow will get more and more indebted until there is a fiscal crisis.  So we can't let welfare states borrow."  To me, reality looks more like, "For over a century now, the the vast bulk of welfare states have done an effective job of managing their debt to gdp ratio and avoiding fiscal crises.  They might screw up their power to borrow, but they might screw up any power we give them."  

5. Keynesians could be right!  It's a big step to go from thinking people are wrong to making their policy recommendations unconstitutional.

As a final matter, it makes intuitive sense to me that borrowing let's governments shift costs into the future, when the public will be richer and able to bear costs with less loss of utility.  Even though future people are paying more (thanks to interest), they might suffer less (because they are richer).  I worry that this is one of those things in economics that seems intuitively right but is in fact wrong, though, so I don't list it as a reason.  

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