Balanced Budget:
Bad Economics

By ROBERT EISNER

Along with two Nobel laureates, Robert Solow of M.I.T. and James Tobin of Yale, I have been soliciting economists' endorsements of a statement opposing a balanced budget amendment to the Constitution. We have initial support from 35 distinguished members of the profession, including seven other Nobel laureates, of various economic philosophy and political persuasion; many hundreds of additional endorsements are now coming in.

I, and many other economists, find the balanced budget amendment personally offensive. We can all understand the views, whether we all share them or not, of those who believe it best to curtail drastically the role of government. But almost all of us recognize that a balanced budget amendment is hardly the best way to accomplish this goal, if it accomplishes it at all. Some conservatives indeed warn that it may prove an invitation either to tax increases to finance still more government expenditures, or to new regulations and mandates on local governments to take the place of federal spending.

Off-Balance

At bottom, the problem is that the amendment would violate the principles of sound economics that many of us have been teaching for decades. Any good accountant -- or informed investor -- knows how difficult and arbitrary measures of "balance," the difference between profit and loss, can be for a company. What is a current expense, how fast do you depreciate, what do you amortize, how do you price inventories, when do you put in special charges, how do you handle pension funds, what do you do about "deferred" taxes? The issues are more complex -- much more complex -- for the federal government, and generally handled in manners that make private accountants cringe.

Take all those federal trust funds, the largest of which by far are for Social Security. Does setting up such separate accounting entities properly put them "off-budget," to use the Washington jargon? I would argue not; the deficit should be defined as the difference between everything the government spends and everything it takes in, regardless of what account is charged or credited. The off-budget accounts are, in fact, currently included in the unified budget deficit that is the target of Congress and the amendment. And with an "off-budget" surplus of some $70 billion per year, that makes a huge difference.

Or consider the handling of portfolio transactions. When an individual buys a stock or bond he hardly classifies that as a current expenditure that may put him into "deficit" or reduce his saving. By federal accounting it would. Thus, a few years ago, when the Treasury was financing the purchase of savings and loans' assets, as part of the S&L bailout, the deficit soared, fueling further, misinformed warnings that the deficit was destroying national saving and hence jeopardizing our future. Then, when the government sold off the old S&L portfolios, our "deficit" miraculously came down.

Another problem: The federal government has no separate capital budget. If federal accounting were to be consistent with that of private business, it would include not current capital outlays but only depreciation charges on existing capital in its measure of surplus or deficit, the counterpart of a firm's profit-and-loss statement. But then how would we measure depreciation? How fast is our vast defense arsenal becoming obsolete? With the end of the Cold War, should we take a special charge and write off much of it? What also should be done about the increasing amounts of investment in intangible capital, in computer software, in research and development, in education and training, and in health?

These are just a few of the oddities of current federal accounting. One may wonder if the congressional supporters of a constitutional amendment intend to order that all accounting rules that would determine "balance" be kept in place. Would we set up commissions to revise them from time to time? Or would we leave it to the courts to determine which rules fit the "intent" of the amendment?

Judging from the response we have had thus far, the effort to stop the balanced budget amendment may prove the most concerted attempt by economists to intervene on a matter of public policy since their sadly unsuccessful effort to prevent enactment of the infamous Smoot-Hawley tariff in the 1930s. The failure to stop that protectionist measure is widely viewed as contributing substantially to the Great Depression.

The balanced-budget amendment, if enacted, could similarly turn any future downturn into a major recession. It would perversely destroy the built-in stabilizers of our fiscal system. Currently, tax receipts go down in economic downturns; outlays, such as for unemployment benefits, go up. This tends to cushion the decline by reducing the fall in purchasing power. If a balanced budget were required and a recession started Congress would be forced, unless a super-majority were to vote an exception, to raise taxes or cut spending; either action would further reduce the public's income.

As proposed in the last Congress, the amendment would allow federal borrowing only if approved by three-fifths majorities of all of the members, a very difficult hurdle. Many say, "I balance my checkbook, and state and local governments have balanced budget provisions in their constitutions, why can't the federal government be the same? Why must it borrow?" In fact, almost all of us borrow -- to finance our homes, to send our children to college, and to buy cars and other durable goods. Businesses borrow -- look at the corporate bond market. State and local governments generally have separate capital budgets; the constraints of balance apply only to current or operating budgets. They borrow for all kinds of capital investment. The balanced budget amendment would put only our federal government under that strict limitation to borrowing.

The balanced-budget amendment, if enacted, could turn any future downturn into a major recession.

Finally, the amendment is ludicrous -- perhaps fortunately -- in its pretense of enforceability. In one section it declares, "Prior to each fiscal year, the President shall transmit to the Congress a proposed budget for the United States Government for that fiscal year, in which total outlays do not exceed total receipts." What would stop the president from simply estimating prospective receipts high enough to equal outlays? Given the general uncertainty and inaccuracy of such projections, this could be done with reasonable honesty.

Section 1 indeed declares, "Total outlays for any fiscal year shall not exceed total receipts for that year... ." But who can say what will actually happen to outlays or receipts? Suppose more people get sick and use more Medicare or Medicaid? Suppose there is a fall in incomes or profits, or employment and tax revenues decline. This section might as well assert that the waves of the Atlantic Ocean shall not cross a certain line. What if they do? Do we put the president or Congress in jail?

On the matter of evasion, I should probably welcome passage of the amendment and set up a consulting firm to make millions by advising how to get around it. One simple technique would be the sale of government assets, which under federal accounting would count as offsets to outlays. We could begin with our national parks, federal land in general, our oil reserves and all parts of the federally owned transportation infrastructure. I suppose some avid privatizers would welcome all this, but evading the amendment should hardly be the motivation.

We could then go on to public buildings, including the Capitol and the White House, perhaps renting them back for current use. We might even sell off our military arsenal, privatize it if you will, and pay on an annual basis to have it maintained -- perhaps we could offer some contractors the responsibility to defend California, others to defend the East Coast and still others to keep Saddam Hussein in line. Of course, eventually we would run out of public assets to sell. But by then perhaps, as with Prohibition, there would be sufficient awareness of the folly of it all for the amendment to be repealed.

Less Local Aid

Another menace the amendment could spawn would be a great increase in regulations and mandates to states, private business and individuals to pay for out of their own budgets what the federal government could no longer afford to pay for out of its own. In general, federal aid to state and local governments, currently some $200 billion per year, might be the first to take the hit, with disastrous results. One need only recall the near-collapses, in recent years, of the economies in New England, California and Texas. Who would bail them out if their own tax revenues again declined and there were surges of claims for unemployment benefits, food stamps and general assistance?

The irony of all this is that our budget deficit has come far down without any constitutional amendment. It has fallen from $270 billion in 1992 to $107 billion in 1996. At 1.3% of our gross domestic product, it is the smallest of any major industrial nation. If Congress and the president decide that a balanced budget is to be achieved -- regardless of the costs -- they can certainly have one. But all economists should band together to stop the passage of a constitutional amendment that would tarnish the economy, the Constitution and our good names.

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