The Agenda

A Structurally Balanced Budget

Alex Tabarrok recently recommended a post by Ed Dolan on Sweden’s fiscal policy lessons for the United States, and I’m glad he did. In Time, Tabarrok endorsed what he calls an unbalanced budget amendment, or unBBA:

 

So instead of a balanced budget amendment I propose a better idea might be an unbalanced budget amendment. Like now, an unbalance budget amendment (unBBA) would allow the government to run a deficit during a recession. But unlike now, the unbalanced budget amendment would require the government to run a budget surplus in good times. So although unBBA allows for deficit spending on things like unemployment and food stamps during a recession, it would have similar effects to a balanced budget amendment over time because surpluses in good times would be spent in bad times. The surpluses, however, would come when we can most afford them, during a boom and the deficits would come when we most need them, during a recession.

The idea of an unbalanced budget amendment is not new. Sweden’s government has been required since 2000 to budget for a 1% surplus over the business cycle. Since implementing their unBBA, Sweden has successfully brought their budget into balance and created a surplus.

Ed Glaeser has endorsed a similar proposal:

Any federal balanced-budget amendment should allow the government to spend more than it collects in taxes during wars and recessions, with the understanding that it will spend less during peaceful times of plenty. If the budget is to be balanced, it should be balanced over the business cycle, not year by year.

I like the Chilean approach, which Dolan described in a post published in late July:

 

The centerpiece of Chilean fiscal policy is a balanced budget rule of a much more sophisticated variety than the one endorsed last week by the U.S. House of Representatives. The House bill calls for strict year-to-year balance of total receipts and outlays, whereas Chile’s rule requires annual balance of the structural budget. The two are not at all the same.

The difference between an annually balanced budget and a structurally balanced budget lies in the operation of an economy’s automatic stabilizers. Automatic stabilizers are elements of the budget that tend to increase revenues during an expansion (such as taxes on incomes and profits) and increase expenditures during a recession (such as spending for unemployment compensation and antipoverty programs). When automatic stabilizers are allowed to operate, the budget automatically swings toward surplus during an expansion and toward deficit during a recession. The automatic move toward surplus helps prevent overheating when the business cycle approaches its peak. At the other end of the business cycle, the automatic stabilizers move toward deficit and help to moderate the depth of the downturn.

One obvious rejoinder is that we should leave the size of the annual budget deficit to the discretion of Congress, as there is always the potential for unforeseen circumstances. I think it should go without saying that a clever fiscal policy straitjacket is not a suicide pact: emergencies beget exceptions, for better or for worse. But Dolan makes a surprisingly good case for having fiscal policy rules in place:

A different kind of instability arises in countries that have no explicit budget rules at all. In the absence of rules, fiscal policy tends to be asymmetrical. During recessions, automatic stabilizers are allowed to operate, leading to substantial deficits. During expansions, short-sighted politicians override the automatic stabilizers. Instead of allowing a surplus to develop, they use cyclical revenue increases to finance tax cuts and new spending programs. The U.S. tax cuts of the early 2000s, combined with increased military spending and introduction of the unfunded Medicare Part D, are a case in point. That kind of asymmetrical fiscal policy is unsustainable in the long run. The debt increases each time there is a recession and fails to shrink during expansions. Eventually these policies cause the debt to grow to the point of crisis.

This strikes me as a reasonable description of the fiscal policy status quo in the United States. Dolan then describes the Chilean solution in more detail:

Chile’s approach is to reject both the procyclicality of a strict annually balanced budget and the long-run unsustainability of asymmetrical policy unconstrained by rules. Instead Chile aims for annual balance of its structural budget. The structural budget balance is the surplus or deficit excluding automatic stabilizers, that is, the difference between the expenditures that would be made and the revenues that would be collected if the economy were operating at potential GDP. A structurally balanced budget guarantees long-run sustainability of the national debt. At the same time, it permits automatic stabilizers to operate freely, with symmetrical surpluses during expansions and deficits during recessions to smooth the peaks and troughs of the business cycle.

There are complications, and Dolan helpfully elaborates on the importance of, for example, depoliticizing the determination of the output gap to the extent possible. I hope that the Chilean approach gets a wider hearing. 

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