Balanced Budget Amendment Would Impede Economic Recoveries

1/25/2011

Over the past 30 fiscal years, the federal government has run a surplus only three times. In the past three years, the government has seen deficits totaling almost $3.5 trillion, and the Congressional Budget Office’s (CBO) baseline prediction shows deficits for at least the next decade. With such a history and with the recent rise of the Tea Party and its fiscally conservative contingent in Congress, it is unsurprising that balanced budget amendments to the Constitution are once again finding their way to the national agenda. While forcing Congress to balance the books through a constitutional mandate may be appealing to many fiscal hawks, a balanced budget amendment could impede economic recoveries following Wall Street meltdowns and other calamities.

A simple balanced budget amendment requires that at the end of the fiscal year, federal revenues match or exceed federal spending. With statutory Pay-As-You-Go (PAYGO) on the books – requiring offsets for any new mandatory spending or tax cuts – a balanced budget amendment seems like the next logical and fiscally responsible step.

Balanced budget amendments were last seriously considered in the mid- to late-1990s when budget deficits were also dominating the political discourse. Indeed, amendments came close to passing twice, once in the 104th Congress and once in the 105th Congress, driven by then-ascendant Republican majorities. Both times, though, the amendment failed to achieve the necessary two-thirds majority in the Senate by only one vote (the House easily passed the amendment in the 104th Congress).

Now, with a Republican House again agitating for what it deems fiscal responsibility, proponents are making another push. Likewise, after the 2010 election, the Senate Republican caucus unanimously approved a resolution calling for a balanced budget amendment, and Sens. Orrin Hatch (R-UT) and John Cornyn (R-TX) recently began circulating a letter asking for cosigners to a Senate version of the amendment.

Passing such an amendment, though, would hinder the government’s capacity for combating economic downturns. A strong majority of economists believe that the government plays an important role in moderating the ups and downs of the business cycle, primarily through increasing aggregate demand; that is, putting enough purchasing power into the economy to get businesses to hire workers to meet the new demand. Federal spending also plays another key role: it helps cushion the blow of a faltering economy through “automatic stabilizers.”

According to the Tax Policy Center, “automatic stabilizers are features of the tax and spending systems that, by design, offset fluctuations in economic activity without direct intervention by policymakers.” In other words, automatic stabilizers are features of the federal budget that automatically adjust in real time when economic tragedy strikes. Examples include programs like unemployment insurance and food stamps, which do not have set enrollment levels and thus see higher usage when the economy dips. Similarly, various tax provisions, such as the Earned Income Tax Credit, function in the same way, but through the tax code.

Automatic stabilizers not only translate into benefits for those hardest hit by recessions, they also have an effect on the greater economy. Thanks to an economic phenomenon known as the multiplier effect, each dollar spent on these programs, either through lower taxes or more benefits, rebounds throughout the nation’s economy, greatly increasing the dollar’s impact. One study found that the automatic stabilizers in the tax code “offset perhaps as much as 8 percent of initial shocks to GDP [Gross Domestic Product].”

However, this spending, which Congress does not specifically offset, automatically increases the deficit. While automatic stabilizers adjust as the economy starts faltering, it would be difficult for legislators to act as fast if a balanced budget amendment required lower spending or higher taxes to offset the stabilizers. More importantly, though, offsetting the cost of the automatic stabilizers defeats their whole purpose: they pump money into the economy just when it needs it. By raising taxes or cutting spending, the government would be giving out money with one hand while taking it back with the other, reducing the stabilizers' effectiveness.

A balanced budget amendment would create a constitutional mandate for such offsets, effectively preventing the government from acting quickly to help modulate GDP fluctuations. Indeed, the practical requirements of a balanced budget amendment might have a wide-ranging effect on the federal budget and could require spending caps or enrollment maximums on mandatory spending programs and tax provisions. Of course, a balanced budget amendment would make actual stimulus bills such as the American Recovery and Reinvestment Act (Recovery Act), which are often deficit-financed, all but impossible to pass.

Many of the balanced budget amendments currently before Congress come with other provisions that would hamper the federal government’s operations. The most drastic of the proposals is House Joint Resolution 1, which, in addition to requiring a balanced budget every year, would also set a limit on spending levels, cap the debt ceiling, and require a super-majority vote for increasing revenues. None of these provisions are necessary for balancing the budget, but they would make it difficult for the government to react to changing fiscal situations. The resolution currently has 98 sponsors in the House.

Balanced budget amendments face other practical problems, as well. First, it is difficult to predict revenue and outlays accurately for the coming fiscal year, again thanks to budget items like automatic stabilizers that rise and fall with economic fortunes. Looking at the federal budget estimates from 1983 to 2005, the Tax Policy Center noted that "the average absolute error in the five-year revenue projection of the Congressional Budget Office (CBO) caused by changes in the economic and technical assumptions was 1.6 percent of GDP, which would be $219 billion at the 2007 level of GDP." With errors like that ($219 billion would be equal to the 2007 budgets of the Departments of Transportation, Education, Health and Human Services, and Homeland Security), Congress could unintentionally violate the amendment after the fact, such as when a year’s unexpectedly low revenues do not cover unforeseen costs.

But there is another issue: which entity would enforce a balanced budget amendment? The balanced budget amendments being considered are all enforced through future legislation, but even that raises a whole host of questions. Would the executive branch be responsible for keeping budgets balanced, say through sequestration? What if the president refused to act? Would the judicial system have to get involved every time Congress passed an unbalanced budget? Would anyone even have standing to bring a lawsuit? Balanced budget amendments exist in a legal gray area of the fiscal world.

Ultimately, while balanced budget amendments have significant support in Congress, it may be impossible to add such an amendment to the Constitution. The current economic slump has shown how important the federal government is in filling fiscal gaps in state budgets, and governors and state legislatures have not missed that lesson, despite remarks by some to the contrary. With stimulus efforts like the Recovery Act playing a large role in helping the states weather the recession, state leaders know how crucial federal economic stabilizers are. With any constitutional amendment requiring ratification by three-fourths of the states, this could prove to be a hard sell.