Sunday, 14 August 2011

Why Obama should propose a Balanced Budget Amendment

It's the one simplest thing President Obama could do to seize control of the economic agenda. It's counterintuitive - but done right, it could be the tonic both for the economy and for a divided political scene. Don't click on your back button yet - I haven't gone crazy.

Obama should propose a Balanced Budget Amendment with the following key features:
  • The balance must be achieved over ten years, not one
  • It should include automatic (not discretionary) investment programmes when unemployment is high, which are scaled down when the economy is doing well
  • It should commit to share the proceeds of future growth between deficit reduction/debt repayment, tax cuts and investment
This policy would provide countercyclical intervention - exactly as a responsible government should. Right now, the US economy could use five to ten million more jobs (that's about $500 billion a year, by the way). Five years ago it didn't need anything like that - there was plenty of private investment going on, so the government wasn't needed so much. We hope that in five years time the same will be true again. Responsible Keynesians promote smaller government in boom times, just as they argue for larger government during recessions.

The stability provided by such an amendment would allow "shovel-ready" plans to be prepared in advance. Any needed stimulus could be spent well, on public goods which genuinely provide physical infrastructure or education that the private sector cannot. Individual states might sometimes decide to execute these plans on their own, if the federal government is in a low-spending year; that is up to them - after all, they're closer to the ground and know the needs of their own people and businesses better.

And by precommitting some of the proceeds of growth - which will increase government revenue - to repay debt, the plan would show responsibility towards the future without hurting current income. It would allow government to grow in absolute terms - something that is probably inevitable - but to grow more slowly than the economy, meaning that government spending as a percentage of GDP would fall in the long run.

There are a number of options which might help strengthen the plan:
  • The debt ceiling rules should change to include an allowance for the government's assets as well as its debts. Voters understand that it's OK to take out a mortgage as long as the value of your house keeps up with it. The figures would look at lot better if the government could put all those roads, schools and aircraft carriers on its balance sheet.
  • A clarification of the Fed's mandate - ideally towards a target for total nominal spending, but almost any change would be an improvement - would reduce uncertainty. In any case, being able to predict the fiscal balance of the economy would make the Fed's job a lot easier.
  • A serious look at the education system would be a worthwhile investment in the future. American education and educators are sometimes unfairly criticised - it really isn't that bad - but the system does fail to give a lot of people the skills they really need to innovate and compete in new industries.
  • The countercyclical argument can be framed like this: Today, we are asking wealthier Americans to lend a little to help their fellow citizens through this time. In five years, they will be repaid with a faster growing economy and lower taxes. The same argument applies across states with low and high unemployment, and across generations.
  • In the long run, it may be more effective to structure the balanced requirement as a rule stabilising the long-term ratio of debt to GDP. However, politically it is probably necessary to reduce this ratio before it can be frozen (at perhaps 60%).
A package like this could surely achieve significant political support across much of the population. It is fiscally responsible; it recognises the need for reform of government (and education) to help the private sector compete better; it includes a hard-to-break commitment to future tax cuts; and it also provides jobs, investment in public goods, and makes available a new future stream for spending when growth allows for it.

I wouldn't pretend that Republicans in Congress are going to jump on board with this - they have a strong political interest in not doing so - but it would reflect the desires of many Republican and independent voters. If Obama wants to bring the country together and transcend partisanship, recognising the validity of some Republican arguments, without caving in directly to Republican politicians, is a good way to do it.

This proposal is hardly a panacea. There are economic problems and budget issues that it doesn't handle; and there are political groups whose anger or alienation won't be assuaged by this kind of coalition-building. But it would be a start. Politically it would spike one of the right's rhetorical weapons, the call for a balanced-budget amendment, and it would make progress towards satisfying the genuinely held economic beliefs of both sides. It might therefore allow that particular left-right battle to fade into the background for a while, allowing space for society to deal with some other issues.

Update: I had missed a recent discussion by Reihan Salam of a similar proposal from Alex Tabarrok, a related (but stricter) offering from Ed Glaeser and the policies of the governments of Sweden and Chile (via Ed Dolan). Thanks to @KhalMojo on twitter for alerting me. I could also mention Gordon Brown's fairly successful policy from around 1997-2006 of a structurally balanced budget (excluding net investment) over the business cycle - which, however, was never enshrined in legislation and was weakened by the lack of an objective definition of "the business cycle".

Those articles focus on the economics of the proposal; I would emphasise that the politics are equally important. This could be a rare opportunity to unite some widely separated constituencies in America.

Update 2: Could this help the US to regain its AAA rating from S&P? Recall that S&P cited politics more than economics as its reason for the rating. Ratings alone aren't a good reason to make economic policy. But it wouldn't do any harm.

Update 3: Mark Thoma has written an article about this proposal today as well. It must be in the air.


JayTrader said...

The Big problem with a balance budget amendment is that policy then becomes inherently pro cyclical. During times of contraction policy would be to lower taxes and reduce spending. These are times when you need spending to make up for lack of demand in private sector. During times of expansion, we would need less spending and more taxes. BBA thus would get monetary/fiscal policy in reverse.

Leigh Caldwell said...

Exactly - that's why I propose doing it over ten years, not one, and why I suggest that countercyclical investment programmes are built into it. The proposal is in fact about enabling investment at exactly the times it is needed, by creating a credible commitment to long-term balance.

JayTrader said...

Hi Leigh-
It sounds good on the surface but a balanced budget amendment is no different than the Grover Norquist pledge to never raise taxes ever. How can you sign on to something that is static in nature especially in a dynamic economy? You say enabling investment but as you know when we give the purse strings to Congress they tend to think its their money. They will never approve to any type of countercylical investment programs especially in the midst of a downturn. These guys live in a pro cyclical world. You give too much credence to human behaivior and far to much credit to the human race in general. People are 100% opposite of the stock market. The stock market in the midst of a downturn will evenly distribute pain to everyone in the most glorious fashion, whereas humans will cut corners just so that they don't have to face the punishment. We don't need a BBA in an MMT world. Their is never a risk to default when gov owns the patent to the green stuff.

Anonymous said...

There is no way to realistically get Congress to think over ten years. The mechanism would either be gamed to sweep problems under the rug until 2 years out and/or accumulate until you run into the equivalent of a gigantic debt-ceiling crisis where the last 10 years of accumulated error would come crashing down.

On the other hand, this might be a genius political idea: attaching Obama's name to a Balanced Budget Amendment is a sure way to get even Tea Party Republicans to stop considering it.

The worry is what even zanier scheme the right will scramble to invent.

James said...

No I dissagree whit you, there are way to many problems around it if he would do that!