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Chapter 14 Balancing the Budget

$14,587,727,605,443.44…

…is a big number. It is the total amount of US government debt outstanding as of June 11, 2011. This number, which changes every day, is reported by the US Treasury Department at the Treasury Direct website (http://www.treasurydirect.gov/NP/BPDLogin?application=np).

The debt of the United States is the subject of a growing political storm in Washington. Indeed, in August 2011 there seemed to be a very real possibility that the US Congress would refuse to raise the “debt ceiling”—an upper limit on the size of the government debt. Had that occurred, the government would no longer have been able to fulfill all its obligations. Many commentators believe that the US government is facing a crisis with respect to its budget policies—specifically, the fact that the government is running persistent budget deficits. The issues are not the stuff of dry academic debate. If you are a typical reader of this book, you will be working and paying taxes over the next 50 years. Yours is the future generation that will be called on to deal with present-day deficits; debates about government deficits today are debates about your standard of living. If deficits matter to anyone, they should matter to you.

Just like a household, a government has income and outlays. If a household’s outlays exceed its income, then it must borrow to finance its spending. And if a household borrows repeatedly, it builds up debt. The same is true of governments. If a government spends more than its income, then it is running a deficit that must be financed by borrowing. Repeated government deficits lead to the existence of a stock of government debt.

In recent decades, the US federal government has run a deficit much more often than not. The federal government has been in deficit for all but 4 years between 1960 and 2011. As a consequence, the stock of debt outstanding in the United States has increased from $290 billion to more than $14 trillion.

Most of us cannot really conceptualize what this sum means. We can try visual images: if we stacked up 14 trillion dollar bills, we would get a pile half a million miles high—more than twice the distance to the moon. But it is easiest to get a handle on the deficit if we divide by the number of people in the economy to obtain the debt per person. As of August 9, 2011, according to the US National Debt Clock (http://www.brillig.com/debt_clock), this number is $46,905.36. This means that if the government wanted to pay off its debt today, each and every woman, man, and child in the United States would have to be taxed by this amount, on average, to pay off the obligations of the government.

US citizens hold more than half of the debt—about 60 percent. So if the government were to pay off its debt, the majority would end up being redistributed in the economy from taxpayers to holders of US government bonds. Foreigners hold the remaining 40 percent, so this money would be transferred from US taxpayers to citizens of other countries. The US government is not proposing to pay off the existing debt, however. To the contrary, the government is projected to run budget deficits for the foreseeable future, meaning that the stock of debt, and the obligation of future generations, will continue to grow.These forecasts are available from the Congressional Budget Office (CBO; http://www.cbo.gov).

In response to concern over government deficits, one proposal has arisen over and over again: a balanced-budget amendment to the US Constitution. Such a measure would simply make deficits illegal. A balanced-budget amendment came within one vote of passing in a 1997 US Senate vote, and one was passed by the US House of Representatives in 1997. Another bill was introduced by a group of US House members in 2003. Here is part of the text of the 2003 bill:

SECTION 1. Total outlays for any fiscal year shall not exceed total receipts for that fiscal year, unless three-fifths of the whole number of each House of Congress shall provide by law for a specific excess of outlays over receipts by a rollcall vote.

SECTION 2. The limit on the debt of the United States held by the public shall not be increased, unless three-fifths of the whole number of each House shall provide by law for such an increase by a rollcall vote.

SECTION 3. 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.Although such bills are typically termed “balanced-budget amendments,” they often, as is the case here, permit surpluses. US House of Representatives, “H.J.RES.22—Proposing a Balanced-Budget Amendment to the Constitution of the United States,” February 13, 2003, accessed July 20, 2011, http://thomas.loc.gov/cgi-bin/query/z?c108:H.J.RES.22:.

The Tea Party, which rose to some political prominence in the United States in 2010, campaigned in favor of a balanced-budget amendment as well. In July 2011, the House of Representatives passed HR 2560, called the Cut, Cap, and Balance Act, which (among other things) called for a constitutional amendment to balance the budget to be transmitted to the states for their consideration.The Cut, Cap, and Balance Bill is presented at “Bill Text Versions: 112th Congress (2011–2012) H.R.2560,” THOMAS: The Library of Congress, accessed September 20, 2011, http://thomas.loc.gov/cgi-bin/query/z?c112:H.R.2560: For ongoing discussion, read Rep. Mike Coffman, “Balanced Budget Amendment Caucus,” accessed July 20, 2011, http://coffman.house.gov/index.php?option=com_content&view=article&id=257&Itemid=10. This bill was not passed by the Senate. Whether this political activity will ever generate a constitutional amendment remains an open question and a point of debate in the 2012 election.

The discussion of constitutional limits on budget deficits is not limited to the United States. In 2009, Germany amended its constitution to limit federal budget deficits to 0.35% of GDP by 2016. This limit applies when the German economy is operating near its potential output. The regulations allow the German government to run deficits during recessions but require surpluses in times of high economic activity.The fiscal situation in Germany is described in “Reforming the Constitutional Budget Rules in Germany,” Federal Ministry of Finance—Economics Department, September 2009, accessed September 20, 2011, http://www.kas.de/wf/doc/kas_21127-1522-4-30.pdf?101116013053.

Should the government be forced to balance its budget each year, as such measures suggest? There are certainly good reasons why households sometimes incur debt—to pay for a house, a new car, or advanced education. Perhaps the same is true of governments. We should not presume that deficits are harmful without first trying to understand why they occur. Others have even argued that deficits are neither good nor bad but are simply unimportant. Indeed, Vice President Cheney is reported to have said that “[President] Reagan proved that deficits don’t matter.”Quoted in Ron Suskind, The Price of Loyalty: George W. Bush, the White House, and the Education of Paul O’Neill (New York: Simon and Schuster), 291.

So are deficits bad for the economy, good for the economy, or just irrelevant? Our goal in this chapter is to understand the economic effects of government budget deficits so that we can evaluate competing claims such as these and ultimately help you answer the following question.

Should the government be forced to balance its budget?

Road Map

We go through five steps in our evaluation of the merits of a balanced-budget amendment:

  1. We make sure that we know what we are talking about. “Debt” and “deficit” are technical terms with precise meanings. We go through their definitions carefully.
  2. We examine the causes of the deficit in an accounting sense. Specifically, we examine how and why the budget deficit depends on the state of the economy. We can then explore the implications—again in an accounting sense—of a balanced-budget law.
  3. We progress to a deeper understanding of why deficits occur. We examine why governments choose to run deficits. At this point, we examine possible benefits of deficits to the economy.
  4. We examine why deficits might be harmful to the economy.
  5. We examine the argument for why deficits might be irrelevant.