The Balanced Budget Proposal: Some Macroeconomic Implications

This brief report outlines some possible macroeconomic implications of observing a statutory or constitutional commitment to balance the Federal budget. It does not address the legal questions about the proposal or their implementation, nor the economic and political questions related to decisions about the level of Federal revenues or expenditures. On the latter, its analysis refers to revenue and expenditure levels, in relation to total national product, typical of recent years.

Order Code KB79229 T H E BALANCED B U D G E T PROPOSAL: S3FE M A C R O Z C O N O K I C IM?LICATIONS UPCATED ~ 7 / 2 9 / 8 5 BY J o h n B. H e n d e r s o n Senior Specialist, Price Economics Congressional Research Service CRS- 1 ISSUE DEPINITICN S e v e r a l p r o p o s a l s h a v e b e e n mafie, o n t h e b a s l s 3 f strong and persistent p u b l i c s e n t l m e n t , t o p r o h l b ~ tt h e F e d e r a i G o v e r n m e n t f r o n r u n n ~ n g a budget deficit i n a n y f ~ s c a ly e a r . S x c h a r e s t r ~ c t ~ oonn t k e f ~ s c a la c t i v ~ t yo f t h e Federal Government would p r o 5 o ~ n C l yalter the role of the Federal Government ,.i t h e H a t - o n ' s e c o n o m y , ~ n a s v ~ cans o n l y t w o o f t h e p a s t t w e n t y - s e v e n f r s c a l part, h9weverr the years' budgets have recorde5 a surplds. For the most p r s p o s a l s m e r e i y d e c l a r e a criterion of p e r f o r m a n c e -- usually to requlre tta:, o n t h e u ~ i f ~ e~ dc d g e tS a s i s , F e d e r a l ~ u d q e zo ~ t l a y s sP.all n o t exceed r e c e ~ p t s ,a l t h o u g n s o r ~ e rece7.t p r o p o s a l s a r e c o n s t r a ~ n e d ~y m a n e a c i n g a l s a aK upper l ~ m o ~ n c t h e l e v e l o f F e d e r a l r e v e n 1 2 e s . T?.Is a l n ~b r ~ e fol2tl:zes some macroeconomic :mpl:cat~ons of observing a statutory 0r possrble constitutional c o m m i t m e n t t o b a l a n c e t h e F e d e r a l b u d g e t . It does not address r h e l e g a l q u e s t ~ o n sa b o u t t h e p r o p o s a l s or therr ~ m p l e m e n t a t i o n , nor the the level of e c o n o m l c a n d p o l i t i c a l questions r e l a t e d t o d e c i s ~ o n s a b o u t latter, its a n a l y s ~ s refers tc F e d e r a l rever.ues o r e x p e n d ~ t u r e s . O n t h e r e v e n u e a n d expenditure l e v e l s , i n r e l a t l o n to total n a t ~ o n a l product, typical o f r e Z e Z t y e a r s . ~ ~ n a l l yt,h e ~ ~ i n~ ir i e fd a e s n G t a t t e m p t c o a z a l y z e t h e e f f e c z of v a r i o u s e s c a p e c l a 2 s e s a t t a c h 2 C t ~ s e v e r a l p r a p o s a l s . - - SACKGROUND The Federal budgec 1s unlike other budgets The Federal budget resembles other budgets Only in that i t i s a n economic p r o s p e c t u s , a d e c l a r a t i o n of intentions. It differs from State and local b u d g e t s in that most subordinate g o v e r n n e n t s d i f f e r e n t i a t e current account b u d g e ~ sf r o m c a p i t a l b u d g e t s , r e q u i r i n g i n m a n y instances balance in the c u r r e n t accounts, w h e r e a s t h e F e d e r a l Governr?,ent m a k e s n o d i s t i n c t i o n b e t w e e n outlays for current expenses and outlays of the nature of investment in social capital. By standards of Federai accounting, many States and municipalities, while adhering to the requirement of current-account balance, would be i n budgetary deficit if they were to consolidate their budgets, since borrowing creates a deficit on capital account. For the same reason, vigorously growing corporations, in issuing new debt in excess of their net income, are practising what i s called deficit spending in reference to the Federal Government. For most households, too, the first purchase of a home associated with a mortgage commitment is relatively a huge excess of outlays over receipts in the year of its acquisition and hence is a l s o a cause of deficit spending. It i s true that the creditworthiness of States, localities, corporations, and households places limits on the scale and terms o n which they a r e a b l e to b o r r o w , a n d t h a t no similar short-term constraint There are long-term limits, however, and applies EO the Federal Government. the ability of subordinate borrowers to service debt finds i t s counterpart in the willingness of the Federal Government to impose taxes to raise revenues. CRS- 2 MB79229 UPDATE-07/29/85 Federal revenues and expenditures cannot be precisely controlled The President's budget is presented to the each January, more which it applies. Its taxicg ane spen5ing proposals determine the estinazes of revenues and e x p e n z i t ~ r e s on the basis of explicit economic Fresanpti3r.s. whether tke a c t 2 2 1 c o u r s e o f e v e n t s w i l l z o n f o r ~ ,t o tP.ese c r e s n a p z i s n s c a n ? = ? S e a s s u r e ? . .4 Congress ..an S m o n t h s S e f o r e t h e b e g i n n i n g o f t h e f i s c a l y e a r t c I f t h e P r e s i d e n t F r e s e ~ t sa S u d g e t i c S a l a n c e , a n C e v e n i f sac?, c h a n g e s a s the Congress nakes leave the Scdget i n Salance a t the tine of the Second C o z c u r r e n z 2 u Z g e t R e s o l c t i o n , w h i c h i s ,eq;ire2 ' S e f c r e = h e Seqinzi'g sf zP.e c . ,iscal y e a r , there 2s still nc assnrance that the Scdgezary o~:cone wili r e s u l t i? a S a l a n c e . T 3 i s i s S u e ts s x c ? f f a c t o r s a s zP.e l ~ c p r e d i c t a S l ez i m i z g cc lozg lead-tine ~ r o j e c t s and of actcal e x p e n d i t u r e s , particularly muiti-year programs; the existence of open-ended programs such as unemp1oyment.assistance; and the variability associated with comn-.Ftments, such a s the payment of interest, a t a n unknown future rate, on the Federal debt. M o r e o v e r , t h e a c t u a l F e d e r a l o x t l a y s C-dring t" :fiscal year xi11 Se a f f e c t e d by u n s p e n t a u t h o r i t y e n a c t e d in earlier years. And the Sudget n ~ ~ b e r as r e , i n some programs, c o n d i z i c n e ~ ~y past co~~ci:nerts -" expen'2itnres th-.b are urela=ive;y ' ~ ~ ~ c ~ ~ r o l l" a b li -e e,. , ye-., y w l YL o congressional action for any change in that fiscal year. Finally, the b u d ~ e t d o c u m e n t r e p o r t s c e r t a i n a c t i v i t i e s t a a t a r e by law "off-budget," most of these outlays being excluded from the unified budget totals. - L. - A =c n ' the M o s t s f a l l , t 9 e u n c e r t a ~ n t y o f t 3 e F e d e r a l b u e g e t o c t c o i ~ e1 s d u e t o ~ m p a c - ,o f t h e s t a c e o f t h e e c o n o m y o n t n e b u d g e t . F o r exanp'le, p e r s o n a l ane corporate lncome levels affect income =ax r e c e ~ p t s . The ievel of suSsldles u n e m p l o y m e n t a f f e c t s p a y m e n t s o f assistance. A n d s o m e g r a n t s a n d vary ln response to economlc condltlons, State and local government e x p e n d i t u r e s a n d r e c e l p t s , etc. The lntent of many of the programs most a f f e c t e d 3 y ~ n es ~ a t eo f t h e e c o n o m y 1 s n o t o n l y tnat cney lncur certaln e x p e n d ~ t u r e sor ralse revenue from speclfled sources, bdt that thsy a c t a s automatic s t a b l l l z e r s o f t h e e c o n o m y , c a d s l n g F e d e r a l outlays to r ~ s e and r e c e l p t s t o f a l l l f e c o n o m l c a c t ~ v l t y1 s r e d u c e d , a n d v l c e v e r s a . Consequently, the budget figures presentee initially S y the President are directly affected not only by the programmatic proposals b u t a l s o by the underlying assumptions about the future performance of the economy. The crucial importance of these assumptions is seldom emphasized, largely because every Adninistration has a political interest in projecting the s u c c e s s Of its economic policies. T h e r e s u l t i s tha: r e l a t i v e l y f e w a l l o w a n c e s a r e m a d e for adverse economic developments. The actual budgetary deficit tends in most cases to exceed, rather than fall short of, the initial expectations, even if no programmatic changes a r e made in the interim. Required budgetary balance may affect the stability of the economy A rigid adherence to Sudgetary balance could severely constrain the stabilizing influence of fiscal policy. For if lower general economic receipts and threatened to cause a activity generated lower Federal tax budgetary deficit, the commitment to balance the budget would necessitate a reduction of expenditures or an increase in taxes, either of which would further reduce economic activity -- a destabilizing process. Equally, if CRS- MB79229 3 UPDATE-07/29/85 t h e r e w e r e t h e same o b l i g a t i o n t o a v o i d s u r p l u s e s , h i g h e r i n c o m e and higher tax receipts might require high expenditures a t the very time when at least not more, Federal s t a b i l i z a t i o n p o l i c y wouid c a l l f o r l e s s , or spending. A l t e r n a t i v e l y , h i g h e r t a x r e c e i p t s c o u l d be c o n s i d e r e d a s a r e a s a n restraint might f o r a c u t ~n t a x r a t e s , a s t i n u l a t i v e a c t i o c a t a t i m e w h e n be aore appropriate. ' F'eeeral q 2 v e r n ~ e r . ze c p e n 2 ; t ~ r e s o c qosSs axe s e r v ~ c e s generate lr.comes, t 2 and F e d e r a l Government z r a ~ s f e r s t o S ~ a t e and local g o v e r n ~ e r - t s and p r i v a t e ~ n d l v l d u a ; s p r o v l d e purchasing p o w e r t o b e exercised u s u a l l y x l t h r n a s h o r c p e r ~ o do f t l n e . P e z e r a l r e c e ~ p t s of all s ~ n 2 s w ~ t c z r a w p7:rchas:cg wnat power f r o n t n e pr1va:e seczor. 'iiowever, t h e ~ m p o r t a n tc o n s : d e r a t ~ o n I S t h s F l l e r a l 3 - d g e t alz;.e, 2s 2c;nq zc a l l g a v e r n p e n t acz:v:zy, a n d n c t 1:s: e e c o ~ ~ c - y , -- >- - e of t n e z r - y a r e s e c t s r s f t n e econony. From t n e -?:eb:po:r.z may c e e r ? , a r . c e d 3 r = o 1 ; n t e r e d b y the f ~ s c a l e f f e c t s cf a e d e r a : f l s c a l ? o l : c y a c t l v ~ t ~ eo fs S t a t e a n d l o c a l g o v e r n m e n t s . - s noteworthy t?at, on z?,e b a s l s o f t h e n a t l o n a l l n c o m e a n d p r o d u c t a c c o u n t s f o r c a l e n d a r y e a r 1984, :he F e d e r a l G o v e r n m e n t d e f l c l t o f $ 1 7 1 . 5 b l l l l o n , w a s partially o f f s e t b y a S t a t e $53.0 b ~ l l i o n . On balance, tF,e whole and l o c a l government surpius of t3 stlnulate esonon;c aczlvrty to a government sector was c3nt:nu:ng s u b s t a n t l a l d e g r e e , especially z n v ~ e wo f t h e r e l a z l v e l y s t r o n g r e c o v e r y t h a z large v e r 17 had Sequn ~n late l982. iYowever, zne eaerqezce of a 1nter2at:ozal c r a z e e e f ~ c : ' s 2 q g e s t s z P L a z f z r e ~ q zs ~ p p 1 : e r s c f '.- . S . c o ? r s d : t y l m p o r t s w e r e m a ~ o r b e n e f i c l a r l e s o f t h l s stimulus.) T . Congressional a c t i o n t o balance t h e budget ~ o l i t i c a lp e r c e p t i o n s I- i s subject t o both l i m i t a t i o n s and A T h e r e i s n o way t o e s t i m a t e by w h a t r i e a n s c h e r e q u i r e d Federal budgetary b a l a n c e would be a c h i e v e d . B u t some a c c o u n c h a s t o b e g i v e n t o t h e f a c t t h a t " r e l a t i v e l y ~ n c o n t r o l l a b l e ' o~u t l a y s ( r e q u i r i n g c o n g r e s s i o n a l a c t i o c t o c h a n g e a n on-going program) a c c o u n t f o r a b o u t t h r e e - q u a r t e r s of t o t a l outlays and, as among t h e s e , o p e n - e n d e d p r o g r a m s i n v o l v i n g p a y ? , s n t s f o r i n d i v i d u a l s , s u c h Social Security, account f o r almost one-haif of total outlays. Of the " r e l a t i v e l y controllablei' o u t l a y s , well over h a l f a r e found in the defense budgetary process sometimes takes budget. I t i s a l s o noteworthy t h a t t h e -- a l o n g e r t o d e c i d e on m a j o r c h a n g e s i n o u t l a y s than changes i n taxes s i t u a t i o n t h a t m i g h t move the Congress to raise taxes rather than cut a s p e n d i n g , t h e o p p o s i t e r e a c t i o n t o t h e i n t e n t o f many of those favoring balanced budget. There i s l i k e l y t o be asymmetry i n c o n g r e s s i o n a l r e s p o n s e s , for tax cuts and eXpen2iture increases cause less diffizulty than tax i n c r e a s e s and expenditure c u t s . I t is possible, of course, that the Congress could respond to the d i f f i c u l t y o f r e d u c - i n g e x p e n d i t u r e s by a l t e r i n g t h e c o v e r a g e o f the budget. A s mentioned e a r l i e r , t h e r e a r e off-budget Federal e n t i t i e s , Federally Owned their outlays excluded from the unified and c o n t r o l l e d b u t w i t h most of b u d g e t t o t a l s , anC n o t s u b j e c t t o the ceilings set by the congressional be changed, by law. budget r e s o l u t i o n s . Their s t a t u s i s c r e a t e d , and can While most of them a r e i n v o l v e 2 i n l o a n p r o g r a m s , C o n g r e s s could choose ta ectity. e x t e n d t h e c o n c e p t 0: a n o f f - b u d g e : In addition, the regulatory activities of the Federal Government are a fashion that, instead of incurring c a p a b l e of b e i n g conducted i n such b u d g e t a r y c o s t s , t h e y could impose c o s t s on t h e p r i v a t e s e c t o r . An immense v a r i e t y of o p t i o n s e x i s t s , r a n g i n g from p r e v e n t i n g l a y o f f s of employees (and CRS- 4 MB79.229 UPDATE-07/29/85 avoiding payment of unemployment benefits) to mandating hig5er product prices instead of subsidizing p r o d u c t i o ~ . m c 9 a n g e ;n ,he S u d g e c a r y p r o c e s c r e s w;ll n o t lea-"'e m c n e t a r y p o l i c y u n a f f e c t e d ,,,ere ir i s a conzifiuo:s rela::c?.shi> Sec-,,ieelS u d q e z a r y a n t f i s c a l p s l i c y , Federal CeSt xanagemert, and monetary policy. T h e l i k e l y c o n s e q 7 ~ e n c e s of a c c m m i t m e n t t o a b a l a n c e d b u d g e t w o n l d b e a d i m i n ~ c i o no f t h e p o w e r a n d scope pclicy, o f f i s c a l aczio?., 2.25 a c o n s e q u s c z i n c r e a s e 2 r e l i a z ~ e o c - 9 n e t a r y especially in t e evenz that zke loss of 'fiscal discretion has a - - s?,01:12 c o t S e f c r g c ~ z l r . , ?.swever, P s s z a S i l i z i n q e z z e c z o ~ .:Pie e c c n 3 s y . rrioRetary p o l i c y canzo: S e a zo?rplece sxSsz;t2te f s r 3 i s c r e ~ : o n a r y f i s. z- a l ?slicy. 3 0 t h budgetary e x p e 3 C i t x r e s a r e t a x e s a r e ~ S l et 3 perfor!? s p e c ~ z i z Cistribctive and allocative functiozs, zhaznelling resol~rcest o certai? types o f p e o p l e , o r g a n i z a ~ i o n s ,i n d u s t r i e s , o r l o c a z i o n s , a n d w i t h d r a x i n g r e s o u r c e s from certain others. Monetary policy cannot do this, and even such a proposal a s credit allocation cannot attain anything like t3e purposefuiness Y o r e o v e r , t3.e S 1 1 d g e t a r y p r o z e s s i n v s l v e s c p e n polit:cal of 5udgetary action. d e l i b e r a t i o n , w h e r e a s m o n e t a r y p o l i c y i s c o n d c c t e d by t h e i n d e p e n c e n t F e d e r a l 3 e s e r v e Sysce?. n 2 d e r c o n 2 i t i o n s o f s z r -; c t e o n f i Z a n t i a l i t y , r ? . o ~ ; q H ~ c r g r e s si s e?.:itle? t o c v e r s e e :fie ???era: perfcrnanz? 25 :?.e Systee. i s r.cz necessary that this independence should co~ti~~ue. On the contrary, the balanced Sudgez might endow the management of monetary policy wich such the curb enhanced and critical power that political pressure would independence of the Federal Reserve System, with uncertain consequences for t3e performance 3 5 the economy. T T t r n l i - -I Ad h o c b u d q e t a r y b a l a n c e a n e s u r p l u s It must be emphasized that nothing in this analysis runs councer to the view that at some times the Sudget shocld be balanced or in surplus; the desiraale budgetary outcome depends on the economic c i r c u m s ~ a n c e s . Sowever, a r i g i d requirement t h a t the F e d e r a l budget s h o u l d be balanced carries th? risk t h a t this might be achieved by measures w h o s e a s s o c i a t e d costs to the Nation, i n terms of equity, efficiency, and economic stability, had not been given adequate consideration. still aassive The budgetary outcome for F Y 8 4 , ended Sept. 3 0 , 1984, i s a d e f i c i t o f $175.3 b i l l i o n , a l b e i t s m a l l e r t h a n t h e $ 1 9 5 . 4 billion of FYE3. In t h e a b s e n c e of s t r o n g a n d prompt action t o reduce e x p e n d i t u r e s o r i n c r e a s e . t a x revenues, there i s little prospect that economic growth will cause the This is because the F Y 8 5 d e f i c i t t o b e s u S s t a n t i a l l y l e s s t h a n $200 b i l l i o n . deficit i s no longer merely a natural accompaniment of cyclical downturns, but a manifestation of a new tendency for Federal expenditures to grow a t a faster rate than Federal revenues in both good years and bad. On the expenditire side, T h e r e a r e many r e a s o n s f o r this development. despite major reductions in some social programs, the increase in real defense spending and the commitment to indexing of many "entitlemect" programs a r e two sources of expenditure growth. Despite the fact that 4 months i n t e r e s t r a t e s h a v e d e c l i n e d by 2-3 p e r c e n t a g e p o i n t s i n t h e p a s t and a r e now 3-4 percentage points below those of a year ago, Federal debt s e r v i c e , o n a larger t o t a l of d e b t , is u n l i k e l y to be a s m a l l e r p r o p o r t i o n of total budgetary expenditures. On the revenue side, budgetary legislative MB79229 CRS- 5 UPDATE-07/29/85 action during 1982 to increase tax collections and reduce some tax favors granted in 1981 i s far from sufficient to recoup the earlier concessions. Even good economic news may, in the short run, yield less than might Se e x p e c ~ e di n c h e r e d u c c i o n o f t h e d e f i c i t . There has been a considerabie and w e l l n a i ~ t a i n e d r e z u c t i o n i n p r i c e i n c r e a s e s s l c c e 1981. TP.e a n n u a l r a t e o f 1983, i n c r e a s e i n r h e c o n s u m e r p r i c e i n d e x , l e s s t h a n 4% i n b o ~ h i932 a n d r e m a ~ n e d a r 4 5 i n 1384. Y e t t h i s m o d e r a t i o n o f p r i z e i n c r e a s e s ir: i z s e l f i s v:ie;y , , ,e5:ce rever.ues x c r e , a n 2 z 3 r e p r a c p t l y , z h a n e:~:penZi=sres, eve:; i f i t p r o m i s e s a b e r t e r f u c n r e e c o n o ~ i cp e r f o r m a n c e . --, v- F, ~ , . e~ a q n i r u d eo f a b o v e 2 1 1 , d e n o z s t r a t e s ha% far i is n e c e s s a r y L O g o c o achieve a b a l a n s e e b u d g e t . ~ n e Adrnlniscraclon's presenc f a r e c a s c fsr 7 ~ 3 5 , a?$ i z s o~;;loo:c f o r 7- -76- 5 , a r e p r e C i c a t e d 3 3 a n anr.cal r e a l .,i -,-, ; -L -a-L e c f gr~x:?. cf 3 % . Y 5 e B ~ d g e z? r 3 s z s a l s f o r T ' f S S , .. sli'sstarzial b~ic as yet undscermised spending cuts, would then envisaqe a decline in tAs deficit over the next few years. T h e annual rate of real growth in gross ..c-,onal p r o P u c t i n t 2 e y e a r e n e e d i n J u n s l?85 w a s a c t u a l l y less than 2%. S o , in t h e a b s e n c e of f u r t h e r c u t s i n s p e n d i n g or of d e c i s i o n s to r a i s e new r e v e ~ . s e s , i t a p p e a r s c h a t a v e r y c o n s i d e r a S l e e x p a n s i c n i n e c o n o x i z azzivi;y w o u l d b e ~ e e d e dt o b a l a n c e t h e b u d g e t e v e n i n 5 y e a r s ' t i m e . .m he d e f i c i t , 7 , - - 7 ?-,.-: S a c P a p e c 3 c o x . i ~e?.vircnmerc c a s z s d o : ~ b ; or. t h e r e 2 l i s ~ , o f s r o ~ c s ~ 5 ga q u i c k r s t u r n t o S u d g e t a r y S a l a n c e , h o w e v e r m ~ c h:?.at b c d g e t a r y o u t c o n e m i q h t be desired a s appropriate to the current needs of, a n d pressures on, the economy. Of c o u r s e i t i s p o s s i b l e t o f o r e c a s t a n o u t c o m e c l o s e r to balance b y u s i n g e c o n o m i c p r e s u m p t i o n s t h a t a r e o v e r l y optimistic; b u t c h a t w o u l d do noching z o assure its achievement. The basic question i s whether giving first priority to a Salancee budget as a goal in itself would cause the economy to weaken and become less manageable. The real issues require expenditures, and decisions on whether the chosen levels of revenues 2nd lasting t h e i r p r o s p e c t i v e c h a n g e s in f u t u r e y e a r s , a r e c o n s i s t e n t with the I t is necessary also to ask whether plans for need for fiscal constraict. Federal expenditures are compatible with resource availability and the financial environment. If n o t , t h e risk i s t h a t a c o m m i t m e n t to refrain f r o m any tax increases, and insufficient constraints on total Federal specding, will frustrate the desired reduction in the deficit. A widening deficit in future, when the economy is moving closer to full employment of its resources, would assuredly threaten to preempt the savings necessary to sustain the greater private demand for investable funds. This threat is all domestic savings have been themore s e v e r e b e c a u s e , s i n c e 1 9 8 3 , U.S. suppiemented S y a massive inflow of foreign capital whose continuation on the s a m e s c a l e c a n n o t be assumed.