Tuesday, February 12, 2013

Who's Afraid of a Balanced Budget Amendment?

Well, I am, for one. And you should be too. Republicans are again trotting out the idea that we ought to have a balanced budget amendment (BBA) to the Constitution. And no, this isn't some fringe member of the party either, this is being arranged by the GOP leadership and is to be unveiled later this week. At first glance, you might think this seems like a prudent and responsible policy, but in reality this couldn't be further from the truth.

First of all, the bill being proposed by the GOP this week would cap federal spending at 18% of GDP. There's a small problem with that, though. Federal spending hasn't been that low since the mid-1960s:

That is to say, Federal spending hasn't been below 18% since before we had Medicare or Medicaid. The logistical problems associated with meeting that 18% spending target have now made themselves abundantly clear. However, in order to fully understand why a BBA is such a dangerous idea, you've got to look beyond the unrealistically low spending target and at the bigger picture.

Imagine, if you will, that the economy is humming along at 5% unemployment with normal, healthy growth rates and government spending levels of 19% of GDP. Suddenly, the economy enters a recession and unemployment spikes to 9%. Tax revenues fall as the unemployed no longer pay taxes and instead begin to collect unemployment insurance. Now imagine that there is also a balanced budget amendment with a 20% spending target.

Government spending under such circumstances would easily spike above that target, which means that Congress would have to start cutting government spending as the economy is still shrinking. This would be akin to tying a piano to the leg of someone who is already drowning. Needless to say, it would be catastrophic if this happened, especially in an environment where the Fed, whether due to inability or incompetence, chose not to soften such a blow to the economy.

But that isn't the only problem with an amendment like this either. Not only would it aggravate the effects of recessions, but it would also--as Matt Yglesias sagely points out--increase the number of inefficient, ham-handed regulations we'd place on businesses:
"The key point is that eliminating the supply of money to finance politically popular public services doesn't eliminate the demand for those services. Instead, it pushes policy entrepreneurs to devise inefficient and non-transparent regulatory cross-subsidy schemes. Look at any really problematic element of the Affordable Care Act, for example, and what you'll see behind it is a kludgy effort to avoid a tax increase while still providing the service. That's how you get the threat to fine employers for not providing health insurance to their full-time employees. But of course it's not "fair" to apply that rule to small businesses, so the smallest employers are exempted from the regulation."
I think Yglesias hits the nail right on the head here. In case the quote above didn't explain it well enough, let me provide an example of my own: the minimum wage. The minimum wage, classic labor economics tells us, raises wages above what the market sets them at and thus leads to an increase in unemployment as more people supply labor while employers--not wanting to bear the higher costs--demand fewer workers. The real-world data on this are muddled and difficult to parse out, but the general consensus is that a minimum wage that is too high will increase unemployment. 

In any case, the point here is that the minimum wage is a regulation we place on businesses ultimately as a means of raising incomes. However, it is, as I've shown above, a ham-handed policy that does, on some level, kill jobs. The ultimate goals of the minimum wage could be realized far more efficiently if we instead used something like an expanded Earned Income Tax Credit or good old fashioned wage subsidies to employers. We would reduce poverty rates with the added bonus of having one less regulation on employers. However, with something like a hard 18% of GDP spending cap, tax credits and welfare programs are bound to be scaled down. Obviously the demand is still there for something to be done to alleviate the plight of the working poor, so policymakers turn to raising the minimum wage, which is a far less efficient way of fighting poverty.

The list of regulations could go on and on:
"Instead of spending money on food stamps, you could require supermarkets to give discounts to low-income families. Instead of taxing gasoline, you could have ever-stricter fuel efficiency standards. And the instead of using the revenue to finance deployment of clean energy technology, you could have a regulatory mandate on utilities to do it. We already do a fair amount of this kind of thing because it makes it easier to hide the ball in terms of who bears the costs. But because these policies are less transparent, they are much more prone to perverse, unintended consequences. Thoughtful people should be trying to move politicians off this incestuous blend of corporate paternalism and over-regulation  and onto the sweet terrain of paying for services with taxes. A constitutional rule barring spending in excess of 18 percent of GDP does just the reverse."
You get the point, I'm sure. Anyways, I'll end this post the same way I started it: by asking who's afraid of a balanced budget amendment? If you weren't before, I hope you are now.