One side effect of the constant bickering over federal debt-related issues is a proliferation of snappy, yet ultimately meaningless, slogans and phrases. “If my family has to balance my budget, the federal government should too” comes to mind. The phrase is short, simple, and scores quick political points by appealing to listeners’ “common sense.” After all, why should the government escape belt-tightening when all of its citizens are forced to make difficult choices with their household budgets?
Yet, as one quickly learns when studying economics, simplistic “common sense” is often wrong. And, given today’s economic circumstances, the family/government budget comparison is dangerously wrong. On one level, it should be obvious that the federal government is really nothing at all like a family, and that this is a comparison of apples and oranges. Imagine trying to fight World War II with a balanced budget. Mobilization and the war effort took high debts from the ongoing Depression and sent gross federal debt skyrocketing past 100 percent of GDP. Top marginal tax rates, above 90 percent, failed to balance the budget — only booming economic growth in the post-war period helped to achieve that.
But put aside the difficulties of comparing two extremely different things for a moment, and focus only on the economic issue at the heart of the comparison: should the federal government be forced to balance its budget during a recession? In a word, no. The explanation is a bit more complicated.
Let’s start off with a quick refresher on Keynesian economics. In a nutshell, John Maynard Keynes, whose book The General Theory of Employment, Interest and Money shaped modern economic thinking, would say that a government should run a surplus during booms and a deficit during busts. That is, it should take in more money than it spends when times are good (raising taxes and cutting spending and the debt), and spend more money than it takes in when the economy tanks (cutting taxes and spending more).
Keynes viewed proper government policy as counter-cyclical, trying to smooth out the economic cycle by putting the breaks on an over-heated economy and speeding up a stagnant one. An economy is powered, essentially, by spending. People use their paychecks to buy goods and services. The money charged for those goods and services help pay for another person’s paycheck. The cycle continues. Savings, too, are channeled into spending, through loans and investments. This further grows the economy as businesses expand and productivity and technological gains are made.
But, during a recession, spending falls precipitously. Businesses lay off workers, and households cut their spending, blowing a huge hole in the economy. If the government were to likewise suddenly balance its budget, it would amplify this damage.
There are two ways a government can balance its budget in any one year:
- Cut spending
- Raise taxes
Or it can pursue some combination of the two. Either way, these policies would have dragged the economy down deeper into recession, perhaps even into a full-fledged depression, had they been implemented back in 2008, and could derail the economy today.
Consider what would happen if the government cut spending immediately. It will need to lay off government workers (meaning they will have less to spend), halt contracts and projects that help employ private sector workers (meaning they will have less to spend), and cut back on programs that encourage or sustain spending. Social safety nets are a good example — food stamps and unemployment benefits are very stimulative because beneficiaries usually spend the money soon after it is received, generating economic activity.
Tax increases to address budget issues have a similar effect, by taking money out of citizens’ pockets instead of encouraging them to invest and spend to get the economy started again.
The result is that trying to balance a budget during a recession or a fragile recovery can actually lead to greater debt and deficits. This is because the state of the economy dictates how much a government will take in in taxes. When the economy is tanking, the government will take in less money in taxes because of falling incomes. When you have a lower income (due to being laid off, having hours cut, having pay cut, etc…) the amount of money you pay in taxes falls.
If the government tries to deal with this fall in revenue levels by raising taxes and cutting spending, it will send the economy down even further, blowing a new hole in the economy, necessitating further cuts and tax increases, etc…
Tax increases and spending cuts are needed as solutions to address debt and deficit issues once the economy is growing steadily again (and then, cuts should usually outnumber tax increases by a 3:1 or 2:1 ratio), but such austerity during the crisis could drive an economy deeper into a recession or derail a fragile recovery.
We only need to look as far as the Great Depression for evidence of this. The idea that governments should always balance their budgets, and that doing so would spur investment and recovery, was widespread before and during that period. Both President Hoover and President Roosevelt raised taxes early in the Great Depression, hampering economic recovery. Increased spending by President Roosevelt (and, more importantly, the stabilization of the nation’s banks and removing the United States from the gold standard) helped the nation begin a fragile recovery.
However, insistence that America balance its budget led to cuts in spending and tax increases that derailed the economy in 1937, plunging it back into recession. This is especially relevant for Americans today, as we debate deficit reduction.
The best policy options for dealing with the current budgetary outlook would be to sustain short-term tax cuts and well-placed spending increases (like on infrastructure projects and extending unemployment benefits), while also laying out a long-term plan addressing budgetary issues (including future tax increases and spending cuts, but mainly restructuring Social Security, Medicare, and Medicaid to make them more sustainable).
The riskiest and worst policy the government could pursue would be balancing its budget “like a family.”
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