Thursday, August 06, 2009

Paca's Long Term Balanced Budget

This is really rough, but I need to do real research to make it better, so let's go with this for now.

With regard to budgets, we in the U.S. are typically offered two choices: 1) no balanced budget rules or 2) an annual balanced budget. Currently, 32 states have a balanced budget amendment in their constitution while 11 more have statutory rules. That's 43 of 50 states. Meanwhile, the federal government has none. As is obvious to anyone watching, there are problems with both solutions.

The major problem with no balanced budget rule is clear: government has a huge tendency to spend for the now and end up with a growing permanent debt. The current national debt, according to this debt clock is about 11.5 TRILLION dollars or $38,000 a person. It could be worse. In WWII, the debt was even higher than now as a percentage of GDP, so we can recover, but that doesn't mean this is good. I'm getting some different numbers depending on where I look, but it seems that we currently pay around 500 or 600 billion dollars every year just on interest payments for the debt. Just 2 years of that interest pays for the entire trillion dollars over 10 years proposed health reform package currently being debated. That's more than the budgets of homeland security, education, HUD, energy, VA, EPA, FDA, and more combined. If I'm reading this correctly, the amount that the U.S. spend on paying interest on our debt is about the size of the UK's entire budget. The whole thing. pdf link, page 12 We could pay interest... or fund the entire government of a major European nation. (Crap! I just remembered that's pounds, so it doesn't work, but it sounds so good that I'm leaving it.) An annual balanced budget rule prevents a government from getting into a hole like we have over the long term by preventing deficit spending.

But there are problems with an annual balanced budget as well. Often we think of deficit spending as inherently bad, but it's actually a very common occurrence among the most fiscally responsible people. The greatest example of routine deficit spending is called retirement. When you retire, you often spend more money than you bring in. However, this can be just fine assuming you have saved enough to make up the difference. The problem with deficit spending comes, of course, when you have no savings.

What an annual balanced budget essentially does is force state governments to operate paycheck to paycheck. Yes, they can save under such requirements, but the motivation to do so evaporates, because you aren't allowed to use those savings when times get tough later. It's like telling people they should save for retirement, but by the way, when they are retired, they can never spend more money than they are bringing in while retired. The motivation for saving would be greatly reduced, because it enforces privation whenever temporary revenues fall. I think this is an important point. Why would someone save for retirement if there's a rule in place saying they can only spend what they earn in social security? Saving for retirement become useless.

Moreover, cutting during bad times, which all the states are doing, can feed right into increasing the bad times. Revenues are down, so you cut all the workers who then don't buy anything, which then decreases revenue, so you cut more workers....

So what's the solution? Why not a longer term balanced budget? Something greater than a year. Here's a guy who says it should be five years. Instead of trying to find the magic year though, it might be better to require the right behavior: Force the government to save when times are good and then allow them to spend when times are bad. How can you do so?

How about requiring a certain percentage of growth in revenue during times of GDP growth to go into savings, and then allowing those savings to be spent only when 1) GDP is declining, 2) there is a major war of national security with a state of war formally declared by Congress (so nothing post-Korean War would count, I don't think), or 3) reasonable leverage, a term to be "defined" later.

Easy ideas so far, but exactly how much are you required to save and how much are you allowed to spend? That's the million dollar question, and not one easily answered. One way to tackle it is to specifically save so as to replace the drop in revenue during a recession cycle. We need three main numbers: 1) percent drop of revenue per annum during downturns, 2) number of years of typical recession, and 3) the distance between recessions. Add 1) and 2) together to get the amount you need to save, and then save a percent in growth years based upon 3), so that it matches 1) and 2). This gives the savings requirement.

OK, I just spent longer than I should have trying to figure out the formula, which it turns out is exceedingly difficult for little old me who's never taken an economics course, but I think the principle is clear. The government is required to save a percentage of growth in good years to replace drops in bad years.

But what about the spending requirements? How much over current yearly revenues can be spent? One answer is that you can spend whatever was saved beyond current revenues, and that's it. Apart from savings, you operate entirely on a year-by-year balanced budget.

But that's a limited answer, because it assumes the government will never have a justifiable reason to take out a loan, even though we allow individuals and businesses to do so all the time. Reasonable leverage is an accepted part of most business models. But what is "reasonable leverage" and what is "stealing from our children"? I haven't figured out the answer, but I have a few ideas. First, reasonable leverage must be deficit neutral over the long term. I have in mind here something like using money now to make medical records electronic which will save more money later. But you can't just say that and let it go, hoping it turns out okay. There has to be a real plan that can be tracked. You must write up a plan saying when the savings will come and then monitor that progress. If it's a 10 year plan and you haven't gotten the money back within 10 years, then the gig is up and you've got to find the lost money from increased revenues or cutting spending. If the program is so vague that nothing can be tracked or it might help our general economy one day... well, that's not "reasonable leverage". That's just something you think is a good idea and must get funded without running a deficit for it. The next requirement is that it must meet some standards for being a safe amount of leverage. I have in mind something like the ratings given by Moody's or Standard & Poor. I have no idea how those work; the key is that reasonable leverage is safe and deficit neutral in the long term.

What I'm ending up with here is not really a balanced budget, but a small set of requirements that all together keep the financial house in order:

a) The government CAN run a deficit, but only in three ways: 1) it can use savings to do it, 2) it must be trackable, verifiable, and small "reasonable leverage", or 3) there's some national emergency such as a state of war (I mean a real state of war per the Constitution, not a police action) when deficits just pale in comparison.

b) When the economy is growing, the government MUST save a portion exactly calculated to compensate for drops in revenue during inevitable recessions.

c) Everything that isn't covered under a) or b) must follow some sort of PAYGO model.


Sammy Jankis said...

OMG! A post that I can actually contribute to with some knowledge and intellect! And I'm too lazy to do it.

blogless troll said...

Paca, it's not the government's money to save.

pacatrue said...

Hey, BT, I'm not talking about raising the tax rates during growth periods, just diverting some of the increased revenues from growth into savings instead of spending it. Are you suggesting that government should maintain the same dollar revenue (not the same rates), so that when there's growth they chop the rates to cut taxes, and when there's a decline, they raise rates?

blogless troll said...

First, I disagree that a government, any government, is capable of “saving” money. Second, on principle I don’t think it should. If there is a surplus, it should be returned to the people who earned it. The government earns nothing. It produces nothing. The increased revenues from increased economic activity generated by returning that money to the people, far outweigh any benefits of the government “saving” that money, because 1) the government won’t save it, it’ll be spent and 2) the people will save or spend it more efficiently.

I may not be reading your original post correctly, but it seems to assume that all government expenditures are legitimate and there is no waste or fraud to be cut. That’s the real problem in my opinion, not economic fluctuations.

In FL we’ve had a balanced budget law for years, and while there are plenty of shenanigans involved in making it balance, it’s the only reason we’re not bankrupt.