Optimal Fiscal Policy

I testified in the House Budget Committee this AM and have many excellent war stories to share. But no time to do so now. Until then, please read my testimony, to which I devoted some thought.

Roughly speaking, the position of the majority Republicans is that you should always balance the budget for... I just sat with these folks for two long hours and I can't really finish that sentence.

Partly for moral reasons. One witness blamed "Keynesianism for the decline in beneficial "Victorian fiscal morality." Another had a macro-model that maintained, contrary to the CBO's analysis of the Republicans' budget resolution, that the deep near-term cuts would boost, not hurt, growth because forward-looking households would realize that Republican spending cuts would eventually lead to greater investment, more tax cuts and higher incomes in the future, so they spend more today to offset the cuts.

One member, touting the folk'ism that since families have to balance their budgets the Feds should too, took issue with my point that in fact, families borrow long-term all the time for things like college and homes. He asked me if I make more than I spend. I told him I certainly went into debt to pay for college, and he said he did too!

Another Republican member went on about how much he hated government debt and I had the chance to ask him, "so, why did you guys pass $570 billion in non-offset tax cuts?!" I think he answered, not unreasonably, something like, "well, maybe that's something we can put on the table."

And so on.

Here are my bullet points:

  • The idea that the budget should always be in balance actually runs counter to optimal fiscal policy in an advanced, dynamic economy like ours. Instead, smart fiscal policy must be flexible, with deficits temporarily rising in recessions to support the weak economy and coming down in recoveries as the economy strengthens.

  • Elevating the goal of a balanced budget above other fiscal priorities risks doing more harm than good. The failure of European austerity -- with those countries choosing fiscal consolidation in the context of weak economies -- provides strong evidence to support this claim.
  • In contemplating questions about fiscal policy, we must never forget the core purpose of federal taxing and spending: to provide the American people with the government services and public goods they need, want, and deserve.
  • We must carry out this core purpose in a way that is fiscally responsible. At the same time, any benefits of fiscal consolidation must always be weighed against this essential government function. Are we disinvesting in critical public goods, like transportation or human capital development? Are we adequately pushing back against market failures like cyclical downturns? Are we providing those who've aged past their working years with adequate retirement and income security? Are we helping the least advantaged among us to meet their basic needs and to get a foothold on the ladder of upward mobility?
  • The answers to these questions imply that we cannot achieve a sustainable budget, where "sustainability" includes strengthening our economy and achieving broadly shared prosperity, solely by cutting spending. Policymakers, including many on this committee, have understandably raised serious concerns about the reckless cuts engendered by sequestration. The recent Republican budget resolution calls for far deeper spending cuts, which would undermine the essential roles government should play.
  • Some argue that because families and states must balance their annual budgets, the federal government must also do so. These analogies are wrong for two reasons. First, neither families nor states really have to balance their budgets; families borrow for various investments and states don't have to balance their capital budgets, so the analogy is faulty. Second, the fiscal lesson to take from this framing of the argument is precisely the opposite of the one often drawn: the fact that states must balance their operating budgets actually provides a stronger rationale for the federal government to temporarily expand budget deficits in downturns.
  • Recent Republican budget plans only achieve balance through a) excessive spending cuts that violate the principles articulated above and b) gimmicks that ignore the impact of large tax cuts that are not offset. Implementing these proposed budgets would thus gut valued investments, reduce economic security, and harm prospects for jobs and wages, while doing much less to reduce deficits and debt than proponents claim.
  • This post originally appeared at Jared Bernstein's On The Economy blog.