The Balanced Budget Constitutional Amendment: An Overview
By Robert Greenstein
Strong action is needed to reduce the long-term deficit. But a constitutional amendment requiring a balanced budget is not a sound way to achieve this goal. It is neither necessary nor wise, from the standpoint of keeping the economy strong, to have the Constitution mandate that the budget never be in deficit in any year. This analysis examines problems inherent in the constitutional amendment that will come to the House and Senate floors early in 1997.
The proposed constitutional amendment could weaken the economy by hastening or deepening recessions. It also would heighten the risk of a government default; once that occurred, even if it lasted only a few days, Treasury borrowing costs could rise. In addition, the amendment would undermine the principle of majority rule on which our system of government rests. Still another concern is that the amendment is likely to limit unduly public investments with long-term payoffs. Also, by making it harder to raise revenues and even to close unproductive tax loopholes than to cut programs, the amendment would tilt policy in favor of the wealthy and well-connected over the middle class and the poor. Finally, while many people point to state balanced budget requirements as evidence that a federal amendment is workable, these state provisions differ significantly from the proposed federal requirement.
Amendment Could Damage the Economy
The proposed constitutional balanced budget amendment would require the budget to be balanced (or in surplus) every year, regardless of whether economic growth is strong or weak. This is highly problematic. In years when growth is sluggish, revenues rise more slowly while costs for programs like unemployment insurance increase. As a result, the deficit widens. Under a balanced budget amendment, more deficit reduction thus would be required in periods of slow growth than in times of rapid growth.
This is precisely the opposite of what should be done to stabilize the economy and avert recessions. The constitutional amendment consequently risks making recessions more frequent and deeper. In the period from 1930 to 1933, for example, Congress repeatedly cut federal spending and raised taxes, trying to offset the decline in revenues that occurred after the great crash of 1929. Yet those spending cuts and tax increases removed purchasing power from the economy and helped make the downturn deeper; they occurred at exactly the wrong time in the business cycle.
This is why a balanced budget requirement is called "pro-cyclical." It exacerbates the natural business cycle of growth and recession. It also is why most economists who favor tough deficit reduction measures strongly oppose a constitutional balanced budget amendment.
In testimony before the House Budget Committee in 1992, one of the nations most respected economists, then-Congressional Budget Office director Robert Reischauer, made a number of these points. "[I]f it worked," Reischauer warned, "[a balanced budget amendment] would undermine the stabilizing role of the federal government." He noted that the automatic stabilizing that occurs when the economy is weak "temporarily lowers revenues and increases spending on unemployment insurance and welfare programs. This automatic stabilizing occurs quickly and is self-limiting it goes away as the economy revives but it temporarily increases the deficit. It is an important factor that dampens the amplitude of our economic cycles." Under the constitutional amendment, Reischauer observed, these stabilizers would no longer operate automatically.1
The amount of budget-cutting or revenue-increasing that would be needed to balance the budget during a recession would be large. CBO and OMB analyses indicate that a moderate recession can cause a fiscal imbalance equal to two percent of the Gross Domestic Product; by 2002, a budget that would be balanced in a normal economy would result in roughly a $200 billion deficit if the economy were in a moderate recession.
Amendment proponents note that the amendment would allow the balanced budget requirement to be waived for a particular year if three-fifths of the full membership of each chamber of Congress so voted. But it is unlikely a three-fifths majority would emerge until after the economy was already in a recession and considerable economic damage had been done. The Office of Management and Budget and the Congressional Budget Office have rarely, if ever, forecast a recession before one started, and we usually do not know we are in a recession until the downturn is at least several months old. The largest deficit reduction measures would likely be taken in years when the economy was weakening but not yet in recession. Yet such actions could tip a faltering economy into recession or make an ensuing recession deeper.
Adding to this problem, a three-fifths majority could be particularly difficult to garner if a recession were regional rather than national, as is usually the case at least at the start of economic downturns. It might well be impossible to obtain three-fifths majorities until a recession had spread to a substantial majority of states and Congressional districts.
Past recessions have started in some regions and taken time to spread; they also have hit some regions much harder than others. In the most recent recession, for example, New England and the mid-Atlantic states began experiencing declines in employment by the second quarter of 1989, a full year before employment turned down in most of the rest of the country. If rising unemployment insurance costs and falling revenues in several regions pushed the federal budget out of balance, would enough Members of Congress from states where economic problems are not yet evident be willing to raise the debt limit and allow a deficit?
Economic downturns also last much longer in some regions than others. In the last recession, employment declines lasted two to four years in California and much of New England and the mid-Atlantic states, while a number of other states recouped their employment losses in a matter of months. In the recession of the early 1980s, this pattern was reversed; that downturn was sharpest and lasted longest in the Midwest and South. The regional patterns that characterize economic downturns raise serious questions about the efficacy of the three-fifths requirement.
CBO Director Robert Reischauer
"A balanced budget rule could make it even harder to conduct discussions of policies on their own merits, and could lead to distortions of policies simply to meet budget goals....[In addition,] burdens might be shifted to state and local governments (through unfunded mandates) or to the private sector (through regulation or trade policy) even when the public good would be enhanced by keeping the programs at the federal level. And spending cuts that would result in immediate savings most likely would be made first, without much consideration of the long-run merits of the programs. Major deficit reduction surely entails spending cuts, but the reductions should be based on the long-run effectiveness of the benefits provided, not on meeting a rigid annual dollar target."*
Amendment Could Increase the Risk of Government Default
The amendment envisions setting the debt limit so the government can no longer borrow funds and requires a three-fifths vote of both houses to raise the debt limit. This aspect of the amendment would be likely both to make crises where a default threatens more frequent and to heighten the risk that a default will actually occur.
Until now, it has taken a simple majority of Congress to raise the debt limit, and such a majority has proved difficult to amass on a number of occasions. Under the constitutional amendment, the votes of three-fifths of the members of both houses would be needed. Securing a three-fifths vote to raise the debt limit could often prove excruciating.
This is of particular concern, because there are likely to be a number of years when a budget that is balanced at the start of the year slips out of balance during the year for reasons beyond policymakers control, such as slower-than-expected economic growth, smaller-than-expected revenue collections, or a natural disaster. When that occurs with part of the fiscal year gone, the budget cuts or tax increases needed to balance the budget for the fiscal year could be precipitous, especially since they would need to be concentrated in the remaining months of the year.
Suppose, for example, government outlays turn out to be two percent higher than the CBO estimate at the start of the year, while revenues turn out to be two percent lower. A budget initially thought to be in balance would develop a deficit of about $30 billion. If the $30 billion deficit was recognized part way into a fiscal year, it would be difficult to address. As a point of comparison, the balanced budget plan embodied in the budget resolution the 104th Congress passed last year would have achieved only $27 billion in savings in fiscal year 1997, and it had a full 12 months in which to realize those savings.
In circumstances such as these, it may prove impossible to secure agreement on the budget cuts or tax increases that would be required to balance the budget, particularly if such measures would further slow a weakening economy. But the alternative enduring a deficit for the year in question entails borrowing funds, and that would require a three-fifths vote. If a three-fifths majority to raise the debt limit and prevent a deficit could not be secured, a default crisis would loom.
The amendment exacerbates this problem by outlawing the principal measures the Treasury Department used to avoid default in late 1995 when it took policymakers months to resolve the impasse that precipitated that years budget crisis and government shutdown. Default crises thus would both be more likely to occur and harder to resolve.
CBO has warned that even a default of a few days could have lasting consequences, because it could erode confidence in the binding nature of financial obligations of the U.S. Government and raise government costs as a result. The national debt is financed at relatively low interest rates because those who purchase government securities are confident they will be repaid in full and on time. Similarly, federal defense and highway contracts are less costly than they would be if contractors lacked confidence of being paid in full and on time. If a default occurred, even if only for a brief period, confidence in the U.S. Governments ability to make payment in full and on time could be shaken, and the cost of borrowing and government contracts could rise.
Undermining Majority Rule
The requirement that the budget must be balanced at all times unless three-fifths of Congress agree to waive this requirement would enable minority factions in Congress to block actions favored by a majority of Congress and the President. It would empower such factions to exercise an unprecedented degree of leverage over national economic and fiscal policy.
Minority factions could withhold support for a balanced budget waiver and an increase in the debt limit when a recession loomed, threatening to plunge the government and the economy into turmoil and the Treasury into default unless they were granted major policy concessions. Minorities willing to threaten turmoil and disruption to achieve their ends could gain unprecedented power. For example, one can envision a minority insisting on large tax cuts that do not expire when the recession ends (with the minority claiming the tax cuts would ignite economic growth) as its price for waiving the balanced budget requirement during a downturn. That, in turn, would require still deeper cuts in basic programs in subsequent years to offset the revenue loss resulting from the tax cut.
Several of the authors of the balanced budget amendment have acknowledged this problem. In a recent paper, Reps. Dan Schaefer and Charles Stenholm, the lead House sponsors of the amendment, state: "Under current law, Members of Congress not infrequently have rounded up 50 percent plus one of the Members of the House to threaten to push the government to the brink of insolvency unless a pet amendment is added to this must-pass legislation" [i.e., legislation to raise the debt limit]. Schaefer and Stenholm admit the balanced budget amendment would, in their words, have the effect of "lowering the blackmail threshold...from 50% plus one in either body to 40% plus one..."2 They agree their amendment would make such extortion easier.
They defend this feature of the amendment with the argument that by making extortion easier, the amendment would increase pressure on Congress and the White House to agree to a balanced budget in the first place. But they gloss over the critical point that even when a balanced budget is approved, a deficit of tens of billions of dollars can materialize within a short period of time due to factors beyond policymakers control. When that occurs and restoring budget balance for the year is not feasible or wise, the government can face a choice between failing to act and thereby risking default and authorizing a deficit and a rise in the debt limit. In such circumstances, minority factions will enjoy substantially enhanced powers of extortion.
Shifts in the Balance of Power
The amendment is likely to lead to major shifts in the balance of powers that has served our nation for more than 200 years. Suppose the budget slips out of a balance during a year, Congress and the President can not agree on budget cuts or tax increases large enough to restore balance, and three-fifths of Congress do not agree to waive the balanced budget stricture and raise the debt limit. In such an event, the President or the courts might take matters into their own hands.
The courts might decide how the constitutional amendment would be enforced. They might order cuts themselves. Alternatively, they might rule that the amendment gives the President unprecedented authority to cut programs unilaterally. Such authority would go far beyond line-item veto authority, which Congress can override and which applies only to recently enacted legislation.
A Constitutional Amendment Isnt Needed
Contrary to popular mythology, the nations track record in limiting deficits to modest levels is, overall, a good one. Furthermore, a recent Congressional Budget Office analysis shows that if deficits are kept to modest levels in the decades ahead, the economy will grow at a solid rate and future generations will be better off than current generations are.
Consider the following. Over the past decade, Congress and several administrations have succeeded in sharply lowering the high deficits of the early 1980s; the deficit has declined from 5.1 percent of the Gross Domestic Product in fiscal year 1986 to 1.4 percent in fiscal year 1996. In addition, a bipartisan agreement to balance the budget by 2002 is likely this year. The oft-sounded claim that policymakers will only balance the budget if a constitutional amendment requires them to do so is on the verge of being proven incorrect.
Nor is the last decade atypical. For more than 200 years, the nation strove to keep deficits small or non-existent, except during wars or recessions.3 The only other time in the past 200 years that the government has adopted policies that sharply widened the deficit was during the early Reagan years, and those policies were adopted in the mistaken hope that the 1981 tax cuts would generate so much economic growth that deficits would not rise. When it became clear this experiment was not working, Congress and three administrations spent the rest of the 1980s and 1990s pushing the deficit genie back into the bottle. The deficit, measured as a percentage of GDP, has shrunk more than 70 percent over the past decade.
This progress was achieved without a constitutional requirement. Evidence is lacking that the nation needs such an amendment, with all the risks it would entail, to pursue responsible fiscal policies and avoid large, damaging deficits.
Moreover, a recent Congressional Budget Office analysis punctures the notion that budget balance must be attained in most or all years. In a report issued in 1996, CBO examined what would happen if deficits through 2030 are held to approximately 1.5 percent of the Gross Domestic Product or about $110 billion a year in 1996 terms.4 (This is about the same level as the deficit in 1996, which equaled 1.4 percent of GDP, or $107 billion.) CBO projected that under such a policy, total income per person would grow 41 percent between now and 2030, after adjusting for inflation. In other words, with moderate deficits of this size, the U.S. economy would continue to grow and living standards would rise. CBO also projected that if the budget were balanced each year through 2030, average income per person would rise 43 percent, nearly the same amount.5 Citing these findings, CBO has noted that "...sustainable policies do not require balanced budgets" if deficits are kept to moderate levels.6 CBOs finding that there would be little difference in average living standards over the next 35 years under a balanced budget approach and a policy of moderate deficits illustrates the fallacy of the claim that the balanced budget amendment is needed to save us from an economic meltdown and a deterioration of the living standards of future generations.
Public Investments with Long-Term Payoffs
Public investment that improves long-term productivity growth such as certain investments in education, infrastructure, research and development can boost long-term economic growth. This type of public investment complements the increased private-sector investment that results from lower deficits. But a constitutional amendment requiring a balanced budget every year would likely result in less such public investment.
The constitutional amendment would largely deny to the federal government a basic practice that most businesses, families, and state and local governments use judicious borrowing to finance investments with long-term payoffs. Businesses borrow to invest in new plant and equipment that help them grow. A business that failed to modernize because it could not borrow would soon be left behind. Families borrow to finance home purchases and college education. State and local governments borrow to finance road construction, the building of new schools, and similar capital projects; they typically balance their operating budgets, not their overall budgets.
Under the proposed constitutional amendment, however, the federal government could borrow to finance needed investment only if three-fifths of the members of both houses agreed to waive the balanced budget requirement and authorize the borrowing to take place. Over time, the likely result would be less public investment.
This is particularly true because the proposed amendment would impose a rigid requirement that the overall budget, including Social Security and Medicare, be balanced every year, even when the baby boom generation is in old age. For total federal expenditures including Social Security and Medicare to equal federal receipts year after year during those years would likely require shrinking public investment to a level unhealthy for long-term economic growth.
Families and states address matters such as these by accumulating savings or reserves that can be drawn down when the need arises. For example, families accumulate savings that are later used to pay for college tuition, and many states have "rainy day" or reserve funds that can be drawn upon when additional state expenditures are needed. But the proposed federal constitutional amendment bars such practices; it would prohibit expenditures in any year from exceeding the revenue the federal government collects in that year, regardless of whether the government had accumulated reserves in prior years. The requirement that the constitutional amendment would impose in this area is akin to requiring a family to pay for a childs college tuition for a given year entirely out of that same years earnings, rather than allowing the family to save money for this purpose in prior years or to borrow money for college that is paid back after the child graduates and begins to earn money. Businesses, families, and state and local governments do not impose upon themselves the fiscal straightjacket that the constitutional amendment would place on the U.S. government.
Amendment Tends to Favor the Wealthy Over Other Americans
While the balanced budget amendment does not dictate any particular approach to deficit reduction, it increases the likelihood that the fiscal policies adopted in coming decades will favor the well-off at the expense of poor and average Americans. It does this because it would alter Congressional voting procedures that have existed for more than 200 years and make it harder to raise revenues than cut programs.
Under current law, legislation can pass by a majority of those present and voting on either a roll call vote or an unrecorded "voice vote." The balanced budget amendment, however, would require that legislation raising taxes be approved on a roll call vote by a majority of the full membership of both houses, rather than a majority of those present and voting. Spending cuts, by contrast, would continue to require only a majority of those present and voting and could be passed on a voice vote.
The amendment thus would require more votes to curb special interest tax breaks such as tax subsidies for the oil and gas industries and other tax breaks considered "corporate welfare" than to cut programs such as Medicare, veterans' benefits, education, environmental programs, and assistance for poor children. Moreover, deficit reduction measures that contain a mix of program cuts and revenue increases as did virtually every deficit reduction package enacted between 1982 and 1993 would require more votes to pass than deficit reduction measures consisting solely of program cuts with no revenue measures whatsoever.
This raises significant equity issues. Wealthy individuals and large corporations receive most of their government benefits through tax subsidies, or "tax expenditures" as they are sometimes called. By contrast, low- and middle-income families receive most of their government benefits through programs. A constitutional amendment that makes it harder to reduce tax subsidies than to cut programs tends to favor the affluent over Americans of lesser means.
Tax expenditures are essentially spending programs that operate through the tax code by reducing the tax liability of particular taxpayers. In testimony in 1994, Federal Reserve Board Chairman Alan Greenspan referred to these measures as "tax entitlements" because they entitle those who qualify for them to government subsidies provided in the form of a special tax reduction. Tax expenditures cost more than $400 billion in forgone revenue in fiscal year 1995, more than the government spends on defense or Social Security.
This aspect of the amendment has particular implications for the elderly. Social Security offices lack information on the current incomes of Social Security and Medicare beneficiaries. As a result, proposals to trim Social Security or Medicare benefits for the well-off elderly while shielding the low- and average-income elderly usually entail using the tax code. For example, the provision of the "Blue Dog" budget (a budget developed by a group of conservative and moderate House Democrats) that would increase Medicare premiums for affluent seniors uses the tax code to collect the added premium charge. Under the constitutional amendment, such a measure would require more votes than an across-the-board increase in Medicare premiums for all beneficiaries or an across-the-board Social Security cut.
How significant is the requirement that a measure which raises revenue must secure the votes of a majority of the full membership of both Houses? Might such a rule ever come into play? The answer is "yes." Had this rule been in effect in 1993, the 1993 Clinton budget would have failed. It initially passed the Senate 50-49; the conference report subsequent passed 51-50 with the Vice-President breaking the tie. Under the amendment, both such votes would have resulted in the budgets defeat.
Amendment Could Adversely Affect Younger Generations
Despite claims that the constitutional amendment is needed to protect our children, the amendment could work against their interests, since it would prohibit adoption of the type of fiscal policies that would treat them most equitably in coming decades. This is particularly true because of the amendments effects on the Social Security system.
Social Security has traditionally operated on a "pay-as-you-go" basis; in other words, the payroll taxes contributed by todays workers finance the benefits of todays retirees. But in coming decades, Social Security faces a large demographic bulge. There will be so many retirees when the baby boomers grow old that it will be very difficult for the workers of that period to support the retired baby boomers without a large increase in payroll taxes.
The 1983 bipartisan Social Security commission headed by Alan Greenspan recognized this problem. It moved Social Security from a pure "pay-as-you-go" system to one under which the baby boomers would contribute more toward their own retirement. The Social Security system is now building up surpluses as a result; by 2019, these surpluses will equal about $3 trillion. After that, as the bulk of the baby boom generation moves into retirement, the Social Security system will draw down the surpluses. This is akin to what families do in saving for retirement during their working years and drawing down their savings when they retire. It is essential to keeping the burden on younger generations from growing too large when the baby boomers retire.
The balanced budget amendment, however, would undermine this approach to protecting Social Security and promoting generational equity. The amendment states that total government expenditures in any year including expenditures for Social Security benefits may not exceed total revenues collected in the same year. This effectively means that the Social Security surpluses could not be used to ease the burden on younger generations of financing the benefit costs of the baby boomers when they retire, since those benefits costs would have to be financed in full by taxes collected from people working in those years. That would eviscerate a central achievement of the Greenspan commission and would almost certainly lead to the imposition of heavy burdens on those whose peak earnings years are between about 2020 and 2040.
In fact, the constitutional amendment would likely precipitate a major crisis in Social Security about 20 years from now even if legislation had been passed in the meantime putting Social Security in long-term actuarial balance. The nation would face an excruciating choice at that time between much deeper cuts in Social Security benefits than are needed to make Social Security solvent and much larger increases in payroll taxes than otherwise would be required. The third and only other alternative would be to finance the Social Security "deficit" in those years (i.e., the amount by which the Social Security benefits paid in those years exceed the payroll taxes collected in those years) by raising other taxes substantially or slashing rather severely the rest of government, with the result that government could fail to provide adequately for basic services, potentially including national defense.
Given the vast numbers of baby boomers who will be retired in those years and their likely political clout, deep cuts in Social Security benefits are not probable at that time. As a result, the constitutional amendment would likely cause those working between 2020 and 2040 to have to shoulder both large increases in taxes and sharp reductions in basic government services. Spreading the retirement costs of the baby boomers over a longer time-frame, as the Greenspan commissions recommendations began to do, would be much more equitable.
Risks to the U.S. Banking System
The constitutional amendment poses a risk to the stability of the U.S. banking system. In the event of a potential banking crisis, the amendment could prevent the U.S. Government from making urgently needed deposit insurance payments if such payments would unbalance the budget, unless Congress was able either to muster a three-fifths majority to waive the balanced budget requirement or to make what could be very large cuts elsewhere in the budget on very short notice to offset the deposit insurance costs. If the government is unable to respond to a banking crisis, the guarantee that the full faith and credit of the U.S. Government stands behind the U.S. banking system will not have as much meaning; that, in turn, could have adverse consequences for financial markets. This is another reason why writing a balanced budget requirement into the Constitution, something no other major national government does, is ill-advised.
Dont States Have to Balance Their Budgets?
Supporters of the constitutional balanced budget amendment often dismiss concerns about its impact, arguing that states balance their budgets and the federal government should also. But these allusions to state balanced budget requirements overlook six critical points made in a GAO study of state balanced budget rules:7
What About Families?
Amendment supporters also frequently say that families balance their budgets, and the federal government should too. But when a family balances its checkbook, it is making sure that incoming cash including borrowed money is sufficient to cover the payments it is making, including payments on debts for such items as mortgages, cars, and student loans.
Few families balance their budgets the way the constitutional amendment would require the government to balance its budget. To do so, families would have to cover the full cost of a home they wished to buy out of that same years income or the full cost of a childs college education out of the current years income.
Families typically save in some years so their expenses can exceed their income in other years. They also borrow for items like a home, a new car, or a college education. If the goal is to require the federal government to act as families do with their own budgets, the constitutional amendment is not the appropriate route to follow. Moreover, if families had to budget by the rules in the constitutional amendment, that would wreak havoc on their finances and render millions unable to buy a home or car or send their children to college.
* * * * *
The deficit reduction packages enacted in 1990 and 1993, along with other measures, have made important progress in shrinking the deficit. Over the past 10 years, the deficit has declined 70 percent as a percentage of the Gross Domestic Product. A budget agreement is likely in 1997 that will eliminate the remaining deficit and balance the budget by 2002.
Further action still will be needed; health care reform with tough cost-containment measures and Social Security reform to place the system in long-term actuarial balance also will be necessary. Achieving a budget agreement this year, followed by action to address health care and Social Security reform, is the course the nation should chart.
Such a course of action does not require altering the U.S. Constitution to write in a rigid fiscal policy prescription. A balanced budget constitutional amendment that risks making recessions deeper and more frequent, heightens the risk of default, weakens our tradition of majority rule, makes it harder to raise revenues, favors wealthy Americans over middle- and low-income Americans, jeopardizes the full faith and credit of the U.S. Government, and leads to reductions in needed investments is neither necessary to achieve fiscal responsibility nor a prudent path for the nation to follow.
1 Statement of Robert D. Reischauer before the House Budget Committee, May 6, 1992.
2 Materials on balanced budget amendment circulated by Reps. Dan Schaefer and Charles Stenholm, November 18, 1996.
3 Until the early 1980s, any deficits in periods other than wars or recessions were sufficiently small that the national debt declined as a percentage of the Gross Domestic Product. For example, the nation ran small or modest deficits during most years of the 1960s and 1970s; between 1960 and 1980, the debt declined as a percentage of GDP.
4 In future years, a deficit equal to 1.5 percent of GDP would constitute a deficit somewhat large than $110 billion, measured in 1996 dollars. This is because economic growth will have raised the Gross Domestic Product in future years to a larger size than in 1996.
5 Congressional Budget Office, The Economic and Budget Outlook: Fiscal Years 1997-2006, May 1996, Chapter 4.
6 Statement of James L. Blum, Deputy Director of the Congressional Budget Office, on "The Long-Term Budget Outlook and Options," before the Senate Budget Committee, January 22, 1997, pp. 16-17.
7 General Accounting Office, Balanced Budget Requirements: State Experiences and Implications for the Federal Government, (GAO/AFMD-95-58BR, March 26, 1993).
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