Weighing the pros and cons of a quixotic proposal.
A balanced budget amendment would be an amendment to the U.S. Constitution that would ban the federal government from spending more money than it brings in every year.
Advantages of a balanced budget amendment
Over the past several decades, the federal government has tended to run a budget deficit. In fact, it hasn't run a surplus since the Clinton administration:
Over time, budget deficits produce growing levels of federal debt:
Supporters of a balanced budget amendment point to growing levels of federal debt as evidence that Congress (and fellow voters) can't be trusted to keep deficits in check.
Because Congress' power to tax and spend money comes directly from the U.S. Constitution, a balanced budget requirement that would tie the hands of future Congresses would require a constitutional amendment.
Too much federal debt would ultimately be unsustainable
Over time, high debt levels could result in higher interest payments, higher taxes, and/or lower spending on government services.
Take a theoretical debt spiral off the table
Supporters of a balanced budget amendment argue that the current trajectory of federal debt will inevitably lead to a financial crisis. At some point in the future, they suggest, investors in Treasury Bonds will lose faith that they'll be paid back and will demand higher interest rates as compensation for higher perceived risk. Higher interest payments would increase budget deficits, producing more debt, thus setting in motion a vicious circle.
Disadvantages of a balanced budget amendment
Intuitively, a balanced budget appears to make sense, but it would suffer from several drawbacks.
Difficult to enforce
While Congress can more or less determine the budget for each coming year, no one knows ahead of time exactly what the federal government's incoming cash flows will be -- those depend in large part on future economic activity.
So an amendment would probably need to work with budget projections, rather than hard figures. But relying on projections could make tinkering with those projections irresistible.
Moreover, an amendment would probably need to allow Congress to suspend the balanced budget requirement in the case of national emergencies, such as war and financial crises. It's possible a future Congress could use the national emergency clause to escape the balanced budget requirement.
No evidence a debt spiral is on the horizon
Countries like the U.S. that issue debt in their own currency have a lot of leeway with creditors. Consider how the UK, U.S., and Japan stack up next to China. Despite larger debt levels, interest rates are much lower for the three, which issue debt in their own currencies.
That suggests that the federal debt burden isn't anywhere near large enough to trigger a financial crisis.
* Most recently available data points as of 5/2/16 from FRED and Bloomberg.
Too much of a good thing
Balanced budgets might be overkill. That's because surpluses aren't necessary to put debt on a sustainable trajectory. What matters is not the total level of debt, but the level of debt as a percentage of the total economy. So all that's needed to keep that figure from rising is for debt to grow less slowly than GDP.
From fiscal 2005 through the first quarter of 2016, Amazon.com's long-term debt climbed more than 450% from $1.4 billion to $8.2 billion. But its earnings-to-interest coverage ratio improved from 5.1 to 6.6 because the company grew faster than its total debt. Likewise, when the economy grows faster than Federal debt, the debt-to-GDP rate declines even if total debt increases.
The following graph shows the change in federal debt as a percentage of GDP. When the growth rate is above zero, the federal debt burden relative to the size of our economy grows, and when it's below zero, that burden shrinks.
Exacerbating recessions
A stringent balanced budget amendment could endanger the economy during difficult economic times.
A recession occurs when economic activity contracts. Weak sales cause weak profits cause layoff cause unemployment cause weak sales. A vicious cycle sometimes emerges that more government spending, through safety nets and other means, can alleviate.
A balanced budget amendment could allow the government to increase spending and lower taxes when times are good and force cutbacks during recessions -- precisely when doing so would weaken economic activity and worsen the recession.
Potentially worsening our debt burden
Deficits tend decrease or increase as a result of economic activity. A strong economy produces more taxes and lessens the need for safety net spending; a weak economy produces fewer taxes and increases the need for safety net spending. Notice in that last graph how debt as a percentage of GDP growth spikes during recessions, which are depicted in gray highlights.
A federal balanced budget amendment that deepened recessions could damage long-term economic growth to such a degree that it ironically creates more debt.
