Economics, Not Ideology

The battle cry of the Tea Party and so-called "fiscal conservatives" is "Households balance their budgets, why can't the federal government?" It's a nice slogan designed to support a strong anti-government ideology, but it has no basis in economics.

Let's do a simple thought experiment.

Imagine a government with a $100B/year revenues from various taxes and spending appropriations of $100B/year to match. This is a government with a balanced budget. The spending equals the revenues and no debt is created. In addition, no free cash is created.

The problem with this scenario is the nature of the revenues. The revenues are directly dependent on the overall health of the macro economy. If the economy grows, revenues grow and we get excess cash (surplus). If the economy shrinks, revenues drop and we either a) fail to pay the bills for our appropriations or b) borrow money to cover the shortfall (deficit).

Obviously, with a growing economy, this isn't so bad. We have a surplus and don't have all of these discussions about deficits and bond ratings. With a legislated balanced budget, we either give that money back to the tax payers or increase spending (or, possibly, simply make an appropriations for a "rain day" fund).

The problem is the shrinking economy. In a shrinking economy, you have a private sector that is pulling back from investing in growth to a more defensive strategy oriented around cutting costs and gaining efficiencies. Companies stop cutting costs when the economy hits rock-bottom and they are operating at maximum efficiency. They begin hiring again when they see predictability in the economy and feel they safely can begin investing in growth.

When the government cuts spending to match lost tax revenues, it does two things:

1. It creates greater recessionary pressure on the economy because government spending is part of the economy. When you remove that spending, you by definition shrink the economy.
2. It adds to economic uncertainty. Under this scenario, forcing a balance budget means that government spending is no longer a fixed, predictable part of the economy. It instead becomes another downward trending point of uncertainty.

When government cuts spending (or raises taxes) during a weak economy, it takes money out of the economy and creates economic uncertainty. It makes the problem worse.

To be fair, running a deficit doesn't come without cost. Every dollar the government borrows today is a potential tax increase tomorrow of $1 plus interest. Let's continue the thought experiment.

Our $100B tax base drops to $75B in the recession. It lasts one year, and then we recover to normal levels. Our spending is now $100B plus debt service on the $25B from the recession. We have to raise taxes at this point to get the money for debt service or hope the economy grows to match.

In short, it's just not as simple as "balance the budget". Running a deficit is bad for long-term economic growth. Cutting spending and raising taxes address the deficit, but they are bad for short-term economic growth. Increasing spending and cutting taxes are good for short-term economic growth, but they create a deficit.

The narrow-minded focus on the deficit as the problem facing the US is causing us to ignore the real problem: jobs. The reason this recovery is so weak is because companies just aren't hiring right now. They aren't hiring because there's so much uncertainty from the government right now. And the uncertainty from the government is almost entirely a result of the bickering in Washington right now because no one really knows what way Washington is going to go on August 2 and even beyond.

Policy certainty is what we need from Washington right now, not balanced budgets or spending programs or tax cuts or tax increases or spending cuts.