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What would a business-cycle balanced budget rule look like in Illinois?

A few years ago, I testified before the U.S. House Judiciary Committee. I’d been invited to talk about the design of a federal balanced budget amendment and much of my testimony drew on the lessons offered from state experience. Since 49 of the 50 states have such requirements, and since these requirements vary from state to state, I noted that federal lawmakers could learn from the state laboratory.

The best requirement, I argued, would have the following characteristics:

  1. Require balance over some period longer than a year. This effectively disarms the strongest argument against a balanced budget amendment: namely, that it would force belt-tightening in the middle of a recession. In contrast, if budgets need to balance over a longer time period, then Congress is free to run deficits in particular years as long as they are countered by surpluses in others.
  2. Allow Congress some time to come into compliance. You don’t have to be a Keynesian to worry that a 45 percent reduction in the deficit overnight might be a shock to the system.
  3. Minimize the gamesmanship associated with revenue estimation: Across the country, states with balanced budget requirements have to estimate revenue throughout the year (I’m a member of Virginia’s Joint Advisory Board of Economists and our responsibility is to pass judgment on the validity of these estimates). But this invites all sorts of questions: what model to use for the economy, should revenue be scored dynamically or statically, etc. One way to sidestep all of these questions is to make the requirement retrospective: require that spending this year not exceed revenue from years past.

Michigan Republican Justin Amash has proposed an amendment along these lines. It would be phased-in over 9 years and from there on out would stipulate that outlays “not exceed the average annual revenue collected in the three prior years, adjusting in proportion to changes in population and inflation.” Because it requires balance over three years rather than one, Amash calls it the “business cycle balanced budget amendment.”

Writing in Time, GMU’s Alex Tabarrok points to Sweden’s positive experience with a similar rule. And economists Glenn Hubbard and Tim Kane also endorse such a rule in their book, Balance.

Now, some Illinois state lawmakers have put together a proposal for a state rule that appears to be largely based on this model. It requires:

Appropriations for a fiscal year shall not exceed the average annual revenue collected for the 3 prior years, adjusting in proportion to changes in population and inflation.

(Unlike the Amash plan, however, the Illinois plan is not phased in over a number of years. Rather, it takes effect immediately upon passage of the bill.)

To see how it might work in a state, I decided to take the Amash Amendment for a test drive, using Illinois data. The solid blue line in the figure below charts Illinois’s actual general revenue from 1990 to 2012 in billions of current dollars. The dashed blue line phases in an Amash-type “business cycle” balanced budget rule. Once fully phased-in, it would limit spending to the average revenue of the three previous years, with an adjustment for inflation and population growth.

BCBBA

Notice three things:

  1. From 1990 to 2002, and from 2004 to 2007, the rule would have kept Illinois spending in line with Illinois revenue, and would have even allowed the state to run surpluses.
  2. In lean years (like 2008) when revenue levels off, the limit actually continues to rise. That’s because it is based on a longer time trend. This means that it wouldn’t require the sort of draconian budget cuts that balanced budget critics often fear. The accumulated surpluses from previous years could also be used to soften the blow.
  3. Lastly, note the (9 percent) revenue uptick from 2011 to 2012. The amendment would prudently make legislators wait a few years before they can go out and spend that money.

What Makes for a Good Balanced Budget Amendment?

Today, the U.S. House will begin debating a balanced budget amendment. This morning, the editorial board of the Wall Street Journal chastised Speaker Boehner for offering a “vanilla amendment that merely calls for a balanced budget, with no spending limitations or supermajority tax requirements.” Their worry is that, “Under Mr. Boehner’s amendment, spending could rise to 25% or 30% or more of GDP, so long as the budget is balanced.”

This is a misplaced worry. Right now, Congress is able to vote benefits for current voters while putting about 45 percent of the tab on non-voters (our posterity). It doesn’t take a complicated economic model to see that this arrangement systematically biases spending upward. And any amendment that requires current voters to pay for current spending will diminish that bias. As I told the House Judiciary Committee last month, in states where balanced budget requirements are stricter, spending is lower.

Moreover, the editors’ preferred amendment—one that includes some sort of spending limitation—is actually unlikely to achieve its goal. Last year, I examined the operation of various spending limits, using data from 49 states covering 30 years (I wrote about my research in an OpEd in the Journal). I found that those tax and expenditure limits “that limit budgets to some share of income had no statistically significant impact on either state-only spending or on combined state and local spending.” It may be that when states bind themselves with such limits, they make sure that the limit is set so high that it fails to actually constrain.

As far as supermajority requirements for tax increases are concerned, research does suggest that these can limit spending. I guess it is a political call as to whether such a requirement should be tied to a balanced budget amendment. In my view, a balanced budget amendment requires strong bipartisan support for it to be effective. But I don’t do politics.

I do agree with the editors in one regard. There is no need to settle for a “vanilla amendment.” There are many different varieties of balanced budget amendments and some of these have much stronger features than others. In my view, the most-effective amendments are those that:

  1. Require balance over some period longer than a year. This effectively disarms the strongest argument against a balanced budget amendment: namely, that it would force belt-tightening in the middle of a recession. In contrast, if budgets need to balance over a longer time period, then Congress is free to run deficits in particular years as long as they are countered by surpluses in others.
  2. Allow Congress some time to come into compliance. You don’t have to be a Keynesian to worry that a 45 percent reduction in the deficit overnight might be a shock to the system.
  3. Minimize the gamesmanship associated with revenue estimation: Across the country, states with balanced budget requirements have to estimate revenue throughout the year (I’m a member of Virginia’s Joint Advisory Board of Economists and our responsibility is to pass judgment on the validity of these estimates). But this invites all sorts of questions: what model to use for the economy, should revenue be scored dynamically or statically, etc. One way to sidestep all of these questions is to make the requirement retrospective: require that spending this year not exceed revenue from years past.

There are amendments that have these characteristics. For example, H.J. Res. 81 (which now has 54 cosponsors), has all three.

In other news, the amazing Cord Blomquist has managed to get my testimony on the YouTubes: