Making Sense of the Federal Budget Impasse
Altig, David, Economic Commentary (Cleveland)
In November, the U.S. Congress passed the Balanced Budget Act of 1995. The bill provided a fiscal package that would, according to Congressional Budget Office projections, balance the federal budget by fiscal year 2002. On November 20, President Clinton signed into law a Continuing Resolution for Fiscal Year 1996 that provided short-term financing for most federal government operations. It also heralded an agreement between the President and Congress on the goal of producing a long-term budget plan that would eliminate the federal deficit on the seven-year schedule proposed in the Balanced Budget Act.
On December 6, the President vetoed the Balanced Budget Act, at the same time proposing the Administration's own seven-year plan. Consistent with the November Continuing Resolution, the President's plan undertook to eliminate the government deficit by 2002.
Although they concur on the balanced-budget goal and the time frame for achieving it, Congress and the President have been unable to agree on a specific plan that is mutually satisfactory. It now appears that no long-term budget plan will be passed in 1996, and that federal budget policy will consist of a series of short-term agreements to fund operations and avoid the liquidity crises associated with the Treasury's debt limit.
To many Americans, this impasse seems frustrating and confusing. Indeed, the popular press is often quick to characterize the problem as political gamesmanship, typical of an election year and devoid of substantive content. As long as there is consensus on the balanced-budget objective and the time needed to achieve it, isn't it silly to haggle over a few trivial details? Why not just split the difference between the Administration's plan and Congress's and let the economy begin enjoying the return to lower deficits?
This Economic Commentary has a simple message: All balanced-budget plans are not created equal, and broad agreement on a zero deficit by a given date does not preclude serious, reasoned differences of opinion on the economic consequences of a particular fiscal package. Central to this message is the proposition that changes in deficits per se provide few clues about the effects of fiscal policy changes. Put more directly, we should concentrate on the specifics of spending and tax policies: The total amount of federal expenditures matters less than what we spend and how we spend it. How much revenue we collect is less important than what we tax and how we tax it.
Although this is a fairly obvious point, readily acknowledged by almost anyone who thinks seriously about the issue, it is often overlooked in policy discussions. In this Commentary, I use three simple examples to illustrate the problems that arise from focusing on the magnitude of the federal deficit rather than the fundamental tax and spending policies that underlie it. The three examples correspond to fiscal policy types that have already been considered, are currently being considered, or are likely to be contemplated in the future: a shift in discretionary spending from one activity to another, unfunded pay-as-you-go Social Security transfers, and a flat-tax proposal. All of them share the characteristic of having potentially large effects on the macro-economy without making any impact at all on the federal budget deficit.
* Spending Is as Spending Does
Consider the following change in government spending policy: One billion dollars that had historically been spent on constructing monuments to great leaders is shifted to the financing of public infrastructure projects like highways. The overall level of spending is, of course, completely unchanged by this policy. Consequently, the policy has no effect whatsoever on the federal deficit.
Would you be willing to argue that this policy is irrelevant simply because the deficit stayed the same? I would guess not. Then let's make the problem a bit more complicated. Suppose the $1 billion expenditure on monuments was replaced with $1. …