An Honest Federal Budget Would Help Control Spending and Debt
Congress and President Trump finally agreed Friday to a spending bill reopening the federal government after another brief shutdown. Success? No. The deal’s spending boost—ahead of large deficits to appear in Monday’s White House budget—should ring alarm bells. What Americans need from our leaders is a new kind of budget.
The debates over taxes, spending, infrastructure and health-care financing center on policy arguments. They pay too little attention to the big picture—a framework for budget choices, how government makes those choices, and who is accountable for them. The political process avoids those questions not because they are insignificant but because they are difficult, and because no institutional mechanism mandates their debate.
For most of American history, balancing fiscal trade-offs was more straightforward. From 1789 until the 1960s, substantial accumulations of public debt were byproducts of wartime. Postwar spending restraint and economic growth reduced the debt significantly as a percentage of gross domestic product. Such outcomes reflected an agreement across party lines that ordinary operations of government were to be funded by balanced budgets. Ordinary operations of government included “public goods” like defense, civil service, and national infrastructure. During peacetime, debt was used only to finance major investments in the nation’s expansion.
The ratio of federal debt held by the public to GDP has skyrocketed, from 26% in 1970 to 75% in 2017. Our present-day arguments over tax burdens notwithstanding, this shift reflects changes in spending. And spending has shifted away from traditional public goods toward private benefits in the form of transfer payments like Social Security and Medicare, while no mechanism forces tax changes to fund current and projected spending.
This observation is not meant to suggest simply that “spending is too high.” Rather, the issue is one of accountability for spending choices. Historically, spending on war or territorial expansion was conceptualized as “capital” spending—benefiting current and future generations, who shared the costs. Regular operations were borne by the people alive at the time. Such an approach does not necessarily mean lower spending, but it does require current taxpayers, not future ones, to pick up the bill.
Our present budget institutions are not up to the task. While vigorous debates occur over individual policies, no real constraints operate on the budget in toto. Attempts to do so in recent years have failed.
The first step toward a remedy is the provision of information to the public about the state of public finances, the future federal debt relative to GDP, and the economic impact of that debt. But this change by itself is likely insufficient for ensuring that today’s taxpayers fund today’s services and transfer payments. To accomplish this shift requires a more rules-based approach. In recent decades, discussion of this idea in the U.S. has focused on forms of a balanced-budget amendment to the Constitution.
Such constraints, of course, raise legitimate concerns about needs for spending in extenuating circumstances beyond regular operations and exacerbating business cycles. But that doesn’t mean a reasonable rule cannot be formulated. One could define a budget rule as a spending limit, rather than a balanced-budget limitation.
The Hoover Institution’s Tim Kane and I have offered one idea—that each year’s total federal spending be limited to the average annual inflation-adjusted revenue of the previous seven years. This formulation attenuates problems posed by inflation and the business cycle. Temporary spending increases could be approved by legislative supermajority votes, with increasing supermajorities required for longer departures from the rule. Such departures would be up to the Congress at the time, as opposed to predefined categories.
A focus on spending necessarily confronts transfer payments, which loom large in current and future budgets. A welfare state financed by current taxpayers could well be smaller than the present one. But that is not an automatic consequence of a spending rule. Voters may like higher spending enough to agree to higher taxes. If, for example, an aging society is deemed to warrant more spending going forward, voters as taxpayers can agree to finance it. Put this way, a spending rule is not a partisan restraint on government. While advocates on the left for higher transfer payments will feel the pinch of a spending rule, so too will tax cutters on the right feel the pinch of explaining spending cuts as a consequence.
The fights over the budget deal and the contentious scramble for revenue to finance tax cuts, all while problems of long-run fiscal sustainability loom large, likely signal a last gasp of our current approach to budgeting. Adding to a discussion of individual policies a deeper conversation about budget institutions is important if we are to balance spending desires with their funding.
Mr. Hubbard, dean of Columbia Business School, was chairman of the U.S. Council of Economic Advisers under President George W. Bush.