Debt Deal Denouement

The U.S. stock market tanked on Monday in the aftermath of Standard & Poor’s lowering its long-term credit rating of the United States—itself a consequence of last week’s debt deal. Superficially, the deal seemed to be a “perfect” political compromise: it split the difference between the White House and congressional Republicans. To be more precise, the Budget Control Act of 2011, as it’s called, would reduce federal spending as a percentage of GDP to the midpoint between the level implied by President Obama’s proposal of last February, and the level implied by the House budget resolution authored by Rep. Paul Ryan (R-WI). Last week’s debt compromise, though in reality far from ideal, may have been the best deal one could have reasonably hoped for in the current political climate. But the result means that federal spending “will still require major changes in Washington, D.C., to truly put the United States federal government’s finances on a genuinely sustainable path,” writes Independent Institute Research Fellow Craig Eyermann.

The debt deal has two parts. The first cuts almost one trillion dollars from the budget over ten years. The second part requires a bipartisan congressional committee to come up with another $1.5 trillion in deficit reductions over ten years. Getting Congress to pass meaningful deficit-reduction measures in the same year as the November 2012 election may be a losing proposition. But if fiscal gridlock ensues, the Budget Control Act will trigger a series of automatic spending cuts in most federal spending programs (the exempt programs include Social Security, Medicaid, veterans benefits, and civil and military pay). Other domestic programs and defense spending would share equally in the spending cuts. Thus, the Budget Control Act ensures that a future budget impasse would offer a silver lining.  As Independent Institute Senior Fellow Ivan Eland writes, “further fiscal deadlock, which seems very possible, would ensure that taxes would not be increased and defense would likely take a larger percentage of cuts than without the stalemate. Thus, continued partisan gridlock may be the best outcome of all.”

What is to be done? Some fiscal conservatives have called for a balanced budget amendment. However, in a symposium of economists convened by Time magazine, Independent Institute Research Director Alex Tabarrok argues that a balanced budget amendment is undesirable because it would cut government spending and/or raise taxes when Americans are the most vulnerable—during recessions—and thus would worsen economic hardship and hamper economic growth at the worst times in the business cycle. Tabarrok proposes what he believes is a far better alternative: an unbalanced budget amendment (unBBA). Under this constitutional constraint, the federal government would be required to maintain budget surpluses when the economy is growing and be allowed to run deficits during recession years. “The idea of an unbalanced budget amendment is not new,” Tabarrok writes. “Sweden’s government has been required since 2000 to budget for a 1% surplus over the business cycle. Since implementing their unBBA, Sweden has successfully brought their budget into balance and created a surplus.”

The Virtues of an Unbalanced Budget Amendment, by Alex Tabarrok (Time, 8/4/11)

Let’s Hope for Continued Fiscal Gridlock, by Ivan Eland (8/4/11)

Visualizing the Debt Deal, by Craig Eyermann (MyGovCost.org, 8/2/11)

More by Craig Eyermann at MyGovCost.org

Recarving Rushmore: Ranking the Presidents on Peace, Prosperity, and Liberty, by Ivan Eland

Entrepreneurial Economics: Bright Ideas from the Dismal Science, edited by Alex Tabarrok

[This post appeared first in the August 9, 2011, issue of The Lighthouse. To receive this weekly email newsletter of publication summaries and event announcements from the Independent Institute, enter your email address here.]