Should the U.S. Government Balance Its Budget?

- You may have heard a politician say, "If the average American household can balance their budget, then the federal government should too."

- It seems like common sense, but it's at the heart of one of the longest and most contentious debates in economic policy.

And with a new administration coming into Washington in the middle of a pandemic and a recession you're probably gonna hear a lot more about it.

- So, let's take a look at why America can't seem to balance its budget and why some people think we shouldn't even bother trying.

(soft music) - In the simplest of terms the government's budget is like a household in that there is income on one side and expenses on the other.

The government generates revenue through taxes and spends that money on everything from the military to entitlement programs to science research.

How a government taxes and spends is known as fiscal policy.

And it starts with the executive branch.

The president works with the treasury secretary and the office of management and budget to draft a budget request.

The budget request is sent to the house and the Senate who each draft their own version of a budget.

If they can hammer out a compromise the final budget is set back to the White House for the president's signature.

- When the government spends more money than it takes in, we call that gap a deficit and it is unfortunately very common.

In fact, it only about a handful of the last 50 years has there been more revenue than expenses known as a surplus.

Just as a household might use a credit card to make ends meet, the government fills that gap by borrowing the money, which adds to the national debt.

So, to reiterate the deficit is the yearly budget shortfall.

The debt is the total that the government owes.

- You might think the government shouldn't be allowed to spend more money than it makes but that's easier said than done.

For one thing, most of the budget isn't even up for debate.

By law the government must honor its entitlement obligations like social security and veterans benefits and pay off interest on its debt, which leaves less than half of the budget for discretionary spending.

Raising taxes and cutting existing programs are both fairly unpopular.

And since the White House and Congress all have to face the wrath of the voters suddenly borrowing the money doesn't seem like such a bad idea.

- But that still leaves the question, who are we borrowing all this money from?

- While it's true that foreign investors own some U.S debt, much more of it is held by the American people in the form of treasury securities.

Heck, we've got some ourselves in exchange for lending the government, some dough we're guaranteed to make some interest down the road.

- And even though America's debt has been growing steadily for decades, confidence in these bonds, hasn't budged.

They're still considered one of the safest investments money can buy.

- Sometimes however, the government needs to borrow a lot of money fast.

And that's where the fed comes in.

- If the White House and Congress are in charge of fiscal policy the federal reserve is in charge of monetary policy which essentially means controlling the supply of currency.

It does this by printing new money, taking money out of circulation and adjusting the interest rate.

The government often borrows money from the fed through the central bank and if things are really dire the fed will make new money available by creating it essentially from thin air.

- This is basically what happened in March of 2020 in response to the coronavirus pandemic.

The fed printed a bunch of new money and loaned it to the government who then distributed it to the American people through the Cares act in the form of tax rebates, unemployment benefits, loan forgiveness and other spending.

- The Cares act is an example of stimulus.

When the government combats a recession by injecting a lot of money into the economy.

The idea was first proposed by the famous economist, John Maynard Keynes in the 1930s as a response to the great depression.

He argued that government spending could kickstart an economy back to life, thanks to something called the multiplier effect.

If the government sends you a check for $1,200 which you use to say, fix your car and the mechanic uses that to pay his staff who then use it to pay their rent, that $1,200 has already created $3,600 of economic activity in theory.

- Keynes ideas became widely accepted across the globe for much of the 20th century, but then, in the seventies and eighties, a series of debt and inflation crises helped propel a new thinking to the forefront, austerity.

- Simply put austerity is a focus on balancing the budget.

Proponents of austerity argue that nations with a lot of debt can scare away investors and lenders leading to a decrease in production and increases in interest rates.

They encourage governments to minimize their deficits by raising taxes, cutting spending or both.

- The International Monetary Fund which offers emergency loans to countries and economic crises embraced austerity, wholeheartedly struggling governments that wanted their help had to agree to a package of measures that focused on generating tax revenue and slashing social spending.

The results weren't so good.

- That's because national budgets don't work like household budgets.

URI could close a gap by raising our income or lowering our expenses but a government makes its income from taxes which are directly proportional to the amount of economic activity.

The more money people are making and the more they're spending, the more tax revenue the government takes in.

Tax hikes and spending cuts tend to decrease overall economic activity which decreases the government's income.

- This is more or less what happened to a lot of countries that embraced austerity.

The measures that were supposed to make them more solvent instead, further stifled economic activity, which increased unemployment and decreased much needed tax revenue not to mention made a lot of citizens Very, very unhappy.

- Stimulus on the other hand has seen quite a resurgence in the last couple of decades.

The recovery act of 2008 is widely credited with helping reverse the great recession and the Cares act with preventing America from sliding into another depression.

In fact, most criticism of these actions is that they may not have gone far enough.

- And a lot of the austerity proponents worst predictions simply haven't come true.

Despite the fed creating trillions of new dollars we haven't seen a meaningful increase in inflation.

Investors haven't lost confidence in treasury bonds or the American dollar and when economists recently predicted that U.S debt would surpass GDP for the first time, nothing happened.

Seems like investors and lenders Care a lot more about the health of the economy than they do about how much the government owes.

- To be clear, no one is saying debt is a good thing as anyone who's ever had a mortgage or a student loan can tell you owning a lot of money is downright nerve wracking.

It would be lovely to run at surpluses most of the time.

And finally see that national debt lines start to go down for once.

The question is not whether we should try to pay off our debts, but when?

- As individuals, we instinctively tighten our purse strings when times are tough and let the wind flow freely when times are good.

But most economists think at the national level, it should be just the opposite.

We should use good times to shore up our finances so we have extra fuel to feed the economy when it slows down.

Unfortunately, our instincts often get the better of us.

In 2017, when the economy was already going gangbusters we passed a massive tax cut that added $2 trillion to the national debt.

Now, in the middle of a pandemic and a recession, Congress is fretting about the cost of another stimulus package.

- Money is the lifeblood of the economy and if it slows down or stops moving, the consequences can be disastrous.

Businesses and families get damaged in ways that aren't easily undone.

- Keynes famously said, "In the long run, we're all dead."

I think he was criticizing the idea that we should use warnings about distant dangers as an excuse not to help people who are suffering today.

- Almost a 100 years later, the current Chair of the federal reserve Jerome Powell echoed his thinking.

The risk of overdoing it is less than the risk of underdoing it.