Debt / Economy / Fiscal policy / Politics

A Federal Balanced Budget: Not a Cure-All, but Definitely Not a Bad Idea

To all the people who believe that a constitutional requirement forcing Congress to pass a balanced budget every year will make the federal debt (and yes, there is a difference between a debt and a deficit: deficit being how much money we have to borrow per year, debt being how much money we have borrowed in total over the history of our nation) go away, I’m afraid that is just simply not true. Even if, starting tomorrow, the federal government didn’t spend a cent more than it takes in, we would still have the $18.1 trillion in debt that we have accrued over the past decades. On top of that, interest on our national loans would continue to accumulate, inflating the debt even more. Nevertheless, passing a balanced budget amendment would be an excellent step in the right direction, allowing the U.S. to finally achieve fiscal solvency and avoid leaving a mountain of debt for future generations to deal with.

As of the beginning of 2015, twenty-four state legislatures have signed a petition to establish a constitutional convention for the purpose of creating a balanced budget amendment to the Constitution, and several more states are considering it. One of the main concerns preventing many states from supporting this convention is that it might not constrain itself to only passing a balanced budget amendment but might instead attempt to make other substantial changes to the Constitution (abortion, gay marriage and welfare programs come to mind). Detractors also say that Congress would not be able to respond to economic crises quickly enough if they have to go through the steps required to bypass a balanced budget amendment. Proponents state that a balanced budget is absolutely necessary to hold Congress accountable for its spending and restore fiscal accountability to our government.

In the recent Senate Budget Committee hearing on February 3, concerning the President’s FY2016 Budget Proposal, several ideas and thoughts were mentioned by Senators from both sides of the aisle worth considering. One remark that specifically caught my attention was when Senator Stabenow said, “we talk a lot about debt and about how we should never spend more than we have…I have a mortgage…a car payment…when something’s important, we spend more than we have.” The problem with this analogy is that the goal in any credit transaction is to pay off the principal balance.

In fact, many people budget in order to pay extra every month so as to lessen the amount of interest they pay. Comparing the federal government to a responsible individual or family taking out a mortgage or car loan is completely incorrect; a more appropriate analogy would be to compare it to the person who already has ten credit cards and keeps opening more in order to keep up with the interest payments on all the others.

Director Donovan of the OMB, the witness for the hearing, repeatedly mentioned during his testimony that the federal deficit had been greatly reduced. The only issue with that is that a reduced deficit is still a deficit, and it is still adding to the debt. Here is a very simple example of how this process works: if you earn $10 and spend $13, then you need to borrow $3. If you do the exact same thing for ten years in a row, at the end of that ten years, you will owe $30. Unfortunately, this process doesn’t take into account interest.

For simplicity’s sake, let’s say that you are charged interest only once a year (instead of the normal once a month) in the amount of ten percent. After the first year, you would accrue thirty cents interest on your borrowed $3. In the second year, you would accrue 63 cents interest on your borrowed $6.30. Fast forwarding to year ten would give you an amount owed of approximately $52.59 and inform you of one simple fact that every finance professor since the dawn of time will tell you: when it comes to debt, compound interest is not your friend.

Conventional wisdom states that it is impossible to get out of debt when you are consistently adding to the debt every year, yet that is exactly what the federal government is trying to do. While creating a balanced budget amendment is not the end-all solution for fixing the fiscal crises that our nation faces currently and which threatens to become disastrous in the future, it is absolutely an extremely important component in the answer. It is high time for the federal government to join the vast number of states that have either constitutional or statutory requirements for a balanced budget.

Pile of Debt by Mikko Saari is licensed under CC BY-NC-SA 2.0