Wednesday, December 1, 2010

What To Do About the Deficit, What To Do, (Much Hand Wringing), Oh, What To Do?

Frankly, no one should be surprised that massive deficit spending authorized by Congress doesn't have much effect on production of real stuff.  Congress authorized spending that would be financed by borrowed money newly created by the Fed.  But as readers of this blog surely know already, you can't borrow what hasn't yet been produced.  Not even if you are the United States Treasury, and not even if Congress said you could.

But what to do about the federal deficit; that's the question of the day, and quite probably the next several weeks. The federal debt and annual budget deficits will not be reduced unless our economy  returns to a long-term sustainable growth path.

Worse sill, until Congress gets the federal debt and annual deficits headed south, the economy is quite unlikely to return to a long-term sustainable growth path.  Congress seems unshakable in its pursuit of the path that the PIIGS have already pursued in Europe.  

Whatever else anyone recommends (notwithstanding the recent report offered by Mr. Simpson and Mr. Bowles), nothing will make a meaningful difference until Congress enacts a single, fundamental change.

Congress must give itself an ironclad budget constraint.

As everyone who's been paying any attention at all knows, for decades Congress has spent whatever it wanted to spend. Congress does so by annually raising the federal debt limit.  The result is that Congress has no budget constraint of any kind.

If we are serious about shrinking the federal debt and annual budget deficits, here's how to do it. Pass a Constitutional amendment that reads something like this:

"Congress is authorized to allocate annual spending that shall not exceed x% of the average of GDP for the most recent past three years, regardless of how that spending is financed."

We can have great political economy debates about what  "x%" should be.  Let's have them.  Based on history in the United States, something around 20% probably wouldn't cause too many people too much heartburn.

Faced with such a genuine budget constraint, members of Congress could debate long into the night each year about how to spend the money.  That's exactly what they're supposed to be doing for us.  But what Congress could not debate is how big the federal budget would be.  That would be fixed at x% of nominal GDP of the most recent past three years.

Over time, what would we expect to happen following amendment to the Constitution as I propose?  I would expect nominal GDP to grow.  I would expect real GDP to grow at about 2% per year, although important technological advances (e.g., computer technology) might accelerate that rate over some decades. 

I would also expect nominal GDP to grow because the Fed will almost certainly continue to grow the supply of money, and will probably do so at about 2% or 3% per year.  Taken together, inflation and real growth would give us something on the order of 5% - 6% growth in nominal GDP per year.  So, the federal budget could grow at something like 5% - 6% per year, too.

I would expect fewer wars.  I would expect fewer earmarks.  I would expect members of Congress to begin acting more like patriots and less like brokers between the federal budget and their electorates.

I would expect the federal debt and annual federal budget deficits to shrink.  The amendment I propose does not say Congress cannot borrow; it just says Congress cannot spend without limit.  Real growth in the economy, coupled with a real budget constraint for Congress, would result in budget surpluses over time, erasing annual deficits.

Imagine that; a federal budget surplus; an annual surplus of tax receipts over federal spending that could be used to pay down the federal debt standing now somewhere in the neighborhood of $14 trillion.

I can hear it now.  Any number of economists will say, "yes, but why should we do that?"  To them I say, "look around."  It really isn't rocket science.  It's really pretty simple.  If Congress hamstrings the economy with growth choking regulation and taxes, and the Fed continues to pump new credit money into the next asset bubble, how will that work out?  Look around.

I invite readers of Econoblast to pose objections to my simple proposal for solving the federal debt and deficit problem.  Comment also about expectations you would have if such an amendment were enacted by we the people.


Mike McMack said...

Id say, forget about the GDP. Pass a constitutional amendment that would force congress never to spend a dime more than the treasury receives in tax revenue. Ever. The "percentage of GDP argument" assumes that GDP numbers are honest. They are not. GDP is private product. Spending must be limited by what the treasury actually receives in tax revenue.

DLK said...

Mike, I agree that avoiding borrowing might be ideal, especially for governments. But prohibiting borrowing altogether may be impractical.

Most people borrow at some time, and borrowing to finance capital goods (stuff like roads, houses, factories, etc.) isn't necessarily a bad idea.

But I definitely see your point; fair enough.