Sunday, December 7, 2014

Why Is the Federal Budget Chronically in Deficit?

    The federal government budget of the United States is chronically in deficit.  Almost unimaginably, the federal deficit topped $1 trillion in each of the years 2009-2012.  Total federal debt tops $17 trillion.  Promised federal spending for Social Security and Medicare exceeds projected tax collections by more than $100 trillion!  Since 1940, the federal budget was not in deficit in only eight years.  And in those years of surplus, highly questionable accounting was usually involved.

1)  Why is the federal budget typically in deficit?
2)  What are the real costs and consequences of federal budget deficits?
3)  What could be done to stop systematic deficits and ever-expanding federal debt?

     Democracy, combined with the political institution of majority rule (let's call it MRD for short), has a built-in flaw.  Under MRD, small minorities with much to gain get their way against large majorities with only a little to lose.  The problem is large, concentrated benefits combined with small, dispersed costs.  For example, wheat farmers in Kansas, who each have thousands of dollars in benefits to gain from a wheat price support program, will lobby loud and long for the program, but each of the rest of us, who each have only pennies to lose if wheat support programs become law, will scarcely pay attention at all.  Each of the rest of us won't spend our scarce time and money to fight the farm bill handout to wheat farmers, funded by federal expenditures.  And so it goes with every special interest. 
     Politicians prosper and get reelected by handing out benefits to supporters who finance campaigns.  A wheat farmer in Kansas has every incentive to donate $1,000 to reelect a politician who will vote for wheat price support.  Each of the rest of us are quite unwilling to donate $1,000 to elect a politician who will vote against the program. 

     Politicians also prosper and get reelected by voting for laws and policies that produce highly visible short run benefits, but generate costs that are mostly invisible, dispersed across millions of citizens, and deferred to the distant future.  The most obvious and largest examples of this phenomenon is Medicare and the evolving PPACA (a.k.a., Obamacare). 

     Federal expenditures can be financed in just three ways: taxes, borrowing, and money creation.  Politicians' propensity to favor borrowing and money creation is no mystery.  By the way, borrowing is deferred taxes; money creation is the most insidious, least visible, and most widely dispersed form of taxing.  Pernicious and growing federal debt—in America and around the world—really poses no mystery at all.

     The real costs and consequences of ever-rising federal debt are ever-growing command of scarce resources by a small number of politicians instead of by a large number of private individuals.  In EconoBlast, we have often discussed how voluntary exchange (a.k.a., free markets), generate prosperity and social coordination.  We have also learned how centralized control of scarce resources generates concentrated benefits, dispersed costs, and prosperity for special interest minorities. 

     Systematic federal deficits and ever-expanding federal debt could be stopped.  I offer four proposals that would end the problem.  First, the political institution of MRD could be replaced with SMRD—super majority rule democracy.  SMRD would require that no law could be passed by Congress without a 4/5ths majority.  Second, we could prohibit individuals from serving more than a single term in Congress.  Third, we could give Congress a budget constraint, stipulating that the federal government cannot spend more than 20% of the average of the most recent three years nominal GDP. Fourth, we could end creation of new money under the direction of just seven people—the Board of Governors of the Federal Reserve, replacing discretionary monetary policy with a money growth rule.

      With SMRD, very few if any laws could be passed that concentrate benefits on small minorities, but disperse costs across the rest of us.  With single-term members of Congress, special interest groups would lose their incentive to finance campaigns for politicians who promise to butter the bread of the special interest group.  With a federal budget constraint tied to GDP, politicians would have to make choices about how to spend tax dollars, instead of deferring taxes with debt and money creation.  Finally, with a monetary growth rule, the growth rate of the money supply would be limited to a rate that makes inflation impossible and promotes wide-spread social cooperation based on knowledge instead of deception.

     If we the people do not have the persistence to insist on fundamental changes, such as the four proposed above, we should stop complaining and just get used to federal deficit spending with no end in sight.  Each and everyone of us can enforce term limits simply by not voting for an incumbent politician, regardless of who it is.  It's a start.  

     The other three fundamental changes I propose would require the help of Congress, and perhaps even constitutional amendments.  But politicians who will serve but a single term might just become statesmen, instead of career practitioners of cronyism.  It's worth a try.