Balanced Budget

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Definition of Balanced Budget:

An individual, company, or government has a balanced budget when its expenditures equals its income.

Detailed Explanation:

Governments have a balanced budget when tax revenues equal government spending. (Note that sometimes a budget where revenues exceed expenses is referred to as balanced, but never when expenses exceed revenue.) Imagine that when your income decreases, your expenses increase. Your budget would become much more difficult to balance. The US Congress faces the same challenge. The Great Recession, a slow economic recovery, and an aging population increased mandatory spending as a percentage of the federal budget between 2008 and 2014. Mandatory expenses such as Social Security and Medicare increase as the US population ages and people live longer. Other mandatory items are triggered by economic conditions. Unemployment insurance, food stamps, and Medicaid increase during recessions. A recession is a period of economic contraction where fewer goods and services are produced. Tax revenues decrease because personal and business incomes decrease. The graph below shows government revenues and spending between 1901 and 2018. (2017 and 2018 are estimates.)


Source: U.S. Government Publishing Office

Businesses borrow money to further their growth. There is no reason a government could not do the same. Borrowing money for investments that increase the rate of government growth such as infrastructure or education can generate additional tax revenue. 

Financial planners recommend that families save and invest during prosperous times, so money is available to pay their bills if a family member loses a job or has a medical emergency. Similarly, most economists believe a nation should save money, strive to minimize debt, or even aim to have a surplus during prosperous periods to prepare for periods of little or no economic growth. When recessions occur, the government could use deficit spending to manage the economy. In other words, fiscal policy should be expansionary (increasing the budget deficit) during recessions, and contractionary (limiting the budget deficit) when the economy is overheated.

Most economists believe that requiring a balanced budget would worsen recessions or further overheat expanding economies. During recessions, unemployment is a concern and many workers work fewer hours. Income decreases, so tax revenues drop. Meanwhile, mandatory spending increases because more people become eligible for programs such as Temporary Assistance to Needy Families (commonly known as welfare), food stamps, and Medicaid. How would the government secure the money it needs? The expenses are fixed, so the only way is to increase revenues, which results in raising taxes. A balanced budget would require an increase in taxes to generate the revenues needed to pay for the increase in mandatory spending. The tax increase would reduce discretionary income, meaning consumers would have less money to spend, which further decreases the country’s aggregate demand (the total number of goods and services consumers would purchase at a given price level). In turn, the economy’s output would drop. Balancing the budget, which in theory is a good thing, in this case would end up deepening a recession.

In theory, Congress could cut spending rather than increase taxes to achieve a balanced budget during a recession. But what should they cut? Remember an act of Congress is required to cut mandatory spending. Assume the government passes a law that reduces entitlements such as Social Security – reducing payments to formerly entitled citizens when they need them most. Imagine the public outcry! It is hard to imagine Congress passing such a law. A cut in government spending would reduce the aggregate demand, which slows economic growth. Requiring a balanced budget would force Congress to cut spending and / or increase taxes—both of which are contractionary and would exacerbate a recession. 

During prosperous periods, the reverse would occur. An overheated economy would result in higher tax revenues, which could result in a budget surplus. Congress would be required to either spend the surplus, or reduce taxes to eliminate the surplus. Each of these actions are expansionary, and increase the demand for most goods and services. If the economy is operating near its full-employment level (which is common in an overheated economy), prices would likely increase.

Economists who favor a balanced budget amendment argue that a balanced budget is necessary because the federal government lacks fiscal discipline. They point to the time lag between recognizing a problem and implementing a solution results in untimely fiscal policy that can be counterproductive. Another problem is that, once implemented, government programs can be hard to discontinue. Regions and individuals become dependent on the income from a project, making it difficult for policy makers to terminate. (Would you vote for a politician who favors closing a military base in your community?) This dependence makes it politically popular to include some “pork” in the budget. Pork is a term used for budget items that benefit special interests or small groups of voters. These items are hidden within larger budgets. A bill is passed when there is enough pork to satisfy enough representatives to pass a bill.

Dig Deeper With These Free Lessons:

The Federal Budget and Managing The National Debt
Fiscal Policy - Managing an Economy by Taxing and Spending
Monetary Policy - The Power of an Interest Rate
Fractional Reserve Banking and The Creation of Money

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