Question about a balanced budget...

we will never find out

quote:

---

If federal govt has a balanced budget, what effect - if any - does it have on the economy as a whole?

---

The problem is that when you spend more than you take in (i.e. deficit) then you incur debt to make up the difference. Unfortunately, we will eventually have to pay off that debt. That is where you the phrase politicians love so much, "mortgaging our children's future."

To pay the debt, we have to do one of three things (or a combination thereof).

1. We can reverse the trend by incurring a budget surplus and using the extra cash to pay down the debt. That can be done by raising tax revenue and/or reducing government spending.

Raising tax rates does not necessarily increase tax revenue and we are already highly taxed as a country. Additional taxes would utlimately lower our GDP and, as a result, potentially reduce tax revenue. I can explain that further if need be.

Since raising tax rates is not the answer, the other option, which is the best choice by far all of the ways to reduce our debt, is for the government to reduce its spending if it wants a budget surplus. This is the least likely because people in power are reluctant to release some of that power. The president and congress would have to work together to shrink the government. Both Republicans and Democrats have demonstrated that they are unlikely to do that.

Therefore, creating a budget surplus, especially to a degree that it could pay down debt substantially, is highly likely.

2. The government can incur more debt to pay off the current debt. Many companies rely on a constant stream of credit to finance day-to-day operations. The problem is when something happens to credit markets, the credibility of the government's ability to pay back the debt, or the interest rates in general. Any negative shock, which is not impossible, will increase our government's cost of borrowing, which of course leads to even higher levels of debt. Our debt payments will be more and more interest and less principal, thereby digging us into an even deeper hole. Relying on debt to finance our government's operations is not a viable long-term solution. Other countries who are not particularly friendly to us have developing economies that are catching up to ours (think China). China actually just became the largest lender to the American government.

3. The third option is to simply print more money to pay the debt. Of course, this is also disasterous because printing more money weakens the dollar and printing enough to pay off our debt will depreciate the dollar greatly and leads to high inflation. High inflation really hurt us in the 70's and the Federal Reserve has tried to control inflation more than anything else since then.

Ultimately, the government will end up doing a combination of 2 and 3 and possibly some of the first one (raising taxes, not reducing spending). However, the need to pay off debt will limit our country's potential to grow.

If the federal government were required to have a balanced budget every fiscal year, then the overall budget would fluctuate depending on tax receipts.

Since some programs cannot politically be cut in any given year (Medicare, Social Security, many others) this means those programs that *can* be cut will be quite drastically. Whether you like this or not probably depends on the program.

For example, in the current economic crisis much is made of the fact that checking accounts are FDIC insured, so you don't have to make a run on the bank. Would they be if you had to choose between that and Social Security? What about that highway project that suddenly isn't getting federal funds this year? Those are the kinds of choices a balanced budget amendment might well require.

I'm not saying that the ability to borrow money is all wonderful though. The most obvious argument against it is a concept referred to as "generational equity" - sure, the feds can step up to insure our checking accounts. And our grandchildren will pay for it.

It's a thorny question without an obvious answer, complicated by the fact that Social Security is basically used to fund the deficit anyway (the SS fund invests in Treasury bonds). But probably it would make economic booms and busts more severe. That could be good or bad for future generations since they wouldn't be paying to smooth out our troubles today.

Let me see if i can filter this down: the immediate effect of a balanced budget on the economy would be an increase/decrease in taxes.

Thanks for the info guys. Not for a class or anything, just trying to edumacate myself.