Thursday, 10 January 2013

James Buchanan's 18th Century Cure for a 21st Century Disease

The Balanced Budget Amendment: Clarifying the Arguments
James Buchanan (1919-2013) called on the genius of the 18th century to correct the mediocrity of the 21st. The 2006 Nobel Prize winner spent 60 years arguing that once the economic philosophy of Adam Smith is applied to politics there will appear a political case for that limited government which Smith had argued for on solely economic grounds. The current global agony over government debt perfectly make’s Buchanan’s point.

Buchanan did not deny there might be a purely economic case for government deficits. Do they stimulate total demand? Perhaps. Can they dispense with temporary tax swings by bridging temporary gaps between government spending and revenue? Certainly. But whatever economic arguments favour them, Buchanan believed his ‘economic theory of politics’ showed that government deficits are a bane, and should be made unconstitutional.

His starting point is his conception of the legislature. He did not see it as a debating chamber,: it was a market place, a political market place. In this political market place different political constituencies strike a bargain to fund each other’s most preferred programs.  'I will give you my support for that, in exchange for your support for this'. Such bargains will never strictly mimic the exchange of genuine market, as the taxation to fund any program will always be borne in part by sections of the electorate not benefitting from the program. Someone else, in other words, is always paying for part of your lunch. In consequence, there will be too much government spending.  But at least every program will have some sort of ‘tax price’

The political market place goes from doubtful to disastrous once programs can be funded by deficits. For the capacity to deficit fund means that there is a zero ‘tax price’ at the margin for any piece of government spending. The beneficiaries of programs can charge all its costs to future generations, who are completely unrepresented in the political market place. Government spending being free, elementary economics says political constituencies will ‘buy’ as much of it as they can. And that is until bond buyers balk at ever being repaid. Thus Greece. The price of avoiding that chaos is forgoing the benefits of ‘demand management’ and ‘tax smoothing’ by disallowing deficits even when they seem desirable.

The upshot is that Buchanan favoured a constitutional amendment to enforce a balanced  budget, and thought it politically attainable. Inflation targeting has proved popular, and it is a constraint no less than the balanced budget rule.  In the US local and state governments already commonly disallow deficits. In March 1995 the U.S. Senate failed by only a single vote to approve such an amendment. And Buchanan believed held that until the mid 1960s the balanced budget rule was ‘an integral part of the broader unwritten constitution of the United States’. It was the advent of Keynesian demand management that made possible a coalition between Democrats and Republicans to revoke that unwritten clause.  Democrats saw stimulus in tax cuts, and to Buchanan’s mind ‘”Tax reduction was from the outset more important to conservatives than budget balancing’. The new coalition expressed itself in 1964 Kennedy tax cuts, and even more pungently in the ‘Jobs and Growth’ tax cuts of George Bush.

Buchanan was alive to the power of this coalition in favour of deficits, and proposed that any balanced budget amendment only kick in seven years after it was passed. He also proposed that the rule apply to budget plans, rather than outcomes, as outcomes will inevitably been disturbed by unforeseen events. He also favoured exempting genuinely income-producing capital assets. And he stressed that it was not a cap on government spending as such. The American public would be able to choose to spend as it likes: it would merely have to pay for it.

Buchanan's favour of the balanced budget illustrates Buchanan’s deep faith in a constitutional remedies for dysfunctional politics. His philosophy amounted to a “constitutional salvationism’, reflecting both the political heritage of the United States and the benefits of the rule of law. But regrettably, what one amendment can enacts, a later amendment can repeal. And would there not be every political incentive to repeal a Balanced Budget Amendment? Buchanan never saw the 'unwritten' balanced budget rule of the pre-Keynesian era as the product of the rational consensus that he believed was foundation of constitution-making. He saw the 'unwritten rule' as (in his words) a ‘fiscal religion’; to break it would have been (in his words) ‘sin’, a transgression beyond the pale. It wasn’t a matter of constitutionality but morality. Perhaps today’s endemic deficits require a moral cure rather than a constitutional one.


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