Message in Europe's Turmoil: Balance the Budget

You might think that Europe’s economic turmoil would inject a note of urgency into America’s budget debate. After all, high government deficits and debt are the root sources of Europe’s problems, and these same problems afflict the United States. But no. Most Americans, starting with the nation’s political leaders, dismiss what’s happening in Europe as a continental drama with little relevance to them.

What Americans resolutely avoid is a realistic debate about the desirable role of government. How big should it be? Should it favor the old or the young? Will social spending crowd out defense spending? Will larger government dampen economic growth through higher deficits or taxes? No one engages this debate, because if rigorously conducted, it would disappoint both liberals and conservatives.

Confronted with huge spending increases—reflecting an aging population and soaring health costs—liberals would need to concede that benefits and spending ought to be reduced. Seeing that even after these cuts total government spending would still rise (more people would receive benefits, even if benefit levels fell), conservatives would have to concede the need for higher taxes. On both left and right, true believers would howl.

The lack of seriousness is defined by three missing words: “Balance the budget.” These words are taboo. In February, President Obama created a National Commission on Fiscal Responsibility and Reform (call it the deficit commission). Its charge is to propose measures that would reduce the deficit to the level of “interest payments on the debt” by 2015 so as “to stabilize the debt-to-GDP ratio at an acceptable level.”

Understand? No? Well, you’re not supposed to. All the mumbo jumbo about stabilizing “debt-to-GDP” and ignoring interest payments are examples of budget-speak, intended to convince people that “something is being done” when little, or nothing, is. For instance, Obama’s target for 2015 implies a deficit of $500 billion, despite a strong economy (unemployment: 5.1 percent). The commission is also supposed to “propose recommendations that meaningfully improve the long-run fiscal outlook,” whatever that means. But balance the budget? There’s no mention.

In a classroom, limiting government debt in relation to GDP can be defended. The idea is to reassure investors (a.k.a. “financial markets”) that the debt burden isn’t becoming heavier, so they will continue lending at low interest rates. But in real life, the logic doesn’t work. Governments inevitably face deep recessions, wars, or other emergencies that require heavy borrowing. To stabilize debt to GDP, you have to aim much lower than your target in good times, meaning that you should balance the budget after the economy has recovered from recessions.

The virtue of balancing the budget is that it forces people to weigh the benefits of government against the costs. It’s a common-sense standard that people grasp. If the deficit commission is serious, it will set a balanced budget in 2020 as a goal. It will then invite think tanks (from the Heritage Foundation on the right to the Center on Budget and Policy Priorities on the left) and interest groups (from the Chamber of Commerce to the AARP) to present plans to reach that goal. Their rival visions could jump-start a debate on the role of government.

The odds seem against this. The deficit commission may embrace debt-to-GDP targets and aim for a “primary balance” (balance without interest payments) because it’s easier politically. Consider. In 2020 the deficit will be $1.254 trillion on spending of $5.67 trillion, according to the Congressional Budget Office. Closing that gap would require steep tax increases or deep spending cuts. But $916 billion of the deficit represents interest payments. Ignoring them instantly “solves” three quarters of the problem.

The message from Europe is that this approach ultimately fails. Intellectually elegant evasions are still evasions. Though financial markets may condone lax government borrowing for years, confidence can shatter unexpectedly. Lenders retreat or insist on punishing interest rates. Markets then impose harsh austerity—benefit cuts or tax increases—far more brutal than anything governments would have needed to do on their own. We are, by inaction and self-deception, tempting that fate.

Correction: In my last column, I misreported Caterpillar’s first-quarter earnings as 55 cents a share. The correct figure was 36 cents. Apologies.

Join the Discussion