Two choices for balancing the budget: pro-Reagan, and anti-Reagan

Take a look at the graphic below depicting two different ways of balancing the budget, then decide which of those two methods you prefer. (Full disclosure: My strong preference is for method 2, the pro-Reagan balanced budget.)




Note the big difference between the anti- and pro-Reagan methods of balancing the budget. The first one indiscriminately labels everything "government spending"; the budget it balances with tax receipts is the unified budget. The second one discriminates between two types of spending, just as Reagan did, and just as most state governments do: (a) immediate expenses, versus (b) investments in the future; the budget it balances  with tax receipts is the operating budget. The first one insists that no more money should be borrowed to fund any type of "government spending" whatsoever; the second one confirms the financial truth that it is perfectly sound financial practice to borrow money for good investments such as defense, infrastructure, and, as many argue, education. The first method fingers "borrowing" in general as the evil demon to be exorcised; the second fingers bad spending and bad investments as the culprits -- which are quite distinct from borrowing for good investments.

Reagan knew the difference between expenses versus investments. For example, he knew that beefing-up our defense and intelligence capabilities (backed by a stronger economy) would generate benefits not immediately, but in the future. That's why he steadfastly and unequivocally exempted national defense from budget-cutting, in spite of objections from all sides (including his own green-eyeshade employee, David Stockman). Exempting defense contributed immediately to the Reagan deficits; the benefits were not immediate, but  accrued a few years later with the end of the Cold War -- which ended the threat of a thermonuclear war between superpowers. It was a good investment, and borrowing money to fund it was sound financial practice. [And to those who are fond of saying "investment" is just a code word for "spending" I ask, Is there really no such thing as an "investment" by our government? Really?)

Unfortunately, the pro-Reagan method has apparently been forgotten by the very people who should be keeping it alive. One example is the ex-governors who tend to brag about having balanced their state budgets when they run for president: they also tend to omit the important detail that it was the operating budget they balanced while they were simultaneously utilizing debt financing to help fund their capital budgets. Another example: The Republicans, of all people, should understand the long-established private sector business lesson that debt is frequently the preferred way to help finance good investments in growth and security -- so why are those Republicans now acting as if that same truth does not apply to government?

In short, the anti-Reagan method (an indiscriminate ban on borrowing) has been gaining a lot of support, driven by, but not limited to, conservative freshmen in the House of Representatives. It's ironic that the message is being amplified by supposedly pro-Reagan voices such as Rush Limbaugh and Sarah Palin. All of them are making a mistake best articulated by Einstein: "Everything should be made as simple as possible, but not simpler."

Keeping the budget under control

The oversimplified, anti-Reagan method supposedly keeps the budget "under control" by way of a constitutional amendment that forbids borrowing for any kind of spending, except during a declared war; see the proposed wording at this link. (Oh well, at least the proposed wording acknowledges that winning a war is a good investment for the future, for which borrowing is permissible. But that begs the question, Why shouldn't it be permissible to borrow money to prevent a war? For example, was having a surplus in the late-90s that much more important than investing at least that much in the intelligence and counterforce capabilities it would have taken to prevent 911, Afghanistan, and Iraq?) Seems to me the anti-Reagan way of balancing the budget can end up saddling us with a heavier debt burden instead of a lighter one.

But the pro-Reagan method would need a control mechanism, too. Capital budgeting isn't a panacea; it is full of potential pitfalls, one of the first of which would be that politicians would scramble to get their pet spending programs labeled "capital investments." The pros and cons were analyzed in this excellent CBO paper in 2008.

The control mechanism

I favor a results-oriented control: the ratio of debt to GDP, because the longer-term results are what count more than the shorter-term debates about the definition of capital. Because good investments tend to foster real growth of the economy (...or to prevent destruction that would damage our economy), the size of our economy (GDP) should play a role in the measure. Higher GDP means higher tax receipts, which in turn mean increased ability to afford the debt it took to fund the investments. (Although other measures may be more to the point, such as Times Interest Taxed, the debt/GDP ratio is more widely recognized and therefore an easier sell.)

Bottom line: Controlling to a specified "ceiling" ratio of debt/GDP permits borrowing for good investments in defense, infrastructure (and education?), and would therefore be far superior to the anti-Reagan method of an outright ban on any type of borrowing. Why the anti-Reagan balanced budget has so much support is beyond me.

Comments

[Tom Filbey]

The reason the pro-Reagan method is opposed (and the anti-Reagan method is supported) is the same reason communism is opposed (and capitalism is supported). Each sounds good in theory but doesn't work in practice. You pointed out the pitfalls that are sure to be exploited by unprincipled politicians. When politicians are involved words lose their original meaning and eventually mean the opposite. Eventually the capital budget will become the non-capital budget. Ex: tax cuts equal spending and tax increases equal savings.

I remain unconvinced.

[Optimist123]

A growing number of people share your view that it is impossible for the government to make a good investment. Fortunately for the country, that faction was only a tiny minority when Reagan was president.

[Anthony Anthony]

As usual, loved the post. This blog (and others like it) needs to become more widely followed. In response to an "investment"? in education: education = a voting population better versed in financial matters. A voting population that better understands financial matters means more politicians who run and get elected on a pro-Reagan method base. In turn, the more "investment" style government spending which takes place, leading to larger future growth. Investments in education pay off in more ways than one.

[Zack Roach]

I have always ascribed to the Adam Smith view of the necessity of Government in limited roles but do feel that investment in such defined roles of Government is critical to the long term success of the United States. I would also include investment in education, as another poster above mentioned, in the critical role of government. However, striking a balance between giving a motivated yet underprivileged student a modicum of help and the tendency to create "social engineering" due to mission creep gives me some amount of pause when sifting through possible scenarios.