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Budget Balance in the Long Run?
Suppose one thinks that in most, though not all, circumstances, "leaning against the wind" by the Federal Reserve, together with the stabilizing effect of automatic, income-change-induced swings in tax revenues and federal spending, would suffice to keep fluctuations in total spending relative to potential output within acceptable limits. Would one then want the federal government, over the long run, to aim at balance in its structural budget (the budget as it would be at potential output)-not as a rigid rule, but as a general presumption?

The trouble with aiming at balance, even under those favorable assumptions, is that it might produce a partition of the GNP between consumption and investment that is undesirable. Consider our current situation. In 1994, the federal deficit amounted to 2.6 percent of the GNP. Suppose that the Congress, in order to achieve balance by 2002, reduces the share in GNP of federal consumption purchases by 1 percentage point (from 6.2 percent in 1994 to 5.2 percent in 2002), and cuts transfer payments (inclusive of interest) and/or raises taxes, relative to GNP, by 1.6 percentage points. A 1.6 point cut in personal disposable income would cause households in the aggregate to reduce their consumption purchases relative to GNP by about .75 x 1.6 = 1.2 points.2 So aggregate consumption, government plus personal, would fall by 1 + 1.2 = 2.2 percentage points. If-and it's a critical "if"-the Federal Reserve will then have driven down interest rates enough to cause domestic investment spending plus net exports to take up the slack, total spending would suffice to purchase 2002's potential output, the federal budget would be in balance, and investment's share of GNP-net domestic plus net U.S. foreign investment-would be 2.2 points larger than in 1994.

Would that be a good outcome? In 1994 we devoted approximately 3.4 percent of the GNP to increasing U.S. net worth in the form of business plant and equipment, civilian infrastructure, housing, inventories, and net American ownership of claims on the rest of the world. The above balanced-budget program would raise that share to 5.6 percent (assuming no changes in private saving propensities and in state and local government budgets relative to GNP). If we want to speed up the growth in our incomes, that would certainly be a great improvement. But even at 5.6 percent, the net investment share would still be smaller than in any year between 1950 and 1981-smaller by a third than the 1950-1979 average of 9 percent.

Barring a dramatic upsurge in private saving3 (it might happen; demographics point that way), restoring U.S. net domestic plus foreign investment to where it was between 1950 and 1979 would require much more stringent fiscal action than merely balancing the federal budget. To supplement meager private saving, we would need positive federal saving-an appreciable surplus at least in the structural operating budget.

I'm not saying that the gain in future income would be worth the cost in lower current consumption; that is a complicated question. The answer depends in part on whose consumption would be lowered; hurting our children-especially the many poor children-for the sake of future grandchildren is a dubious proposition. But as long as we focus on the deficit as such, we will not ask that question. And if we don't, we will keep making the choice between consumption and investment blindly.

Notes

1. Net U.S. foreign investment-recently it has been disinvestment-equals U.S. exports (including receipts of factor income, in other words, wages and profits accruing to Americans from the rest of the world) minus U.S. imports (including payments of factor income to the rest of the world) plus capital grants received by the U.S. (net) minus transfer payments to the rest of the world (net).
2. I rely again on the empirical observation that a $1 cut in disposable income will typically elicit something like a 75-cent cut in personal consumption.
3. It is national saving-private plus public-that matters. Increases in private saving that result from revenue-losing tax concessions help only if they exceed the loss in public saving. (There is much uncertainty about the responsiveness of private saving to relatively higher after-tax real yields. And most tax measures that would encourage private saving would increase the inequality of income. As James Tobin put it, "Maybe the future is being shortchanged, but we should be cautious in seeking remedies that would increase contemporaneous inequalities of income and wealth in order to increase saving and investment for the benefit of future consumers, most of whom will be better off than most Americans today.")

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