Democracy in Deficit: The Political Legacy of Lord Keynes

James M. Buchanan.
Buchanan, James M. and Richard E. Wagner
(1919- )
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Indianapolis, IN: Liberty Fund, Inc.
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Foreword by Robert D. Tollison.
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Chapter 12A Return to Fiscal Principle

The Thrill Is Gone


Our principal emphasis in this book is on history, analysis, and diagnosis, three separate but related elements in a critical interpretation of the Keynesian legacy. Our post-Keynesian economic order has not performed as promised. This seems clear as diagnosis, and diagnosis is our main task in this book. We do not conceive our own role as "saviors," and we do not consider ourselves obliged to preach some new "religion" to those who must, directly or indirectly, make economic-political policy choices. There may exist several ways to "recover" adequately from the deficit-ridden, inflation-prone policy pattern that seems inherent in the workings of ordinary democratic process as they are presently constituted. At best, therefore, any proposal that we advance in this final chapter should be treated as only one among several possible alternatives.


Perhaps the most sanguine stance, and one that is probably held by some of those who still would classify themselves as truly "Keynesian," embodies the faith that practicing politicians and, by implication, their voting constituencies will begin to behave "responsibly." Holders of this view tend to believe that, once politicians come to understand the long-term results of short-term policy errors, they will start behaving like economic statesmen. This roseate projection of a modified political and public behavior, without basic structural or institutional change, would, if it came true, refute the central thesis of this book. Such a refutation would indeed be welcome, and we should, quite willingly, relegate this book to the dustbin of anachrony, happy in our newfound knowledge that things were not really so bad as they seemed to us in 1976, when this book was written.


An almost equally hopeful outlook, and one that would also partially if not wholly refute our arguments, embodies the conviction that the required structural-institutional reforms have been taken, that the Budget Reform Act of 1974, when viewed from the vantage point of hindsight in, say, 1990, will be seen as having worked miracles. Our own analysis suggests that the reforms reflected in this particular legislation are not those required for the democratic political process to rid itself of the fundamental biases left from the Keynesian legacy. The reforms promised by the 1974 budget legislation are aimed at a set of flaws in budget making that are quite different from those we have examined here. This legislation aims to correct those problems stemming from the piecemeal consideration by Congress of the federal government's budget. To the extent that the newly established committees and procedures are effective, Congress will come closer to considering the budget a normative unit subject to explicit choice, and not a result that emerges from the behavior of many noncoordinated revenue and expenditure committees. This step, in itself, well may act to increase the overall responsibility in budgetary decision making.


But there is nothing in the 1974 legislation, or in its subsequent institutional changes, that imposes a norm for relating the two sides of the fiscal account, nothing that acts as a putative replacement for budget balance in the old-time or pre-Keynesian fiscal constitution. After 1976, if the intentions of the Budget Reform Act are to be followed, Congress will be somewhat more explicit in the creation of budget deficits. Such explicitness may reduce somewhat the size of the deficits, although the possibility that deficits could become larger cannot be ruled out. Regardless of particular direction, however, it seems beyond the limits of plausibility to suggest that explicitness alone will literally transform the behavior of modern politicians.


Nonetheless, this legislation, along with other observed events, surely attests to the verdict that the Keynesian allure is waning. The 1974 legislation was, in one sense, a direct response to the impoundment controversy that arose in the early 1970s, a controversy that called public attention to the explosive growth in federal spending and to the budget deficits that facilitated this growth. The constitutional issues raised during this controversy, although important in their own right, are not relevant here except insofar as the outcome tended to place upon Congress the charge to get its own house in order.


There are additional signs of a gradual awakening to the Keynesian dangers. In the summer of 1975, a Senate subcommittee held hearings on the possible desirability of a constitutional amendment that would require the federal government to balance its budget, except in times of declared national emergency. Such hearings would have been inconceivable in 1965. Members of the Democratic Research Organization of the House of Representatives commenced in early 1976 to consider alternative means of restoring fiscal responsibility.

The Case for Constitutional Norms


These various activities indicate a widening recognition of a developing fiscal-economic crisis, and the gradual acknowledgment by members of Congress that attempts must be made to put institutional halters on their own tendency to spend without taxing and, in consequence, to spend too much. The absence of an effective budgetary rule or norm, something against which budget making can be evaluated, is coming to be acutely sensed by those involved in it. The dwindling number of overt Keynesians to be found offer nothing other than the ultimately dangerous "budget balance at high employment" norm. This norm, which gives the appearance of promoting fiscal responsibility, seems almost ideally tailored to promote the opposite.


There are two quite distinct steps to be taken in moving toward genuinely effective fiscal reform. The first is that of recognizing explicitly that a meaningful constitutional norm is required, independently of just what this norm might be within rather broad limits. Budgets cannot be left adrift in the sea of democratic politics. They must be constructed within constraints that impose external form and coherence on the particular decisions about size and distribution which an annual budget reflects. The elected politicians, who must be responsive to their constituents, the governmental bureaucracy as well as the electorate, need something by way of an external and "superior" rule that will allow them to forestall the persistent demands for an increased flow of public-spending benefits along with reduced levels of taxation. Even those who might disagree most strongly with our favorable interpretation of the potential effectiveness of the rule for budget balance may acknowledge the necessity of some alternative rule that will constrain specific budget making within defined limits, a rule that is "constitutional" in this basic meaning of the term.


There are several qualities that any such rule must possess if it is to be effective. First of all, it must be relatively simple and straightforward, capable of being understood by members of the public. Highly sophisticated rules that might be fully understood only by an economists' priesthood can hardly qualify on this count alone. Secondly, an effective rule must be capable of offering clear criteria for adherence and for violation. Both the politicians and the public must be able readily to discern when the rule is being broken. Finally, and most importantly, the fiscal rule must reflect and express values held by the citizenry, for then adherence to the precepts of the rule may, to some extent, be regarded as sacrosanct. These three basic qualities add up to a requirement that any effective budgetary rule must be understood to "make sense" to the ordinary voter.

The Case for Budget Balance


It is in recognition of these qualities that we are led to a specific rule, the second step in any proposal for fiscal reform. We are led to propose an avowed reversal of the Keynesian destruction of budget balance, an outcome that would be accomplished through an explicit reestablishment of balance between the two sides of the fiscal account as the overriding constraint on public outlays. The principle of budget balance has the great advantage of simplicity. It was, is, and can be understood by everyone, and the translation of the principles for private financial responsibility to those for governments tends to facilitate such an understanding. Furthermore, and perhaps most importantly, despite the Keynesian conversion of our politicians, there remain significant residues of this norm in prevailing public attitudes, residues that can be brought to bear productively in any genuine restoration.


Given the fact of the Keynesian conversion, however, along with the observed political and public disrespect for the balanced-budget rule since the 1960s, there is little chance for reincarnation of the rule in some informal and unwritten, yet binding, element of our fiscal constitution. Precisely because we have allowed the Keynesian teachings to destroy the constraining influence of this part of our previously informal fiscal constitution, restoration must now involve something more formal, more specific, more explicitly confining than that which fell victim to the Keynesian onslaught. Restoration will require a constitutional rule that will become legally as well as morally binding, a rule that is explicitly written into the constitutional document of the United States.


It is on the basis of such considerations as these that we have supported, and continue to support, efforts to amend the United States Constitution so as to require the federal government to balance its budget, efforts which, as noted above, themselves suggest a growing awareness of the potentially disastrous Keynesian legacy.*81 Various versions of proposed amendments have been offered, almost all of which contain escape clauses that allow for departures from budget balance (presumably, to allow for budget deficits; little or no note is made of departures in the opposing direction) during periods of declared national emergencies. Political reality indicates to us that some such escape clause must be incorporated, but this, in itself, need not seriously inhibit the potential force of a budget-balance rule. The escape clauses proposed require that the Congress, in a separate resolution requiring perhaps two-thirds of each house, declare the existence of a national emergency, either war or economic distress. The centrally important element of the budget-balance rule, treated as a formal amendment to the Constitution, is that the Congress recognize it to be such, and that departures from the rule be acknowledged as departures from a standard that is itself independently existent and which remains invariant through time.

Fiscal Decisions under Budget Balance


It is perhaps as important to discuss what such a constitutional rule will not do as it is to discuss what it will do. Our emphasis has been on the constraining influence of such a rule, on its potential for eliminating the biased growth of the public sector of the economy and for reducing dramatically the sources of inflation. But too much should not be made of the constraints in any absolute sense. Nothing in a straightforward rule for budget balance dictates, and indeed nothing should so dictate, that total government spending be maintained at some predetermined level, either in absolute terms or relative to national income. Decisions concerning the amount of resources to be allocated governmentally will be made through the ordinary political processes, with or without the existence of a rule for budget balance. The restoration of the balanced-budget rule will serve only to allow for a somewhat more conscious and careful weighting of benefits and costs. The rule will have the effect of bringing the real costs of public outlays to the awareness of decision makers; it will tend to dispel the illusory "something for nothing" aspects of fiscal choice.


Nor is there anything in a balanced-budget rule, as such, that influences the allocation of outlays within the overall budget. The mix between, say, defense and welfare may be explicitly defined either with or without a constraining rule requiring overall budget balance. And the introduction of such an external constraint should do nothing to tilt or bias the political process either toward more defense or toward more welfare spending.

Tax Rates and Spending Rates as Residual Budget Adjustors


A constitutional requirement that the federal government balance outlays with revenues, except in extraordinary times, well might remain unenforced and unenforceable if its language fails to specify means through which balance between the two sides of the fiscal account is to be maintained. What would happen if the budgeted outlays, approved by both the Congress and the president, should be projected to exceed (or to fall short of) tax receipts? It is relatively easy to think of situations in which a constitutional requirement for balance might exist without an adjustment mechanism, in which case budget deficits might continue to emerge, with little or no feedback effects on the decision-making process itself. (In this respect, the requirements might operate much as the legal limit on the size of the national debt.) In order to avoid this possibility, it seems necessary that any formal rule for budget balance include a specific adjustment mechanism, one that would be triggered automatically by an emergence of an outlay-revenue differential over and beyond some defined threshold. The adjustment should be automatic in the sense that it would be effectively immunized from current decision making; it should come into play through the operation of the rule itself.


As with the form of the rule itself, however, there are alternative ways of constructing the adjustment mechanism. Either rates of tax or rates of outlay may serve as the residual adjustors, or some combination of both might suffice. In this connection, we may recall an alleged "principle" in nineteenth-century public-finance theory. Individuals, so the principle goes, must adjust spending to income. Governments, by contrast, may adjust incomes (revenues) to spending requirements or "needs." Independently considered, this so-called "principle" is wholly fallacious because the concept of "requirements" or "needs" is as open-ended for governments as it is for private persons. But insofar as a difference exists, the implication is that, under a balanced-budget rule, tax rates "should" be the residual adjusting device. That is to say, if rates of outlay threaten to exceed rates of revenue collection, the emerging gap should trigger an automatic increase in tax rates, estimated to be sufficient to close the gap within defined threshold limits. This form of adjustment tends to bias the rule in favor of the public as opposed to the private sector; an impending budget deficit is reconciled by tax increases which reduce the demand for privately provided services.*82


On the other hand, the constitutional rule might include adjustment in rates of outlay rather than in rates of tax. If prospective outlays, as budgeted, threaten to exceed revenue receipts by more than defined limits, this might require specific cutbacks in rates of outlay, with tax rates remaining invariant. Under this method of adjustment, the deficit is contained by spending reductions which will increase the demands for private market services. The choice between these two methods of adjustment can influence the allocation of resources between private and public sectors. While our preferred adjustment would involve rates of outlay rather than rates of tax, in part reflecting a reaffirmation that the principles of sound finance are essentially the same for governments and persons, the choice among adjustment mechanisms is insignificant relative to the establishment of an effective rule for budget balance per se.*83


If the residual adjustment is defined in rates of outlay, the simplest version would require across-the-board reductions in rates of spending on all budgetary components when the threshold of imbalance is exceeded. More complex variants of an automatic adjustment might insulate certain budgetary components as "untouchable" under the restrictions of the norm, while concentrating all of the possibly dictated outlay reductions on remaining components. (Something closely akin to this actually happens in state-local governments which act to postpone capital spending programs when faced with unexpected revenue shortfalls, while, at the same time, these units try to maintain more or less stable rates of operational spending.)*84

A Specific Proposal


In the explicit acknowledgment that our proposal is only one among several possible alternatives that might be discussed, we should recommend that the Constitution of the United States be amended so as to include the following provisions:

1.  The president shall be required to present annually to Congress a budget that projects federal outlays equivalent to federal revenues.
2.  The Congress, both in its initial budgetary review, and in its subsequent approval, shall be required to act within the limits of a budget that projects federal outlays equivalent to federal revenues. (There is, of course, no requirement that the congressional budget be the same as that submitted by the president.)
3.  In the event that projections prove in error, and a budget deficit beyond specified limits occurs, federal outlays shall be automatically adjusted downward to restore projected balance within a period of three months. If a budget surplus occurs, funds shall be utilized for retirement of national debt.
4.  Provisions of this amendment shall be made fully effective within five years of its adoption. To achieve an orderly transition to full implementation, annual budget deficits shall be reduced by not less than 20 percent per year in each of the five years subsequent to the adoption of the amendment. Departure from this 20-percent rule for annual adjustment downward in the size of the deficit shall be treated in the same manner as departure from budget balance upon full implementation.
5.  Provisions of this amendment may be waived only in times of national emergency, as declared by two-thirds of both houses of Congress, and approved by the president. Declarations of national emergency shall expire automatically after one year.


As an example, assume that the amendment proposed here is adopted in 1980, when the federal government's budget deficit is $100 billion on an annual basis. For 1981, the first year of the transition period, the deficit would have to be reduced to not more than $80 billion. If, in this first year, projected outlays exceed revenues by more than $80 billion, across-the-board reductions in all federal outlays would be required to attain this level of deficit.*85 Each subsequent year in the transition period of five years would be treated similarly, with the amendment becoming fully effective in 1985, from which time budget balance would be required rather than declining deficits. Requiring that the size of the deficit be reduced in each succeeding year of the transition period and that the deficit be wholly eliminated at the end of this period does not necessarily imply that federal spending programs in being at the time of the adoption of the amendment be curtailed or eliminated. The amendment proposed is aimed directly at controlling the size of the budget deficit, not at the absolute size of federal spending. To comply with the provisions of the proposed amendment, Congress may choose to increase tax rates or to reduce rates of growth in governmental outlays, or some combination of both. As noted earlier, the amendment will require only that the costs and benefits of public-spending programs be taken more explicitly into account.

Debt Retirement and Budget Surplus


As proposed, there is nothing in the constitutional rule that will allow for the accumulation of budgetary surpluses which might be utilized to amortize outstanding issues of national debt. Genuine return to the old-time fiscal religion would embody some attempt at reducing the amount of federal debt outstanding. This purpose may, however, be accomplished without the explicit creation of budgetary surpluses, simply by utilizing the parallel operations of the monetary authority, the Federal Reserve Board, in its role of providing new money for the economy as the economy grows. With a federal or national debt of the magnitude that exists (more than $700 billion in 1977), the monetary authority can use this resource as the means of increasing the monetary base for many years. In effect, the national debt would become monetized through time, and the annual budgetary burden of interest payments could be reduced gradually and finally eliminated.


To this point, we have said nothing specifically about the monetary "constitution." There is nothing about our constitutional proposals that would guarantee that the Federal Reserve Board would act responsibly to ensure that aggregate monetary stocks keep pace with the growth of real output in the economy. In the face of a constitutional amendment requiring budget balance, it seems highly improbable that the monetary decision makers would act as irresponsibly in this respect as they did in the tragic years of the 1930s. To guarantee against and to forestall such behavior, however, as well as to add still further predictability to the inclusive financial constitution, fiscal and monetary, we would support a supplementary constitutional amendment that would direct the Federal Reserve Board to increase the monetary base at a rate roughly equivalent to the rate of growth in real output in the national economy.*86 This supplementary monetary rule would have the effect of promoting approximate stability in the level of product prices. To the extent that real output should grow through time, the Federal Reserve Board, in following this monetary rule, would find it necessary to add to the monetary base. They could be directed to do this exclusively by the purchase and subsequent amortization of outstanding federal debt.*87

In Summation


In several places and in several ways, our analysis should have made it clear that some set of fiscal principles must be restored; the Keynesian-inspired budgetary anarchy that we observe cannot continue. There are two complementary elements in our overall theme: One deals with the behavior of politicians and the other deals with the nature of our economic order.


Even if we accept the Keynesian story about the functioning of our economic order, democratic political pressures are likely to generate an asymmetrical application of the Keynesian prescriptions. For reasons that we explored in Part II, the Keynesian destruction of the balanced-budget constraint is likely to produce a bias toward budget deficits, monetary expansion, and public-sector growth. Politicians naturally want to spend and to avoid taxing. The elimination of the balanced-budget constraint enables politicians to give fuller expression to these quite natural sentiments.


If monetary changes were neutral in their impact on the economy, the inflationary bias of Keynesianism, in itself, would provide little reason for concern. But monetary changes are not neutral, for such changes affect the behavior of real variables within the economy. It is this nonneutrality of monetary changes that renders the Keynesianist inflationary bias so destructive. Money creation falsifies the signals that operate within the economy. In consequence, labor and capital move into employments where they cannot be sustained without increasing inflation. The false signals also reduce the informational content of such devices as standard accounting practices, thereby increasing the errors in decision making that are made by the participants in the economic process.


Politicians necessarily confront a tragic choice setting, for, being unable to satisfy all desires, they must deny the desires of some. In the absence of a balanced-budget constraint, politicians can avoid confronting this setting directly. Since a decision to award benefits to some citizens must necessarily entail a decision to impose costs on others, is it so unreasonable to ask that this denial be made openly and honestly? Under such circumstances, a choice to approve spending that would benefit some citizens requires only that the politicians state openly just on whom it is that less will be spent, or just on whom it is that more taxes will be levied.


It might be objected that citizens have come to expect bread and circuses from their politicians. If their politicians do not provide such things, they will elect other politicians in their place. In view of such expectations, there are few politicians who would refuse to provide such bread and circuses. After all, is it not more pleasant to fulfill than to reject the desires of constituents? It is far more satisfying to give than to refuse, especially if it is not necessary to count the cost of giving. Who would not want to play Santa Claus? When a private citizen finds himself unable or unwilling to reject such desires, however, it is he who bears the cost of his actions. Politicians, however, act for the whole constituency. Their folly is our folly.


If a politician is forced by a balanced-budget constraint to reject various claimants, and loses office as a result, that may be regrettable, but no national harm is done. Should the politician be permitted to appease his normal gregariousness and avoid saying "no," however, the nation undermines both its prosperity and its liberty. A nation cannot survive with political institutions that do not face up squarely to the essential fact of scarcity: It is simply impossible to promise more to one person without reducing that which is promised to others. And it is not possible to increase consumption today, at least without an increase in saving, without having less consumption tomorrow. Scarcity is indeed a fact of life, and political institutions that do not confront this fact threaten the existence of a prosperous and free society.*88


American prosperity and liberty were once the envy of the world, and the two went hand in hand. Our relative position in the national league tables has been declining, a fact that cannot be disguised. Several countries in Western Europe have moved ahead of the United States in terms of measured income per head. Moreover, most Americans feel that individual liberty has been reduced. Regulations and controls have become ubiquitous, and, once installed, these seem impossible to remove or even to modify, despite widespread citizen complaint.


Although many other factors are surely present, some part of our difficulty can be blamed on the conversion to Keynesian ideas. A self-adjusting free economy, operating within a stable fiscal-monetary framework, lost its support, and we came to believe that only Keynesian management could ensure continued prosperity. The irony of our present situation is that the Keynesian fears may be coming true and, in the process, may be on the way to becoming part of a self-fulfilling prophecy.


We have suggested one set of proposals for fiscal and monetary reform, which, if enacted, would reverse the observed pattern. As noted, these are only one among several alternative sets that might be discussed. A first step in any such discussion is an understanding of the effects of Keynesianism on democratic political order. Only after such understanding can we begin to consider particular proposals for reform. In our view, a balanced budget would be one element in almost any acceptable constitutional framework. A democratic government is simply unable to act as a stabilizing force, and any attempts to force it to do so must ultimately be destabilizing.


There is simply no evidence at all that a free economy operating with a regime of fiscal-monetary stability is inherently unstable, or that such an economy must suffer excessive unemployment. There is accumulating evidence that an economy subject to attempted Keynesian management will be unstable, and that such management will itself produce unpredictable changes in employment. A few of the better textbooks of the 1970s have begun to relegate Keynesian economic theory to its appropriate place, as a model that partially explained the tragic events of a bizarre depression decade that is forty years in history. Surely it is time that the policy proposals derived from that theory also be displaced, along with the aging politicians whose time has also passed. The "Keynesian revolution" did take place; this fact itself should give us faith that Keynesian ideas can, also, be removed from our political consciousness.


We remain firm in our faith that Americans can shape their own destiny. Like the Spirit of Christmas Yet to Come, we hope that our conditional predictions will come to be refuted. We hope that our institutions and practices may be reformed in time to prevent "what may be" becoming "what is." Like Robert Frost's traveler, we confront a choice between alternative roads. On the one side, there lies the falsely attractive path toward "national economic planning," a choice that would have us allow government to go beyond traditional bounds because it has failed even to fulfill its more limited promises. On the other side, there is the way of the free society, of men and women living within a constitutional contract that also keeps governments in well-chosen harness. This way, so well understood by Americans two centuries past, has been obscured by the underbrush of burgeoning bureaucracy. Will we, like Robert Frost's traveler, choose the road less traveled?

Notes for this chapter

For a 1975 statement in support of these efforts, see James M. Buchanan and Richard E. Wagner, "Deficit Spending in Constitutional Perspective," in Balancing the Budget, Hearings before the Subcommittee on Constitutional Amendments, Committee of the Judiciary, United States Senate, 94th Congress, 1st Session, 23 September 1975 (Washington: U.S. Government Printing Office, 1975), pp. 61-64.

In the discussion prior to the enactment of the budget reform legislation of 1974, William Niskanen advanced a proposal that would have required that tax rates be automatically increased if Congress failed to keep spending within its own chosen target levels. See William Niskanen, Structural Reform of the Federal Budget Process (Washington: American Enterprise Institute, 1973).

For a general discussion of the residual adjustment in budgets, as these affect fiscal choices, see James M. Buchanan, Public Finance in Democratic Process (Chapel Hill: University of North Carolina Press, 1967), Chs. 7 and 8 especially.

One thing to be avoided in any variant of an automatic adjustment scheme would seem to be attempts to protect outlays on salaries for legislative and bureaucratic personnel. In fact, a strong case could be made for requiring disproportionate adjustment in this component of the federal budget, since this would provide an indirect means of encouraging compliance with the constitutional norm for maintaining overall balance in the fiscal account. It would be difficult to think of much legislative or bureaucratic agitation to exceed budget-balance guidelines if the penalties were known to include explicit reductions in governmental salaries.

Such an approach to restoring a balanced budget is also advocated in Raymond J. Saulnier, "Federal Spending, Budget Deficits, Inflation and Jobs," Tax Review 37 (June 1976): 21-24.

The complementary of rules for steady monetary growth and for a continually balanced budget, along with supporting argument for both, is developed in Robert E. Lucas, Jr., "An Equilibrium Model of the Business Cycle," Journal of Political Economy 83 (December 1975): 1113-1144.

For a specific discussion of alternative monetary constitutions, see Leland B. Yeager, ed., In Search of a Monetary Constitution (Cambridge: Harvard University Press, 1962).

A widely acknowledged fact of political history is the increasing difficulty of dislodging incumbent members of Congress. This has often been attributed to the costs of entry and to similar financial barriers. Our argument suggests that a supplementary cause well may lie in the illusion that incumbent modern legislators do avoid facing up to scarcity constraints.

End of Notes


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