Is There Hope for a Strong Balanced Budget Rule in the United States?

A gradual and lagged implementation could make it politically feasible

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The US federal government is in an increasingly dangerous fiscal position, running annual deficits of $2 trillion with no relief in sight. This is a predictable outcome of a budget process without meaningful restraints or sustainable budget goals. The current system rewards endless spending, putting America’s long-term future in peril.

While most countries struggle with similar pressures, a few have made progress by adopting binding rules that rein in deficits and enforce fiscal discipline. The United States, by contrast, clings to a broken process that is once again culminating in a tax-cut-and-spend bill, which would further inflate the already unsustainable US debt. The “One Big Bloated Bill” reflects fiscal dysfunction driven more by electoral incentives than serious economic deliberation.

With America facing a looming fiscal crisis, many have argued for a balanced budget rule to reduce deficits and restore long-term fiscal sustainability. In this post, I will make two primary points. First, the international experience suggests that such a rule must be carefully designed to be effective. Second, a gradual and lagged implementation gives the best chance for a strong rule with minimal loopholes to gain the requisite political support for enactment.

Over one hundred countries are now subject to fiscal rules, with Germany and Switzerland standing out as success stories. Their rules hold constitutional status, impose meaningful constraints on the budget, account for emergencies and cyclical fluctuations, and enjoy strong public support. However, the rules in many other countries have disappointed, largely due to loopholes in their design.

One potential loophole is exempting certain spending categories, such as investment or defense, from consideration. Britain’s so-called “golden rule” in 1997 allowed borrowing solely for investment purposes, and in a surprising move earlier this year, Germany exempted a significant amount of investment and defense spending from its rule. These exemptions effectively soften the constraints of the fiscal rule and can create perverse incentives for politicians to shoehorn new spending into the exempt categories, especially if those categories are not well-defined. Indeed, what expenditures should and should not count as “investment” is far from clear and would likely be subject to intense political debate in the United States.

A second potential loophole is allowing for a fiscal rule to be suspended. Even if a fiscal rule accounts for fluctuations in the business cycle, a country may reasonably want to suspend a fiscal rule in emergency situations such as wars, recessions, pandemics, or natural disasters. However, suspension provisions have been abused. Italy has repeatedly circumvented its balanced budget rule since it came into effect in 2014, largely because approving deficits only requires a majority in each house of Parliament. Additionally, in the wake of the Global Financial Crisis and the COVID pandemic, many countries neglected to “un-suspend” their rules and continued running deficits well after the crises were over.

Even if these and other loopholes were addressed, another potential problem remains: What if politicians can easily amend the fiscal rule? If an enacted rule necessitates cutting spending or raising taxes – both likely to be politically unpopular – politicians may try to amend the rule or eliminate it altogether. An obvious solution would be to add the rule to the Constitution, thereby making it more resistant to modification. However, very few countries have constitutional fiscal rules, likely due to the short-term political incentives that also make loopholes attractive. Politicians may recognize the dangers of rising debt, but they face a trade-off: By enacting a strong fiscal rule that requires unpopular spending cuts, they damage their future electoral prospects. The public supports lower deficits and debt in the abstract, but no group wants to pay for them. Unfortunately, America’s fiscal situation is so dire that every group will likely have to pay. Prefacing her recent budget proposal to avert a debt crisis, Jessica Reidl writes that “there is something for everyone to oppose.”

Is it possible for politicians to overcome electoral incentives and enact a strong fiscal rule that both imposes fiscal discipline and resists political tampering? Nobel Laureate economist James Buchanan suggested a two-pronged strategy. The first prong is gradually implementing the fiscal rule. For example, if a country enacts a balanced budget rule when it is running a $1 trillion deficit, it could gradually implement the requirements over a five-year period. The maximum deficit could be $800 billion in the first year, $600 billion in the second year, and so on. Many variations are possible. The second prong is lagging the implementation process itself. For example, the country above could begin its gradual rule implementation three years after the rule’s enactment.

This strategy increases the probability that politicians will enact a strong rule because it directly reduces the expected electoral costs of the rule. Making a series of smaller cuts over multiple years is less politically costly than one large cut, and the lagged implementation means that politicians may not even be in office when cuts must eventually be made. The strategy also allows time to build political consensus around difficult spending decisions, and it minimizes disruptions to citizens’ expectations in their capacities as taxpayers and program beneficiaries.

Germany serves as a valuable case study of how this strategy could work. Germany’s constitutional balanced budget rule was approved in 2009 and began a gradual implementation in 2011, with the transition period lasting until 2016 for the national government. Over the implementation period, the structural deficit from 2010 had to be reduced in equal increments across the years, which the government successfully accomplished. Germany’s debt-to-GDP ratio declined significantly, and a new working paper finds strong evidence that the fiscal rule was indeed responsible for the consolidation. As a result, Germany’s public finances are among Europe’s strongest, as the following graph shows.

There are some potential downsides to the gradual and lagged implementation strategy. First, facing budget cuts in the near future, politicians may engage in a spending spree and blow out the deficit, damaging the credibility of the rule. Second, even without a spending spree, short-term fiscal adjustment will be limited at best. Third, an emergency such as a war, recession, or pandemic may arise before or during the implementation of the rule, complicating its enforcement.

While these are valid criticisms, one must ask: What’s the alternative? A balanced budget rule of any sort (much less constitutional) currently has little support in Congress, and the above implementation strategy could help catalyze serious discussions and minimize the loopholes in an eventual proposal. Something must be done to address America’s debt, and while a balanced budget rule can theoretically impose the needed fiscal discipline, electoral incentives must be reckoned with to ensure political feasibility.

Andrew Berryhill holds a PhD in Economics from Indiana University. Check out his personal website.