The Compensatory Budget

December 19, 1949

A few weeks ago fourteen academic economists, several of whom might be expected to know better, came out in favor of “counter-cyclical fiscal action”—i.e., “surpluses in good times and deficits in bad.” I was forced to pass this by at the time because a worldwide monetary earthquake fell in the same week. But the admirable analysis of the “compensatory budget” theory in the December letter of the National City Bank provides a fresh occasion to take it up.

“Annual budget balancing,” declare the fourteen economists, “is both difficult in practice and unsound in principle.” That it is difficult in practice all history attests. So is any other virtue or worth-while goal. But “maintenance of the national credit by a Federal budget annually balanced” (to quote the pledge of the Democratic platform on which Franklin D. Roosevelt ran in 1932) is an incomparably sounder principle than the foggy alternative offered by the fourteen.

Even they put in a patronizing word for the annually balanced budget. “One great merit it does have: it provides a yardstick. . . . Every government program undertaken has to be paid for in a clear and unequivocal sense . . . This is a principle every citizen can understand.”

And dropping that principle has led and will lead in practice only to fiscal irresponsibility, inflationism, and eventual disaster.

An annually balanced budget has one enormous advantage. Everyone knows exactly how long a year is. Everyone knows on what day it begins and on what day it will end. But nobody knows how long a boom or depression is going to last while we are in it. Even hindsight can’t answer this question exactly. How do we know how far we are above or below normal unless we know what “normal” is? How do we know on just what day even a past depression stopped? Each set of statistics yields a different answer. Which set do we go by? How dependable are the statistics themselves?

The fourteen want to throw away the only real yardstick we have. The decision whether to plan for a surplus or a deficit, and exactly how big a deficit, would then be determined by somebody’s guess about the economic future. “We can, however, reasonably expect that the budget be formulated in the light of economic judgment available.” Whose judgment? Leon Keyserling’s, say? And suppose the economic forecasts of the Administration prove as bad in the future as in the past? Well, better luck next time.

The compensatory-budget theory subordinates or disregards the maladjustments in costs and prices that may be causing stagnation. It especially ignores the relationship of unemployment to excessive wage rates. It assumes that booms or depressions are the purely mechanical result of the volume of money available for spending. It overlooks what Albert Hahn has called the “compensating reactions to compensatory spending”—the chief of which is the destruction of business confidence.

But even if it had none of these economic weaknesses, the political consequences of the “compensatory” budget are alone decisive against it. The budget is to be balanced only when conditions are “normal,” and overbalanced only when they are positively booming. At such times the politicians are to increase taxes and reduce expenditures to bring the boom to a halt. This reversal would be politically unpopular and perhaps politically fatal.

Even at the height of an inflationary boom, therefore, the party in power could never be brought to admit that the boom was quite high enough to be halted. We have seen an example of this even within the last twelve months. So even in a year when we count our national income at the second dizziest height it has reached, we face a probable budget deficit of $5,000,000,000 to $8,000,000,000.

The compensatory-spending philosophers merely put into the hands of the inflationists and spendthrift politicians a theory that they can and will use to their own ends.