The Delicate Art of Balancing the Budget
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Government budgets represent between 25% and 50%
of he Gross Domestic Product (GDP), depending on the country. The
members of the European Union (Germany, France) and the
Scandinavian countries represent the apex of this encroachment
upon the national resources. Other countries (Great Britain, to
name one) fare better. But even the more developed countries in
South East Asia do not clear the 25% hurdle.
The government budget, therefore, is the single
most important economic decision, the most crucial economic event
every (fiscal) year.
The government finances its budget mainly by
taxing individuals and corporations. Ultimately, households pay
the bill. Even corporations are owned by individuals and earn
their money by selling products and services to individuals.
Higher taxes are likely to be passed on to customers or to
employees. There are numerous kinds of taxes, regressive and
progressive, direct and indirect, on earnings and on property -
but they all serve to finance the budget.
Another method of financing the budget is by
borrowing either in the capital markets (by selling bonds as the
government of the USA does) - or by "voluntarily"
deducting part of the wages (as Israel used to do until a decade
ago). Such borrowing has grave repercussions: the national debt
grows, debt service (repayments of interest on the debt plus the
principal of the debt) consumes more and more of the national
resources and the government crowds individuals and - more
importantly - businesses out of the credit markets. In other
words, the money that is lent to the government is not available
to finance consumption, investments and working capital for
businesses. The competition on the scarce resource of capital
increases its price, interest rates. Government borrowing has
disastrous economic consequences in the long term: reduced
consumption, heightened interest rates, stagnant investments -
all leading to recession and negative or reduced growth rates.
Recognizing these unfortunate results,
governments the world over have been converted to the new
religion of balanced budgets or, at least, reduced and controlled
The two best known examples are the United
States and the European Union.
One of the things which used to distinguish
between political camps in the USA - Democrats versus Republicans
- was their attitude towards the role of government in the
economy. The Democrats believed in an active government, whose
role it is to ameliorate the excesses of the markets. This
logically led to less hysteria over the size of budget deficits.
The Republicans firmly believe in Bad Big Government and in the
overriding necessity to constrain it and to abolish as many of
its functions as politically and economically feasible. Small
Government was a pillar of the treaty with the people which led
the Republicans to their landslide Congressional victory in 1994.
It is an absurd that it was a Republican
president (Reagan) who was responsible for the biggest increase
in the national debt since the USA was established. He reduced
the interference of government in economic life mainly by
reducing taxes - without the commensurate slimming down of
government itself. The result was apocalyptic: enormous twin
deficits (budget and trade), a collapse in the exchange rates of
the Dollar against all major currencies, recession and the
steepest stock market crash in 1987.
Today, the USA owes 5 trillion USD. True, this
is only 60% of the GNP - but this time statistics is misleading.
The interest payments on this "benign" level of debt
amount to 15% of the budget, or 250,000,000,000 USD per annum.
This is more than any other expenditure item in the budget,
barring defence. And it is getting worse.
This, however, belongs to the past. Clinton is
as much a Republican as any and both parties share the conviction
that the budget must be balanced by the beginning of the century.
It seems that it is well on its way there. The projections of the
objective and reliable Congressional Budget Office (CBO) are
positive: the budget will be balance shortly, long before it was
projected to do so.
But it was an American, Benjamin Franklin, who
once (1789) said: "Only two things are certain in this world
- death and taxes". This spectre of a balanced budget
already provokes interest group to pressurize the administration
to be less tight fisted and possessed more of a social conscience.
Nowhere was the new "less deficits"
doctrine more apparent than in the Maastricht Treaty and,
especially, in its criteria. The latter determine which of the
member countries of the EU will join the Euro single currency
zone in the first wave of entrants in 1999. One of the more
important criteria is that the deficit in the government's budget
will not exceed 3.0% of GDP ("three point zero" -
emphasize the Germans who are very worried about the stability of
the currency which will replace their treasured DM).
As a result of this rigid criterion,
governments have increased taxes (France), imposed one time
levies (Italy), engaged in creative accounting (again France with
many others) or unsuccessfully tried to do so (the failed attempt
to revalue the gold reserves in the coffers of the Bundesbank in
Germany). Some were aided by buoyant economies (France), others
by favourable public opinion (Italy), yet others by
farsightedness (Germany's Kohl). All of them pay a dear economic,
political and social price. By restraining the budget deficit,
they induce recession or fail to encourage budding economic
expansions. Unemployment rates remain stubbornly high, so do
This is the price of adhering to an economic
Balanced or low deficits budgets are a good
things when the economy is roaring ahead. But there are certain
things that only governments can do: defending the country,
maintaining law and order, disaster relief, ensuring market
competition. One of the more important functions of any
administration is to act anti-cyclically, to encourage economic
activity in times of recession - and to hold the economic horses
when they go wild. A government cannot do this when its hands are
tied behind its back by a totally arbitrary limitation: no more
than 3% budget deficit (why 3? why not 2.65%?). This Maastricht
criterion will prove, in the long run, to be lethal to the very
idea of a European Union.
What is a budget?
It is a program. It charts the government's
expenditures and allocates its resources for a period of one
fiscal year. Some fiscal years start and end in January (Israel),
others in October (the USA). But budgets always relate to fiscal
years because of their dependence on tax revenues. Modern
government budgets make a clear separation between current
expenditures and the development elements. These were mixed in
the past and this served to cloud issues and to disguise gross
misuse of funds.
But this structural separation did not change
anything basic. Budgets are statements, mainly of policy. The
budget delineates clearly - and if it doesn't do so, it
surrenders through careful reading and analysis - the political,
economic and social priorities and goals of the government which
prepared it. Politicians can talk a lot about the importance of
this or that - but it is only when they put (other people's)
money where their mouth is that an indisputable priority is
established. Money talks (loudly) and the budget proclaims the
true face of the government which conceived it.
In this sense, a budget is also a monitoring
tool. By comparing financial projections, finances allocated to
specific purposes in the budget - to the actual use made of the
funds and to the extent that they were expended, it becomes clear
whether the government "has kept its word", "changed
its mind", or "reneged on its promises". A budget
is a promise, it is a contract between the elected government and
the nation, it is approved by parliament and has the status of a
law. A budget can be altered only through a vote in parliament.
It is a document of unparalleled importance, second only to the
Still, budgets (moreso than constitutions) are
like living organisms:
As circumstances change, new priorities and
emergencies alter the allocation of resources. The budget is
based on economic projections and predictions, not all of them
successful and come true.
This is why additional or supplementary budgets
are introduced by governments during the fiscal year. These are
updated versions of the original budget. They reflect the changed
reality better than the outdated original. They help to redefine
national priorities, reallocate resources, modify national
These budgets usually include tax increases,
new economic or social programs, or additional specific
expenditures. In some countries, the legislator must show where
will money be found to finance the newfound enthusiasm embedded
in the new expenditure items.
Budgets are also influenced by exogenic factors,
not controlled by the government. Force Majeure cases, like the
floods in the Czech Republic (3 billion USD) and in Poland (2
billion USD). Geopolitical processes like wars and peace
agreements in the Middle East (the 1979 peace cost Israel almost
4 billion USD to implement). The onerous, depressingly uniform
demands of the IMF from poor countries: austerity, fiscal
tightening, a monetary squeeze, privatization, deregulation and
Some countries are voluntarily subject to
externalities: the EU countries agreed to amend their budget in
order to comply with the Maastricht criteria. The French and
German Premiers appointed special committees to review the budget.
The reports submitted by these committees forced the governments
to cut spending, increase taxes and tighten the fiscal discipline
(never mind that the French committee failed to take into account
the renaissance of the French economy and greatly exaggerated the
projected budget deficit). In all these cases an act of
rebalancing the budget is called for.
The USA has a peculiar budgetary procedure. Its
Federal budget is made up of 13 separate bills. They are
submitted to Congress for approval by the administration. When
the President and Congress disagree, some of the bills are not
approved and certain government operations are shut down. This
happened in the 1996 fiscal year. In fact, the budget for fiscal
year 1996 has been approved only after the 1997 budget was.
In the case of such a deadlock, stop gap
budgets are passed by Congress to allow the government to
continue to function until a final budget is positively voted on.
Budget are acts of humans. They
represent hard data implausibly coupled with aspirations,
projections, goals and hopes. They are prone to mistakes, greed,
cronyism, ulterior motives. The existence of a mechanism to amend
budgets is, therefore, of the essence and to be greeted. A budget
amendment is often ceased upon by the opposition as proof of the
government's fallibility and failure. But in a changing world -
they who do not adapt through change are doomed. Governments that
amend their budgets midway merely admit that they are made of
humans and are doing their nation a service.
About the AuthorSam Vaknin is the author of "Malignant Self Love - Narcissism
Revisited" and "After the Rain - How the West Lost the
East". He is a columnist in "Central Europe Review", United
Press International (UPI) and ebookweb.org and the editor of mental health
and Central East Europe categories in The Open Directory, Suite101 and
searcheurope.com. Until recently, he served as the Economic Advisor to the
Government of Macedonia.
His web site: http://samvak.tripod.com
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Article Published/Sorted/Amended on Scopulus 2006-07-16 02:01:35 in Economic Articles