Pursuing Budget Balance

Background

One indicator of smart fiscal practices is maintaining balance between spending and revenues. Occasionally deficits may be necessary. They may even be sensible to counteract economic downturns or spur growth. Annual deficits are caused when spending exceeds revenue in a given year. They can accumulate into on-going debt The amount of money owed by the government, which is the accumulation of all prior annual deficits. , the grand total of all past annual deficits and surpluses. During periods of low interest rates, government may have the capacity to handle high debt The amount of money owed by the government, which is the accumulation of all prior annual deficits. with relative ease.

Historically, the federal government has often run annual budget deficits. Since the turn of the century, deficits have grown far above historic averages, hitting record levels in the wake of the COVID-19 pandemic.

Unsustainable deficits and debt The amount of money owed by the government, which is the accumulation of all prior annual deficits. can cause stress to economic systems over time. Eventually, they may undermine investor confidence in government bonds. Interest rates may increase, investments and productivity may decline, and economic growth may be undermined. Deficits and debts may force the government to cut spending and limit policymakers’ ability to react to economic crises.

Federal policymakers face challenges in attempting to balance the budget. They need to adopt fiscal policies that cut the deficitThe amount by which annual expenditures exceed annual revenues.  to sustainable levels without risking economic growth or essential programs serving vulnerable populations. Periods of solid economic growth are the most opportune moments to keep the national debt The amount of money owed by the government, which is the accumulation of all prior annual deficits. under control.

Balancing budgets has its own set of unique challenges at the state and local level. State revenues tend to decrease during economic contractions, while their spending needs remain the same or grow. State budget dynamics are different from those of the federal government, due in part to states’ balanced budget requirements. It means that states cannot finance their deficits by issuing debt The amount of money owed by the government, which is the accumulation of all prior annual deficits. . Almost every state has such a requirement in some form. Generally, this requirement applies only to a state’s operating budget, leaving open an option to issue debt The amount of money owed by the government, which is the accumulation of all prior annual deficits. to fund public investments.

Some states use rainy-day fundsState budget-stabilization funds that policymakers add to when the economy and therefore tax revenue are strong and spend from when the economy and therefore tax revenue are weak. to help them maintain budget balance. This is a special fund built up during good economic times and used to cushion the blow of unexpected economic adversity. These funds often help sustain spending on needed public programs during recessions.

In contrast, states with balanced budget requirements but no rainy-day fundsState budget-stabilization funds that policymakers add to when the economy and therefore tax revenue are strong and spend from when the economy and therefore tax revenue are weak. must reduce spending during recessions to cover for reduced revenue streams. This removes even more money from the economy and compounds the effects of the recession.

During economic downturns, some states need new revenue sources to keep the budget balanced. These revenue sources can be temporary, one-time, variable, or declining. Such unstable funding cannot sustain vital long-term programs over the long term.

PURSUING BUDGET BALANCE: Policy

PURSUING BUDGET BALANCE: Policy

Rainy-day funds

When economic conditions permit, states should accumulate budget reserves adequate to maintain services during recessions. The use of rainy-day fundsState budget-stabilization funds that policymakers add to when the economy and therefore tax revenue are strong and spend from when the economy and therefore tax revenue are weak. should be restricted to times when revenues adjusted for inflation decline.

The process of restoring the balance of rainy-day fundsState budget-stabilization funds that policymakers add to when the economy and therefore tax revenue are strong and spend from when the economy and therefore tax revenue are weak. should be made more automatic. Governments could earmark a specified fraction of current revenue for this purpose.

Prioritizing

DeficitThe amount by which annual expenditures exceed annual revenues.  -reduction efforts should avoid cuts in programs that serve low- and moderate-income populations.

States should not tie essential spending programs to unstable revenue sources.

Budget balance

The federal government must strive for long-term fiscal balance. However, the need to reduce long-term fiscal imbalances should be tempered by the occasional need for short-term fiscal stimuli, emergency spending, and long-term investment.