The Myth of the 'Balanced Approach' to Fiscal Policy

Economist and Research Fellow, Hoover Institution

The talk in Washington about a balanced approach to the U.S. federal budget deficit reminds us of the Old Testament account of Solomon's Judgment. Two women who shared a house in Israel, sisters-in-law, approached King Solomon, each claiming to be the mother of the same infant and calling the other a liar.

"Fetch me a sword," Solomon said, according to 1 Kings 3:24. Then, "Divide the living child in two, and give half to the one, and half to the other." One of the women, spiteful and bitter in the heat of the argument, agreed to the split. The other cried out and begged Solomon not to slay the child, rather give it wholly to the other woman, who been revealed as the false mother. King Solomon gave the child to the one who truly loved the infant after the truth had been tricked into the open.

Today, Washington faces a similar dilemma. Instead of a baby, it fights over an ailing economy. Instead of two warring sisters-in-law, we have two political parties and two approaches to the trillion-dollar budget deficit. The liberal approach is to raise taxes and the conservative approach is to slow the growth of government expenditures.

President Barack Obama, speaking almost exactly one year ago, called for a "balanced approach" to budget reform that would split the difference. We often read editorials and observers calling for the same, an apparently moderate, centrist, compromise. Even if the president were sincere in his call for "shared sacrifice," which we doubt based on his record so far, this notion of balance is a mistake.

Obama's conception of "balance" and "sharing the burden" is, at heart, nothing more than splitting the baby. His idea of sharing the burden of taxes is to raise tax rates on people with high incomes in the next few years, namely successful employers. And his idea of cutting government means sequestering Pentagon dollars while hiring more health care bureaucrats.

A smarter concept of fiscal policy balance is one that prioritizes outcomes (more jobs, faster growth, less poverty) over inputs. The goal of good fiscal policy is less about equating revenue with outlays and more about the fiscal mix which optimizes long-term prosperity. The fact that the liberal "War on Poverty" launched half a century ago has failed to make a dent in poverty is a sign of the government's imbalanced thinking. Balance means putting incentives for job creation first, not good intentions to alleviate suffering. Most importantly, true growth requires a political balance that reflects citizens' interests. Political polarization has unbalanced our fiscal policy, and overcoming the special interest trap requires a fundamental reform of the ways Congress passes its budget, maybe even an amendment to the Constitution.


In November, voters will be asked to decide between two different philosophies, both claiming to be the mother of growth. Obama says the status quo is working, that trillion-dollar deficits during each year of his tenure needs one simple fix: more taxes. Our view of balanced fiscal policy is more in line with Christina Romer, the first chair of Obama's Council of Economic Advisers. In 2010, she published a study in the American Economic Review that said, "Tax increases appear to have a very large, sustained, and highly significant negative impact on output." Romer found that, on average, every tax increase of one percent of GDP is linked to a three percent drop in real GDP over the next 10 quarters. A tax increase is the false mother to prosperity.

Of course, we don't get to pass judgment. In American democracy, the voter is king. And unlike some of our peers, we actually have faith in the voter's judgment, if only it could be heard. The political process has become so dominated by special interests, consultants, lobbyists and fear-mongering incumbents that clear judgment is difficult. Congress has run exponentially larger deficits for over 40 years now, pushing an imbalance ever closer to collapse.

America's fiscal imbalance inspired us to start a new blog this week at Let's think a little harder about avoiding the fate of ancient Rome, Ming China, and the empires of Europe. And let's think less about balanced sacrifices and more about balanced growth.