ON THE (RELATIVE) UNIMPORTANCE OF A BALANCED BUDGET

This paper explores the reasoning underlying Milton Friedman's prefere nce for a small, unbalanced budget over a large, balanced one. Because the marginal return from government spending is less than the margina l cost (measured in terms of the amount of income private individuals remain free to spend), government expenditures have more of an adverse impact on the economy in his view than does the method of financing t hat spending. Using a panel data set comprising the 50 states plus the District of Columbia, we report evidence from the years 1967 through 1992 that growth rates in income per capita tend to be higher in state s with smaller public sectors. Moreover, we find that while both defic its and taxes reduce the rate of income growth in a state, the negativ e impact of government spending is considerably larger at the margin.