Fallacy of composition, balanced budget version

Nicholas Johnson at the Center on Budget and Policy Priorities argues that the federal government, unlike states, shouldn't have to balance the budget:

From the economy’s perspective, the fact that states have to balance their budgets even in recessions makes it even more important not to require the federal government to do the same. States’ balanced budget requirements force them to cut spending and/or raise taxes at the worst possible time: when the economy is weak and needs more public and private spending, not less. These measures help keep state budgets in balance, but they can also make downturns longer and deeper — and the current downturn is no exception.

There's more to the story. States balance their budgets for a reason— if states attempt to use fiscal policy (government spending) to stimulate the economy, much of the stimulus leaks into bordering states. A New Hampshire stimulus package would end up stimulating Massachusetts, Maine, Vermont, and Canada. Because of these leaks, fiscal policy is less useful to New Hampshire policymakers. State government may perform better by forsaking weak attempts at fiscal policy and sticking to a balanced budget.

Fiscal policy at the federal level is much more effective because it covers a larger area, and there's less leaking as a proportion of the stimulus. It also solves the coordination problem between states (where New Hampshire policymakers don't account for the stimulus to Massachusetts, and Massachusetts policymakers ignore stimulatory effects on New Hampshire).

The macroeconomic policy lesson that we've learned over the last few years is that fiscal policy can matter a lot. Forsaking it at the federal level, where it works best, would be extremely foolish.