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Archive for the ‘Balanced Budget’ Category

If you asked a bunch of Republican politicians for their favorite fiscal policy goals, a balanced budget amendment almost certainly would be high on their list.

This is very unfortunate. Not because a balanced budget amendment is bad, per se, but mostly because it is irrelevant. There’s very little evidence that it produces good policy.

Before branding me as an apologist for big government or some sort of fiscal heretic, consider the fact that balanced budget requirements haven’t prevented states like California, Illinois, Connecticut, and New York from adopting bad policy.

Or look at France, Italy, Greece, and other EU nations that are fiscal basket cases even though there are “Maastricht rules” that basically are akin to balanced budget requirements (though the target is a deficit of 3 percent of economic output rather than zero percent of GDP).

Indeed, it’s possible that balanced budget rules contribute to bad policy since politicians can argue that they are obligated to raise taxes.

Consider what’s happening right now in Spain, as reported by Bloomberg.

Spain’s acting government targeted an extra 6 billion euros ($6.7 billion) a year from corporate tax as it tried to persuade the European Commission not to levy its first-ever fine for persistent budget breaches. …Spain is negotiating with the European Commission over a new timetable for deficit reduction, as well as trying to sidestep sanctions after missing its target for a fourth straight year. Spain is proposing to bring its budget shortfall below the European Union’s 3 percent limit in 2017 instead of this year, Guindos said.

Wow, think about what this means. Spain’s economy is very weak, yet the foolish politicians are going to impose a big tax hike on business because of anti-deficit rules.

This is why it’s far better to have spending caps so that government grows slower than the private sector. A rule that limits the annual growth of government spending is both understandable and enforceable. And such a rule directly deals with the preeminent fiscal policy problem of excessive government.

Which is why we’ve seen very good results in jurisdictions such as Switzerland and Hong Kong that have such policies.

The evidence is so strong for spending caps that even left-leaning international bureaucracies have admitted their efficacy.

I’ve already highlighted how the International Monetary Fund (twice!), the European Central Bank, and the Organization for Economic Cooperation and Development have acknowledged that spending caps are the most, if not only, effective fiscal rule.

Here are some highlights from another study by the Organization for Economic Cooperation and Development.

…the adoption of a budget balance rule complemented by an expenditure rule could suit most countries well. As shown in Table 7, the combination of the two rules responds to the two objectives. A budget balance rule encourages hitting the debt target. And, well-designed expenditure rules appear decisive in ensuring the effectiveness of a budget balance rule (Guichard et al., 2007). Carnot (2014) shows also that a binding spending rule can promote fiscal discipline while allowing for stabilisation policies. …Spending rules entail no trade-off between minimising recession risks and minimising debt uncertainties. They can boost potential growth and hence reduce the recession risk without any adverse effect on debt. Indeed, estimations show that public spending restraint is associated with higher potential growth (Fall and Fournier, 2015).

Here’s a very useful table from the report.

As you can see, expenditure rules have the most upside and the least downside.

Though it’s important to make sure a spending cap is properly designed.

Here are some of the key conclusions on Tax and Expenditure Limitations (TELs) from a study by Matt Mitchell (no relation) and Olivia Gonzalez of the Mercatus Center.

The effectiveness of TELs varies greatly depending on their design. Effective TEL formulas limit spending to the sum of inflation plus population growth. This type of formula is associated with statistically significantly less spending. TELs tend to be more effective when they require a supermajority vote to be overridden, are constitutionally codified, and automatically refund surpluses. These rules are also more effective when they limit spending rather than revenue and when they prohibit unfunded mandates on local government. Having one or more of these characteristics tends to lead to less spending. Ineffective TELs are unfortunately the most common variety. TELs that tie state spending growth to growth in private income are associated with more spending in high-income states.

In other words, assuming the goal is better fiscal policy, a spending cap should be designed so that government grows slower than the productive sector of the economy. That’s music to my ears.

And the message is resonating with many other people in Washington who care about good fiscal policy.

P.S. Hopefully this column explains why I’ve only mentioned “balanced budget amendment” eight times in nearly 4,300 columns over the past seven-plus years. And most of those mentions were incidental or dismissive.

P.P.S. Simply stated, it’s a mistake to focus on the symptom of red ink rather than the underlying disease of excessive government spending.

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The Congressional Budget Office has just released its new 10-year fiscal forecast and the numbers are getting worse.

Most people are focusing on the fact that the deficit is rising rather than falling and that annual government borrowing will again climb above $1 trillion by 2022.

This isn’t good news, of course, but it’s a mistake to focus on the symptom of red ink rather than the underlying disease of excessive spending.

So here’s the really bad news in the report.

  • The burden of government spending has jumped from 20.3 percent of GDP in 2014 to 21.2 percent this year.
  • By the end of the 10-year forecast, the federal government will consume 23.1 percent of the economy’s output.

In other words, the progress that was achieved between 2010 and 2014 is evaporating and America is on the path to becoming a Greek-style welfare state.

There are two obvious reasons for this dismal trend.

Here’s a chart that shows what’s been happening. It shows the rolling average of annual changes in revenue and spending. With responsible fiscal policy, the red line (spending) will be close to 0% and have no upward trend.

Unfortunately, federal outlays have been moving in the wrong direction since 2014 and government spending is now growing twice as fast as inflation.

By the way, don’t forget that we’re at the very start of the looming tsunami of retiring baby boomers, so this should be the time when spending restraint is relatively easy.

Yet if you’ll allow me to mix metaphors, bipartisan profligacy is digging a deeper hole as we get closer to an entitlement cliff.

Now let’s shift to the good news. It’s actually relatively simple to solve the problem.

Here’s a chart that shows projected revenues (blue line) and various measures of how quickly the budget can be balanced with a modest bit of spending restraint.

Regular readers know I don’t fixate on fiscal balance. I’m far more concerned with reducing the burden of government spending relative to the private sector.

That being said, when you impose some restraint on the spending side of the fiscal ledger, you automatically solve the symptom of deficits.

With a spending freeze, the budget is balanced in 2020. If spending is allowed to climb 1 percent annually, the deficit disappears in 2022. And if outlays climb 2 percent annually (about the rate of inflation), the budget is balanced in 2024. And if you want to give the politicians a 10-year window, you get to balance by 2026 if spending is “only” allowed to grow 2.5 percent per year.

In other words, the solution is a spending cap.

Here’s my video on spending restraint and fiscal balance from 2010. The numbers obviously have changed, but the message is still the same because good policy never goes out of style.

Needless to say, a simple solution isn’t the same as an easy solution. The various interest groups in Washington will team up with bureaucrats, politicians, and lobbyists to resist spending restraint.

P.S. A final snow update. Since my neighbors were kind enough to help me finish my driveway yesterday, I was inspired to “pay it forward” by helping to clear an older couple’s driveway this morning (not that I was much help since another neighbor brought a tractor with a plow).

It’s amazing that these good things happen without some government authority directing things!

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The fact that there’s widespread support for spending caps from groups that support limited government is hardly a surprise.

After all, we have lots of real world evidence that limits on the growth of government spending – if sustained for multi-year periods – can quickly shrink the burden of government and reduce red ink.

So the real key is figuring how to impose rules that ensure long-run spending restraint. That’s why, for instance, the Swiss Debt Brake is attracting so much positive attention.

But what’s really remarkable is that there’s also growing support for spending caps (sometimes called “expenditure limits”) from establishment organizations that normally lean to the left.

I’ve already highlighted how both the International Monetary Fund (twice!) and the Organization for Economic Cooperation and Development have acknowledged that spending caps are the most, if not only, effective fiscal rule.

By the way, these international bureaucracies are not motivated by a desire for limited government. Instead, they focus on fiscal balance. In other words, they want to control deficits and debt, which I think is a misguided focus since red ink is merely the symptom of the real problem of excessive spending.

Yet regardless of their focus, research from the IMF and OECD has shown that spending caps are the only approach that works (hardly a surprise since symptoms go away if underlying problems are addressed).

Now we can add another establishment voice to the chorus. The European Central Bank (ECB) has just published a study on the efficacy of fiscal rules for countries in the European Union. Let’s look at some excerpts to see what was found.

First, it was discovered that balanced budget rules aren’t very effective since they allow too much spending when the economy is growing and generating lots of tax revenue. Moreover, such rules are difficult to sustain during downturns when revenues fall.

…during a boom phase fiscal rules do not prevent fiscal policy from turning expansionary, while at times of a recession fiscal policy is potentially restrictive as governments need to comply with the rules’ requirements. This effect is assumed to be particularly pronounced in periods of limited fiscal space, while it might be less obvious in an environment of high fiscal space.

By the way, “fiscal space” refers to the maneuvering room politicians have. A government with a budget surplus, for instance, has “fiscal space” under a balanced-budget requirement.

But if a budget is balanced, then a government doesn’t have “fiscal space” if something happens (like a downturn) that causes lower revenues and higher spending.

Anyhow, the ECB study found that expenditure rules were the most effective.

We find strong evidence for fiscal rules being associated with higher fiscal space, i.e. the fiscal room for manoeuvre is higher in those countries which have established fiscal rules. This may not be surprising as fiscal rules are implemented to keep primary balances under control… When splitting the results by different types of fiscal rules, we find significant coefficients for expenditure and, to a lesser extent, balanced budget rules, but none for debt rules.

Here are some of the details about spending caps.

Regarding the different types of fiscal rules, we find particularly strong coefficients for expenditure rules, possibly reflecting the fact that expenditure rules are easier to monitor and are thereby more credible. …If a country had a fiscal rule in place for the past ten years the average fiscal space for those years is around 22% of GDP higher. The coefficient is proportional to the number of years in which a fiscal rule has been in place.

All this makes sense. The longer a spending cap is in place, the better the results. Which may be why more and more nations are moving in this direction.

The study highlights a very important reason why spending caps are successful. They make it difficult for politicians (as we’ve seen in Greece, Alberta, Puerto Rico, California, and Alaska) to increase spending when there is fiscal space (i.e., extra revenue).

…if governments have fiscal rules in place, the results suggest that governments can no longer fully use their fiscal space and (on average) are even forced to reduce their current expenditures.

Last but not least, the study also generated some findings that should be of considerable interest to fans of Keynesian economics. These are the folks who think an extra burst of government spending can stimulate an economy, so they are strongly opposed to balanced budget rules that are perceived to be “procyclical” since they require belt-tightening when there’s a recession and revenues shrink (while also allowing more spending when the economy is strong and revenues are growing).

But as you can see, spending caps generally avoid this problem.

…an increase in fiscal space indeed seems to be associated with fiscal policy being more procyclical. Yet if fiscal rules are in place, this positive link seems to be significantly smaller. …balanced budget rules…and expenditure rules…are correlated with a lower coefficient for fiscal space on procyclicality. This is in line with our findings above that expenditure rules might restrict discretionary expenditures.

This makes perfect sense. If you look at what’s happened with the Swiss Debt Brake (which is actually a spending cap), government spending has increased about 2 percent annually. That’s a frugal approach when the economy is growing and revenues are increasing, so advocates of small government can applaud.

But when the economy is weak and revenues are flat, Keynesians can applaud because government is still allowed to grow by 2 percent each year.

And since spending grows by less than the private sector over the long run, the net result is not only a smaller burden of government spending, but also shrinking debt levels, which is why we’re also getting applause from the OECD, IMF, and now the ECB.

P.S. Not all spending caps are created equal. There are very successful spending caps in places such as Switzerland and Hong Kong, in large part because these caps are explicitly designed to keep government from consuming ever-larger shares of economic output.

But I was recently in Texas as part of a program to discuss spending caps, organized by the Texas Public Policy Foundation.

Texas has a spending cap, but as you can see from this slide presented by State Senator Van Taylor, it’s not exactly working as well as the Swiss Debt Brake.

You can watch a video of the event by clicking here.

My message was that a spending cap is like a speed limit in a school zone. If the limit is 90 MPH, it doesn’t do any good.

The goal – at the very least – should be to prevent government from consuming ever-larger shares of economic output. This is the giant challenge in the developed world.

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Earlier this month, Americans for Prosperity held a “Road to Reform” event in Las Vegas.

I got to be the warm-up speaker and made two simple points.

First, we made a lot of fiscal progress between 2009 and 2014 because various battles over debt limits, shutdowns, and sequestration actually did result in real spending discipline.

Second, I used January’s 10-year forecast from the Congressional Budget Office to explain how easy it would be to balance the budget with a modest amount of future spending restraint.

Here’s my speech (you can see the entire event by clicking here).

I realize I sound uncharacteristically optimistic in these remarks, but it is amazing how easy it is to make progress with even semi-effective limits on the growth of government.

Genuine spending cuts would be very desirable, of course, but we move in the right direction so long as government spending grows slower than the private sector.

The challenge, needless to say, is convincing politicians to limit spending.

Well, we now have some new data in that battle. The CBO released its Update this morning, which means the numbers I shared in Nevada are now slightly out of date and that I need to re-do all my calculations based on the new 10-year forecast.

But it doesn’t really make a difference.  As you can see from the chart, we can balance the budget by 2021 if spending is capped so that it grows by 2 percent annually. And even if spending is allowed to grow by 3 percent per year (about 50 percent faster than projected inflation), the budget is balanced by 2024.

At this point, I feel compelled to point out that the goal should be smaller government, not fiscal balance.

But since fiscal policy debates tend to focus on how to eliminate red ink and balance the budget, I may as well take advantage of this misplaced focus to push a policy (spending restraint) that would be desirable even if we had a budget surplus.

And that’s the purpose of this video I narrated for the Center for Freedom and Prosperity back in 2010. The numbers obviously have changed over the past five years, but the underlying argument about the merits and efficacy of spending restraint are exactly the same today.

For more information on the merits of smaller government, here’s my tutorial on government spending.

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As far as I’m concerned, a key gateway test of whether someone might be a libertarian is whether they get upset when ordinary people are mistreated or brutalized by government.

Though admittedly any decent person should get upset by those examples.

So perhaps we need something more detailed to identify supporters of limited government, individual freedom, and personal responsibility. So when one of my friends sent me the “definitive political orientation test,” I immediately was tempted to see my score.

I don’t know if it’s the “definitive” test, but it seems reasonably accurate. As you can see, I’m about as libertarian as you can be without being an anarchist who wants zero government.

Though I should point out that there aren’t any questions on anarchism. I think the test probably assumes anarchism if your answers are both anti-welfare state and anti-defense.

This “circle test” is probably a simpler way of determining where you are on the big government-some government-no government spectrum.

But the most more sophisticated measure of libertarianism is Professor Bryan Caplan’s test. I only got a 94 out of a possible 160, which sounds bad, but that was still enough for my views to be considered “hard-core.”

And since we’re looking at online surveys, here are my results from the “I Side With” quiz. I don’t endorse candidates (as if anyone would care), but this quiz suggests that Rand Paul is closest to my views, followed by Scott Walker and Marco Rubio.

For what it’s worth, I’m not exactly shocked to see Hillary Clinton and Bernie Sanders at the bottom.

By the way, since we’ve shifted to a discussion of the 2016 race, I was the warm-up speaker for Governor Jeb Bush at a recent “Road to Reform” event in New Hampshire sponsored by Americans for Prosperity. Here’s what I said about fixing the budget mess in Washington.

You can watch the entire event and also see what the governor said by clicking here.

And for folks in Nevada, I’ll be the warm-up speaker for a similar event with Ted Cruz on August 14.

P.S. The most inaccurate political quiz was the one that classified me as a “moderate” with “few strong opinions.”

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When I first came to Washington back in the 1980s, there was near-universal support and enthusiasm for a balanced budget amendment among advocates of limited government.

The support is still there, I’m guessing, but the enthusiasm is not nearly as intense.

There are three reasons for this drop.

  1. Political reality – There is zero chance that a balanced budget amendment would get the necessary two-thirds vote in both the House and Senate. And if that happened, by some miracle, it’s highly unlikely that it would get the necessary support for ratification in three-fourths of state legislatures.
  2. Unfavorable evidence from the statesAccording to the National Conference of State Legislatures, every state other than Vermont has some sort of balanced budget requirement. Yet those rules don’t prevent states like California, Illinois, Connecticut, and New York from adopting bad fiscal policy.
  3. Favorable evidence for the alternative approach of spending restraint – While balanced budget rules don’t seem to work very well, policies that explicitly restrain spending work very well. The data from Switzerland, Hong Kong, and Colorado is particularly persuasive.

Advocates of a balanced budget amendment have some good responses to these points. They explain that it’s right to push good policy, regardless of the political situation. Since I’m a strong advocate for a flat tax even though it isn’t likely to happen, I can’t argue with this logic.

Regarding the last two points, advocates explain that older versions of a balanced budget requirement simply required a supermajority for more debt, but newer versions also include a supermajority requirement to raise taxes. This means – at least indirectly – that the amendment actually is a vehicle for spending restraint.

This doesn’t solve the political challenge, but it’s why advocates of limited government need to be completely unified in favor of tax-limitation language in a balanced budget amendment. And they may want to consider being more explicit that the real goal is to restrain spending so that government grows slower than the productive sector of the economy.

Interestingly, even the International Monetary Fund (which is normally a source of bad analysis) understands that spending limits work better than rules that focus on deficits and debt.

Here are some of the findings from a new IMF study that looks at the dismal performance of the European Union’s Stability and Growth Pact. The SGP supposedly limited deficits to 3 percent of GDP and debt to 60 percent of GDP, but the requirement failed largely because politicians couldn’t resist the temptation to spend more in years when revenue grew rapidly.

An analysis of stability programs during 1999–2007 suggests that actual expenditure growth in euro area countries often exceeded the planned pace, in particular when there were unanticipated revenue increases. Countries were simply unable to save the extra revenues and build up fiscal buffers. …This reveals an important asymmetry: governments were often unable to preserve revenue windfalls and faced difficulties in restraining their expenditure in response to revenue shortfalls when consolidation was needed. …The 3 percent of GDP nominal deficit ceiling did not prevent countries from spending their revenue windfalls in the mid-2000s. … Under the SGP, noncompliance has been the rule rather than the exception. …The drawbacks of the nominal deficit ceiling are particularly apparent when the economy is booming, as it is compatible with very large structural deficits.

The good news is that the SGP has been modified and now (at least theoretically) requires spending restraint.

The initial Pact only included three supranational rules… As of 2014, fiscal aggregates are tied by an intricate set of constraints…government spending (net of new revenue measures) is constrained to grow in line with trend GDP. …the expenditure growth ceiling may seem the most appealing. This indicator is tractable (directly constraining the budget), easy to communicate to the public, and conceptually sound… Based on simulations, Debrun and others (2008) show that an expenditure growth rule with a debt feedback ensures a better convergence towards the debt objective, while allowing greater flexibility in response to shocks. IMF (2012) demonstrates the good performance of the expenditure growth ceiling

This modified system presumably will lead to better (or less worse) policy in the future, though it’s unclear whether various nations will abide by the new EU rules.

One problem is that the overall system of fiscal rules has become rather complicated, as illustrated by this image from the IMF study.

Which brings us back to the third point above. If the goal is to restrain spending (and it should be), then why set up a complicated system that first and foremost is focused on red ink?

That’s why the Swiss Debt Brake is the right model for how to get spending under control. And this video explains why the objective should be spending restraint rather than deficit reduction.

And for those who fixate on red ink, it’s worth noting that if you deal with the underlying disease of too much government, you quickly solve the symptom of deficits.

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It’s amazingly simple to reduce the burden of government spending. Policy makers simply need to impose some modest spending restraint so that government doesn’t grow faster than the economy’s productive sector.

In a display of humility that can only be found in Washington, DC, I call this Mitchell’s Golden Rule.

And, amazingly, even the International Monetary Fund agrees that spending caps are the most effective strategy for good fiscal policy.

Since I’m not a fan of the IMF, this is definitely a case of strange bedfellows!

Let’s look at some case studies of what happens when there are limits on the growth of government.

A review of data for 16 nations reveals that multi-year periods of spending restraint lead to lower fiscal burdens and less red ink.

Between 2009 and 2014, a de facto spending freeze at the federal level dramatically reduced burden of spending in the United States.

Thanks to a spending cap, Switzerland has shrunk the public sector, balanced its budget and reduced government debt .

These real-world examples provide compelling evidence on the value of long-run spending restraint.

By the way, when I challenge my leftist friends to provide similar examples of nations that have achieved good results by raising taxes, they become uncharacteristically quiet. Just like you can hear crickets chirping when I present them with my two-question challenge to identify statist nations that are good role models.

But I’m digressing. Let’s get back to the main topic.

In addition to the data cited above, there are also hypothetical examples showing why it is important to have government grow slower than the private sector.

A column published by Investor’s Business Daily reveals that the United States would have avoided the multi-trillion dollar deficits of the Obama years had a Swiss-style spending cap been in effect.

The oil-rich Canadian province of Alberta would have avoided its current fiscal crisis had it followed my Golden Rule over the past 10 years.

Now let’s add to our list of hypothetical examples. Writing for Real Clear Markets, Professor Jeffrey Dorfman of the University of Georgia cleverly suggests that Republicans simply take Bill Clinton’s last budget and then adjust it for inflation and population growth.

…a Clinton is ready to show them a path to nearly everything a dream Republican budget might have. …President Bill Clinton’s last budget was for fiscal year 2001, which began just before the 2000 election. That budget spent $1.86 trillion, less than half of what President Obama is proposing. If this final Clinton budget is adjusted upwards for subsequent inflation (32 percent) and population growth (12 percent), we arrive at a figure of $2.76 trillion, still only 69 percent as much as President Obama wants to spend. This difference is what Republicans should exploit.

And since federal revenues for next year are projected to be $3.46 trillion, that means not only a smaller burden of government spending, but also a huge budget surplus.

Professor Dorfman then proposes that this gives Republicans leeway to show that they can compromise.

… appropriate spending for each agency equal to a minimum of the population and inflation adjusted amount in President Bill Clinton’s final budget plus 50 percent of the additional growth between President Obama’s proposal and the adjusted Clinton budget. That is, Republicans would not even try to roll federal spending back to when we last had a balanced budget, but only move to reverse half of the enormous spending increases that have occurred under Presidents George W. Bush and Barack Obama. Such a budget would spend $3.25 trillion and would come with an estimated budget surplus of $220 billion based on the latest Congressional Budget Office projections of 2016 federal revenue.

Dorfman hypothesizes that this rhetorical approach will give advocates of smaller government the upper hand.

After all, the statists presumably wouldn’t want to say Bill Clinton’s last budget was somehow draconian or heartless. And if Republicans are proposing to take that Clinton budget, adjust it for inflation and population, and then add even more money, it should be equally improbably to characterize their proposals as being draconian and heartless.

At a time when Hillary Clinton certainly appears set to run for president, Republicans can stake their claim to reduced spending in many areas by pointing out that they are being 50 percent more generous in inflation and population adjusted spending than President Clinton was. Will Democrats in Congress, or even President Obama, want to claim that President Clinton was insufficiently generous with the poor and working classes? Will they really want to take a stand in opposition to the Clintons at this point in time? I doubt it. Certainly Hillary Clinton is unlikely to want to criticize a Clinton budget. That will make other Democrats hesitate and likely bite their tongues. Using the Clintons against the rest of the Democrats offers the Republicans in Congress a clear path to almost all their budgetary wishes.

I agree that this is an astute strategy. I particularly like it because it puts the focus on how much government has grown since Bill Clinton left office.

And the notion of letting the budget grow as fast as population plus inflation is very similar to Colorado’s Taxpayer Bill of Rights, which is the best spending cap in America.

That being said, I’m far less optimistic than Professor Dorfman that this approach will produce a victory in the short run. Simply stated, President Obama is too ideologically committed to big government. Moreover, I doubt that he will feel any special pressure to accept Bill Clinton’s last budget as some sort of baseline.

But having this debate would still be useful and could pay dividends in 2017 and beyond.

P.S. Speaking of President Obama, let’s close with some political humor that showed up in my inbox yesterday.

P.S. If you want more Obama humor, check out this t-shirt, this Pennsylvania joke, this Reagan-Obama comparison, this Wyoming joke, this Bush-Obama comparison, this video satire, this bumper sticker, and this very timely bit of Bowe Bergdahl humor.

And sometime there’s even humor that makes me sympathize with the President.

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