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Archive for the ‘Mitchell’s Golden Rule’ Category

Iceland is a tiny little country with just 338,000 people (about the population of Santa Ana, CA), but that doesn’t mean it can’t teach us lessons about public policy.

I wrote about the nation’s approach to fisheries in 2016, and explained that the property rights-based system is the best way of protecting fish stocks from over-harvesting.

And in 2013, I wrote about how modest spending restraint was helping to solve fiscal problems created by the financial crisis.

Today, I want to further explore Iceland’s fiscal policy, largely because of this remarkable chart that accompanied a Bloomberg report on the country’s budget strategy.

As you can see, debt skyrocketed during the financial crisis and has since plummeted at a very rapid rate.

This shows debt reduction is possible. Indeed, there can be huge reductions in a very short period of time.

So there may be hope for nations that are in the midst of fiscal crisis (such as Greece), nations that are about to suffer fiscal crisis (Italy is a prime candidate), and nations that will suffer a crisis if there isn’t reform (most developed nations, including the United States).

But what are the specific policy lessons?

Here are some excerpts from the accompanying article, which basically tells us that the government is focused on spending restraint.

Iceland will continue to reduce public debt and sustain a budget surplus even as it lowers taxes in the next five years, Finance Minister Bjarni Benediktsson said. The plan is part of a financial road map… The balancing act between austerity and the proposed fiscal concessions means less room for the government to…step up other spending… “We will need to impose certain measures of restriction,” Benediktsson said. The government may have to seek cost savings of as much as 5 billion kronur ($42 million), he said. …The financial plan projects a decrease in taxes as well as the Treasury’s debt levels and interest burden. It also expects the bank tax to be lowered in four steps.

But the article didn’t tell us why Iceland’s debt fell so quickly.

So I dug into the IMF’s World Economic Outlook database and crunched some numbers. I specifically wanted to find out why debt fell, both before and after the 2008 crisis.

And I focused on three sets of numbers.

  • Annual inflation rate
  • Annual growth of government spending burden
  • Annual increase in nominal gross domestic product

Here are those numbers, both for the years leading up to the 2008 crisis, as well as what happened starting in 2009.

For both the 2001-07 period and 2009-19 period, Iceland followed my Golden Rule. Government spending (the orange bars) grew slower than the economy (the grey bars).

So it shouldn’t be a surprise that debt fell during both eras.

But debt fell much faster starting in 2009 for the simple reason that the gap between spending growth and GDP growth was very significant over the past 10 years. This is the reason for the big reduction in debt.

And this spending restraint also generated some data that’s even more important – the burden of government spending has dropped from more than 48 percent of economic output in 2009 to less than 41 percent of GDP this year.

During the 2001-2007 period, by contrast, Iceland only barely satisfied the Golden Rule. Indeed, one could argue that spending was growing much too fast since the economy was in an unsustainable boom (Ireland was similarly profligate during the same period).

P.S. I recently shared an excellent IMF study showing three examples of big debt reductions in the pre-World War I era.

P.P.S. Unsurprisingly, the OECD has been pushing for higher taxes in Iceland.

P.P.P.S. If you want to read about all of Iceland’s pro-market economic, Prof. Hannes Gissurarson has a must-read article in Econ Journal Watch.

P.P.P.P.S. Voters in Iceland had an opportunity to vote on bank bailouts and 93 percent said no.

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In the absence of genuine entitlement reform, the United States at some point is going to suffer from a debt crisis.

But red ink is merely a symptom. I used numbers from Greece in this interview to underscore the fact that the real problem is government spending.

The discussion was triggered by comments from the Chairman of the Federal Reserve.

Federal Reserve Chairman Jerome Powell said Wednesday that reducing the federal debt needs to return to the forefront of the agenda, warning that the government’s finances are unsustainable. “I do think that deficits matter and do think it’s not really controversial to say our debt can’t grow faster than our economy indefinitely — and that’s what it’s doing right now,” Powell said.

As I noted in my comments, Powell is right, but he’s focusing on the wrong variable.

The real crisis is that spending is growing faster than the private sector (Powell needs to learn the six principles to guide spending policy).

To be more specific, politicians are violating my Golden Rule.

Spending grew too fast under Bush. It grew too fast under Obama (except for a few years when the “Tea Party” was in the ascendancy). And it’s growing too fast under Trump.

Most worrisome, the burden of spending is expected to grow faster than the private sector far into the future according to the long-run forecast from the Congressional Budget Office.

That doesn’t mean we’ll have a crisis this year or next year. We probably won’t even have a crisis in the next 10 years or 20 years.

But I cited Greek data in the interview to point out that excessive spending eventually does create a major problem.

Here’s the data from International Monetary Fund’s World Economic Outlook database. To make matters simple (I should have done this for the interview as well), I adjusted the numbers for inflation.

So how can America avoid a Greek-style fiscal nightmare?

Simple, just impose a spending cap. At the end of the interview, I added a plug for the very successful system in Switzerland, but I’d also be happy if we copied Hong Kong’s spending cap. Or the Taxpayer Bill of Rights from Colorado.

The bottom line is that spending restraint works and a constitutional spending cap is the best way to achieve permanent fiscal discipline.

P.S. By contrast, proponents of “Modern Monetary Theory” argue governments can finance ever-growing government by printing money. For what it’s worth, nations that have used central banks to finance big government (most recently, Venezuela and Zimbabwe) are not exactly good role models.

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I’ve been in Lebanon for the past few days, but not because I’m seeking a replacement for the Princess of the Levant.

Instead, I’m here because the Lebanese Institute for Market Studies arranged a briefing in the Parliament on the perilous state of the nation’s finances.

Lebanon is in trouble because policy makers have violated my Golden Rule by allowing spending to grow too fast. As such, even though the overall fiscal burden of government is relatively modest, red ink has climbed to about 150 percent of economic output. That’s higher than Italy today, and higher than Greek debt when that nation’s fiscal crisis occurred.

I’ve pointed out before that there’s not an automatic tipping point when a debt crisis occurs. It happens whenever investors decide that they no longer trust that a government will pay its debt.

I’m not going to predict exactly when Lebanon reaches that point, but I suspect sooner rather than later. Unless, of course, Lebanon changes direction.

And that’s exactly what I’m recommending. I made three points.

First, higher taxes are not a solution. Given the IMF’s awful track record of pushing tax hikes in the region, I repeated my standard joke about arresting any of those bureaucrats who enter the country.

Second, a rule requiring a balanced budget is not the ideal solution. Not because balanced budgets are a bad idea, but because such rules put fiscal policy at the mercy of the business cycle.

This chart showing Lebanon’s revenue makes my point. When there’s strong growth and revenues are increasing rapidly (between 2001-2004 and 2006-2009), big spending increases are possible. But when the economy is weak and revenues are flat (between 2004-2006 and 2009-2016), politicians are very resistant to fiscal discipline during a downturn.

Even the IMF and OECD agree with me that this is a big reason why anti-deficit rules don’t work.

Which leads me to my third point, which is that Lebanon should copy Hong Kong and Switzerland by adopting an annual limit on spending growth.

I didn’t specify a specific number for a spending cap. Instead, I emphasized that the key goal is to make sure spending – over time – grows slower than the private sector.

But I did show what would have happened if lawmakers had limited nominal annual spending increases to 6 percent starting in 1992 (that sounds far too high, but keep in mind that inflation averaged about 4 percent over the past 25 years).

I told the audience that they would have a budget surplus today, and also very little debt, if a spending cap had been in effect (same results would hold for America).

And I also pointed out that lawmakers could avoid boom-bust budgeting with a long-run spending cap. With a fixed limit on annual spending increases, they would not have to cut outlays during a recession, but they also would not be able to have a spending orgy during a boom.

That’s a good recipe for Lebanon. It’s also the right recipe for the United States.

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I wrote yesterday about the continuing success of Switzerland’s spending cap.

Before voters changed the Swiss constitution, overall expenditures were growing by an average of 4.6 percent annually. Ever since the “debt brake” took effect, though, government spending has increased by an average of just 2.1 percent.

For all intents and purposes, Switzerland is getting good results because it is now complying with fiscal policy’s Golden Rule.

Unfortunately, the same cannot be said for the United States. The Congressional Budget Office just released its new long-run forecast of the federal budget.

The most worrisome factoid in the report is that the overall burden of federal spending is going to expand significantly over the next three decades, jumping from 20.6 percent of the economy this year to 29.3 percent of economic output in 2048.

And why will the federal budget consume an ever-larger share of economic output? The chart tells you everything you need to know. Our fiscal situation is deteriorating because government is growing faster than the private sector.

Actually, the chart doesn’t tell you everything you need to know. It doesn’t tell us, for instances, that tax increases simply make a bad situation worse since politicians then have an excuse to avoid much-need reforms.

And the chart also doesn’t reveal that entitlement programs are the main cause of ever-expanding government.

But the chart does a great job of showing that our fundamental problem is growth of government. Which presumably makes it obvious that the only logical solution is a spending cap.

The good news is that there already is a spending cap in Washington.

But the bad news is that it only applies to “appropriations,” which are a small share of the overall federal budget.

And the worse news is that politicians voted to bust that spending cap in 2013, 2015, and earlier this year.

The bottom line is that we know spending restraint works, but the challenge is figuring out a system that actually ties the hands of politicians. Switzerland and Hong Kong solved that problem by making their spending caps part of their national constitutions.

Sadly, there’s little immediate hope of that kind of reform in the United States.

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A balanced budget requirement is neither necessary nor sufficient for good fiscal policy.

If you want proof for that assertion, check out states such as IllinoisCalifornia, and New Jersey. They all have provisions to limit red ink, yet there is more spending (and more debt) every year. There are also anti-deficit rules in nations such as GreeceFrance, and Italy, and those countries are not exactly paragons of fiscal discipline.

The real gold standard for good fiscal policy is my Golden Rule. And the best way to make sure government doesn’t grow faster than the private sector is to have a constitutional rule limiting the growth of government.

That’s why I’m a big fan of the “debt brake” in Switzerland’s constitution and Article 107 in Hong Kong’s constitution.

And it’s also why the 49 other states, assuming they want an effective fiscal rule, should look at Colorado’s Taxpayer Bill of Rights (TABOR) as a role model.

Colorado’s Independence Institute has a very informative study on how TABOR works and the degree to which it has been effective. Here’s a good description of the system.

Colorado voters adopted The Taxpayer’s Bill of Rights in 1992. TABOR allows government spending to grow each year at the rate of inflation-plus-population. Government can increase faster whenever voters consent. Likewise, tax rates can be increased whenever voters consent. …The Taxpayer’s Bill of Rights requires that excess government revenues be refunded to taxpayers, unless taxpayers vote to let the government keep the revenue.

And here are the headline results.

Cumulatively, TABOR refunds have been over $800 per Coloradan, or $3,200 for a family of four. …If Colorado government had continued growing at the same high rate (8.56% compound annual rate) as in 1983-92, the average Coloradan would have paid an additional $442 taxes in 2012. The cumulative two-decade savings per Coloradan are $6,173—or more than $24,000 for a family of four.

However, the study notes that TABOR was most effective during its first 10 years. It was less effective in its second decade because voters acquiesced to a “TABOR time-out” as part of referendum C in 2005.

The final decade included the largest tax increase in Colorado history, enacted as Referendum C in 2005. Decade-2 was also marked by increasing efforts to evade TABOR by defining nearly 60% of the state budget as “exempt” from TABOR. …Rapid government growth resumed in Decade-2, mainly because of Referendum C.

This chart from the study shows that outcomes were much better during the first decade of TABOR.

But a weakened TABOR is better than nothing. Here’s the conclusion of the report.

The Taxpayer’s Bill of Rights Amendment has worked well to achieve its stated intention to “slow government growth.” Although government has still continued to grow significantly faster than the rate of population-plus-inflation, the Taxpayer’s Bill of Rights did partially dampen excess government growth. …In terms of economic vitality, Colorado’s Decade-1 was best for Colorado. Unlike in the pre-TABOR decade, or in TABOR Decade-2 with its record increase in taxes and spending, because of Referendum C. Colorado’s first TABOR decade saw the state economy far outperform the national economy.

But keep in mind that the economic gains occurred in the first decade.

The bottom line is that spending caps are like speed limits in school zones. If they’re set too high, that defeats the purpose.

And in Colorado, the vote for Referendum C allowed a spending surge that made a mockery of TABOR.

But only temporarily, which is why that period was known as the “TABOR time-out.” The rules once again limit spending growth to population plus inflation.

For instance, TABOR made it difficult for state politicians to spend the additional tax revenues produced by marijuana legalization.

Needless to say, the political crowd hates having their hands tied. Which is why the pro-spending lobbies are agitating to once again gut TABOR. Here’s a clip from a local news report that does a good job of describing the current fight.

The battle actually started a couple of years ago. Here are some excerpts from a 2016 report by the Associated Press.

By 2030, Colorado’s population will grow from 5 million to 7 million people, thanks in part to a strong and diverse economy, the state’s famed Rocky Mountain quality of life, and its constitutionally-mandated low taxes. …The state’s Democratic governor, John Hickenlooper, is trying to find ways to squeeze more revenue for roads from the budget, while Republicans don’t want to tamper with the fabled 1992 constitutional amendment known as TABOR that keeps a tight limit on those taxes. …Under TABOR, voters must approve any state and local tax hike. Democrats are still stung by a resounding defeat of a 2013 ballot initiative to raise $1 billion for schools.

I’m amused by the fact that the above passage starts by noting the state has a “strong” economy. Too bad the reporter didn’t put 2 and 2 together and recognize that TABOR deserves some of the credit.

Likewise, this next passage cites a leftist who acknowledges growth in the state, but pretends that it’s exogenous, like the weather.

Liberals think that’s a recipe for disaster, especially in a growing state. “What we have to stop doing is pitting necessary priorities like roads against other necessary priorities like schools and colleges,” said Tim Hoover, spokesman for the Colorado Fiscal Institute, which favors dismantling the amendment. “TABOR forces us to do that.” So far the low-tax crowd is winning. Even Hickenlooper acknowledges there isn’t a popular appetite to raise taxes, and his hopes of changing the classification of an arcane fee in the budget to free up revenue are opposed by Republicans… Republicans say the real problem is growing Medicaid spending. Colorado, which expanded the program under the Affordable Care Act, is spending about $2.5 billion on the health care plan.

Note that TABOR critics object to various interest groups having to compete for money.

But that’s exactly why a spending limit is so desirable. Politicians are forced to abide by the rules that apply to every household and business in the state. In other words, they have to (gasp!) prioritize.

Let’s conclude by reviewing some passages from a pro-TABOR column published last week in the Steamboat newspaper.

Colorado’s  has grown by nearly two-thirds since 1992, one of the fastest increases in the country. If you are part of the more than two million new residents who have arrived over this time, there are a few things you should know…the Taxpayer’s Bill of Rights is responsible for much of the state’s economic success, which likely drew you here in the first place. Between 1992 and 2016, median household income in Colorado grew by 30 percent, adjusted for inflation. …TABOR helped end years of economic stagnation and laid the groundwork for the state’s future success by keeping resources in the hands of Colorado residents who could put them to their highest valued use and checking overzealous government spending. …Its requirement that excess revenues must be refunded to taxpayers has also resulted in more than $2 billion being returned to the private economy… TABOR has empowered voters to reject roughly a dozen advocacy-backed tax hike proposals.

My favorite part is when they cite critics, who confirm that TABOR is successful.

Denver Post editorial last year complained, “TABOR’s powerful check on government spending in reality has been a padlock on the purse-strings of the General Assembly.” The check on spending is exactly the point, and it still allows spending to grow in-line with inflation and population growth. If government wants more money, all it has to do is ask. Requiring consent is hardly a “padlock.”

Amen. We could use some more padlocks in the rest of the country. TABOR should be nationally emulated, not locally emasculated.

P.S. Enjoy this amusing video from the Independence Institute. It shows politicians in a group therapy session about TABOR.

P.P.S. By the way, there is a spending cap in Washington, though it only applies to a small portion of the budget (appropriated outlays). Sadly, that very modest example of fiscal restraint has not been very effective. The group therapy session in Washington, otherwise known as Congress, voted to bust those spending caps in 2013, 2015, and earlier this year. Sort of D.C.’s lather-rinse-repeat version of Referendum C.

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I’ve half-joked in the past that spending restraint is the answer to every fiscal problem.

But I wouldn’t be surprised if it’s the right answer to 98 percent of fiscal problems. Some fiscal discipline is what we need in America, for instance, and it’s certainly an approach that works whenever and wherever it is tried.

Could it also be the answer in Jordan, which has stumbled into a fiscal crisis and is now facing domestic unrest?

The trouble began in January when the government announced a big IMF-supported tax increase. Here’s some of what was reported by Reuters.

Jordans cabinet announced on Monday a major package of IMF-guided tax hikes… The package announced on state media includes removing exemptions on general sales tax and unifying low 4 to 8 percent rates on a large number of items at 10 percent while leaving it at 16 percent ceiling for others, alongside raising special taxes on tobacco, premium gasoline and streamlining customs duties.

Interestingly, the article acknowledged that the country got in a fiscal mess because of too much spending.

The debt is at least in part due to successive governments adopting an expansionist fiscal policy characterized by job creation in the bloated public sector, and by lavish subsidies for bread and other staple goods. …Economists said Jordans ability to maintain a costly subsidy system and a large state bureaucracy was increasingly untenable in the absence of large foreign capital inflows or infusions of foreign aid.

But politicians almost always prefer tax hikes rather than spending restraint (even though – or perhaps because – higher taxes are not an effective way of controlling red ink).

The victims of those tax increases are not happy. As reported earlier this month, they took to the streets.

Jordanians took to the streets of the capital Amman on Sunday in a fourth day of nightly protests against IMF-backed price increases that have shaken the kingdom, witnesses said. …demonstrators who converged near the cabinet office chanted slogans calling for the sacking of Prime Minister Hani Mulki and saying they would disband only if the government rescinded a tax bill it sent to parliament last month which critics say worsens living standards. …Public anger over IMF-driven government policies has grown since a steep general sales tax hike earlier this year… The government says it needs more funds for public services and argues that tax reforms reduce social disparities by placing a heavier burden on high earners.

And the protests worked.

The New York Times has the cheerful news.

The government of Jordan announced on Thursday that it would withdraw a divisive tax bill after nationwide protests rocked the country, leading to the resignation of the prime minister and his cabinet. The newly appointed prime minister, Omar Razzaz, said in a statement that he had consulted members of both houses of Parliament, and that there was a consensus that the tax bill should be withdrawn. …The decision to withdraw the bill, which proposed increasing the tax rate on workers by at least five percentage points and on businesses by 20 to 40 percentage points, was lauded by many in Jordan.

Incidentally, taxpayers in the United States have been subsidizing Jordanian profligacy.

In 2015, the Obama administration and Jordan signed a three-year agreement in which the United States pledged $1 billion in assistance annually, subject to the approval of Congress. More recently, Washington pledged $6.3 billion in aid through 2022, making Jordan one of the top recipients of American foreign assistance.

These three news reports were interesting, but I wondered if they told the full story.

Maybe, just maybe, the IMF is right and tax increases are necessary because there is no leeway to reduce the burden of government spending. Perhaps the government already has been complying with Mitchell’s Golden Rule and has slashed the budget, meaning that higher revenues are the only feasible option still on the table.

So I decided to check the IMF’s World Economic Outlook database. Lo and behold, I discovered that the budget has soared from 2 billion dinar in 2000 to more than 9 billion dinar this year. What’s especially remarkable is that government spending has grown far faster than needed to keep pace with inflation.

In other words, what happened in Jordan is exactly what happened in Greece. Government grew too fast. But not just Greece. The mess in Jordan is a repeat of what happened in Western Australia. In Puerto Rico as well. And don’t forget Alberta and Alaska. The list could go on and on.

It’s sort of like the sun rising in the east and setting in the west. Or the swallows returning to Capistrano.

And for those who value predictability, it’s no surprise to once again see the IMF pushing for higher taxes. Those bureaucrats are the Dr. Kevorkian of the global economy and there’s only one medicine they prescribe.

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I wrote two days ago about how the country of Georgia has achieved impressive economic performance thanks to major reforms to reduce the size and scope of government.

Indeed, Georgia jumped from #56 to #8 in Economic Freedom of the World between 2004 and 2015, a remarkable climb.

Today, I want to focus on what the country has achieved with regard to fiscal policy.

In part, this is an opportunity to highlight that Georgia is one of many nations to adopt a flat tax. Georgia’s 20 percent flat tax not only has a single rate, but also doesn’t have destructive forms of double taxation like a death tax or capital gains tax (it also has an Estonian-style corporate tax).

But my main goal is to draw attention to the fiscal rules in Georgia. Both the nation’s Constitution and its Organic Law have provisions that are designed to limit the growth of government.

First, let’s look at Article 94 of the Georgian Constitution, which states that no new taxes are allowed unless approved by a vote of the people.

The Organic Law also has good provisions on taxation, most notably a prohibition on using a referendum to adopt a discriminatory “progressive” tax (too bad we don’t have such a provision in America!).

Here’s the part that I really like.

There’s an aggregate spending cap. The government’s budget can’t consume more than 30 percent of economic output.

It also includes European Union-style “Maastricht” limits on deficits and debt, though I’ll simply observe that those rules are irrelevant if there’s a limit on overall spending.

In any event, the burden of spending in Georgia does comply with the spending cap, according to IMF data. Though I’ll be curious to see what happens if there’s ever a serious recession. If that happens, GDP falls, which could make it politically difficult to obey the cap.

Which is why I prefer the Swiss approach of simply allowing government to grow by a small amount every year. That seems more politically sustainable. But I’m happy with anything to fulfills my Golden Rule.

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