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Archive for the ‘Mitchell’s Golden Rule’ Category

When writing a few days ago about the newly updated numbers from Economic Freedom of the World, I mentioned in passing that New Zealand deserves praise “for big reforms in the right direction.”

And when I say big reforms, this isn’t exaggeration or puffery.

Back in 1975, New Zealand’s score from EFW was only 5.60. To put that in perspective, Greece’s score today is 6.93 and France is at 7.30. In other words, New Zealand was a statist basket cast 40 years ago, with a degree of economic liberty akin to where Ethiopia is today and below the scores we now see in economically unfree nations such as Ukraine and Pakistan.

But then policy began to move in the right direction, especially between 1985 and 1995, the country became a Mecca for market-oriented reforms. The net result is that New Zealand’s score dramatically improved and it is now comfortably ensconced in the top-5 for economic freedom, usually trailing only Hong Kong and Singapore.

To appreciate what’s happened in New Zealand, let’s look at excerpts from a 2004 speech by Maurice McTigue, who served in the New Zealand parliament and held several ministerial positions.

He starts with a description of the dire situation that existed prior to the big wave of reform.

New Zealand’s per capita income in the period prior to the late 1950s was right around number three in the world, behind the United States and Canada. But by 1984, its per capita income had sunk to 27th in the world, alongside Portugal and Turkey. Not only that, but our unemployment rate was 11.6 percent, we’d had 23 successive years of deficits (sometimes ranging as high as 40 percent of GDP), our debt had grown to 65 percent of GDP, and our credit ratings were continually being downgraded. Government spending was a full 44 percent of GDP, investment capital was exiting in huge quantities, and government controls and micromanagement were pervasive at every level of the economy. We had foreign exchange controls that meant I couldn’t buy a subscription to The Economist magazine without the permission of the Minister of Finance. I couldn’t buy shares in a foreign company without surrendering my citizenship. There were price controls on all goods and services, on all shops and on all service industries. There were wage controls and wage freezes. I couldn’t pay my employees more—or pay them bonuses—if I wanted to. There were import controls on the goods that I could bring into the country. There were massive levels of subsidies on industries in order to keep them viable. Young people were leaving in droves.

Maurice then discusses the various market-oriented reforms that took place, including spending restraint.

What’s especially impressive is that New Zealand dramatically shrank government bureaucracies.

When we started this process with the Department of Transportation, it had 5,600 employees. When we finished, it had 53. When we started with the Forest Service, it had 17,000 employees. When we finished, it had 17. When we applied it to the Ministry of Works, it had 28,000 employees. I used to be Minister of Works, and ended up being the only employee. …if you say to me, “But you killed all those jobs!”—well, that’s just not true. The government stopped employing people in those jobs, but the need for the jobs didn’t disappear. I visited some of the forestry workers some months after they’d lost their government jobs, and they were quite happy. They told me that they were now earning about three times what they used to earn—on top of which, they were surprised to learn that they could do about 60 percent more than they used to!

And there was lots of privatization.

…we sold off telecommunications, airlines, irrigation schemes, computing services, government printing offices, insurance companies, banks, securities, mortgages, railways, bus services, hotels, shipping lines, agricultural advisory services, etc. In the main, when we sold those things off, their productivity went up and the cost of their services went down, translating into major gains for the economy. Furthermore, we decided that other agencies should be run as profit-making and tax-paying enterprises by government. For instance, the air traffic control system was made into a stand-alone company, given instructions that it had to make an acceptable rate of return and pay taxes, and told that it couldn’t get any investment capital from its owner (the government). We did that with about 35 agencies. Together, these used to cost us about one billion dollars per year; now they produced about one billion dollars per year in revenues and taxes.

Equally impressive, New Zealand got rid of all farm subsidies…and got excellent results.

…as we took government support away from industry, it was widely predicted that there would be a massive exodus of people. But that didn’t happen. To give you one example, we lost only about three-quarters of one percent of the farming enterprises—and these were people who shouldn’t have been farming in the first place. In addition, some predicted a major move towards corporate as opposed to family farming. But we’ve seen exactly the reverse. Corporate farming moved out and family farming expanded.

Maurice also has a great segment on education reform, which included school choice.

But since I’m a fiscal policy wonk, I want to highlight this excerpt on the tax reforms.

We lowered the high income tax rate from 66 to 33 percent, and set that flat rate for high-income earners. In addition, we brought the low end down from 38 to 19 percent, which became the flat rate for low-income earners. We then set a consumption tax rate of 10 percent and eliminated all other taxes—capital gains taxes, property taxes, etc. We carefully designed this system to produce exactly the same revenue as we were getting before and presented it to the public as a zero sum game. But what actually happened was that we received 20 percent more revenue than before. Why? We hadn’t allowed for the increase in voluntary compliance.

And I assume revenue also climbed because of Laffer Curve-type economic feedback. When more people hold jobs and earn higher incomes, the government gets a slice of that additional income.

Let’s wrap this up with a look at what New Zealand has done to constrain the burden of government spending. If you review my table of Golden Rule success stories, you’ll see that the nation got great results with a five-year spending freeze in the early 1990s. Government shrank substantially as a share of GDP.

Then, for many years, the spending burden was relatively stable as a share of economic output, before then climbing when the recession hit at the end of last decade.

But look at what’s happened since then. The New Zealand government has imposed genuine spending restraint, with outlays climbing by an average of 1.88 percent annually according to IMF data. And because that complies with my Golden Rule (meaning that government spending is growing slower than the private sector), the net result according to OECD data is that the burden of government spending is shrinking relative to the size of the economy’s productive sector.

P.S. For what it’s worth, the OECD and IMF use different methodologies when calculating the size of government in New Zealand (the IMF says the overall burden of spending is much smaller, closer to 30 percent of GDP). But regardless of which set of numbers is used, the trend line is still positive.

P.P.S. Speaking of statistical quirks, some readers have noticed that there are two sets of data in Economic Freedom of the World, so there are slightly different country scores when looking at chain-weighted data. There’s a boring methodological reason for this, but it doesn’t have any measurable impact when looking at trends for individual nations such as New Zealand.

P.P.P.S. Since the Kiwis in New Zealand are big rugby rivals with their cousins in Australia, one hopes New Zealand’s high score for economic freedom (3rd place) will motivate the Aussies (10th place) to engage in another wave of reform. Australia has some good polices, such as a private Social Security system, but it would become much more competitive if it lowered its punitive top income tax rate (nearly 50 percent!).

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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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Much of my work on fiscal policy is focused on educating audiences about the long-run benefits of small government and modest taxation.

But what about the short-run issue of how to deal with a fiscal crisis? I have periodically weighed in on this topic, citing research from places like the European Central Bank and International Monetary Fund to show that spending restraint is the right approach.

And I’ve also highlighted the success of the Baltic nations, all of which responded to the recent crisis with genuine spending cuts (and I very much enjoyed exposing Paul Krugman’s erroneous attack on Estonia).

Today, let’s look at Cyprus. That Mediterranean nation got in trouble because of an unsustainable long-run increase in the burden of government spending. Combined with the fallout caused by an insolvent banking system, Cyprus suffered a deep crisis earlier this decade.

Unlike many other European nations, however, Cyprus decided to deal with its over-spending problem by tightening belts in the public sector rather than the private sector.

This approach has been very successful according to a report from the Associated Press.

…emerging from a three-year, multi-billion euro rescue program, Cyprus boasts one of the highest economic growth rates among the 19 eurozone countries — an annual rate of 2.7 percent in the first quarter. Finance Minister Harris Georgiades says Cyprus turned its economy around by aggressively slashing costs but also by avoiding piling on new taxes that would weigh ordinary folks down and put a serious damper on growth. “We didn’t raise taxes that would burden an already strained economy,” he told The Associated Press in an interview. “We found spending cuts that weren’t detrimental to economic activity.”

Cutting spending and avoiding tax hike? This is catnip for Dan Mitchell!

But did Cyprus actually cut spending, and by how much?

That’s not an easy question to answer because the two main English-language data sources don’t match.

According to the IMF data, outlays were sliced to €8.1 billion in 2014, down from a peak of €8.5 in 2011. Though the IMF indicates that those numbers are preliminary.

The European Commission database shows a bigger drop, with outlays of €7.0 billion in 2015 compared to €8.3 billion in 2011 (also an outlay spike in 2014, presumably because of a bank bailout).

The bottom line is that, while it’s unclear which numbers are most accurate, Cyprus has experienced a multi-year period of spending restraint.

And having the burden of government grow slower than the private sector always has been and always will be the best gauge of good fiscal policy.

By contrast, there’s no evidence that tax increases are a route to fiscal probity.

Indeed, the endless parade of tax hikes in Greece shows that such an approach greatly impedes economic recovery.

Though not everybody in Cyprus supports prudent policy.

Critics have accused the government of working its fiscal gymnastics on the backs of the poor — essentially chopping salaries for public sector workers. Pambis Kyritsis, head of the left-wing PEO trade union, said the government’s “neo-liberal” policies coupled with the creditors’ harsh terms have widened the chasm between the have and have-nots to huge proportions. …Georgiades turned Kyritsis argument around to reinforce his point that there shouldn’t be any let-up in the government’s reform program and fiscal discipline.

In the European context, “liberal” or “neo-liberal” means pro-market and small government (akin to “classical liberal” or “libertarian” in the United States).

Semantics aside, it will be interesting to see whether Finance Minister Georgiades is correct about maintaining spending discipline as the economy rebounds.

As the above table indicates, there are several examples of nations getting good results by limiting the growth of government spending. But there are very few examples of long-run success since very few nations have politicians with the fortitude to control outlays if the economy is growing and generating an uptick in tax revenue (which is why states like California periodically get in trouble).

This is why the best long-run answer is some sort of constitutional spending cap, similar to what exists in Switzerland or Hong Kong.

The bottom line if that spending restraint is good short-run policy and good long-run policy. Though I doubt Hillary Clinton will learn the right lesson.

P.S. Cyprus also is a reasonably good role model for how to deal with a banking crisis.

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There’s a very powerful statement, variously attributed to Alexis de Toqueville, Benjamin Franklin, or Alexander Tytler, that basically warns that democracy is doomed when people figure out they can vote themselves money.

There’s no evidence that any of them actually spoke or wrote those words, though I guess it doesn’t matter that the quote didn’t originate with someone like Franklin. What does matter is that it accurately captures something very important, which is the tendency for governments to over-tax and over-spend once people decide that it’s okay to use government coercion to take other people’s money.

But it’s still nice to be able to cite something accurate. With this in mind, I came up with my Theorem of Societal Collapse. And I think it’s actually more accurate than the vote-themselves-money quote because democracy doesn’t necessarily lead to statism. What leads to bad outcomes is democracy combined with bad values.

And a pervasive belief in redistributionism is a bad value. Heck, it’s a self-destructive value. Consider Greece. When you add together the people getting welfare and disability to the people getting pension payments to the people on the government payroll, it turns out that a majority of people in the country are riding in the wagon of government dependency.

That’s bad. But what makes the Greek situation so hopeless is that those are the same people who vote. Which means there’s very little chance of getting a government that would implement good policy.

After all, why would the recipients of other people’s money vote for politicians who support limits on redistribution?

But I’m not just blaming voters. Politicians also deserve scorn and disdain because they are the ones who often seek votes by promising to take other people’s money.

Some observers would like to believe that these politicians will use their supposed superior expertise and knowledge about public policy to make appropriate tradeoffs and prevent the system from becoming over-burdened.

But that’s somewhat naive.

Indeed, there’s an entire school of thought in economics, known as “public choice,” which is based on making real-world assumptions about the self-interested behavior of politicians and interest groups. Here’s a partial description from the Library of Economics and Liberty.

As James Buchanan artfully defined it, public choice is “politics without romance.” The wishful thinking it displaced presumes that participants in the political sphere aspire to promote the common good. …public officials are portrayed as benevolent “public servants” who faithfully carry out the “will of the people.” …public choice, like the economic model of rational behavior on which it rests, assumes that people are guided chiefly by their own self-interests… As such, voters “vote their pocketbooks,” supporting candidates and ballot propositions they think will make them personally better off; bureaucrats strive to advance their own careers; and politicians seek election or reelection to office. Public choice, in other words, simply transfers the rational actor model of economic theory to the realm of politics. …collective decision-making processes allow the majority to impose its preferences on the minority.

In other words, both voters and politicians can have an incentive for ever-larger government, even if the end result is Greek-style fiscal chaos because taxes and spending reach ruinous levels.

I call this “Goldfish Government” because some think that a goldfish lacks the ability to control its appetite and therefore will eat itself to death when presented with unlimited food.

Indeed, public choice scholars explicitly recognize that unconstrained democracy can lead to bad results.

Public choice scholars have identified…deep…problems with democratic decision-making processes.

That’s the bad news.

The good news is that their research suggests ways to compensate for the natural tendency of ever-expanding government.

Like that founding father of the American constitutional republic, public choice recognizes that men are not angels and focuses on the importance of the institutional rules… If, for example, democratic governments institutionally are incapable of balancing the public budget, a constitutional rule that limits increases in spending and taxes to no more than the private sector’s rate of growth will be more effective.

Hmmm…., a rule that limits the government so it doesn’t grow faster than the private sector.

Sounds like an idea worth embracing.

But while I like anything that builds support for the Golden Rule, I’m not sure it’s a sufficient condition for good policy.

Simply stated, we have too many examples of nations that followed the Golden Rule for several years, only to then fall off the wagon with a new splurge of spending.

There are two ways to deal with this problem. First, make the spending restraint part of a jurisdiction’s constitution, as we see in Switzerland and Hong Kong.

Second, augment the internal constraint of a spending cap with the external constraint of tax competition. Bluntly stated, destructive tax policies will be less likely when politicians are afraid that taxpayers will move across borders.

I spoke about this topic at a recent conference in Slovakia.

I also discuss the critical role of demographic change toward the end of my speech.

P.S. America’s Founding Fathers had the right solution. They set up a democratic form of government, but they strictly limited the powers of the central government. This system worked remarkably well for a long period, but then the Supreme Court decided that the enumerated powers listed in the Constitution were just a suggestion.

P.P.S. While it’s bad news to combine democracy with bad value, I want to emphasize that the problem is bad values. Most non-democratic societies have policies that are so evil and destructive (think Cuba and North Korea) that they make France seem like a beacon of economic liberty.

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As I’ve repeatedly explained, governments generally get in fiscal trouble because politicians can’t resist spending lots of money when the economy is buoyant and therefore generating lots of tax revenue.

And this is why I’m a huge fan of spending caps. If outlays can’t grow faster than, say, 3 percent annually, that make it difficult for politicians to enact unsustainable spending commitments (as we’ve seen in Greece, Alberta, Puerto Rico, California, and Alaska) in years when there is extra revenue.

Now I have a new example, and it’s extra painful because the politicians literally want me to pay for their profligacy.

Here’s part of what was recently written in the Washington Post about the supposed budget hardships in my home county of Fairfax in Virginia.

Virginia’s largest municipality is fraying around the edges. A population that is growing older, poorer and more diverse is sharpening the need for basic services…even as a sluggish local economy maintains a chokehold on the revenue stream. Since the 2008 recession, local officials have whittled away at programs to the tune of $300 million. …Since 2008, the county has eliminated 700 jobs. Libraries operate on shorter schedules and with fewer books, class sizes have swelled past 32 students in some schools… County agencies are stretching out vehicle maintenance — including for school buses and fire engines — and officials say aging athletic courts and deteriorating playgrounds await nearly $20 million in repairs. …The county slashed $3.8 million in summer school funding in 2015 and is trying to use $374,000 less in paper this year.

But all this budget “slashing” apparently isn’t enough to balance the budget.

…there is no fat left to trim. Instead, they are searching for ways to raise taxes… The county is searching for new revenue to cover some of what officials estimate are hundreds of millions of dollars worth of unmet needs. …“We’ve been punting for seven years now,” said John C. Cook (R-Braddock), a county supervisor. “There’s really nothing easy left to cut.” …the County Board of Supervisors will decide whether to raise residential property taxes by as much as four cents — to $1.13 per $100 of assessed value.

Gee, sounds like the government has “cut spending to the bone” and imposed “savage austerity,” which means higher taxes are the only option, right?

Not exactly, Professor Don Boudreaux of George Mason University digs through the data and exposes the truth.

What budget cuts?  In fiscal year 2016 Fairfax County’s government will spend $7.13 billion dollars – the highest inflation-adjusted annual expenditure in County history.  And this real expenditure is the highest in County history even on a per-capita basis.  …Fairfax County’s government today spends, per county resident, 168 percent more real dollars than it spent in 1975, 144 percent more than in 1986, 30 percent more than in 2001, and 1.6 percent more than in 2008 – the year that your reporter suggests marks the beginning of Fairfax County’s budget austerity. …it is emphatically not true that the Fairfax leviathan has cut its spending or suffered budget cuts.  Quite the opposite.

Don included a table of data, which I’ve put into a chart.

Let me know if you can find where spending was “slashed.”

Remember, this is inflation-adjusted spending, and also per-capita-adjusted spending, which means we can do apples-to-apples comparisons.

And the comparison that really matters is that the local government is now spending more than twice as much as it did 30 years ago.

  • Are the schools more than twice as good? No.
  • Are the roads more than twice as good? No.
  • Are the parks more than twice as good? No.

So where did all the money go? Beats me, though I’m going to take a wild guess that the country bureaucracy is now far bigger and getting paid much more.

In other words, the same theorem of government that explains the behavior of Washington also applies at the local level.

P.S. Let’s close with a very appropriate joke about the type of people who create fiscal crises.

A father told his 3 sons when he sent them to the university: “I feel it’s my duty to provide you with the best possible education, and you do not owe me anything for that. However, I want you to appreciate it. As a token, please each put $1,000 into my coffin when I die.”

And so it happened. His sons became a doctor, a lawyer, and a financial planner, each very successful financially. When their father’s time had come and they saw their father in the coffin, they remembered his wish.

First, it was the doctor who put 10 $100 bills onto the chest of the deceased.

Then, came the financial planner, who also put $1,000 there.

Finally, it was the heartbroken lawyer’s turn.He dipped into his pocket, took out his checkbook, wrote a check for $3,000, put it into his father’s coffin, and took the $2,000 cash.

He later went on to become a member of Congress…

If you want more jokes about politicians, click here.

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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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Republicans are probably going to surrender on spending caps, thus allowing Obama to reverse his biggest-ever defeat.

Moreover, GOPers almost surely will get nothing in exchange for raising the debt limit, thus squandering an opportunity to limit profligacy in Washington.

So I should be feeling very glum. And, truth be told, I am routinely frustrated by what happens in DC.

But one thing I’ve learned over the past three decades is that it’s very hard to win battles without doing the hard work that helps to build a consensus for policy reform.

With this in mind, I’m going to express some optimism about the case for long-run spending restraint. This may seem counter intuitive given the probable defeats that will occur in the next month or two on the BCA spending caps and the debt limit.

But I’m thinking this may be Obama’s last hurrah and that things will change dramatically after the 2016 elections.

My medium-term hopefulness isn’t based on the election of any specific candidate. Instead, it’s a reflection of the growing consensus for good policy.

For instance, Congressman Kevin Brady of Texas, writing in National Review, says that the BCA spending caps need to be expanded.

Congress’s latest effort at fiscal restraint — the Budget Control Act of 2011 — targeted the one-third of federal spending that goes for discretionary programs. This act has helped to shrink Washington’s budget deficit by two-thirds and shave Washington’s spending by a significant three percentage points of GDP. …Unfortunately, the…Budget Control Act does not address entitlements. And without common-sense reforms, the massive uncontrolled growth in entitlements will leave America with a bleak fiscal future. …Congress must build on the success of the Budget Control Act. We need smarter, 21st-century budget guardrails… The upcoming fight over the federal debt limit gives Congress an opportunity to think smartly and act boldly by enacting a responsible spending cap that limits federal spending in relation to the size of our economy.

Congressman Brady has a specific plan to cap spending growth, and he explains that it is similar to Switzerland’s very effective approach.

The Maximizing America’s Prosperity Act of 2015 (MAP) would cap federal primary spending (which includes both discretionary and entitlement spending) as a percentage of potential GDP. Under MAP, primary spending would gradually decline from 19 percent of potential GDP in fiscal year 2016 to 16 percent of potential GDP over ten years. …MAP is a very prudent approach similar to the “debt brake” that has successfully capped the growth of government spending in Switzerland.

Since I’ve already written favorably about the Swiss Debt Brake and specifically noted that the MAP Act is the closest thing to that approach in the Untied States, it’s obvious that I like spending caps.

But what about other fiscal experts in Washington?

Well, there’s significant agreement on this issue.

Kevin Hassett of the American Enterprise Institute testified on the issue earlier this month.

…countries have increasingly begun to rely on specific expenditure targets… The adoption of such targets makes a great deal of sense. …Marking spending to potential GDP would be an effective way to enact budget legislation that is transparent and difficult to game. …I encourage Congress to consider adopting a budget rule that caps spending in the U.S. (other than interest payments) at some agreed upon fraction of GDP.

By the way, Kevin mentioned in his testimony that even the IMF has identified spending caps as the only effective fiscal rule.

Returning to the views of American fiscal experts, Romina Boccia of the Heritage Foundation shared favorable thoughts about spending caps in an article for The National Interest.

…how could Congress…make long-overdue spending reforms? One way is to enact spending caps in line with Congress’s budget to pave the way for concrete reforms with the threat of automatic cuts. Such a statutory spending cap would encourage lawmakers to prioritize federal spending, enable them to say “no” to special interests, and help to protect American taxpayers from wasteful spending burdens. Lawmakers should build on the success of the Budget Control Act and its spending caps enforced by sequestration to motivate entitlement reforms. Rep. Kevin Brady (R-TX) recently reintroduced the Maximizing America’s Prosperity Act (H.R. 2471), which would impose a statutory spending cap across all non-interest outlays, in line with the spending targets established in Congress’s budget resolution.

And here’s some of what Veronique de Rugy wrote for the Mercatus Center.

…the caps and accompanying sequestration enforcement mechanism have been successful in constraining the discretionary share of the federal budget. …One of the chief criticisms of the caps is that they are largely limited to the discretionary programs, which comprise an increasingly smaller share of the overall federal budget. That’s a fair criticism. …policymakers should lock in these gains for taxpayers and seek to expand limits on federal funding to include more of the mandatory side of the budget.

By the way, here’s a chart Veronique prepared showing how the BCA spending caps have saved taxpayers a lot of money.

From this chart, you can see why I think it’s so important to preserve the spending caps and not surrender to Obama’s veto threats.

But let’s not dwell on potential bad developments and instead focus on the best approach, which is expanding the caps to constrain a far greater share of the federal budget.

Here are some excerpts from an article in Reason by A. Barton Hinkle, who explains how spending caps produce fiscal progress.

How do we avoid the iceberg up ahead? …sequestration has helped slow the growth of the federal government. Before it took effect, federal spending was on track to consume one-fourth of America’s GDP. By last year, Washington sopped up only one-fifth of America’s wealth. …there’s a[n]…option that could put America in the black… Hold the growth of government spending to 2 percent per year. That’s it. If Washington did only that, the federal budget would be balanced within six years. …many other advanced democracies have held their spending in similar check. Sweden, Canada, the Netherlands, and Italy did so during the 1990s; Germany, Switzerland, Israel and Taiwan did so in the 2000s. And because their economies grew somewhat faster, their government debt burdens shrank.

Wow. If you have Cato, AEI, Heritage, Mercatus, and Reason all endorsing spending caps, that’s a noteworthy development.

And remember that this approach also has been lauded by the International Monetary Fund, which definitely is not part of the vast right wing conspiracy.

Here’s the bottom line, which presumably explains the growing support for spending caps.

We have lots of examples of countries that have successfully addressed fiscal problems with multi-year periods of spending restraint.

And we have further evidence that explicit spending caps are the only sure-fire way of ensuring long-run fiscal discipline.

So no wonder lots of people and institutions are joining forces in the campaign to create a successful enforcement mechanism for fiscal policy’s Golden Rule.

But I don’t want to get cocky. Building a coalition for good policy is a necessary but not sufficient condition for reform.

I’ll feel more confident about possible changes if some of the presidential candidates openly embrace spending caps and put forth plans to restrain the burden of government spending.

But if we get enough people in the parade for good policy, I suspect a few politicians will suddenly see the wisdom of getting to the front of the line.

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