A Spending Cap Amendment Is Far Better than a Balanced Budget Amendment

The Swiss Debt Brake and Colorado’s TABOR work because they limit spending. Balanced budget requirements, by contrast, have a weak track record.

My point in the above discussion with the Soul of Enterprise is mostly based on economics.

Our fiscal challenge in the United States is excessive government spending. And the problem is projected to worsen in coming decades because of demographic change and poorly designed entitlement programs.

So it makes sense to directly address the problem with a spending cap.

By contrast, a balanced budget amendment is merely designed to inhibit debt-financed spending. That’s a good goal, but it won’t lead to good results if politicians react by simply increasing tax-financed spending. Or if they finance spending with bad monetary policy.

As I point out in the video, balanced budget requirements and anti-deficit rules have not produced good results in American states or EU nations.

The takeaway is that good policymakers should push for spending caps for theoretical reasons and practical reasons.

P.S. I was very pleasantly surprised when the German government recently endorsed EU-wide spending caps.

P.P.S. Remarkably, there are pro-spending-cap studies from left-leaning bureaucracies such as the International Monetary Fund (here and here) and the Organization for Economic Cooperation and Development (here and here). There are also similar studies from the European Central Bank (here and here).

P.P.P.S. It should go without saying, but I’ll say it anyhow, that a spending cap should be set at a level that actually results in less government.

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The Simple (but Definitely not Easy) Way to Avert America’s Fiscal Crisis

Every six months or so, the Congressional Budget Office produces a 10-year forecast and most fiscal experts focus on the projections for deficit and debt.

Those are important (and worrisome) numbers, but I first look at the data showing what will happen to taxes and spending.

And you can see from this chart that the fiscal burden of the federal government is projected to grow at a very rapid pace over the next decade.

Other fiscal experts fret that deficits and debt are increasing between now and 2033, but the above chart shows that the real problem is that the spending burden is rising faster than the tax burden.

The real fiscal fight in Washington is how to close the gap between the red spending line and the green revenue line (supporters of Modern Monetary Theory say we can just print money to finance big government, but let’s ignore them for purposes of today’s column).

Since I think Washington is spending far too much, I want to close the gap by restraining the growth of government.

So here’s a second chart illustrating what would happen if there was some sort of spending cap. As you can see, a spending freeze (like we had from 2009-2014) would balance the budget by 2030.

And spending would have to be limited to 1.3 percent annual growth if the goal is to balance the budget within 10 years,

We can solve the problem. That’s the good news.

The bad news is that politicians don’t want to restrain spending.

And, even if they did want to do the right thing, adhering to a 1.3 percent spending cap would require serious entitlement reform. So don’t hold your breath hoping for immediate progress.

P.S. The numbers are out of date, but here’s a video that explains how spending restraint is the key to fiscal balance. And here’s a video on how some other nations made enormous progress with multi-year spending restraint.

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Time for a Constitutional Convention?

Yesterday’s column was about the referendum for a new leftist constitution in Chile.

Fortunately, Chilean voters overwhelmingly rejected that awful plan (a surprisingly positive outcome since those same voters were foolish enough to vote for a leftist president last December).

Today, we’re going to look at potential constitutional changes in the United States. But our focus won’t be on how the Constitution should (or should not) be changed, but rather on the process.

Why? Because there’s a serious effort for a constitutional convention, similar to the meeting back in 1787 (though it’s unclear whether we have people like James Madison and Alexander Hamilton today).

This is something that is allowed by the Constitution, so long as it has support from 34 states. Here’s a map showing what’s happened to date.

The map comes from an article that Grace Panetta and Brent Griffiths wrote for Business Insider.

They have a good description of how the process works.

Article V to the US Constitution provides two ways to amend the nation’s organizing document… The first is for a two-thirds majority of Congress to propose an amendment, with three-fourths of states ratifying it. This is how all 27 of the current amendments to the Constitution were added… The second method — never before accomplished — involves two-thirds of US states to call a convention. …two-thirds of the state legislatures are needed to call a convention and three-fourths must vote to ratify any amendments. …Conservatives and liberals alike say this requirement would doom hyperpartisan or plain loony amendments.

Conservatives are the main proponents of a constitutional convention.

The December 2021 ALEC meeting represents a flashpoint in a movement spearheaded by powerful conservative interests…to alter the nation’s bedrock legal text since 1788. It’s an effort that has largely taken place out of public view. But interviews with a dozen people involved in the constitutional convention movement, along with documents and audio recordings reviewed by Insider, reveal a sprawling, well-funded…and impassioned campaign taking root across multiple states. …Rob Natelson, a constitutional scholar and senior fellow at the Independence Institute who closely studies Article V of the Constitution, predicted to Insider there’s a 50% chance that the United States will witness a constitutional convention in the next five years.

Some folks on the left also like the idea.

The right isn’t alone in pursuing a convention. On the left, Cenk Uygur, a progressive commentator, founded Wolf PAC… Five Democratic states passed Wolf PAC’s call for a campaign finance reform-focused convention: California, New Jersey, Illinois, Vermont, and Rhode Island.

Now the issue is getting more attention.

Writing for the New York Times yesterday, Carl Hulse reports on the campaign for a new constitutional convention.

Elements on the right have for years been waging a quiet but concerted campaign to convene a gathering to consider changes to the Constitution. They hope to take advantage of a never-used aspect of Article V, which says in part that Congress, “on the application of the legislatures of two-thirds of the several states, shall call a convention for proposing amendments.” …backers of the convention idea now hope to harness the power of Republican-controlled state legislatures to…strip away power from Washington and impose new fiscal restraints, at a minimum. …leading proponents of the convention idea come from the right and include representatives of the Tea Party movement, the Federalist Society, grass-roots right-wing activists… And some liberals have welcomed the idea of a convention as a way to modernize the Constitution and win changes in the makeup and power of the Supreme Court, ensure abortion rights, impose campaign finance limits and find ways to approach 21st-century problems such as climate change.

I have two comments regarding this effort.

First, much of the impetus comes from prudent people who are disturbed by the reckless profligacy in Washington. These folks are right to be concerned, but I have been telling them that they need to pursue a spending limit amendment (like the Swiss “Debt Brake” or Article 107 of Hong Kong’s Basic Law) rather than a balanced budget requirement.

Simply stated, spending caps work.

Second, I wonder whether any sort of constitutional change can get the necessary support from 3/4ths of the states. I doubt left-wing states like California, New Jersey, and Illinois would ratify a good amendment to control spending, just like right-wing states like Texas, South Dakota, and Utah presumably would reject a leftist amendment to do something like restrict political speech.

Maybe Colorado’s TABOR can be a role model.

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America’s Future Fiscal Crisis Can Be Averted

I’m not optimist about America’s fiscal future. Thanks primarily to entitlement programs, the long-run outlook shows an ever-increasing burden of government spending.

And rather than hit the brakes, Biden wants to step on the gas with new giveaways, especially his plan to gut Bill Clinton’s welfare reform by creating new per-child handouts that would subsidize idleness and family dissolution.

But that doesn’t mean the problems can’t be fixed. We simply need to replace fiscal profligacy with spending restraint.

To set the stage for this discussion, here’s a look at what’s happened to the budget over the past several decades.  You can see how the burden of federal spending has steadily increased, with noticeable one-time bumps in 2008-2009 (TARP and Obama’s so-called stimulus) and 2020-2021 (coronavirus).

The chart also includes projections between 2021 and 2031, based on new numbers from the Congressional Budget Office.

For today’s column, I want to focus on the next 10 years and show how the current fiscal mess can be averted with some modest spending restraint.

This second chart shows that spending actually drops over the next two years as coronavirus-related spending comes to an end. But once we get to 2023, the orange line shows that “baseline” spending (what happens to the budget if things are left on autopilot) climbs rapidly, more than twice the rate needed to keep pace with inflation.

But if there’s any sort of fiscal restraint (a freeze or some sort of spending cap), then the numbers look much better.

More specifically, a freeze or a 1-percent spending cap would actually produce a budget surplus by the year 2031.

But I’m not fixated on getting to a balanced budget. What’s more important is that the burden of government spending shrinks when the budget grows slower than the private sector.

In other words, we get good results when policy makers follow fiscal policy’s Golden Rule.

P.S. While it’s difficult to convince politicians to support spending restraint, it’s worth noting that the nation enjoyed a five-year spending freeze between 2009-2014.

P.P.S. In the long run, a spending freeze almost certainly requires genuine entitlement reform.

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The CRFB Fiscal Quiz

I’ve shared all sorts of online quizzes that supposedly can detect things such as whether you’re a pure libertarian.

Or even whether you’re a communist.

Today, courtesy of the folks at the Committee for a Responsible Budget, you can agree or disagree with 24 statements to determine your “budget personality.”

I have some quibbles about some of the wording (for instance, I couldn’t answer “neither” when asked to react to: “The government should spend more money on children than on seniors”).

But I can’t quibble with the results. Given the potential outcomes, I’m glad to be a “Minimalist” who is “in favor of smaller government.”

Though I’m disappointed that I apparently didn’t get a perfect score on “Size of Government.”

And I need to explain why I got a mediocre score on the topic of “Fiscal Responsibility.”

The budget geeks at the Committee for a Responsible Federal Budget (CRFB) have a well-deserved reputation for rigorous analysis. I regularly cite their numbers and appreciate the work that they do.

That being said, they mistakenly focus on deficits and debt when the real problem is too much government.

I agree with Milton Friedman, who wisely observed that ““I would rather have government spend one trillion dollars with a deficit of a half a trillion dollars than have government spend two trillion dollars with no deficit.”

The folks at CRFB would disagree.

Indeed, they are so fixated on red ink that they would welcome tax increases.

At the risk of understatement, that would be a very bad approach.

The evidence from Europe shows that higher taxes simply lead to higher spending. And more debt.

Indeed, Milton Friedman also commented on this issue, warning that, “History shows that over a long period of time government will spend whatever the tax system raises plus as much more as it can get away with.”

The bottom line is that CRFB not only has the wrong definition of “Fiscal Responsibility,” but they also support policies that would make matters worse – even from their perspective!

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Even after the Coronavirus Spending Spree, It’s Simple to Balance the Budget Without Tax Increases

There are two reasons why I generally don’t write much about government debt.

• First, red ink is not desirable, but it’s mostly just the symptom of the far more important problem of excessive government spending.
• Second, our friends on the left periodically try to push through big tax increases by hypocritically exploiting anxiety about red ink.

The one thing I can state with full certainty, however, is that tax increases are guaranteed to make a bad situation worse.

We’ll get a weaker economy (perhaps much weaker since the left is now fixated on pushing for the kinds of tax increases that do the most damage).

Equally worrisome, the biggest impact of a tax increase is that politicians won’t feel any need to control spending or reform entitlements. Indeed, it’s quite likely that they’ll respond to the expectation of higher revenue by increasing the spending burden.

To complicate matters further, any tax increase probably won’t generate that much additional revenue because of the Laffer Curve.

All of which explains why budget deals that include tax increases usually lead to even higher budget deficits.

This analysis is very timely and relevant since advocates of bigger government somehow claim that the new fiscal forecast from the Congressional Budget Office is proof that we need new taxes.

So I’m doing the same thing today I did back in January (and last August, and in January 2019, and many times before that starting back in 2010). I’ve crunched the numbers to see what sort of policies would be needed to balance the budget without tax increases.

Lo and behold, you can see from this chart that we wouldn’t need draconian spending cuts. All that’s needed for fiscal balance is to limit spending so that it grows slightly less than 1 percent per year (and this analysis even assumes that they get to wait until 2022 before imposing a cap on annual spending increases).

To be sure, politicians would not want to live with that kind of limit on their spending. So I’m not optimistic that we’ll get this type of policy in the near future.

Especially since the major parties are giving voters a choice between big-spender Trump and big-spender Biden.

But the last thing that we should do is worsen the nation’s fiscal outlook by acquiescing to higher taxes.

P.S. It’s worth noting that there was a five-year nominal spending freeze between 2009 and 2014 (back when the Tea Party was influential), so it is possible to achieve multi-year spending restraint in Washington.

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Tax Increases Will Generate More Spending, More Debt, and Less Prosperity

Because of changing demographics and poorly designed entitlement programs, the burden of government spending in the United States (in the absence of genuine reform) is going to increase dramatically over the next few decades.

That bad outlook will get even worse thanks to all the coronavirus-related spending from Washington.

This is bad news for America since more of the economy’s output will be consumed by government, leaving fewer resources for the private sector. And that problem would exist even if all the spending was magically offset by trillions of dollars of unexpected tax revenue.

Many people, however, think the nation’s future fiscal problem is that politicians will borrow to finance  that new spending. I think that’s a mistaken view, since it focuses on a symptom (red ink) rather than the underlying disease (excessive spending).

But regardless of one’s views on that issue, fiscal policy is on an unsustainable path. And that means there will soon be a fight between twho different ways of addressing the nation’s grim fiscal outlook.

• Restrain the growth of government spending.
• Divert more money from taxpayers to the IRS.

Fortunately, we now have some new evidence to help guide policy.

A new study from the Mercatus Center, authored by Veronique de Rugy and Jack Salmon, examines what actually happens when politicians try to control debt with spending restraint or tax increases.

Here’s what the authors wanted to investigate.

Fiscal consolidation can take two forms: (1) adopting a debt-reduction package driven primarily by tax increases or (2) adopting a package mostly consisting of spending restraint. …What policymakers might not know is which of these two forms of consolidation tend to be more effective at reining in debt levels and which are less harmful to economic performance: tax-based (TB) fiscal consolidation or expenditure-based (EB) fiscal consolidation.

Here’s their methodology.

Our analysis focuses on large fiscal consolidations, or consolidations in which the fiscal deficit as a share of GDP improves by at least 1.5 percentage points over two years and does not decrease in either of those two years. …A successful consolidation is defined as one in which the debt-to-GDP ratio declines by at least 5 percentage points three years after the adjustment takes places or by at least 3 percentage points two years after the adjustment. …Episodes in which the consolidation is at least 60 percent revenue increases are labeled TB, and episodes in which the consolidation is at least 60 percent spending decreases are labeled EB.

And here are their results.

…of the 45 EB episodes, more than half were successful, while of the 67 TB episodes, less than 4 in 10 were successful. …The results in table 2 show that while in unsuccessful adjustments most (74 percent) of the changes are on the revenue side, in successful adjustments most (60 percent) of the changes are on the expenditure side. In successful adjustments, for every 1.00 percent of GDP increase in revenues, expenditures are cut by 1.50 percent. By contrast, in unsuccessful adjustments, for every 1.00 percent of GDP increase in revenues, expenditures are cut by less than 0.35 percent. From these findings we conclude that successful fiscal adjustments are those that involve significant spending reductions with only modest increases in taxation. Unsuccessful fiscal adjustments, however, typically involve significant increases in taxation and very modest spending reductions.

Table 2 summarizes the findings.

As you can see, tax increases are the least effective way of dealing with the problem. Which makes sense when you realize that the nation’s fiscal problem is too much spending, not inadequate revenue.

In my not-so-humble opinion, I think the table I prepared back in 2014 is even more compelling.

Based on IMF data, it shows nations that imposed mutli-year spending restraint and how that fiscally prudent policy generated very good results – both in terms of reducing the spending burden and lowering red ink.

When I do debates at conferences with my left-wing friends, I almost always ask them to show me a similar table of countries that achieved good results with tax increases.

Needless to say, none of them have ever even attempted to prepare such a list.

That’s because nations that repeatedly raise taxes – as we’ve seen in Europe – wind up with more spending and more debt.

In other words, politicians pull a bait-and-switch. They claim more revenue is needed to reduce debt, but they use any additional money to buy votes.

Which is why advocates of good fiscal policy should adamantly oppose any and all tax increases.

Let’s close by looking at two more charts from the Mercatus study.

Here’s a look at how Irish politicians have mostly chose to restrain spending.

And here’s a look at how Greek politicians have mostly opted for tax increases.

It goes without saying (but I’ll say it anyhow) that the Greek approach has been very unsuccessful.

P.S. For fiscal wonks, one of the best parts of the Mercatus study is that it cites a lot of academic research on the issue of fiscal consolidation.

Scholars who have conducted research find – over and over again – that spending restraint works.

In a 1995 working paper, Alberto Alesina and Roberto Perotti observe 52 efforts to reduce debt in 20 Organisation for Economic Co-operation and Development (OECD) countries between 1960 and 1992. The authors define a successful fiscal adjustment as one in which the debt-to-GDP ratio declines by at least 5 percentage points three years after the adjustment takes place. In successful adjustments, government spending is reduced by almost 2.2 percent of gross national product (GNP) and taxes are increased by less than 0.5 percent of GNP. For unsuccessful adjustments, government expenditure is reduced by less than 0.5 percent of GNP and taxes are increased by almost 1.3 percent of GNP. These results suggest that successful fiscal adjustments are those that cut spending and include very modest increases in taxation.

International Monetary Fund (IMF) economists John McDermott and Robert Wescott, in a 1996 paper, examine 74 episodes of fiscal adjustment in which countries attempted to address their budget gaps. The authors define a successful fiscal adjustment as a reduction of at least 3 percentage points in the ratio of gross public debt to GDP by the second year after the end of an adjustment. The authors then divide episodes of fiscal consolidation into two categories: those in which the deficit was cut primarily (by at least 60 percent) through revenue increases, and those in which it was reduced primarily (by at least 60 percent) through expenditure cuts. Of the expenditure-based episodes of fiscal consolidation, almost half were successful, while of the tax-based episodes, less than one out of six met the criteria for success.

Jürgen von Hagen and Rolf Strauch observe 65 episodes in 20 OECD countries from 1960 to 1998 and define a successful adjustment as one in which the budget balance stands at no more than 75 percent of the initial balance two years after the adjustment period. …it does find that successful consolidations consist of expenditure cuts averaging more than 1.2 percent of GDP, while expenditure cuts in unsuccessful adjustments are smaller than 0.3 percent of GDP. The opposite pattern is true for revenue-based adjustments: successful consolidations consist of increases in revenue averaging around 1.1 percent, while unsuccessful adjustments consist of revenue increases exceeding 1.9 percent.

American Enterprise Institute economists Andrew Biggs, Kevin Hassett, and Matthew Jensen examine over 100 episodes of fiscal consolidation in a 2010 study. The authors define a successful fiscal adjustment as one in which the debt-to-GDP ratio declines by at least 4.5 percentage points three years after the first year of consolidation. Their study finds that countries that addressed their budget shortfalls through reduced spending burdens were far more likely to reduce their debt than countries whose budget-balancing strategies depended upon higher taxes. …the typical successful adjustment consists of 85 percent spending cuts and just 15 percent tax increases.

In a 1998 Brookings Institution paper, Alberto Alesina and coauthors reexamined the research on the economic effects of fiscal adjustments. Using data drawn from 19 OECD countries, the authors assess whether the composition of fiscal adjustments results in different economic outcomes… Contrary to the Keynesian view that fiscal adjustments are contractionary, the results of this study suggest that consolidation achieved primarily through spending reductions often has expansionary effects.

Another study that observes which features of fiscal adjustments are more or less likely to predict whether the fiscal adjustment is contractionary or expansionary is by Alesina and Silvia Ardagna. Using data from 20 OECD countries during 1960 to 1994, the authors label an adjustment expansionary if the average GDP growth rate in the period of adjustment and in the two years after is greater than the average value (of G7 countries) in all episodes of adjustment. …The authors conclude, “The composition of the adjustment appears as the strongest predictor of the growth effect: all the non-expansionary adjustments were tax-based and all the expansionary ones were expenditure-based.”

French economists Boris Cournède and Frédéric Gonand adopt a dynamic general equilibrium model to compare the macroeconomic impacts of four debt reduction scenarios. Results from the model suggest that TB adjustments are much more costly than spending restraint when policymakers are attempting to achieve fiscal sustainability. Annual consumption per capita would be 15 percent higher in 2050 if consolidation were achieved through spending reductions rather than broad tax increases.

In a review of every major fiscal adjustment in the OECD since 1975, Bank of England economist Ben Broadbent and Goldman Sachs economist Kevin Daly found that “decisive budgetary adjustments that have focused on reducing government expenditure have (i) been successful in correcting fiscal imbalances; (ii) typically boosted growth; and (iii) resulted in significant bond and equity market outperformance. Tax-driven fiscal adjustments, by contrast, typically fail to correct fiscal imbalances and are damaging for growth.”

Economists Christina and David Romer investigated the impact of tax changes on economic activity in the United States from 1945 to 2007. The authors find that an exogenous tax increase of 1 percent of GDP lowers real GDP by almost 3 percent, suggesting that TB adjustments are highly contractionary.

…the IMF released its annual World Economic Outlook in 2010 and included a study on the effects of fiscal consolidation on economic activity. The results of studying episodes of fiscal consolidation for 15 OECD countries over three decades…reveals that EB fiscal adjustments tend to have smaller contractionary effects than TB adjustments. For TB adjustments, the effect of a consolidation of 1 percent of GDP on GDP is −1.3 percent after two years, while for EB adjustments the effect is just −0.3 percent after two years and is not statistically significant. Interestingly, TB adjustments also raise unemployment levels by about 0.6 percentage points, while EB adjustments raise the unemployment rate by only 0.2 percentage points.

…a 2014 IMF study…estimates the short-term effect of fiscal consolidation on economic activity among 17 OECD countries. The authors of the IMF study find that the fall in GDP associated with EB consolidations is 0.82 percentage points smaller than the one associated with TB adjustments in the first year and 2.31 percentage points smaller in the second year after the adjustment.

Focusing on the fiscal consolidations that followed the Great Recession, Alesina and coauthors…find that EB consolidations are far less costly for economic output than TB adjustments. They also find that TB adjustments result in a cumulative contraction of 2 percent of GDP in the following three years, while EB adjustments generate very small contractions with an impact on output not significantly different from zero.

A study by the European Central Bank in 2018…finds that macroeconomic responses are largely caused by differences in the composition of the adjustment plans. The authors find large and negative multipliers for TB adjustment plans and positive, but close to zero, multipliers for EB plans. The composition of adjustment plans is found to be the largest contributor to the differences in economic performance under the two types of consolidation plans.

The bottom line is that nations enjoy success when they obey fiscal policy’s Golden Rule. Sadly, that doesn’t happen very often because politicians focus mostly on buying votes in the short run rather than increasing national prosperity in the long run.

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The Media’s Pervasively Dishonest Coverage of Trump’s New Budget

I would prefer not to write about President Trump’s new budget, largely because I know it’s not a serious proposal.

Even before he was elected, I pointed out that Trump was a big-government Republican who had no intention of dealing with serious fiscal issues such as the rising burden of entitlement spending.

So I wasn’t surprised that he capitulated to swamp-friendly budget deals in 2017, 2018, and 2019. And I’m depressingly confident that the same thing will happen this year.

That being said, I want to comment on how the media is covering his latest budget.

Take a look at some of the headlines that are dominating the news this morning.

From Reuters.

From New York magazine.

From the Washington Times.

From NBC.

From the Associated Press.

From Bloomberg.

From International Business Times.

From Fox.

From the Wall Street Journal.

All of these headlines make is seem like Trump is proposing a Reagan-style budget with lots of cuts, especially with regards to domestic programs.

All of that would be great news…if it was true.

In reality, here’s what Trump is projecting for total spending over the next 10 years.

Can you find the spending cuts?

And here’s what’s happening with domestic spending (mandatory outlays plus domestic discretionary) according to Trump’s budget.

Can you find the spending cuts?

Last but not least, here’s Trump’s plan for domestic discretionary spending.

Can you find the spending cuts?

So why is there such a big disconnect in the media? Why are there headlines about cutting and slashing when government is growing by every possible measure?

For the simple reason that the budget process in Washington is pervasively dishonest, as I’ve explained in interviews with John Stossel and Judge Napolitano. Here are the three things you need to know.

1. The politicians created a system that automatically assumes big increases in annual spending, called a baseline.
2. When there’s a proposal to have spending grow slower than the baseline, the gap between the proposal and the baseline is called a cut.
3. It’s like being on a diet and claiming progress because you’re gaining two pounds each month rather than five pounds.

Defenders of this system argue that programs should get built-in increases because of things such as inflation, or because of more old people, which leads to more spending for programs such as Social Security and Medicare.

It’s certainly reasonable for them to argue that budgets should increase for these reasons.

But they should be honest. Be forthright and assert that “Spending should climb X percent because…”

Needless to say, that won’t happen. The pro-spending politicians and interest groups like the current approach because it allows them to scare voters by warning about “savage” and “draconian” spending cuts.

Remember how Obama said the sequester would wreak havoc because of massive cuts? Except there weren’t any cuts, massive or otherwise. As Thomas Sowell pointed out, Obama was trying to deceive voters.

P.S. The British also use dishonest budgeting.

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Washington’s Budget Outlook: Still Getting Worse, but Still Fixable

When the Congressional Budget Office released its Budget and Economic Outlook yesterday, almost everyone in Washington foolishly fixated on the estimate of $1 trillion-plus annual deficits.

What’s far more important – and much more worrisome – is that the burden of government spending is projected to relentlessly increase, violating the Golden Rule of fiscal policy.

More specifically, the federal budget currently is consuming 21 percent of gross domestic product, but will consume 23.4 percent of economic output in 2030 if fiscal policy is left on autopilot.

Here is a chart, based on CBO’s new data, that shows why we should be very concerned.

By the way, last year’s long-run forecast from CBO shows the problem will get even worse in the following decades, especially if there isn’t genuine entitlement reform.

We’re in trouble today because government has been growing too fast, and we’ll be in bigger trouble in the future for the same reason.

But the situation is not hopeless. The problem can be fixed with some long-overdue and much-needed spending restraint.

We don’t even need to cut spending, though that would be very desirable.

As this next chart illustrates, our budgetary problems can be solved if there’s some sort of spending cap.

The grey line shows the current projection for federal spending and the orange line shows how much tax revenue Washington expects to collect (assuming the Trump tax cut is made permanent). There’s a big gap between those two lines (the $1 trillion-plus deficits everyone else is worried about).

My contribution to the discussion is to show we can have a budget surplus by 2028 if spending only grows by 1 percent annually and we can balance the budget by 2030 if spending grows by 1.7 percent per year.

Needless to say, I’m not fixated on balancing the budget and eliminating red ink.

The real goal is to change budgetary trend lines with a spending cap so that the fiscal burden of government begins to shrink as a share of the nation’s economy.

The bottom line is that modest spending restraint (government growing at 1.7 percent annually, nearly as fast as projected inflation) would slowly but surely achieve that goal by gradually reversing the big-government policies of Bush, Obama, and Trump.

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A Practical Reason to a Support a Spending Cap Instead of a Balanced-Budget Requirement

I gave a speech this past weekend about the economy and fiscal policy, and I made my usual points about government being too big and warned that the problem would get much worse in the future because of demographic change and poorly designed entitlement programs.

Which is probably what the audience expected me to say.

But then I told the crowd that a balanced budget requirement is neither necessary nor sufficient for good fiscal policy.

Which may have been a surprise.

To bolster my argument, I pointed to states such as Illinois, California, and New Jersey. They all have provisions to limit red ink, yet there is more spending (and more debt) every year. I also explained that there are also anti-deficit rules in nations such as Greece, France, and Italy, yet those countries are not exactly paragons of fiscal discipline.

To help explain why balanced budget requirements are not effective, I shared this chart showing annual changes in revenue over the past two decades for the federal government (Table 1.1 of OMB’s Historical Tables).

It shows that receipts are very volatile, primarily because they grow rapidly when the economy is expanding and they contract – sometimes sharply – when there’s an economic downturn.

I pointed out that volatile revenue flows make it very difficult to enforce a balanced budget requirement.

Most important, it’s extremely difficult to convince politicians to reduce spending during a recession since that’s when they feel extra pressure to spend more money (whether for Keynesian reasons of public-choice reasons).

Moreover, a balanced budget requirement doesn’t impose any discipline when the economy is growing. If revenues are growing by 8%, 10%, or 12% per year, politicians use that as an excuse for big increases in the spending burden.

Needless to say, those new spending commitments then create an even bigger fiscal problem when there’s a future downturn (as I’ve noted when writing about budgetary problems in jurisdictions such as Cyprus, Alaska, Ireland, Alberta, Greece, Puerto Rico, California, etc).

So what, then, is the right way of encouraging or enforcing prudent fiscal policy?

I told the audience we need a federal spending cap, akin to what exists in Switzerland, Hong Kong, and Colorado. Allow politicians to increase spending each year, preferably at a modest rate so that there’s a gradual reduction in the fiscal burden relative to economic output.

I’ve modified the above chart to show how a 2% spending cap would work. Politicians could increase spending when revenues are falling, but they wouldn’t be allowed to embark on a spending spree when revenues are rising.

Spending caps create a predictable fiscal environment. And limiting spending growth produces good outcomes.

If you’re still not convinced, this video hopefully will make a difference.

P.S. Spending caps work so well that even left-leaning international bureaucracies such as the OECD and IMF have acknowledged that they are the only effective fiscal rule.

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There’s Very Bad News in CBO’s New Fiscal Forecast, but there Is a Solution to Excessive Government Spending

The Congressional Budget Office (CBO) just released its new 10-year forecast. Unsurprisingly, it shows that Trump’s reckless spending policy is accelerating America’s descent to Greek-style fiscal profligacy.

Most people are focusing on the estimates of additional red ink, but I point out in this interview that the real problem is spending.

Some folks also are highlighting the fact that CBO isn’t projecting a recession, but I don’t think that’s important for the simple fact that all economists are bad at making short-run economic predictions.

That being said, I think CBO’s long-run fiscal forecasts are worthy of close attention (unfortunately, I didn’t state this very clearly in the interview).

And what worries me is that the numbers show that government spending will be consuming an ever-larger share of the nation’s economic output.

However, it’s not time to give up.

Modest spending restraint (i.e., obeying the Golden Rule of fiscal policy) generates very good results in a remarkably short period of time.

What matters most is reducing the burden of spending. But when you address the problem of government spending (as the chart shows), you also solve the symptom of red ink.

The challenge, of course, is convincing politicians that spending should be frozen. Or, at the very least, that it should only grow at a modest pace.

We have enjoyed periods of spending restraint, including a five-year spending freeze under Obama, as well as some fiscal discipline under both Reagan and Clinton.

But if we want long-run spending discipline, we need a comprehensive spending cap, sort of like the very successful systems in Hong Kong and Switzerland.

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Debating Fiscal Policy and Red Ink for USA Today

The folks at USA Today invited me to opine on fiscal policy, specifically whether the 2017 tax cut was a mistake because of rising levels of red ink.

Here’s some of what I wrote on the topic, including the all-important point that deficits and debt are best understood as symptoms of the real problem of too much spending.

Now that there’s some much needed tax reform to boost American competitiveness, we’re supposed to suddenly believe that red ink is a national crisis. What’s ironic about all this pearl clutching is that the 2017 tax bill actually increases revenue beginning in 2027, according to the Joint Committee on Taxation. …This isn’t to say that America’s fiscal house is in good shape, or that President Donald Trump should be immune from criticism. Indeed, the White House should be condemned for repeatedly busting the spending caps as part of bipartisan deals where Republicans get more defense spending, Democrats get more domestic spending and the American people get stuck with the bill. …The real lesson is that red ink is bad, but it’s only the symptom of the real problem of a federal budget that is too big and growing too fast.

I also pointed out that the only good solution for our fiscal problems is some sort of spending cap, similar to the successful systems in Hong Kong and Switzerland.

Heck, even left-leaning international bureaucracies such as the OECD and IMF have pointed out that spending caps are the only successful fiscal rule.

Now let’s look at a different perspective. USA Today also opined on the same topic (I was invited to provide a differing view). Here are excerpts from their editorial.

…more than anyone else, Laffer gave intellectual cover to the proposition that politicians can have their cake and eat it, too. …Laffer argued — on a cocktail napkin, according to economic lore, and elsewhere — that tax reductions would pay for themselves. These “supply side” cuts would stimulate growth so much, revenue would rise even as tax rates declined. This is, of course, rubbish. In the wake of the massive 2017 tax cuts, …the budget deficit is projected to run a little shy of $1 trillion… To run such large deficits a decade into a record economy recovery, is a massive problem because they will soar to dangerous heights the next time a recession strikes.

I think the column misrepresents the Laffer Curve, but let’s set that issue aside for another day.

The editorial also goes overboard in describing the 2017 tax cut as “massive.” As I noted in my column, that legislation actually raises revenue starting in 2027.

That being said, the main shortcoming of the USA Today editorial is that it doesn’t acknowledge that America’s long-run fiscal challenge (even for those who fixate on deficits and debt) is entirely driven by excessive spending growth.

Indeed, all you need to know is that nominal GDP is projected to grow by an average of about 4.0 percent annually over the next 30 years while the federal budget is projected to grow 5.2 percent per year.

This violates the Golden Rule of sensible fiscal policy.

And raising taxes almost certainly would make this bad outlook even worse since the economy would be weaker and politicians would jack up spending even further.

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The (Seemingly) Inexorable Increase in the Burden of Federal Spending

Earlier this year, I reviewed new fiscal projections from the Congressional Budget Office (CBO) and showed that balancing the budget would be relatively easy if politicians simply limited spending so that it didn’t grow faster than inflation.

Though I made sure to point out that the primary goal should be to limit the burden of spending. That’s because government spending, regardless of whether it’s financed by taxes or financed by borrowing, undermines prosperity by diverting resources from the productive sector of the economy.

We now have some new numbers from CBO. The number-crunching bureaucrats have put together their estimates of the latest Trump budget and that’s generated some predictable squabbling between Republicans and Democrats.

Most of the finger-pointing has focused on the (relatively trivial) fiscal impact of the Trump tax cuts.

The Wall Street Journal wisely put the focus instead on the growth of government.

You wouldn’t know it from the press coverage, but there’s some modest good news about the federal budget. The deficit is rising, but not as much as feared because tax revenues are increasing due to faster economic growth. …So why has the federal deficit increased by $145 billion this fiscal year to $531 billion? Because federal spending continued to rise rapidly—7% in the first seven months to $2.571 trillion. That’s $178 billion more than in the same period a year ago. …The media blame deficits on tax reform, but the facts show the main culprit is spending. No one in the political class wants to talk about entitlements but that’s where the money is.

The WSJ’s editorial focused on short-run data.

I want to augment that analysis by looking at medium-run and long-run numbers.

We’ll start with this chart looking at what will happen over the next 10 years. As you can see, Washington is violating my Golden Rule by allowing spending to grow faster than the private economy.

As a result, the burden of federal spending, measured as a share of gross domestic product, is projected to climb over the next decade.

That’s not good news.

(For what it’s worth, since tax revenues will be growing at the same pace as spending, there won’t be any meaningful change in the deficit as a share of GDP.)

Now let’s look at the most-recent long-run data from CBO. These numbers are even more depressing because the spending burden continues to grow faster than the private sector. A lot faster.

Which is why the burden of federal spending is projected to increase from less than 21 percent of GDP today to nearly 29 percent of GDP by 2049.

That’s terrible news.

And if you include spending by state and local governments (which currently consumes more than 11 percent of economic output and also is projected to increase), the terrible news gets even worse.

Moreover, the tax burden is projected to climb as well, and that doesn’t even include any estimate of what will happen if politicians manage to impose a value-added tax, an energy tax, a wealth tax, a financial transactions tax, or any of the other revenue-raising schemes under consideration in Washington.

In other words, the U.S. is on track to become just like Greece, France, and Italy.

P.S. There is an alternative to this dismal future. But can we convince politicians to adopt a spending cap and then make it work with genuine entitlement reform? I’m not holding my breath for any of that to happen.

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Busting the Spending Caps…Again

There are two things everyone should understand about the federal budget.

• First, America faces a grim future because Washington spending will consume an ever-larger share of economic output because of demographic changes and poorly designed entitlement programs.
• Second, the problem could be easily fixed with policies – especially genuine entitlement reform – designed to limit overall spending so that the budget grows slower than the productive sector of the economy.

Sadly, the politicians in Washington generally aren’t interested in sensible fiscal policy. They have a “public choice” incentive to spend more money in hopes of buying more votes.

Congressman Chip Roy, a freshman from Texas, is one of the few lawmakers who objects to the spend-like-there’s-no-tomorrow mentality in Washington.

Here’s some of what he wrote for the Hill.

…both parties appear to have reached a consensus on one major issue: busting spending caps is their solution to disagreements over spending. …Members of my party would be happy to agree with Democrats’ demands to spend outside our means, so long as they get all the money they want for defense. …The truth is Washington is all about power rather than solving the problem. It’s politically easier for Republicans to press for defense spending and Democrats to push for non-defense spending… Years of out-of-control spending and poor decision making is catching up with us.

He specifically wants to maintain the spending caps that apply to annually appropriated outlays.

Instead of wringing our hands and finding political convenient reasons to spend outside our means, Congress should stick to the caps. Doing so will force us – Republicans and Democrats – to sit at the table and negotiate—a lost art in Washington… allowing an across-the-board sequester to kick-in is more responsible than what Congress appears on track to do. …we must act now to do our job. We must stick to the budget caps.

He’s right about the desirability of a sequester.

Indeed, the sequester that took place in 2013 was the biggest victory for fiscal discipline during Obama’s presidency.

Sadly, politicians since then have been jumping through all sorts of hoops to avoid a second sequester. And the Democrats in the House of Representatives are proposing to bust the spending caps once again.

Here’s a chart prepared by Republicans on the House Budget Committee.

By the way, I’m not citing material from Republicans because they deserve praise.

• I augmented their infographic by noting that GOPers supported a “bad” 2013 deal to bust the spending caps.
• They then busted the spending caps a second time in 2015 and that deal was even “worse” on spending.
• Then the deal Republicans did with Trump in 2018 to bust the spending caps was “awful” for taxpayers.

So even though House Democrats are now proposing something that’s “absurdly terrible,” Republicans don’t have much credibility on the issue.

I’ll close with an observation about Greece’s fiscal tragedy.

There was no single decision that caused that country’s economic crisis. Instead, it was hundreds of short-sighted choices to spend more on Program A, Initiative B, Plan C, and Project D, along with every kind of tax increase under the sun.

And when some people warned that the fiscal orgy eventually would produce bad consequences, they were dismissed or ignored.

Sadly, American is heading down the same path. We know the solution, but politicians are more interested in buying votes than doing what’s right for America.

That includes the President. Trump has the power to force a sequester. All he has to do is veto any spending bill that busts the caps. But don’t hold your breath waiting for that to happen.

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New CBO Numbers Confirm that Modest Spending Restraint Is the Ideal Way of Balancing the Budget

The Congressional Budget Office just released it’s annual Budget and Economic Outlook, and that means I’m going to do something that I first did in 2010 and most recently did last year.

I’m going to show that it’s actually rather simple to balance the budget with modest spending restraint.

This statement shocks many people because they’ve read about out-of-control entitlement spending, pork-filled appropriations bills, big tax cuts, and trillion-dollar deficits.

But  the first thing to understand when contemplating how to fix America’s fiscal problems is that tax revenues, according to the new CBO numbers, are going to increase by an average of nearly 5 percent annually over the next 10 years. And that means receipts will be more than $2.1 trillion higher in 2029 than they are in 2019.

And since this year’s deficit is projected to be “only” $897 billion, that presumably means that it shouldn’t be that difficult to balance the budget.

By the way, I don’t even think balance should be the goal. It’s far more important to focus on reducing the burden of government spending. After all, the economy is adversely affected if wasteful outlays are financed by taxes, just as the economy is hurt when wasteful outlays are financed by borrowing.

In other words, too much government spending is the disease. Deficits are best understood as a symptom of the disease.

But I’m digressing. The point for today is simply that the symptom of borrowing can be addressed if a good chunk of that additional $2.1 trillion of new revenue is used to get rid of the $897 billion of red ink.

Unfortunately, the CBO report projects that the burden of government spending also is on an upward trajectory. As you can see from our next chart, outlays will jump by about $2.6 trillion by 2029 if the budget is left on autopilot.

The solution to this problem is very straightforward.

All that’s needed is a bit of spending restraint to put the budget on a glide path to balance.

I’m a big fan of spending caps, so this next chart shows the 10-year fiscal outlook if annual spending increases are limited to 1% growth, 2% growth, or 2.5% growth.

As you can see, modest spending discipline is a very good recipe for fiscal balance.

Our final chart adds a bit of commentary to illustrate how quickly we could move from deficit to surplus based on different spending trajectories.

I’ll close with a video from 2010 that explains why spending restraint is the best way to achieve fiscal balance. Especially when compared to tax increases.

The numbers are different today, but the analysis hasn’t changed.

As I noted at the end of the video, balancing the budget with spending restraint may be simple, but it won’t be easy.

If we want spending to grow, say, 2% annually rather than 5% annually, that will require some degree of genuine entitlement reform. And it means finally enforcing some limits on annual appropriations.

Those policies will cause lots of squealing in Washington. But we saw during the Reagan and Carter years, as well as more recently, that spending discipline is possible.

P.S. The video also exposed the dishonest way that budgets are presented in Washington.

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Rand Paul’s Sensible Budget Rejected, but Here’s the Silver Lining

During the election season, I speculated Trump was a big government Republican, and he confirmed my analysis this past February when he acquiesced to an orgy of new spending and agreed to bust the spending caps.

That awful spending spree gave huge increases to almost every part of the budget, and I pointed out that the deal probably will create the conditions for future tax hikes.

I got so upset at profligate GOPers that I crunched the numbers and revealed that (with the notable exception of Reagan) Republican presidents are even bigger spenders than Democrats.

Well, Senate Republicans recently had a chance to atone for their sins by voting for a proposal from Rand Paul to balance the budget.

So what did they do? Rejected it, of course.

In a column for Reason, Eric Boehm justly condemns Republicans for being big spenders.

The Senate on Thursday resoundingly rejected the Kentucky Republican’s plan to balance the federal budget by 2023, voting 76 to 21 against a bill that would have required a $400 billion cut in federal spending next year, followed by 1 percent spending increases for the rest of the next decade. …Paul’s proposal never really had a chance of passing, coming as it did just months after Congress approved enormous spending hikes that busted Obama-era caps once championed by Republicans as necessary for fiscal restraint. …Paul’s plan would have balanced the budget by 2023, as long as revenue met current CBO projections. By 2028, his proposal envisioned a $700 billion surplus instead of the $1.5 trillion deficit currently projected by the CBO.

A Lifezette column by Brendan Kirby was even more critical of big-government Republicans.

Sen. Rand Paul (R-Ky.) was hoping his Republican colleagues would be embarrassed by their vote to jack up federal spending earlier this year and support his plan to phase in a balanced budget. Few were. Paul got 20 other Republican senators on Thursday — less than half of the Senate GOP caucus — to vote for his “penny plan,” which would balance the federal budget over five years… No Democrats back the proposal. …Even though Paul’s bid failed, it did pick up the support of some senators who voted for the spending bill in February, including Senate Majority Whip John Cornyn (R-Texas). The others were Sens. Marco Rubio (R-Fla.), John Barrasso (R-Wyo.), Joni Ernst (R-Iowa), Deb Fischer (R-Neb.) and Jerry Moran (R-Kan.). …Paul also got more votes than he did for a similar proposal last year.

Kirby’s article ended on an upbeat note based on voting patterns.

I also want to close on an upbeat note, but for an entirely different reason. Here are the annual numbers from the CBO baseline (what will happen to spending and revenue if government continues on its current path) and the numbers for Senator Paul’s proposal.

And why do these depressing numbers leave me with a feeling of optimism?

For the simple reason that they show how simple it is to make progress with some modest spending restraint. The lower set of number show that Senator Paul quickly gets to a balanced budget by imposing an overall reduction of about 2 percent on spending in 2019, followed by annual increases of about 1 percent until 2025.

I think that’s a great plan, but I’d also be happy with a plan that allows spending to grow by 1 percent each year. Or even 2 percent each year.

My bottom line is that we need some sort of spending cap so that the burden of government spending grows slower than the productive sector of the economy. In other words, comply with the Golden Rule.

And what’s especially remarkable is that solving our fiscal problems is still quite feasible notwithstanding the reckless spending bill that was recently approved (Paul’s proposal, incidentally, leaves in place the small – and temporary – tax cut from the recent reform legislation).

P.S. Senator Paul would achieve a balanced budget in just five years by letting spending grow during that period by a bit less than 4/10ths of 1 percent per year. Does that sound impossibly radical? Well, it’s what Republicans managed to achieve during the heyday of the Tea Party revolution, when they actually produced a five-year nominal spending freeze. In other words, zero spending growth! If they could impose that level of discipline with Obama in the White House, why not do the same with Trump (who quasi-endorsed the Penny Plan) at the other end of Pennsylvania Avenue?

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In a Single Image, Everything You Need to Know about the New CBO Budget Numbers

The Congressional Budget Office just released its annual Economic and Budget Outlook, and almost everyone in Washington is agitated (or pretending to be agitated) about annual deficits exceeding $1 trillion starting in the 2020 fiscal year.

All that red ink isn’t good news, but I’m much more concerned (and genuinely so) about this line from CBO’s forecast. In just 10 years, the burden of federal spending is going to jump from 20.6 percent of GDP to 23.6 percent!

Simply stated, we’ve entered the era of baby boomer retirement. And because we have some very poorly designed entitlement programs, that means the federal budget – assuming we leave it on autopilot – is going to consume an ever-growing share of our national economic output.

The bottom line is that Washington is violating my Golden Rule.

Let’s look at the underlying numbers. Federal spending is projected by CBO to grow by an average of about 5.5 percent per year over the next decade while nominal GDP is estimated to grow by just 4.0  percent annually.

And that unfortunate trend isn’t limited to the nest 10 years. CBO’s latest long-run forecast, which I discussed last year, shows a never-ending deterioration of America’s fiscal position.

Hello Greece.

Fortunately, there is a solution to this mess.

A modest amount of spending restraint can quickly reverse our fiscal troubles and put us on a path to a balanced budget. More importantly, limits on the growth of spending can slowly reduce the size of the federal government relative to the private sector.

Here’s a chart, based on CBO’s numbers, that shows how much Uncle Sam is spending this year (a bit over $4.1 trillion), along with a blue line showing projected tax revenues over the next 10 years (blue line). And I’ve shown what happens if spending is “only” allowed to increase by either 2 percent annually (orange line) or 3 percent annually (grey line) over the next decade.

This chart is basically everything you need to know. It shows that our fiscal situation is not hopeless. All we have to do is make sure government is growing slower than the productive sector of the economy.

A good rule of thumb, as suggested in the chart title, is that government shouldn’t grow faster than the rate of inflation.

And we’ve done it before.

• During the Clinton years, the United States enjoyed a multi-year period of spending restraint. We got a balanced budget because of that frugality. More important, spending fell as a share of GDP.
• During the Obama years, we benefited from a five-year de facto spending freeze. Deficits dropped dramatically and the nation experienced the biggest drop in the relative burden of spending since the end of World War II.

And many other nations also have also managed multi-year periods of spending restraint.

Let’s close with a video I narrated which illustrates how modest spending discipline generates good outcomes.

It’s from 2010, so the numbers are no longer relevant, but otherwise the analysis applies just as strongly today.

P.S. I’m not overly optimistic that President Trump is serious about solving this problem. His proposed a semi-decent amount of spending restraint in last year’s budget, but then he signed into law a grotesque budget-busting appropriations bill.

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Everything You Need to Know about Federal Spending in Five Charts

I write constantly (some would say incessantly and annoyingly) about entitlement spending. And I occasionally write about discretionary spending.

It’s time to address the budget in a comprehensive fashion. Let’s look at five charts to put everything in context and to show how we got into our current mess.

Our first chart (based on Table 8.2 from the Office of Management and Budget’s Historical Tables) shows what has happened to major spending categories from 1962 to 2017. And all the data is in inflation-adjusted dollars (2009 benchmark) to accurately gauge how and why the burden of federal spending has grown.

This next chart shows the actual percentage increases in the major spending categories during this time period. The two big takeaways are that 1) the defense budget is not the cause of our long-run fiscal problems (though that doesn’t mean it should be exempt from cuts), and 2) entitlement expenditures have exploded.

And if you look at the data I shared from the Congressional Budget Office’s long-run forecast, you would see that these same trends will prevail for the next three decades.

In other words, our fiscal problems start with entitlements and end with entitlements.

If you want to look at the problem with a broader lens, this next chart shows that the problem is domestic spending (i.e., the combination of entitlement and domestic discretionary outlays).

If you’re pressed for time, you can stop reading now. You have the key information already.

But if you want to get a bit wonky, here are two other charts that help explain the intricacies of how budgets work (or don’t work!) in Washington.

The first thing to realize is that there are two budget processes in Washington. There are entitlement programs, which basically operate on autopilot. For all intents and purposes, the President and Congress could go on vacation for the next three years and programs such as Social Security, Medicare, Medicaid, and Obamacare would mechanically continue. But there is also “discretionary” spending for the Pentagon and various domestic programs, all of which is determined through an annual “appropriations” process. Whenever you read about a government shutdown, it’s because politicians can’t agree on the level of funding for the discretionary part of the budget.

Now let’s get to my favorite part, which is figuring out how to limit the size of the federal leviathan.

This last chart shows that net interest spending is genuinely untouchable (unless one wants a Greek-style or Argentine-style default). The rest of the budget, however, can be addressed. Entitlements can be changed through “reconciliation”, which is a legislative process designed to minimize procedural roadblocks (in general, tax bills also use reconciliation legislation). And discretionary programs can be changed via annual appropriations legislation.

I should add that net interest may not be directly touchable, but interest payments can be reduced by controlling spending and thus reducing red ink.

Another thing to understand is that the budget caps (yes, the ones that were weakened in 2013, 2015, and earlier this year) only apply to discretionary spending.

And the most important thing to realize is that the only solution to our budget mess is genuine entitlement reform. Which is why we need constitutional (and comprehensive) limits on total outlays. Politicians will only do what’s right if every other option is off the table.

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When America’s Fiscal Crisis Hits, Be Forewarned that Tax Increases Will Make a Bad Situation Worse

At some point in the next 10 years, there will be a huge fight in the United States over fiscal policy. This battle is inevitable because politicians are violating the Golden Rule of fiscal policy by allowing government spending to grow faster than the private sector (exacerbated by the recent budget deal), leading to ever-larger budget deficits.

I’m more sanguine about red ink than most people. After all, deficits and debt are merely symptoms. The real problem is excessive government spending.

But when peacetime, non-recessionary deficits climb above $1 trillion, the political pressure to adopt some sort of “austerity” package will become enormous. What’s critical to understand, however, is that not all forms of austerity are created equal.

The crowd in Washington reflexively will assert that higher taxes are necessary and desirable. People like me will respond by explaining that the real problem is entitlements and that we need structural reform of programs such as Medicaid and Medicare. Moreover, I will point out that higher taxes most likely will simply trigger and enable additional spending. And I will warn that tax increases will undermine economic performance.

Regarding that last point, three professors, led by Alberto Alesina at Harvard, have unveiled some new research looking at the economic impact of expenditure-based austerity compared to tax-based austerity.

…we started from detailed information on the consolidations implemented by 16 OECD countries between 1978 and 2014. …we group measures in just two broad categories: spending, g, and taxes, t. …We distinguish fiscal plans between those that are expenditure based (EB) and those that are tax based (TB)… Measuring the macroeconomic impact of a plan requires modelling the relationship between plans and macroeconomic variables.

Here are their econometric results.

There is a large and statistically significant difference between the effects on output of EB and TB austerity. EB fiscal consolidations have, on average, been associated with a very small downturn in output growth: a spending based plan worth one percent of GDP implies a loss of about half of a percentage point relative to the average GDP growth of the country, which lasts less than two year. Moreover, if an EB austerity plan is launched when the economy is not in a recession, the output costs are zero on average. …On the other hand TB plans are associated with large and long lasting recessions. A TB plan worth one per cent of GDP is followed, on average, by a two percent fall in GDP relative to its pre-austerity path. This large recessionary effect lasts several years.

Here’s a chart from the study showing that economic performance drops farther and farther to the extent taxes are part of an austerity package.

In addition to the core results, the authors explain why tax-based austerity packages are bad for capital…

…investment growth responds very differently following the introduction of the two types of austerity plans. It responds positively to EB plans and negatively to TB plans. …in their sample of OECD countries, business confidence increases immediately at the start of an EB consolidation plan, much more so that at the beginning of a TB plan.

…and why tax-based austerity packages are bad for labor.

…clearly tax hikes and spending cuts – beyond other effects – have different effects on labor supply. …EB plans are the least recessionary the longer lived is the reduction in government spending. Symmetrically, TB plans are more recessionary the longer lasting is the increase in the tax burden and thus in distortions.

Since capital and labor are the two factors of production, the obvious and inevitable conclusion is that the economy does worse when taxes are higher.

The study also make a critical point about the futility of tax increases when the burden of government spending is rising faster than the private sector. Simply stated, that’s a recipe for ever-increasing taxes, sort of like a dog chasing its tail.

…a TB plan which does not address the automatic growth of entitlements and other spending programs which grow over time if much less like likely to produce a long lasting effect on the budget. If the automatic increase of spending is not addressed, taxes will have to be continually increased to cover the increase in outlays.

That’s why spending restraint is the only way to successfully address red ink.

It doesn’t even require dramatic spending cuts, even though that would be desirable. All that’s needed is some modest fiscal restraint so that spending grows slower than the productive sector of the economy.

Nations that follow this approach for a multi-year period always get good results. But if you want examples of nations that have achieved good outcomes with tax increases, you’ll have to explore a parallel universe because there aren’t any on this planet.

P.S. I need to update the table because both the United States (between 2009-2014) and the United Kingdom (between 2010-2016) enjoyed dramatic improvements in fiscal outcomes in recent years because of spending restraint.

P.P.S. Politicians don’t like spending restraint, which is why most periods of good fiscal policy come to an end. To achieve good long-run outcomes, some sort of constitutional spending cap is probably necessary.

P.P.P.S. The study cited above builds upon research I cited in 2016.

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In Just Six Minutes, Everything You Need to Know about Spending Caps

Back in April, I shared a new video from the Center for Freedom and Prosperity that explained how poor nations can become rich nations by following the recipe of small government and free markets.

Now CF&P has released another video. Narrated by Yamila Feccia from Argentina, it succinctly explains – using both theory and evidence – why spending caps are the most prudent and effective way of achieving good fiscal results.

Ms. Feccia covers all the important issues, but here are five points that are worth emphasizing.

1. Demographics – Almost all developed nations have major long-run fiscal problems because welfare states will implode because of aging populations and falling birthrates (Ponzi schemes need an ever-growing number of new people to stay afloat).
2. Golden Rule – If government spending grows slower than the private sector, that reduces the relative burden of government spending (the underlying disease) and also reduces red ink (the symptom of the underlying disease).
3. Success Stories – Simply stated, spending caps work. She lists the nations that have achieved very good results with multi-year periods of spending restraint. She points out that the U.S. made a lot of fiscal progress when GOPers aggressively fought Obama. And she shares the details about the very successful constitutional spending caps in Hong Kong and Switzerland.
4. Better than Balanced Budget Amendments or Anti-Deficit Rules – The video explains why policies that try to target red ink are not very effective, mostly because tax revenues are very volatile.
5. Even International Bureaucracies Agree – Remarkably, the International Monetary Fund (twice!), the European Central Bank, and the Organization for Economic Cooperation and Development (twice!) have acknowledged that spending caps are the most, if not only, effective fiscal rule.

I touch on some of these issues in one of my chapters in the Cato Handbook for Policymakers. The entire chapter is worth reading, in my humble opinion, but I want to share an excerpt echoing Point #4 that I just shared from Ms. Feccia’s video.

There’s a very practical reason to focus on capping long-run spending rather than trying to balance the budget every year. Simply stated, the “business cycle” makes the latter very difficult. …when a recession occurs and revenues drop, a balanced-budget mandate requires politicians to make dramatic changes at a time when they are especially reluctant to either raise taxes or impose spending restraint. Then, when the economy is enjoying strong growth and producing lots of tax revenue, a balanced-budget requirement doesn’t impose much restraint on spending. All of which creates an unfortunate cycle. Politicians spend a lot of money during the good years, creating expectations of more and more money for various interest groups. When a recession occurs, the politicians suddenly have to slam on the brakes. But even if they actually cut spending, it is rarely reduced to the level it was when the economy began its upswing. Moreover, politicians often raise taxes as part of these efforts to comply with anti-deficit rules. When the recession ends and revenues begin to rise again, the process starts over—this time from a higher base of spending and with a bigger tax burden. Over the long run, these cycles create a ratchet effect, with the burden of government spending always reaching new plateaus.

It’s not that I want to belabor this point, but the bottom line is that it is very difficult to amend a country’s constitution (at least in the United States, but presumably in other nations as well).

So if there’s going to be a major campaign to put a fiscal rule in a constitution, then I think it should be one that actually achieves the goal. And whether people want to address the economically important goal of spending restraint or the symbolically important goal of fiscal balance, what should matter is that a spending cap is the effective way of getting there.

P.S. The narrator is from the soccer-mad country of Argentina, which has a big rivalry with the soccer-mad nation of Brazil. Like most Americans, I don’t quite get the appeal of that sport. That being said, I will cheer for Brazil the next time it plays against Argentina for the simple reason that it just adopted a constitutional amendment to cap government spending. If Ms. Feccia wants me to cheer for her country’s team, she needs to convince her government to do something similar.

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The Five Most Important Takeaways from Trump’s Budget

It’s both amusing and frustrating to observe the reaction to President Trump’s budget.

I’m amused that it is generating wild-eyed hysterics from interest groups who want us to believe the world is about to end.

But I’m frustrated because I’m reminded of the terribly dishonest way that budgets are debated and discussed in Washington. Simply stated, almost everyone starts with a “baseline” of big, pre-determined annual spending increases and they whine and wail about “cuts” if spending doesn’t climb as fast as previously assumed.

Here are the three most important things to understand about what the President has proposed.

First, the budget isn’t being cut. Indeed, Trump is proposing that federal spending increase from $4.06 trillion this year to $5.71 trillion in 2027.

Second, government spending will grow by an average of almost 3.5 percent per year over the next 10 years.

Third, because the private economy is projected to grow by an average of about 5 percent per year (in nominal terms), Trump’s budget complies with the Golden Rule of fiscal policy.

Now that we’ve established a few basic facts, let’s shift to analysis.

From a libertarian perspective, you can argue that Trump’s budget is a big disappointment. Why isn’t he proposing to get rid of the Department of Housing and Urban Development? What about shutting down the Department of Education? Or the Department of Energy? How about the Department of Agriculture, or Department of Transportation?

And why is he leaving Social Security basically untouched when taxpayers and retirees would both be better off with a system of personal retirement accounts? And why is Medicare not being fundamentally reformed when the program is an ever-expanding budgetary burden?

In other words, if you want the federal government to reflect the vision of America’s Founders, the Trump budget is rather disappointing. It’s far from a Liberland-style dream.

But for those who prefer to see the glass as half-full, here are a couple of additional takeaways from the budget.

Fourth, as I wrote yesterday, there is real Medicaid reform that will restore federalism and save money.

Fifth, domestic discretionary spending will be curtailed.

But not just curtailed. Spending in the future for this category will actually be lower if Trump’s budget is approved. In other words, a genuine rather than fake budget cut.

I’ll close with my standard caveat that it’s easy to put good ideas (or bad ideas) in a budget. The real test is whether an Administration will devote the energy necessary to move fiscal reforms through Congress.

Based on how Trump was defeated in the battle over the final spending bill for the current fiscal year, there are good reasons to be worried that good reforms in his budget won’t be implemented. Simply stated, if Trump isn’t willing to use his veto power, Congress will probably ignore his proposals.

P.S. You may have noticed that I didn’t include any discussion of deficits and debt. And I also didn’t address the Administration’s assertion that the budget will be balanced in 10 years if Trump’s budget is approved. That’s because a fixation on red ink is a distraction. What really matters is whether the burden of spending is falling relative to the private sector’s output. In other words, the entire focus should be on policies that generate spending restraint and policies that facilitate private sector growth. If those two goals are achieved, the burden of red ink is sure to fall. Whether it happens fast enough to balance the budget in 2027 is of little concern.

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Medicaid Reforms in Trump Budget Are Necessary and Desirable

When President Trump released his so-called “skinny budget” back in March (dealing with the parts of Leviathan that are annually appropriated), I applauded several of the specific recommendations.

• Shutting down the wasteful National Endowment for the Arts.
• Defunding National Public Radio and the Corporation for Public Broadcasting.
• Terminating the scandal-plagued Community Development Block Grant program.

The only problem is that I didn’t sense – and still don’t see – any serious effort to push through these much-needed fiscal reforms (and the same is true for his proposed tax cut).

The bottom line is that Trump has the power to achieve the bulk of his agenda, but only if he is willing to veto pork-filled bills and force a partial government shutdown. But he’s already blinked once in this type of battle, so the spending lobbies feel confident that he can be rolled again.

But let’s set that aside. The White House is about to release the President’s full budget and there already is considerable angst about potential reforms to Medicaid. Here are some excerpts from a report in the Washington Post.

President Trump’s first major budget proposal on Tuesday will include massive cuts to Medicaid…more than $800 billion over 10 years. …Trump’s decision to include the Medicaid cuts is significant because it shows he is rejecting calls from a number of Senate Republicans not to reverse the expansion of Medicaid that President Barack Obama achieved as part of the Affordable Care Act. The House has voted to cut the Medicaid funding… The proposed changes will be a central feature of Trump’s first comprehensive budget plan…it will seek changes to entitlements — programs that are essentially on auto­pilot and don’t need annual authorization from Congress.

I have two reactions to this story.

First, the Washington Post is lying (and not for the first time). There will be no Medicaid cuts in Trump’s budget. Contrary to the headline, there aren’t “big cuts” and there won’t be any “slashing.” We won’t see the actual numbers until tomorrow, but I can state with complete certainty that the Trump Administration is merely going to propose a reduction in how fast the program’s budget increases.

Second, it’s a very good idea to slow down the growth of Medicaid spending.

Here is some background information on the program, starting with an article in The Week by Shikha Dalmia

Medicaid is arguably the civilized world’s worst health insurance program. …This joint federal and state program has historically allowed the feds to give states 50 cents for every dollar they spent on purchasing health coverage for the poor. Because of this federal largesse, Medicaid has grown astronomically, becoming the single biggest ticket item on virtually every state budget. …President Obama essentially money-bombed states into expanding it even further. He told states that Uncle Sam would pick up 100 percent of the tab for the first three years for every additional person they covered up to 138 percent of the poverty level. …Medicaid now covers almost 75 million Americans. And even before ObamaCare took effect, Medicaid paid for almost half of all births in America. …The combined annual cost of the program now exceeds half a trillion dollars (with the feds’ share at 63 percent and states’ at 37 percent) — which adds up to roughly $7,000 for every man, woman, and child covered by the program. …Several reputable studies have found that Medicaid patients experience no better health outcomes than uninsured people, and arguably even slightly worse outcomes. …ObamaCare is like a Rube Goldberg contraption. Taking it apart and reassembling it is easier said than done — even if it’s the right and smart thing to do. And if Republicans can’t figure out a way to do so, American patients and taxpayers will be the big losers.

And here are some excerpts from a Wall Street Journal editorial.

The…important goal is to change the incentives over the long term and eliminate the perverse formulas that discount the welfare of the truly needy. …A helpful revolution in Medicaid would be to end the match rate that rewards higher spending and move to block grants. States would get some fixed pot of money annually, determined by how many people are enrolled. The pots might be expensive in the early years, but states would become accountable for marginal per capita spending growth over time. Governors can be assuaged by ending Medicaid’s command-and-control regulatory model, freeing them to use new tools to control costs.

James Capretta of the American Enterprise has additional details, particularly showing how the “federal medical assistance percentage” encourages higher spending.

In 1965, the authors of Medicaid thought they were creating a program that would provide federal structure, uniformity, and some funding for the many state programs that were already providing relatively inexpensive “indigent care” services to low-income households. …Medicaid has grown into the largest health care program in the country by enrollment, with 66 million participants and with annual federal and state costs of more than $550 billion. …Medicaid spending has increased rapidly nearly every year since the program was enacted, creating significant pressure in federal and state budgets. …The Medicaid FMAP is the fundamental flaw in the program’s current design and the main reason it is so costly. States can initiate new spending in Medicaid—spending that often will boost economic activity in the state—and federal taxpayers pay for at least half the cost. At the same time, savings from state-initiated Medicaid-spending cuts are also shared with federal taxpayers. For instance, in a state where the FMAP is 60 percent, the governor and state legislators face the unattractive prospect of keeping only $1.00 of every $2.50 in Medicaid savings they can identify and implement. The other $1.50 goes to the federal treasury. Put another way, governors and state legislators are reluctant to impose $2.50 in budgetary pain for a $1.00 gain to their bottom line.

The solution to this rigged system, he explains, is block grants or per-capita caps.

The…important structural change would be the switch to some form of fixed federal funding to states. The federal government would continue to heavily support the Medicaid program, but the commitment would have a limit, which would give states a strong incentive to manage the program for efficiency and cost control. One approach would be a block grant. Under a block grant, the federal government would make fixed, aggregate payments to the states based on historical spending patterns. Cost overruns at the state level would require the state to find additional resources within the state budget. Conversely, states that were able to control costs would enjoy the full benefits of their efforts. …Under per capita caps, the federal government would establish for each state a per-person payment for each of the main eligibility categories in the Medicaid program: the elderly, the blind and disabled, nondisabled adults, and children. The federal government would then make payments to the states based on the number of Medicaid enrollees in each of these categories. The per capita payment would be based on historical spending rates for the various categories of beneficiaries in each state and, again, would be indexed to a predetermined growth rate.

By the way, I previously shared two very depressing charts from Jim’s article.

In a 2012 column for Forbes, Avik Roy explains why reform will produce good results.

People on Medicaid have far worse health outcomes than those with private insurance, and in many cases those with no insurance at all. …there are…substantial efficiencies that can be gained by giving states broad flexibility in the way they care for the poor. Indeed, this is what made block-granting welfare in 1996 such a spectacular success. …three states—Rhode Island, Indiana, and New York—have taken advantage of more flexibility to save money while delivering better care. …Rhode Island was able to save $100 million, and slow the growth of Medicaid from 8 percent per year to 3 percent, by making a few tweaks to their program that they couldn’t before…under a block-grant system, states can identify ways to save money while improving care, and other states can adopt best practices.

Writing for the Wall Street Journal, Professor Regina Herzlinger and Dr. Richard Boxer elaborate on how a new system would work.

Republicans should combine two ideas popular in their party: block grants and health savings accounts. The former would let states tailor their Medicaid policies to their local communities, while the latter would give enrollees the ability to choose their own insurers and providers. In essence, Washington could give the states Medicaid block grants, allocated per capita, to provide beneficiaries with high-deductible insurance and health savings accounts. …Health savings accounts, which force medical providers to compete for consumers who pay out of their own pocket, also reduce overall costs. When employers introduce such accounts, health-care costs are reduced by about 5% for each of the next three years, according to a 2015 study from the National Bureau of Economic Research.

Nicholas Eberstadt, in an article for Commentary, points out the Medicaid is an employment killer.

21st-century America has witnessed a dreadful collapse of work. …According to the Census Bureau’s SIPP survey (Survey of Income and Program Participation), as of 2013, over one-fifth (21 percent) of all civilian men between 25 and 55 years of age were Medicaid beneficiaries. For prime-age people not in the labor force, the share was over half (53 percent). …means-tested benefits cannot support a lavish lifestyle. But they can offer a permanent alternative to paid employment, and for growing numbers of American men, they do. The rise of these programs has coincided with the death of work for larger and larger numbers of American men not yet of retirement age.

And the icing on the cake is that Medicaid finances much of the opioid problem in America.

[The Medicaid card] pays for medicine—whatever pills a doctor deems that the insured patient needs. …For a three-dollar Medicaid co-pay, therefore, addicts got pills priced at thousands of dollars, with the difference paid for by U.S. and state taxpayers. A user could turn around and sell those pills, obtained for that three-dollar co-pay, for as much as ten thousand dollars on the street. …Medicaid inadvertently helped finance America’s immense and increasing appetite for opioids in our new century.

And if we want a cherry on top of the icing, Medicaid also is a cesspool of fraud, as reported by Reason.

Every year, the Government Accountability Office (GAO) releases a report putting a dollar figure on the amount of improper payments in Medicaid. …it shows that the program…spends a substantial portion of its annual budget…On fraud, on waste, on services not rendered, not medically necessary, or incorrectly billed. Last year, for example, the GAO found that about 9.8 percent of federal Medicaid expenditures, or about $29 billion, was spent improperly. …This year, the total has risen once again. About 10.5 percent, or $36 billion, of federal spending on the program isn’t up to snuff, according to a GAO report released this morning.

On that issue, my “favorite” example of Medicaid fraud was perpetrated by Russian diplomats.

Last but not least, Charlie Katebi discusses Medicaid problems in a column for the Federalist.

Trump advisor Kellyanne Conway said Trump wants to “block-grant Medicaid to the states” to ensure “those who are closest to the people in need will be administering.” …Block grants would cap federal Medicaid funding and let states decide how to use those dollars. It would introduce flexibility and budget discipline to a program that sorely needs both. …Medicaid’s funding formula incentivizes policymakers to expand the program at the expense of core state government functions. …Medicaid’s structure also hurts its beneficiaries. …Washington bars reformers from making meaningful changes without going through a lengthy and restrictive approval process. This forces states to control costs the only way they can: paying doctors less. States have cut Medicaid’s reimbursement so low that many providers simply refuse to treat its beneficiaries. …Block grants promise to break Medicaid’s vicious cycle of rising costs and declining care. Spendthrift politicians would no longer be able to expand Medicaid and expect the federal government to foot the bill. But state-level reformers will enjoy greater authority to streamline and improve the program.

I may as well close with the video I narrated for the Center for Freedom and Prosperity.

The video was released in 2011, but nothing has changed…except that the numbers today are far worse, in part because of Obama’s Medicaid expansion.

P.S. Based on CBO’s long-run forecast, Trump also should reconsider his views on old-age entitlements and support Medicare reform and Social Security reform.

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New CBO Numbers and the Simple Formula for Good Fiscal Policy, Part II

Based on new 10-year fiscal estimates from the Congressional Budget Office, I wrote yesterday that balancing the budget actually is very simple with a modest bit of spending restraint.

If lawmakers simply limit annual spending increases to 1 percent annually, the budget is balanced by 2022. If spending is allowed to grow by 2 percent annually, the budget is balanced by 2025. And if the goal is balancing the budget by the end of the 10-year window, that simply requires that spending grow no more than 2.63 percent annually.

I also pointed out that this wouldn’t require unprecedented fiscal discipline. After all, we had a de facto spending freeze (zero percent spending growth) from 2009-2014.

And in another previous column, I shared many other examples of nations that achieved excellent fiscal results with multi-year periods of spending restraint (as defined by outlays growing by an average of less than 2 percent).

Today, we’re going to add tax cuts to our fiscal equation.

Some people seem to think it’s impossible to balance the budget if lawmakers are also reducing the amount of tax revenue that goes to Washington each year.

And they think big tax cuts, such as the Trump plan (which would reduce revenues over 10 years by $2.6 trillion-$3.9 trillion according to the Tax Foundation), are absurd and preposterous.

After all, if politicians tried to simultaneously enact a big tax cut and balance the budget, it would require deep and harsh spending cuts that would decimate the federal budget, right?

Nope. Not at all.

They just need to comply with my Golden Rule.

Let’s examine the fiscal implications of a $3 trillion tax cut. If you look at CBO’s baseline revenue forecast for the next 10 years, the federal government is projected to collect more than $43 trillion during that decade. If you reduce that baseline by an average of $300 billion each year, receipts will still grow. Indeed, they’ll rise from $3.4 trillion this year to $4.8 trillion in 2027.

And since CBO is forecasting that the federal government this year will spend more than $3.9 trillion, we simply have to figure out the amount of spending restraint necessary so that outlays in 2027 don’t exceed $4.8 trillion.

That’s not a difficult calculation. It turns out that the American people can get a substantial $3 trillion tax and a balanced budget if politicians simply exercise a modest amount of fiscal discipline and limit annual spending increases to 1.96 percent annually.

In other words, if the crowd in Washington does nothing more than simply have government grow just a tiny bit less than the projected rate of inflation, lots of good things can be achieved.

P.S. I can’t resist pointing out yet again that we shouldn’t fixate on balancing the budget. The real goal should be to shrink the burden of federal spending so more resources are allocated by the productive sector of the economy. That being said, if lawmakers address the underlying disease of excessive spending, that automatically solves the symptom of red ink.

P.P.S. Higher taxes, by contrast, generally lead to higher deficits and debt.

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New CBO Numbers and the Simple Formula for Good Fiscal Policy, Part I

The Congressional Budget Office, as part of The Budget and Economic Outlook: 2017 to 2027, has just released fiscal projections for the next 10 years.

This happens twice every year. As part of this biannual exercise, I regularly (most recently here and here) dig through the data and highlight the most relevant numbers.

Let’s repeat that process. Here’s what you need to know from CBO’s new report.

• Under current law, tax revenues over the next 10 years are projected to grow by an average of 4.2 percent each year.
• If left on autopilot, the burden of government spending will rise by an average of 5.2 percent each year.
• If that happens, the federal budget will consume 23.4 percent of economic output in 2027 compared to 20.7 percent of GDP in 2017.
• Under that do-nothing scenario, the budget deficits jumps to $1.4 trillion by 2027.

But what happens if there is a modest bit of spending restraint? What if politicians decide to comply with my Golden Rule and limit how fast the budget grows every year?

This shouldn’t be too difficult. After all, even with Obama in the White House, there was a de facto spending freeze between 2009-2014. In other words, all the fights over debt limits, sequesters, and shutdowns actually yielded good results.

So if the Republicans who now control Washington are serious about protecting the interests of taxpayers, it should be relatively simple for them to adopt good fiscal policy.

And if GOPers actually decide to do the right thing, the grim numbers in the CBO’s new report quickly turn positive.

• If spending is frozen at 2017 levels, there’s a budget surplus by 2021.
• If spending is allowed to grow 1 percent annually, there’s a budget surplus by 2022.
• If spending is allowed to grow 2 percent annually, there’s a budget surplus by 2025.
• If spending is allowed to grow 2.63 percent annually, the budget is balanced in 10 years.
• With 2.63 percent spending growth, the burden of government spending drops to 18.4 percent of GDP by 2027.

To put all these numbers in context, inflation is supposed to average about 2 percent annually over the next decade.

Here’s a chart showing the overall fiscal impact of modest spending restraint.

By the way, it’s worth pointing out that the primary objective of good fiscal policy should be reducing the burden of government spending, not balancing the budget. However, if you address the disease of excessive spending, you automatically eliminate the symptom of red ink.

For more background information, here’s a video I narrated on this topic. It was released in 2010, so the numbers have changed, but the analysis is still spot on.

P.S. Achieving good fiscal policy obviously becomes much more difficult if Republicans in Washington decide to embark on a foolish crusade to expand the federal government’s role in infrastructure.

P.P.S. Achieving good fiscal policy obviously becomes much more difficult if Republicans in Washington decide to leave entitlement programs on autopilot.

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All I Want for Christmas Is…a Spending Cap

What could be more fun than to spend the day before Christmas reading about fiscal policy?

I realize there are probably endless ways to answer that question, particularly since normal people are probably more concerned about the rumor that the feds are going to arrest Santa Claus.

But America’s fiscal future is very grim, so hopefully some of you will be interested in some relevant new research on spending caps.

My buddy Sven Larson has a scholarly article about deficits and the Swiss Debt Brake that has just been published by the Journal of Governance and Regulation.

The first half of his article is a review of the academic debate on whether deficits are good (the Keynesians) or bad (the austerity crowd). This literature review is necessary for that sort of article, though I think it’s a distraction because deficits are merely a symptom. The real problem is excessive government.

Sven then gets to the meat of his article, which considers whether the Swiss Debt Brake (which imposes a cap on annual spending increases) is a better approach because it isn’t focused on annual budget deficits (which are susceptible to big swings because income tax revenues can dramatically increase or decline based on the economy’s performance).

…the Swiss Debt Brake…focuses primarily on the non-cyclical, i.e., structural part of the deficit in Switzerland (Geier 2011). By focusing on the long-term debt outlook rather than the short-term or annual ebbs and flows, the debt brake allows the economy to move through a business cycle without disruptive fiscal-policy incursions. …Since it was introduced in 2003 it appears to have worked as intended. Beljean and Geier (2013) present evidence suggesting that the brake has ended a long period of sustained government deficits.

Sven then cites my Wall Street Journal column on the Debt Brake, which is nice, and he then shares some new evidence about the economic benefits of the Swiss spending cap.

The Swiss economy grew faster in the first decade after the brake went into effect than in the decade immediately preceding its enactment.

And, in his conclusion, he speculates that the United States could reap similar economic benefits with a spending cap.

Should Congress manage to pass and comply with an adapted version of the Swiss debt brake, it is reasonable to expect…stronger economic growth. As an indication of the potential macroeconomic gains, a real growth rate of three percent as opposed to two percent over a period of ten years would add more than $2.3 trillion in annual economic activity to the U.S. GDP.

The degree of additional growth that would be triggered by a spending cap is an open question, of course, but if we could get even half of that additional growth, it would be a boon for American living standards.

Let’s now shift to an article with a much more hostile view of spending caps.

I wrote very recently about the adoption of a spending cap in Brazil. This new system will limit government spending so that it can’t grow faster than inflation. Sounds very reasonable to me, but Zeeshan Aleem has a Vox column that is apoplectic about the supposed horrible consequences.

Americans worried that Donald Trump will try to shred the nation’s social welfare programs can take some grim comfort by looking south: No matter what Republicans do, it will pale in comparison with the changes that are about to ravage Brazil. On Thursday, a new constitutional amendment goes into effect in Brazil that effectively freezes federal government spending for two decades. Since the spending cap can only increase by the rate of inflation in the previous year, that means that spending on government programs like education, health care, pensions, infrastructure, and defense will, in real terms, remain paused at 2016 levels until the year 2037.

Since the burden of government spending in Brazil has been rising far faster than the growth of the private sector (thus violating fiscal policy’s Golden Rule), I view the spending cap as a long-overdue correction.

Interesting, Aleem admits that the policy is being welcomed by financial markets.

As far as inspiring faith from investors, the amendment appears to be working. Brazil’s currency and stocks rose during December in part because of the passage of the measure.

But the author is upset that there won’t be as much redistribution spending.

…the spending cap…places the burden of reining in government spending entirely on beneficiaries of government spending — all Brazilians, but especially the poor and the vulnerable.

Instead, Aleem wants big tax increases.

…the amendment does a great deal to limit the expenditure of government funds, it doesn’t do anything to directly address how to generate them directly: taxes. “The major cause of our fiscal crisis is falling revenues,” Carvalho says… Carvalho says taking an ax to spending is coming at the expense of discussing “taxing the very rich, who do not pay very much in taxes, or eliminating tax cuts that have been given to big corporations.”

Wow, methinks Professor Carvalho and I don’t quite see things the same way.

I would point out that falling revenues in a deep recession is not a surprise. But that’s an argument for policies that boost growth, not for big tax hikes.

Especially since the long-run fiscal problem in Brazil is a growing burden of government spending.

And it’s worth noting that overall impact of the spending cap, even after 10 years, will be to bring the size of the public sector back to where it was in about 2008.

Let’s close by reviewing an article by Charles Blahous of the Mercatus Center. Chuck starts by noting that we have a spending problem. More specifically, the burden of government is expanding faster than the private economy.

…to say we have a problem with deficits and debt is an oversimplification. What we have instead is an overspending problem, and the federal debt is essentially a symptom of that problem. …federal spending has grown and will grow (under current projections) faster than our Gross Domestic Product (GDP).

The solution, he explains, is a procedural version of a spending cap.

To solve this, future federal budgets in which spending grows as a percentage of GDP from one year to the next should require a congressional supermajority (e.g., three-fifths or two-thirds) to pass. Only if spending in the budget does not rise as a percentage of GDP from one year to the next could it be passed with a simple majority.

Chuck explains why there should be a limit on spending increases.

…we cannot permanently continue to allow federal spending to grow faster than America’s production. …as government spending growth exceeds GDP growth, we all lose more control over our economic lives. As individuals we will have less of a say over the disposition of each dollar we earn, because the government will claim a perpetually-growing share.

And higher taxes are never a solution to a spending problem.

…this problem cannot be solved by raising taxes. Raising taxes…does not avoid the necessity of keeping spending from rising faster than our productive output. Raising taxes may even have the downside of deferring the necessary solutions on the spending side.

The last sentence in that abstract is key. I’ve written about why – in theory – I could accept some tax increases in order to obtain some permanent spending reforms. In the real world of Washington, however, politicians will never adopt meaningful spending restraint if there’s even the slightest rumor that higher taxes may be an option.

He concludes that current budget rules need to be updated.

…budget rules apply no procedural barriers to continuing unsustainable spending growth rates, while legislative points of order protect baseline fiscal practices in which both federal spending and revenues grow faster than the economy’s ability to keep pace.

I certainly agree, though it would be nice to see something much stronger than just changes in congressional procedures.

Perhaps something akin to the constitutional spending caps in Hong Kong and Switzerland?

Now that would be a nice Christmas present for American taxpayers.

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New CBO Numbers Confirm Simple Task of Balancing the Budget with Modest Spending Restraint

It’s not a big day for normal people, but today is exciting for fiscal policy wonks because the Congressional Budget Office has released its new 10-year forecast of how much revenue Uncle Sam will collect based on current law and how much the burden of government spending will expand if policy is left on auto-pilot.

Most observers will probably focus on the fact that budget deficits are projected to grow rapidly in future years, reaching $1 trillion in 2024.

That’s not welcome news, though I think it’s far more important to focus on the disease of too much spending rather than the symptom of red ink.

But let’s temporarily set that issue aside because the really big news from the CBO report is that we have new evidence that it’s actually very simple to balance the budget without tax increases.

According to CBO’s new forecast, federal tax revenue is projected to grow by an average of 4.3 percent each year, which means receipts will jump from 3.28 trillion this year to $4.99 trillion in 2026.

And since federal spending this year is estimated to be $3.87 trillion, we can make some simple calculation about the amount of fiscal discipline needed to balance the budget.

A spending freeze would balance the budget by 2020. But for those who want to let government grow at 2 percent annually (equal to CBO’s projection for inflation), the budget is balanced by 2024.

So here’s the choice in front of the American people. Either allow spending to grow on autopilot, which would mean a return to trillion dollar-plus deficits within eight years. Or limit spending so it grows at the rate of inflation, which would balance the budget in eight years.

Seems like an obvious choice.

By the way, when I crunched the CBO numbers back in 2010, they showed that it would take 10 years to balance the budget if federal spending grew 2 percent per year.

So why, today, can we balance the budget faster if spending grows 2 percent annually?

For the simple reason that all those fights earlier this decade about debt limits, government shutdowns, spending caps, and sequestration actually produced a meaningful victory for advocates of spending restraint. The net result of those budget battles was a five-year nominal spending freeze.

In other words, Congress actually out-performed my hopes and expectations (probably the only time in my life I will write that sentence).*

Here’s a video I narrated on this topic of spending restraint and fiscal balance back in 2010.

Everything I said back then is still true, other than simply adjusting the numbers to reflect a new forecast.

The bottom line is that modest spending restraint is all that’s needed to balance the budget.

That being said, I can’t resist pointing out that eliminating the deficit should not be our primary goal. It’s not good to have red ink, to be sure, but the more important goal should be to reduce the burden of federal spending.

That’s why I keep promoting my Golden Rule. If government grows slower than the private sector, that means the burden of spending (measured as a share of GDP) will decline over time.

And it’s why I’m a monomaniacal advocate of spending caps rather than a conventional balanced budget amendment. If you directly address the underlying disease of excessive government, you’ll automatically eliminate the symptom of government borrowing.

Which is why I very much enjoy sharing this chart whenever I’m debating one of my statist friends. It shows all the nations that have enjoyed great success with multi-year periods of spending restraint.

During these periods of fiscal responsibility, the burden of government falls as a share of economic output and deficits also decline as a share of GDP.

I then ask my leftist pals to show a similar table of countries that have gotten good results by raising taxes.

As you can imagine, that’s when there’s an uncomfortable silence in the room, perhaps because the European evidence very clearly shows that higher taxes lead to bigger government and more red ink (I also get a response of silence when I issue my challenge for statists to identify a single success story of big government).

*Congress has reverted to (bad) form, voting last year to weaken spending caps.

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More Evidence that Balanced Budget Rules Don’t Work as Well as Spending Caps

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 Simple Solution to America’s Deteriorating Fiscal Outlook

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.

• Notwithstanding laughable claims from the White House, Obamacare is contributing to rising spending on healthcare entitlements.
• Republicans keep capitulating on the BCA spending caps, enabling more wasteful outlays for so-called discretionary programs.

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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More Evidence (from the Establishment!) for Spending Caps

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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A Very Simple Plan to Balance the Budget by 2021

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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