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Posts Tagged ‘Fiscal Policy’

To be blunt, Republicans are heading in the wrong direction on fiscal policy. They have full control of the executive and legislative branches, but instead of using their power to promote Reaganomics, it looks like we’re getting a reincarnation of the big-government Bush years.

As Yogi Berra might have said, “it’s deja vu all over again.”

Let’s look at the evidence. According to the Hill, the Keynesian virus has infected GOP thinking on tax cuts.

Republicans are debating whether parts of their tax-reform package should be retroactive in order to boost the economy by quickly putting more money in people’s wallets.

That is nonsense. Just as giving people a check and calling it “stimulus” didn’t help the economy under Obama, giving people a check and calling it a tax cut won’t help the economy under Trump.

Tax cuts boost growth when they reduce the marginal tax rate on productive behavior such as work, saving, investment, or entrepreneurship. When that happens, people have an incentive to generate more income. And that leads to more national income, a.k.a., economic growth.

Borrowing money from the economy’s left pocket and then stuffing checks (oops, I mean retroactive tax cuts) in the economy’s right pocket, by contrast, simply reallocates national income.

Indeed, this is one of the reasons why the economy didn’t get much benefit from the 2001 Bush tax cut, especially when compared to the growth-oriented 2003 tax cut. Unfortunately, Republicans haven’t learned that lesson.

Republicans have taken steps in the past to ensure that taxpayers directly felt the benefits of tax cuts. As part of the 2001 tax cuts enacted by President George W. Bush, taxpayers received rebate checks.

The article does include some analysis from people who understand that retroactive tax cuts aren’t economically beneficial.

…there are also drawbacks to making tax changes retroactive. …such changes would add to the cost of the bill, but would not be an effective way to encourage new spending and investments. “It has all of the costs of the tax cuts but none of the economic benefits,” said Committee for a Responsible Federal Budget President Maya MacGuineas, who added that “you don’t make investments in the rear-view mirror.”

I’m not always on the same side as Maya, but she’s right on this issue. You can’t encourage people to generate more income in the past. If you want more growth, you have to reduce marginal tax rates on future activity.

By the way, I’m not arguing that there is no political benefit to retroactive tax cuts. If Republicans simply stated that they were going to send rebate checks to curry favor with voters, I’d roll my eyes and shrug my shoulders.

But when they make Keynesian arguments to justify such a policy, I can’t help but get upset about the economic illiteracy.

Speaking of bad economic policy, GOPers also are pursuing bad spending policy.

Politico has a report on a potential budget deal where everyone wins…except taxpayers.

The White House is pushing a deal on Capitol Hill to head off a government shutdown that would lift strict spending caps long opposed by Democrats in exchange for money for President Donald Trump’s border wall with Mexico, multiple sources said.

So much for Trump’s promise to get tough on the budget, even if it meant a shutdown.

Instead, the back-room negotiations are leading to more spending for all interest groups.

Marc Short, the White House’s director of legislative affairs, …also lobbied for a big budget increase for the Pentagon, another priority for Trump. …The White House is offering Democrats more funding for their own pet projects.

The only good news is that Democrats are so upset about the symbolism of the fence that they may not go for the deal.

Democrats show no sign of yielding on the issue. They have already blocked the project once.

Unfortunately, I expect this is just posturing. When the dust settles, I expect the desire for more spending (from both parties) will produce a deal that is bad news. At least for those of us who don’t want America to become Greece (any faster than already scheduled).

Republican and Democratic congressional aides have predicted for months that both sides will come together on a spending agreement to raise spending caps for the Pentagon as well as for nondefense domestic programs.

So let’s check our scorecard. On the tax side of the equation, we’ll hopefully still get some good policy, such as a lower corporate tax rate, but it probably will be accompanied by some gimmicky Keynesian policy.

On the spending side of the equation, it appears my fears about Trump may have been correct and he’s going to be a typical big-government Republican.

It’s possible, of course, that I’m being needlessly pessimistic and we’ll get the kinds of policies I fantasized about in early 2016. But I wouldn’t bet money on a positive outcome.

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There are some charming traditions, like the swallows returning every year to the Mission of San Juan Capistrano.

But other traditions are far less impressive, most notably the make-believe hysteria that occurs every time the federal government approaches its “debt limit.”

High-level government officials will publicly fret that a failure to increase the limit will produce an unprecedented calamity because the Treasury Department will be forced to default on U.S. government debt, thus triggering a global panic.

And this triggers anxiety in predictable quarters.

A story in USA Today is representative of the sky-is-falling mentality.

Congress will confront a potentially devastating financial crisis in September as lawmakers scramble to…prevent the nation from defaulting on its debt for the first time in history. …The debt limit, set by Congress, is the legal amount the U.S. Treasury can borrow to pay the government’s existing bills, including Social Security and Medicare benefits, military salaries, tax refunds, interest on the national debt, and other obligations. The government has never defaulted on its debt before, and no one knows for sure what the impact would be. However, economists warn that it could plunge the U.S. back into recession and spark a global economic crisis.

Paul Krugman is predictably hysterical about the prospect.

The odds of a self-inflicted US debt crisis now look pretty good: hard-line Republicans are eager to hold the economy hostage… So it looks fairly likely that by October or so there will come a day when the U.S. government stops paying some of its bills, including interest on debt. How bad will that be? The truth is that we don’t know.. Until now, US debt has played a special role in the world economy, because it is — or was — the ultimate safe asset, the thing people can use to secure transactions with no questions about it retaining its value. …Taking away that role could be very nasty.

Even some establishment voices are fanning the flames, including Maya MacGuineas of the Committee for a Responsible Federal Budget.

Our economic standing is too sterling and the global economy too important to imperil over the disagreements of American domestic politics — as fundamental as they may be. It is the height of recklessness — a view held for decades reflected in the fact that raising the debt ceiling was once a mundane piece of housekeeping that garnered no attention. It was practically automatic.

And Professor Edward Kleinbard of the University of Southern California also thinks the apocalypse is nigh.

Sometime in October, the United States is likely to default on its obligation to pay its bills as they come due, having failed to raise the federal debt ceiling. This will cost the Treasury tens of billions of dollars every year for decades to come in higher interest charges and probably trigger a severe recession. …almost all economists and policy makers agree on the enormous fiscal, economic and reputational costs of default. That’s why, in the past, we’ve always managed to avoid it.

Sounds ominous, right?

And I agree that it would be very bad news if the U.S. government didn’t pay all interest and principal to bondholders, as scheduled.

But here’s the good news. The odds of that happening are about the same as the odds of me being the keynote speaker at the next convention of the Socialist Party.

As I’ve said over the years in television interviews, at press conferences, and in congressional testimony (on more than one occasion), there won’t be a default for the simple reason that the federal government collects far more money than needed to pay all bondholders without any delay.

And nothing has happened to the budget numbers to change that analysis.

Here are the latest CBO projections on major budget aggregates. I’ve circled total tax receipts for the next three years, as well as annual net interest payments. As you can see, the Treasury will be collecting more than 10 times as much revenue as needed to fulfill obligations to the folks who have lent money to Uncle Sam.

By the way, some of you may be thinking I’m a cranky libertarian who is blind to the danger of default.

Well, I am a libertarian, and I do get cranky about the various shenanigans in Washington, so let me engage in what’s known as an “appeal to authority.”

Here’s what the Congressional Budget Office said in its recent report on the debt limit.

When Would the Extraordinary Measures and Cash Run Out, and What Would Happen Then? If the debt limit is not increased above the amount that was established on March 16, 2017, the Treasury will not be authorized to issue additional debt that increases the amount outstanding. …That restriction would ultimately lead to delays of payments for government programs and activities, a default on the government’s debt obligations, or both.

In other words, the government can choose to pay interest on the debt and defer other bills. As I’ve repeatedly said in all my public pronouncements, a default will occur only if an administration wants it to occur.

But that’s not going to happen. Just as Obama’s various Treasury Secretaries would have “prioritized” payments to bondholders, Trump’s Treasury Secretary will do the same thing if push comes to shove.

Some budget experts on the left know this is true so they try to blur the issue by stating that it is “default” to postpone payment on any type of government spending. Here’s some of what Kleinbard wrote in his column.

…some conservative policy makers besides Mr. Mulvaney have convinced themselves that crashing into the debt ceiling won’t be a big deal because the government can “prioritize” its bill payments, so that interest on Treasury debt will be paid on a current basis, while other bills sit unpaid. Understanding the false allure of prioritization requires a little background. …there are profound doubts as to whether the Treasury could even implement prioritization, beyond ring fencing interest payments, because its payment systems are designed to pay all claims as they are due, regardless of their origin. More important, prioritization is default by another name. The consequences are the same, regardless of which i.o.u.s Treasury chooses to dishonor. All valid claims against the United States are backed by the credit of the United States… The deliberate nonpayment of billions of dollars of uncontested claims every month thus constitutes default, even if the Treasury is paying some of its other debts.

The last sentence in the above excerpt is bunk. Postponing or deferring bills is not good budget policy. It’s basically what happens in poorly governed places like Greece and Illinois. But it’s not default. There wouldn’t be any risk to financial markets if the Treasury Department was late in disbursing farm subsidy checks or Medicaid reimbursements.

Let’s close by indulging one of my fantasies. If Donald Trump wanted to force good policy from Congress, he could threaten to veto any debt limit that wasn’t accompanied by something desirable such as a spending cap or entitlement reform. The politicians on Capitol Hill would balk of course, but Trump could shrug his shoulders and start “prioritization” once the debt limit was reached. So long as all bondholders received promised payments, there would be no danger to financial markets. By contrast, however, the various interest groups feeding at the federal trough would begin to squeal once their checks started slowing down. At some point, Congress would be forced to capitulate.

In other words, Trump has the capacity to score a big victory on the debt limit, just like he has the unilateral ability to score a big victory on Obamacare repeal and/or the 2018 spending bills.

I’m not holding my breath for this to happen, but it’s nice to dream. Especially since a big fight over the debt limit today (if successful) could save us from something far worse in the future.

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According to leftists like Bernie Sanders, European nations have wonderfully generous welfare states financed by high tax rates on the rich.

They’re partly right. There are very large welfare states in Europe (though I wouldn’t use “wonderfully” and “generous” to describe systems that have caused economic stagnation and high levels of unemployment).

But they’re wrong about how those welfare states are financed. Yes, tax rates on the rich are onerous, but not that much higher than in the United States. Instead, the big difference between America and Europe is that ordinary people pay much higher taxes on the other side of the Atlantic.

Indeed, I’ve previously cited Tax Foundation data showing that the United States arguably has the most “progressive” tax system in the developed world. Not because we tax the rich more, but simply because we impose comparatively modest burdens on everyone else.

And now we have some new evidence making the same point. Joseph Sternberg of the Wall Street Journal has some very sobering data on how the German tax system imposes a heavy weight on poor and middle-income taxpayers.

Europeans believe their tax codes are highly progressive, giving lower earners a break while levying significant proportions of the income of higher earners and corporations to fund generous social benefits. But that progressivity holds true only for direct taxes on personal and corporate income. Indirect taxes, such as the value-added tax on consumption and social-security taxes (disguised as “contributions”), are a different matter. The VAT disproportionately affects lower earners, who spend a higher proportion of their incomes. And social taxes tend to kick in at lower income levels than income taxes, and extract a higher and more uniform proportion of income. …if you look at the proportion of gross household income paid in all forms of tax, the rate varies by only 25 points. The lowest-earning 5% of households pay roughly 27% of their income in various taxes—mainly VAT—while a household in the 85th income percentile pays total taxes of around 52%, mostly in social-security taxes that amount to nearly double the income-tax bill.

Here’s a chart the WSJ included with the editorial.

As you can see, high payroll taxes and the value-added tax are a very costly combination.

And the rest of Europe is similar to Germany.

…Germany is not unique. The way German total revenues are split among income taxes, social taxes and the consumption tax is in line with the rest of Western Europe, as are its tax rates, according to OECD data. If other countries are more progressive than Germany, it’s only because Germany applies its second-highest marginal income-tax rate of 42% at a lower level of income than most.

Speaking of the OECD, here’s the bureaucracy’s data on the burden of government spending.

Germany is in the middle of the pack, with the public sector consuming 44 percent of economic output (Finland edges out France and Greece for the dubious honor of having the most expensive government).

The overall burden of the public sector is far too high in the United States, but we’re actually on the “low” side by OECD standards.

According to the data, total government spending “only” consumes 37.7 percent of America’s GDP. Only Ireland, Switzerland, and Latvia have better numbers (though my friend Constantin Gurdgiev explains we should be cautious about Irish economic data).

But I’m digressing. The point I want to emphasize is that punitive taxes on poor and middle-income taxpayers are unavoidable once politicians decide to impose a large welfare state.

Which is why I’m so inflexibly hostile to any tax increase, especially a value-added tax (or anything close to a VAT, such as the BAT) that would vacuum up huge amounts of money from the general population. Simply stated, politicians in Washington will have a hard time financing a bigger burden of government if they can only target the rich.

Sternberg makes the same point in his column.

Tax cuts have emerged as an issue ahead of Germany’s national election next month, with both major parties promising various timid tinkers… Not gonna happen. The VAT and social taxes are too important to the modern welfare state. The great lie is that there are a) enough “rich people,” b) who are rich enough, that c) taxing their incomes heavily enough can pay for generous health benefits and an old-age pension at 65. None of those propositions are true, and the third is especially wrong in an era of globally mobile capital and labor. That leaves the lower and middle classes, and taxes concealed in price tags or dolled up as “insurance contributions” to obscure exactly how much voters are paying for the privilege of their welfare states. …reform of the indirect taxes that impose such a drag on European economies awaits a more serious discussion about the proper role of the state overall.

Exactly.

There’s no feasible way to ease the burden on ordinary German taxpayers (or regular people in other European nations) unless there are sweeping reforms to reduce the welfare state.

And the moral of the story for Americans is that we better enact genuine entitlement reform if we don’t want to suffer the same fate.

P.S. If you don’t like German data, for whatever reason, I wrote last year about Belgium and made the same point about how a big welfare state necessarily means a bad tax system.

P.P.S. By the way, even the OECD admitted that European nations would grow faster if the burden of government was reduced.

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It’s depressing to see how Republicans are bungling the Obamacare issue. But it’s also understandable since it’s politically difficult to reduce handouts once people get hooked on the heroin of government dependency (a point I made even before Obamacare was enacted).

Unfortunately, I fear that the GOP might bungle the tax issue as well. I was interviewed the other day by Dana Loesch on this topic and highlighted several issues.

Here’s the full discussion.

What’s especially frustrating about this issue is that taxes should be reduced. A lot.

Brian Riedl of the Manhattan Institute debunks six tax myths. Here they are, followed by my two cents.

Myth #1: Long-term deficits are driven by tax cuts and falling revenues

Fact: They are driven entirely by rapid spending growth

Brian nails it. I made this same point earlier this year. Indeed, because the tax burden is projected to automatically increase over time, it is accurate to say that more than 100 percent of the long-run fiscal problem is caused by excessive spending (particularly poorly designed entitlement programs).

Myth #2: Democratic tax proposals would significantly reduce the deficit

Fact: Their most common proposals would raise little revenue

Once again, Brian is right. There are ways to significantly increase the tax burden in America, such as a value-added tax. But the class-warfare ideas that attract a lot of support on the left won’t raise much revenue because upper-income taxpayers have substantial control over the timing, level and composition of their income.

Myth #3: Taxing millionaires and corporations can balance the long-term budget

Fact: These taxes cannot cover Washington’s current commitments, much less new liberal wish lists

Since even the IRS has admitted that upper-income taxpayers finance a hugely disproportionate share of the federal government, it hardly seems fair to subject them to even more onerous penalties. Especially since the IRS data from the 1980s suggest punitive rates could lead to less revenue rather than more.

Myth #4: The U.S. income tax is more regressive than other nations

Fact: It is the most progressive in the entire OECD

There are several ways to slice the data, so one can quibble with Brian’s assertion. But when comparing taxes paid by the rich compared to taxes paid by the poor, it is true that the United States relies more on upper-income taxpayers than any other developed nation. Not because we tax the rich more, but because we tax the poor less.

Myth #5: The U.S. tax code is becoming more regressive over time

Fact: It has become increasingly progressive over the past 35 years

Brian is right. Child credits, changes in the standard deduction and personal exemptions, and the EITC have combined in recent decades to take millions of households off the tax rolls. And since the U.S. thankfully does not have a value-added tax, lower-income people are largely protected from taxation.

Myth #6: Tax rates do not matter much to economic growth

Fact: They are among the most important factors

There are many factors that determine a nation’s economic success, including trade policy, regulation, monetary policy, and rule of law, so a good tax code isn’t a guarantor of prosperity and a bad tax system doesn’t automatically mean malaise. But Brian is right that taxation has a significant impact on growth.

In the interview, I said that I had two fantasies. First, I want to junk the corrupt internal revenue code and replace it with a simple and fair flat tax.

Second, I’d ultimately like to shrink government so much that we could eliminate the income tax entirely.

Many people don’t realize that income taxes only began to plague the world about 100 years ago.

If we can somehow restore the kind of limited government envisioned by America’s Founders, the dream of no income tax could become a reality once again.

But if Republicans can’t even manage to cut taxes today, when they control both the executive and legislative branch, then neither one of my fantasies will ever become reality.

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I wrote yesterday about a very depressing development in the United Kingdom. Politicians in that country – including some supposed fiscal conservatives – are contemplating a big expansion in the burden of government spending in order to give pay hikes to the bureaucracy.

What makes this so unfortunate is that the country has been making fiscal progress. Ever since 2010, government spending has grown by an average of 1.6 percent annually. And since the private economy has expanded at a faster pace, this period of restraint has satisfied my golden rule. In other words, the public sector – though still very large – is now a smaller burden on the private sector.

This progress could be quickly reversed, though, with a new spending binge. And it would be especially foolish to throw in the towel just to give more money to government employees. Just like in the U.S., bureaucrats already are overcompensated compared to their counterparts in the productive sector of the economy.

Let’s take a closer look at whether U.K. policymakers should end “austerity” and expand the relative burden of government spending.

The Centre for Policy Studies in London has examined the issue, and this new research from CPS debunks the notion that there should be large increases in bureaucrat compensation.

But since we covered that topic yesterday, let’s focus instead on what CPS discovered when reviewing the impact of spending restraint on various economic aggregates.

…when examining OECD countries that were left with a large budget deficit in 2010 (those countries with a deficit of over 5% of GDP in 2010), it appears that there is a strong correlation between those countries that cut spending by a higher degree, on average, and countries which achieved a larger reduction in deficit, higher average growth rates, a larger fall in proportionate unemployment and marginally better wage growth (see Figures 5, 6, 7 and 8). Of course, correlation does not necessarily mean causation. However, this provides strong evidence that there is no link between austerity and lower growth, higher unemployment and weaker wage growth.

Let’s look at the charts referenced in the excerpt.

We’ll start with Figure 5, which looks at relationship between spending restraint and deficit reduction. Nobody should be surprised to see that the symptom of red ink shrinks when there’s a reduction in the underlying disease of too much government spending.

I think the most important data is contained in Figure 6, which maps the relationship between economic growth and spending restraint. As you can see, a lower burden of government spending is associated with better economic performance.

There’s also a connection between smaller government and lower joblessness, as shown in Figure 7.

Last but not least, Figure 8 shows the positive relationship between lower spending and higher wages.

As explained in the CPS report, correlation is not causation. But since these results are in sync with research from academic scholars (and even research from left-leaning bureaucracies such as the IMF, World Bank, and OECD), the only prudent conclusion is that the U.K. should not give up on fiscal responsibility.

And perhaps the real lesson is that a constitutional spending cap should be enacted whenever a consensus for good policy materializes. That way, there’s a much lower risk of backsliding when politicians get weak-kneed.

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One of my favorite charts shows how nations achieve great results when they engage in multi-year periods of spending restraint.

The most important benefit is that the burden of government shrinks relative to the private sector, but it’s also worth noting that the symptom of red ink begins to disappear when there is a serious effort to deal with the underlying disease of excessive spending.

But sharing this chart also a bittersweet experience since it shows – in almost all cases – that it is just a matter of time before politicians go back to fiscal profligacy.

This is why I’m a huge fan of a permanent spending cap, ideally as part of a nation’s constitution.  Jurisdictions that have adopted this approach, such as Hong Kong and Switzerland, have very strong long-run fiscal performance rather than just temporary blips of good policy.

At the risk of understatement, it’s increasingly obvious that the United Kingdom needs this kind of permanent structural reform.

As you can see from this chart I shared back in February, there’s been some decent spending restraint in that country ever since 2010.

Let’s augment those numbers. I pulled together the data on government spending from the OECD, the IMF, and the UK government. They all have slightly different methodologies with slightly different numbers, but they all tell the same story.

Ever since 2010, the burden of government spending has expanded by an average of about 1.6 percent annually. Spending is still growing, needless to say, but the private sector has been growing faster, so British policymakers have been satisfying my golden rule.

And because the productive sector of the economy has grown faster than government, this means that relative burden of spending has declined. Which is exactly what we see in this chart.

That’s the good news.

The bad news is that politicians are tired of being responsible. They are salivating at the prospect of a new spending binge. Even Tory politicians now want to play Santa with other people’s money.

The U.K.-based Times has some of the unpleasant details.

Ministers are pushing to delay or abandon a series of tax cuts to fund an increase in public sector pay, The Times has learnt. Philip Hammond, the chancellor, is being urged to scrap commitments to reduce corporation tax and raise the thresholds for the personal allowance and the 40 per cent income tax rate. …At a meeting of the political cabinet last week, Jeremy Hunt, the health secretary, Justine Greening, the education secretary, and Sir Patrick McLoughlin, the party chairman, are understood to have called for more money for public sector workers.

Opening the spending spigot would be a terrible mistake. Especially to finance higher pay for bureaucrats.

The Wall Street Journal recently opined on this new threat to fiscal responsibility on the other side of the Atlantic.

…the Prime Minister’s Tories now want to abandon their claim to fiscal discipline. Rather than blame a feckless campaign, wobbly Tory leaders have decided that voters are exhausted with “austerity” and government employees are happy to step in with spending demands. Those government workers and their patrons in the opposition Labour Party are demanding an end to the 1% annual pay-rise cap imposed by former Prime Minister David Cameron and Chancellor George Osborne in 2013 after several years of pay freezes.

Even worse, they want to cancel tax cuts and/or impose tax hikes to finance more money for the bureaucracy.

…cabinet grandees Boris Johnson and Michael Gove…seem willing to pay for it by reducing scheduled corporate tax-rate cuts or increasing individual taxes by reducing the threshold at which the second-highest 40% rate applies.

You won’t be surprised to learn that British bureaucrats (just like their American cousins) are not underpaid compared to workers in the economy’s productive sector.

Britain’s government workers aren’t suffering from a pay crisis compared to their peers in the private (that is, productive) economy. For most of the period since 2000, average weekly nominal earnings for public employees have exceeded the private average, according to the Office for National Statistics. And that excludes government pensions that are far more generous than what most private employees enjoy. Government workers were also shielded from the worst of the post-2008 downturn. The 1% cap amounted to steady nominal wage growth while private wages fell sharply…. Government workers were also spared the worst of the job cuts private employers imposed. …The 1% nominal pay cap mainly has given private workers an opportunity to catch up to government pay. …Voters are frustrated by an economic recovery that has largely failed to deliver inflation-adjusted earnings growth. But the solution isn’t to further stifle wage growth in the private economy by raising taxes to benefit public employees.

Tim Worstall also explains that the bureaucracy is not suffering from a lack of compensation.

We’ve just had a massive recession and thus we are indeed worse off. That’s what a recession is all about. So the question should be: are we all sharing that pain? We are not. Public sector pay has fallen by less than private. The people paying the tax have suffered more than those who eat the tax – hardly a good argument in favour of tax-eater pay rises. …It is also true, as the IFS points out, that public sector pay rose substantially in the 2000 to 2005 period. Pay rose more and then pay fell less. I simply can’t see an argument for a public sector pay rise or the lifting of that cap here.

My colleague at the Cato Institute, Ryan Bourne, is a citizen of the United Kingdom, and he points out that one of the problems is that bureaucrat pay levels are determined nationally, which makes no sense when the cost of living varies widely across the country.

….they should phase out national pay bargaining where it remains in the public sector. Previous research by Allison Wolf has shown the high cost of having national pay scales and bargaining. …Poorer regions…suffer as very high pay relative to the private sector crowds out private sector growth.

Ryan explains that Sweden successfully adopted this reform.

Sweden shows the solution. There, collective bargaining was entirely replaced by individual contracts between staff and their local public sector employer, with little fuss. If applied here, managers would then have genuine flexibility in the creation of new posts. It would liberate them to set pay to reflect more accurately local conditions, while varying wages to fulfil difficult positions.

Of course, the ideal situation would be genuine federalism, with local communities raising their own funds and then deciding how lavishly to compensate the bureaucrats they hire. The U.K. actually took a baby step in that direction years ago by giving greater autonomy to Scotland.

I’ll close with a rather depressing observation. It was only two months ago that I suggested Tories might be poised to make big policy improvements in the United Kingdom. Now it appears that they’ll be competing with the Labour Party on how to spend other people’s money. The great Margaret Thatcher is probably spinning in her grave.

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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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