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Posts Tagged ‘Spending Cap’

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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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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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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If you look at oil-rich jurisdictions around the world, it’s easy to see why experts sometimes write about the “resource curse.” Simply stated, governments don’t have much incentive to be responsible when they can use oil as a seemingly endless source of tax revenue.

From the perspective of voters, this seems like a good deal. They can get lots of goodies from government without themselves paying much tax.

This is definitely a good description of how fiscal policy operates in Alaska, a state I just visited to give a speech to the Alaska Alliance.

But everything I said during my remarks will be familiar to regular readers, so instead I want to share some state-specific information from a presentation earlier this year by Professor Gunnar Knapp of the University of Alaska Anchorage. As you can see from one of his charts, the tax burden on households is very low.

But the fact that households don’t pay much tax doesn’t mean the Alaska government is starved of money.

That’s because the state, on average, collects 90 percent of its revenue from severance taxes on natural resources.

And since there’s a lot of oil, that adds up to a lot of revenue. A lot.

Here’s a map from the Tax Foundation, looking at per-capita state tax collections.

It turns out that Alaska is actually a very high-tax state, collecting more money than 48 other states. It’s just that one sector of the economy pays the overwhelming majority of that tax burden.

By the way, notice that oil-rich North Dakota has the highest tax burden and resource-rich Wyoming has the third-highest tax amount of tax revenue.

I suppose there’s some lesson to learn by comparing Alaska and Wyoming, which have lots of energy-related revenue and no state income taxes, with North Dakota, which has both.

But for purposes of today’s column, I want to emphasize a point about the boom-bust cycle and the value of spending caps.

Let’s return to Professor Knapp’s presentation and peruse a chart showing spending, revenue, and fiscal balance from 2005-present. Knapp’s slide puts the focus on surpluses and deficits, but I want to draw your attention to the fact that spending (the blue line) basically tripled from 2005 to 2013.

In other words, politicians in Alaska were not following Mitchell’s Golden Rule, which would have required them to limit spending so that it grew slower than the private sector.

Instead, they responded to the influx of oil revenue during the boom years the same way alcoholics respond to an open bar. They had a spending orgy.

It’s no surprise that more revenue enabled more spending.

That’s why it’s a mistake to “feed the beast.”

But let’s focus on the fact that Alaska is now in the midst of fiscal turmoil and make the very simple point that some sort of spending cap, starting back in 2005, would have prevented the current crisis.

If spending was limited so that it grew by 2 percent annually, outlays today would only be about $500 million higher than they were in 2005. Given the plunge in oil-related revenue, even that might not have been enough to balance the budget for 2015 or 2016, but the state would have had plenty of money in the state’s rainy day funds (technically known as the “statutory budget reserve fund” and the “constitutional budget reserve fund”) to fill in the fiscal gap.

And this is why spending caps are so important. Governments get in trouble because politicians have a hard time resisting the urge to spend money during growth years, when plenty of tax revenue is being generated.

I’ve made this point when looking at data from California. It also applies when looking at the fiscal mess in Puerto Rico. And Greece.

But perhaps most relevant for Alaska, it’s exactly when happened in oil-rich Alberta. Politicians from a supposedly conservative party in that Canadian province also went on a spending binge when energy prices were high. But then oil prices dropped, energy-related tax collections fell, the ruling party was defeated at the polls, and a new leftist government has used the over-spending mess as an excuse to impose additional taxes.

Yet none of that would have happened if Alberta had a spending cap.

Just as the crisis in Alaska wouldn’t exist if there had been some mechanism to stop politicians in Juneau from over-spending.

Needless to say, there’s also a lesson here for Washington (one that actually was heeded between 2009-2014, but the real key is permanent, structural spending restraint).

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A new fiscal year starts October 1, and this is terrifying news for Republicans in Washington. They’re scared that if they don’t give Obama everything he wants, they’ll get “blamed” when the President vetoes annual spending bills and shuts down the government.

If this sounds like déjà vu all over again, that’s for a good reason. There were big shutdown fights during the Clinton years, a near-shutdown fight in 2011, and then another major shutdown fight in 2013 (as well as rumors of possible shutdown fights in 2012 and 2014). And Republicans ostensibly were at fault in every case.

Now, thanks to big disagreements about whether to renege on the Budget Control Act and/or whether to subsidize Planned Parenthood, it could happen again.

At least if Republicans don’t preemptively surrender.

I realize I’m a lone voice crying in the wilderness, but there’s a strong case to be made that GOPers should exhibit some backbone and fight for spending restraint even if President Obama decides to pick a shutdown fight.

First, fighting can lead to better policy.

During Bill Clinton’s presidency, a multi-year period of spending restraint starting in 1995 and ending in the late 1990s paid big dividends. The burden of federal spending dropped from more than 20 percent of GDP to less than 18 percent of economic output, and a big budget deficit became a big budget surplus.

The fiscal fights in recent years (involving not just a shutdown and shutdown threats, but also sequester battles and debt limit conflicts) also led to better fiscal outcomes. There was a de facto spending freeze starting in 2010 and ending in 2014, and the burden of government spending fell during those years, dropping from more than 24 percent of GDP to 20.3 percent of economic output.

Second, it’s unclear whether shutdowns actually lead to political blowback. Yes, the polling data seems to show that the GOP gets blamed when there’s an actual shutdown in Washington, and they obviously face unified hostility from the media and various interest groups whenever they hold firm.

That being said, there’s precious little evidence that they suffer on election day.

Republicans retained control of the House and Senate after their shutdown fight with Bill Clinton, and even picked up two Senate seats in 1996.

The 2013 shutdown fight over Obamacare was followed by a massive GOP landslide in 2014, which rewarded Republicans for opposing Obamacare.

So maybe the lesson is that voters don’t really care about shutdowns, particularly if they don’t take place close to an election. And I’ll pat myself on the back for predicting  – both at the start and the end of the 2013 shutdown – that there wouldn’t be any negative political consequences.

That being said, these policy and political arguments apparently aren’t very convincing to GOPers on Capitol Hill.

As reported by The Hill, Republican leaders think the possibility of a shutdown fight is a “crisis” to be avoided.

House Republicans will huddle in a pivotal closed-door meeting Wednesday morning as they face mounting pressure to defund Planned Parenthood — including threats to shut down the government. …Boehner and his Senate counterpart, Majority Leader Mitch McConnell (R-Ky.), are in no mood to reprise the shutdown of 2013. They believe another headline-grabbing crisis would severely damage the party at a time when they’re trying to show that Republicans can govern and take back the White House.

By the way, this isn’t just a fight about Planned Parenthood getting subsidies while selling parts of aborted babies.

Obama also says he’ll shut down the government if Republicans don’t give him more spending.

Here are some excerpts from a story in the Washington Examiner.

President Obama…called on Republicans to pass his budget when Congress reconvenes next month. He also threatened to veto any budget that did not increase spending. …”And if they don’t, they’ll shut down the government for the second time in two years,” said Obama.

Wow, let’s think about what’s actually going on. First, the President is reneging on the deal he agreed to back in 2011, which says something about ethics, character, and honesty. Second, his threatened veto, should it occur, is the only reason there would be a shutdown.

So why would that be the fault of Republicans?

Even more remarkable, President Obama even claims a shutdown would harm the economy.

President Obama on Thursday warned Congress not to “kill” the growing economy by risking a government shutdown this fall.

He must have a short memory (or no shame) because he made the same Keynesian-based argument that a sequester would hurt the economy. And he was wrong.

And he made the same claim about the 2013 shutdown and how it supposedly would hurt the economy. And was wrong then as well.

So what’s the bottom line?

At a minimum, advocates of fiscal responsibility should fight to protect the spending caps. There also should be a natural alliance between libertarians and social conservatives to end Planned Parenthood’s handouts.

Simply stated, some fights are worth having.

Though it’s important to understand this doesn’t guarantee victory.

The Wall Street Journal has a sober assessment of the challenge facing the GOP.

…the real GOP problem isn’t John Boehner or Mitch McConnell. It’s James Madison, who designed a government of checks and balances that is hard to overcome without the White House. …the party simply doesn’t have the votes to pass most of its preferred policy outcomes, much less to override a Democratic President.

The editors at the WSJ still think Republicans should fight, but the battlefield should be a separate piece of legislation rather than annual spending bills.

They should still fight and frame the issues to educate the public. They can even use budget reconciliation to send a budget to Mr. Obama’s desk with only GOP votes. But the project for the next 14 months should be to achieve what they can within divided government… Another failed government shutdown will make that harder.

I agree and disagree. Yes, not all fights need to be part of the annual appropriations legislation.

But unilaterally ceding the fight on the yearly spending bills would be wrong since Obama could successfully impose a higher burden of government spending.

I can understand why Obama wants to gut the spending caps. After all, they led to his biggest-ever defeat on fiscal policy.

That doesn’t mean, though, that the GOP leadership should hand him a victory without a fight.

P.S. There’s a humorous fringe benefit to government shutdowns, as you can see by clicking here, here, here, here, and here.

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