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Posts Tagged ‘Swiss Debt Brake’

For a land-locked nation without many natural resources, Switzerland is remarkably successful.

One reason for the country’s success is pro-market policy. Switzerland routinely scores in the top 5 according to both Economic Freedom of the World and Index of Economic Freedom.

More specifically, I’m a big fan of the country’s fiscal policy, especially the “Debt Brake,” which was imposed when voters overwhelmingly adopted the provision (84.7 percent approval) early this century.

There’s always been a debate, however, whether Switzerland’s good outcomes are because of the debt brake, or because of some random reason, such as the sensibility of Swiss voters.

Three academic economists, Michele Salvi, Christoph Schaltegger, and Lukas Schmid, investigated this issue in a study for Kyklos, a scholarly journal published by the University of Basel.

A prominent means to prevent excess debt accumulation is the use of fiscal rules. In fact,fiscal rules focus on securing solvency of governments by concentrating on the intertemporal budget constraint. …there is a strong positive association between constrained fiscal discretion and improved fiscal performance. …Our paper presents evidence on the effect of a fiscal rule with a strict enforcement mechanism… We analyze the consequences of the centrally imposed balanced budget rule on public debt in Switzerland. …the Swiss debt containment rule stands out as a clearly defined fiscal rule with a constitutional basis that constrains deviating from a balanced budget in the long-term. …The rule consists of a simple mechanism stating that expenditure may not exceed revenues over the course of an economic cycle. …The debt containment rule brings a“top-down”element into the budgeting process, which has a strong disciplinary appeal and leads to more accurate budgeting. …one key aspect is the fact that the debt containment rule sets a clear expenditure ceiling.

The key parts from the above excerpt are “expenditure may not exceed” and “clear expenditure ceiling.”

Those statements ratify my oft-made point that the debt brake is really a spending cap. And spending caps are far and away the only effective macro-fiscal rule.

The policy certainly has generated good results for Switzerland. Here’s what the authors found when thy crunched numbers to compare the country’s current fiscal trajectory with what would have happened without a spending cap.

To construct the counterfactual outcome of the debt ratio for Switzerland without a debt containment rule, we select a control group…countries expected to be driven by a similar structural process as Switzerland. …Due to the availability of comprehensive debt data, the observation period is restricted to last from 1980 until 2010. …we divide the time period into a pre-treatment period from 1980 to 2002 and a postintervention period from 2003 to 2010. …Figure 2 displays the central government debt ratio for Switzerland and its synthetic counterpart during the study period. …In 2003, the two debt ratio curves start to diverge. …it appears that the introduction of the debt containment rule led to a substantial and persistent decrease in the debt ratio in Switzerland.

And here’s the relevant set of charts from the study.

Here’s one more sentence I want to cite since it echoes the argument I’ve made to my Keynesian friends about how they also should support a Swiss-style spending cap.

The debt containment rule has made a significant contribution to switching from a procyclical to a cyclically appropriate fiscal policy.

Simply stated, the political tradeoff embedded in the debt brake is that politicians get to modestly increase spending during a downturn, even though revenues are falling, but they also can only enact modest spending increases during growth years, even if revenue is growing much faster.

By the way, you will have noticed that the study focused on how the debt brake helped to reduce red ink.

Regular readers know that I’m far more interested in focusing on the real fiscal problem, which is excessive government spending.

So I’ll close by looking at some additional evidence from Switzerland. Here’s a chart, based on IMF data, showing that the growth rate of spending fell sharply after the debt brake was adopted.

I looked at the 2003-2010 period, since it matched the years in the study discussed above.

But I also calculated the spending growth rate for 2003-2019 and confirmed that the debt brake’s success hasn’t just been a temporary phenomenon.

P.S. Click here for a short presentation on the debt brake, as well as similar presentations on Hong Kong’s spending cap and Colorado’s TABOR spending cap.

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There are many threats to prosperity, both in the short run and long run.

Those are all things we should worry about. But here’s the issue that worries me the most.

  • More government spending resulting from demographic change and entitlements.

Fortunately, there’s a solution. Governments should copy Switzerland and impose a spending cap. I explained this system in a column for the Wall Street Journal back in 2012.

…85% of its voters approved an initiative that effectively requires its central government spending to grow no faster than trendline revenue. The reform, called a “debt brake” in Switzerland, has been very successful. Before the law went into effect in 2003, government spending was expanding by an average of 4.3% per year. Since then it’s increased by only 2.6% annually. …politicians aren’t able to boost spending when the economy is doing well and the Treasury is flush with cash. Equally important, it is very difficult for politicians to increase the spending cap by raising taxes.

By the way, I just updated the calculations using IMF data. Looking at the numbers from 2003-2018, government spending has grown by an average of 2.1 percent per year since the debt brake went into effect.

In other words, the policy is becoming more successful over time.

Some argue, by the way, that spending restraint is bad for an economy. The Keynesians think that more government is “stimulus.” And many of the international bureaucracies (including the IMF) argue that more government is an “investment.”

There’s lots of evidence that smaller government is the right route for prosperity. But for today’s purposes, let’s focus just on the United States and Switzerland.

Both nations are prosperous by world standards, though the United States generally enjoyed a small advantage in terms of per-capita economic output according to the Maddison database. But in the past 15 years, Switzerland has jumped ahead.

Time for a big caveat. There are dozens of policies that help determine a nation’s prosperity, so it would be improper to claim that Switzerland overtook the United States solely because of the spending cap.

Switzerland ranks above the United States in Economic Freedom of the World, so many factors doubtlessly contributed to the nation’s superior performance. Both theory and evidence, however, suggest that fiscal discipline is good for prosperity.

But what about government debt? Did the spending cap in the debt brake succeed in controlling red ink?

The answer is yes, an emphatic yes.

Here are two charts, based on data from the International Monetary Fund’s World Economic Outlook database for the years since the debt brake went into effect. We can see that both gross debt and net debt increased in advanced countries and euro countries. In Switzerland, however, debt levels fell.

In other words, while debt levels have jumped in other industrialized nations, the level of red ink in Switzerland has declined. While other European nations have experienced fiscal crisis and ever-increasing amounts of debt, Switzerland has been an island of budgetary tranquility.

By the way, I can’t resist pointing out that Switzerland relies on spending restraint, and red ink fell. Other nations have adopted lots of tax increases, and red ink rose.

Hmmm…, maybe there’s a lesson to be learned?

P.S. Hong Kong also has a spending cap.

P.P.S. You can watch short presentations about their respective spending caps from Swiss and Hong Kong diplomats at an event I organized for staffers on Capitol Hill.

P.P.P.S. That event also included a speech about the very successful spending cap (TABOR) in Colorado.

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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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