Tag: Mitchell’s Golden Rule

The Golden Rule of Spending Restraint

My tireless (and probably annoying) campaign to promote my Golden Rule of spending restraint is bearing fruit.

The good folks at the editorial page of the Wall Street Journal allowed me to explain the fiscal and economic benefits that accrue when nations limit the growth of government.

Here are some excerpts from my column, starting with a proper definition of the problem.

What matters, as Milton Friedman taught us, is the size of government. That’s the measure of how much national income is being redistributed and reallocated by Washington. Spending often is wasteful and counterproductive whether it’s financed by taxes or borrowing.

So how do we deal with this problem?

I’m sure you’ll be totally shocked to discover that I think the answer is spending restraint.

More specifically, governments should be bound by my Golden Rule.

Ensure that government spending, over time, grows more slowly than the private economy. …Even if the federal budget grew 2% each year, about the rate of projected inflation, that would reduce the relative size of government and enable better economic performance by allowing more resources to be allocated by markets rather than government officials.

I list several reasons why Mitchell’s Golden Rule is the only sensible approach to fiscal policy.

A golden rule has several advantages over fiscal proposals based on balanced budgets, deficits or debt control. First, it correctly focuses on the underlying problem of excessive government rather than the symptom of red ink. Second, lawmakers have the power to control the growth of government spending. Deficit targets and balanced-budget requirements put lawmakers at the mercy of economic fluctuations that can cause large and unpredictable swings in tax revenue. Third, spending can still grow by 2% even during a downturn, making the proposal more politically sustainable.

The last point, by the way, is important because it may appeal to reasonable Keynesians. And, in any event, it means the Rule is more politically sustainable.

I then provide lots of examples of nations that enjoyed great success by restraining spending. But rather than regurgitate several paragraphs from the column, here’s a table I prepared that wasn’t included in the column because of space constraints.

It shows the countries that restrained spending and the years that they followed the Golden Rule. Then I include three columns of data. First, I show how fast spending grew during the period, followed by numbers showing what happened to the overall burden of government spending and the change to annual government borrowing.

Golden Rule Examples

Last but not least, I deal with the one weakness of Mitchell’s Golden Rule. How do you convince politicians to maintain fiscal discipline over time?

I suggest that Switzerland’s “debt brake” may be a good model.

Can any government maintain the spending restraint required by a fiscal golden rule? Perhaps the best model is Switzerland, where spending has climbed by less than 2% per year ever since a voter-imposed spending cap went into effect early last decade. And because economic output has increased at a faster pace, the Swiss have satisfied the golden rule and enjoyed reductions in the burden of government and consistent budget surpluses.

In other words, don’t bother with balanced budget requirements that might backfire by giving politicians an excuse to raise taxes.

If the problem is properly defined as being too much government, then the only logical answer is to shrink the burden of government spending.

Last but not least, I point out that Congressman Kevin Brady of Texas has legislation, the MAP Act, that is somewhat similar to the Swiss Debt Brake.

We know what works and we know how to get there. The real challenge is convincing politicians to bind their own hands.

A Fiscal Lesson from Germany

Germany isn’t exactly a fiscal role model.

Tax rates are too onerous and government spending consumes about 44 percent of economic output.

That’s even higher than it is in the United States, where politicians at the federal, state, and local levels divert about 39 percent of GDP into the public sector.

Germany also has too much red tape and government intervention, which helps to explain why it lags other European nations such as Denmark and Estonia in the Economic Freedom of the World rankings.

But I have (sort of) defended Germany a couple of times, at least on fiscal policy, explaining that the Germans didn’t squander much money on Keynesian spending schemes during the downturn and also explaining that Paul Krugman was wrong in his column on Germany and austerity.

Today, though, I’m going to give Germany some unambiguous praise.

If you look at last decade’s fiscal data, you’ll see that our Teutonic friends actually followed my Golden Rule on fiscal policy for a four-year period.

Here’s a chart, based on IMF numbers, showing total government spending in Germany from 2003-2007. As you can see, German policy makers basically froze spending.

German Fiscal Restraint

I realize that I’m a libertarian and that I shouldn’t be happy unless the burden of spending is being dramatically reduced, but we’re talking about the performance of European politicians, so I’m grading on a curve.

By that standard, limiting spending so it grows by an average of 0.18 percent is rather impressive. Interestingly, this period of fiscal discipline began when the Social Democrats were in power.

And because the economy’s productive sector was growing at a faster rate during this time, a bit more than 2 percent annually, the relative burden of government spending did fall.

The red line in this next chart shows that the public sector, measured as a share of economic output, fell from almost 49 percent of GDP to less than 44 percent of GDP.

German Spending+Deficit as % of GDP

It’s also worth noting that this four-year period of spending restraint also led to a balanced budget, as shown by the blue line.

In other words, by addressing the underlying problem of too much government, the German government automatically dealt with the symptom of red ink.

That’s the good news.

The bad news is that the German government wasn’t willing to sustain this modest degree of fiscal discipline. The Christian Democrats, who took office in mid-2005, allowed faster spending growth beginning in 2008. As I noted above, the budget increases haven’t been huge, but there’s been enough additional spending that Germany no longer is complying with the Golden Rule and the burden of the public sector is stuck at about 44 percent of GDP.

The moral of the story is that Germany shows that good things happen when spending is restrained, but long-run good performance requires long-run spending discipline.

That’s why I’m a fan of Switzerland’s spending cap. It’s called the “debt brake,” but it basically requires politicians to limit spending so that the budget doesn’t grow much faster than inflation plus population.

And that’s why Switzerland has enjoyed more than a decade of good policy.

To see other examples of nations that have enjoyed fiscal success with period of spending restrain, watch this video.

The Canadian example is particularly impressive.

For Any Fiscal Policy Question, Spending Restraint Is the Answer

Okay, I’ll admit the title of this post is an exaggeration. How to fix the mess at the IRS is a fiscal policy question, and that requires tax reform rather than spending restraint.

But allow me a bit of literary license. We just had a big debt limit battle in Washington and, after a lot of political drama, politicians kicked the can down the road.

So we need to ask ourselves whether that fight accomplished anything?

It did focus attention of the flaws of Obamacare, and I suppose there’s some value in that.

But the debt limit was not a vehicle - as has been the case in the past - for changes in fiscal policy. We didn’t get something good, like the sequester which resulted from the 2011 debt limit legislation. And we didn’t get something bad, like the tax hike in the 1985 debt limit legislation

Some are asking whether we should even have a debt limit. A number of critics have suggested we should get rid of the borrowing cap because it creates the risk of default. I think those concerns are very overblown.

I’m more persuaded by those who argue that the debt limit diverts attention from better options to improve fiscal policy.

Testifying to the Joint Economic Committee about “Debt Limit Brinksmanship”

As we get closer to the debt limit, the big spenders in Washington are becoming increasingly hysterical about the supposed possibility of default if politicians lose the ability to borrow more money.

I testified yesterday to the Joint Economic Committee on “The Economic Costs of Debt-Ceiling Brinkmanship” and I explained (reiterating points I made back in 2011) that there is zero chance of default.

Why? Because, as I outline beginning about the 3:10 mark of the video, annual interest payments are about $230 billion and annual tax collections are approaching $3 trillion.

I actually made five points in my testimony. The first three should be quite familiar to regular readers.

First, America’s main fiscal problem is that government is too big. That’s the disease. Deficits and debt are symptoms of that underlying problem.

Second, you achieve good fiscal policy by following “Mitchell’s Golden Rule” so that government grows slower than private sector economic output.

Third, we’ve made some progress in the last two years thanks to genuine fiscal restraint, and we can balance the budget in a very short period of time if lawmakers impose a very modest bit of spending discipline in the future.

The fourth point, which I already discussed above, is that there’s no risk of default - unless the Obama Administration deliberately wants that to happen. But that’s simply not a realistic possibility.

My fifth and final point deserves a bit of extra discussion. I explained that Greece is now suffering through a very deep recession, with record unemployment and harsh economic conditions. I asked the Committee a rhetorical question: Wouldn’t it have been preferable if there was some sort of mechanism, say, 15 years ago that would have enabled some lawmakers to throw sand in the gears so that the government couldn’t issue any more debt?

Debt limit jokesYes, there would have been some budgetary turmoil at the time, but it would have been trivial compared to the misery the Greek people currently are enduring.

I closed by drawing an analogy to the situation in Washington. We know we’re on an unsustainable path. Do we want to wait until we hit a crisis before we address the over-spending crisis? Or do we want to take prudent and modest steps today - such as genuine entitlement reform and spending caps - to ensure prosperity and long-run growth.

Seems like the answer should be simple…at least if you’re not trying to get reelected by bribing voters with their own money.

P.S. My argument for short-term fighting today to avoid fiscal crisis in the future was advanced in greater detail by a Wall Street expert back in 2011.

P.P.S. You can enjoy some good debt limit cartoons by clicking here and here.

Tax and Expenditure Limits: The Challenge of Turning Mitchell’s Golden Rule from Theory into Reality

The main goal of fiscal policy should be to shrink the burden of government spending as a share of economic output. Fortunately, it shouldn’t be too difficult to achieve this modest goal. All that’s required is to make sure the private sector grows faster than the government.

But it’s very easy for me to bluster about “all that’s required” to satisfy this Golden Rule. It’s much harder to convince politicians to be frugal. Yes, it happened during the Reagan and Clinton years, and there also have been multi-year periods of spending discipline in nations such as Estonia, New Zealand and Canada.

But these examples of good fiscal policy are infrequent. And even when they do happen, the progress often is reversed when a new crop of politicians take power. Federal spending has jumped to about 23 percent of GDP under Bush and Obama, for instance, after falling to 18.2 percent of economic output at the end of the Clinton years.

This is why many advocates of limited government argue that some sort of external force is needed to somehow limit the tendency of politicians to over-tax and over-spend.

I’ve argued on many occasions that tax competition is an important mechanism for restraining the greed of the political class. But even in my most optimistic moments, I realize that it’s a necessary but not sufficient condition.

Another option is budget process reform. If you can somehow convince politicians to tie their own hands (in the same way that alcoholics can sometimes be convinced to throw out all their booze), then perhaps rules can be imposed that improve fiscal policy.

But what sort of rules? Europe has “Maastricht” requirements that theoretically limit deficits and debt, and 49 states have some sort of balanced budget requirement, but these policies have been very unsuccessful - perhaps because they mistakenly focus on the symptom of red ink rather than the underlying disease of government spending.

Are there any budget process reforms that do work? Well, I’ve written about Switzerland’s “debt brake,” which has generated some good results over the past 10 years because it actually imposes an annual spending cap.

Some American states also impose expenditure limits. Have they been successful?

Explaining Ryan’s Budget in the Wall Street Journal

Even though I’ve already made clear that I am less-than-overwhelmed by the thought of Mitt Romney in the White House, I worry that people will start to think I’m a GOP toady.

That’s because I’ve been spending a lot of time providing favorable analysis and commentary on the relative merits of the Ryan budget (particularly proposed reforms to Medicare and Medicaid) compared to President Obama’s statist agenda of class warfare and bigger government.

I’ve already done a couple of TV interviews on Ryanomics vs Obamanomics and the Wall Street Journal this morning published my column explaining the key features of the Ryan budget.

Here are some highlights.

In one of my early paragraphs, I give Ryan credit for steering the GOP back in the right direction after the fiscal recklessness of the Bush years.

…the era of bipartisan big government may have come to an end. Largely thanks to Rep. Paul Ryan and the fiscal blueprint he prepared as chairman of the House Budget Committee earlier this year, the GOP has begun climbing back on the wagon of fiscal sobriety and has shown at least some willingness to restrain the growth of government.

I probably should have also credited the Tea Party, but I’ll try to make up for that omission in the future.

These next couple of sentences are the main point of my column.

The most important headline about the Ryan budget is that it limits the growth rate of federal spending, with outlays increasing by an average of 3.1% annually over the next 10 years. …limiting spending so it grows by 3.1% per year, as Mr. Ryan proposes, quickly leads to less red ink. This is because federal tax revenues are projected by the House Budget Committee to increase 6.6% annually over the next 10 years if the House budget is approved (and this assumes the Bush tax cuts are made permanent).

Some conservatives complain that the Ryan budget doesn’t balance the budget in 10 years. I explain how that could happen, but I then emphasize that what really matters is shrinking the burden of government spending.

To balance the budget within 10 years would require that outlays grow by about 2% each year. …There are many who would prefer that the deficit come down more quickly, but from a jobs and growth perspective, it isn’t the deficit that matters. Rather, what matters for prosperity and living standards is the degree to which labor and capital are used productively. This is why policy makers should focus on reducing the burden of government spending as a share of GDP—leaving more resources in the private economy. The simple way of making this happen is to follow what I’ve been calling the golden rule of good fiscal policy: The private sector should grow faster than the government.

Actually, I’ve been calling it Mitchell’s Golden Rule, but I couldn’t bring myself to be that narcissistic and self-aggrandizing on the nation’s most important and influential editorial page.

One final point from the column that’s worth emphasizing is that Ryan does the right kind of entitlement reform.

One of the best features of the Ryan budget is that he reforms the two big health entitlements instead of simply trying to save money. Medicaid gets block-granted to the states, building on the success of welfare reform in the 1990s. And Medicare is modernized by creating a premium-support option for people retiring in 2022 and beyond. This is much better than the traditional Beltway approach of trying to save money with price controls on health-care providers and means testing on health-care consumers. …But good entitlement policy also is a godsend for taxpayers, particularly in the long run. Without reform, the burden of federal spending will jump to 35% of GDP by 2040, compared to 18.75% of output under the Ryan budget.

The last sentence of the excerpt is critical. If the Golden Rule of fiscal policy is to have the private sector grow faster than government, then the Golden Goal is to reduce government spending as a share of GDP.

I’ve commented before how America will become Greece in the absence of reform. Well, that’s basically the Obama fiscal plan, as illustrated by this amusing cartoon.

What makes the Ryan budget so impressive is that it includes the reforms that are needed to avoid this fate.

No, it doesn’t bring the federal government back down to 3 percent of GDP, so it’s not libertarian Nirvana.

But we manage to stay out of fiscal hell, so that counts for something.

Here’s Why the Cayman Islands Is Considering Fiscal Suicide

What Do Greece, the United States, and the Cayman Islands Have in Common?

At first, this seems like a trick question. After all, the Cayman Islands are a fiscal paradise, with no personal income tax, no corporate income tax, no capital gains tax, and no death tax.

By contrast, Greece is a bankrupt, high-tax welfare state, and the United States sooner or later will suffer the same fate because of misguided entitlement programs.

But even though there are some important differences, all three of these jurisdictions share a common characteristic in that they face fiscal troubles because government spending has been growing faster than economic output.

I’ve written before that the definition of good fiscal policy is for the private sector to grow faster than the government. I’ve humbly decided to refer to this simple principle as Mitchell’s Golden Rule, and have pointed out that bad things happen when governments violate this common-sense guideline.

In the case of the Cayman Islands, the “bad thing” is that the government is proposing to levy an income tax, which would be akin to committing fiscal suicide.

The Cayman Islands are one of the world’s richest jurisdictions (more prosperous than the United States according to the latest World Bank data), in part because there are no tax penalties on income and production.

So why are the local politicians considering a plan to kill the goose that lays the golden eggs? For the simple reason that they have been promiscuous in spending other people’s money. This chart shows that the burden of government spending in the Cayman Islands has climbed twice as fast as economic output since 2000.

Much of this spending has been to employ and over-compensate a bloated civil service (in this respect, Cayman is sort of a Caribbean version of California).

In other words, the economic problem is that there has been too much spending, and the political problem is that politicians have been trying to buy votes by padding government payrolls (a problem that also exists in America).

The right solution to this problem is to reduce the burden of government spending back to the levels in the early part of last decade. The political class in Cayman, however, hopes it can prop up its costly bureaucracy with a new tax—which euphemistically is being called a “community enhancement fee.”

The politicians claim the tax will only be 10 percent and will only be imposed on the expat community. But it’s worth noting that the U.S. income tax began in 1913 with a top rate of only seven percent and it affected less than one percent of the population. But that supposedly benign tax has since become a monstrous internal revenue code that plagues the nation today.

Except the results will be even worse in Cayman because the thousands of foreigners who are being targeted easily can shift their operations to other zero-income tax jurisdictions such as Bermuda, Monaco, or the Bahamas. Or they can decide that to set up shop in places such as Hong Kong and Singapore, which have very modest income tax burdens (and the ability to out-compete Cayman in other areas).

As a long-time admirer of the Cayman Islands, I desperately hope the government will reconsider this dangerous step. The world already has lots of examples of nations that are following bad policy. We need a few places that are at least being semi-sensible.

By they way, I started this post with a rhetorical question about the similarities of Greece, the United States, and the Cayman Islands. Let’s elaborate on the answer.

Here’s a post that shows how Greece’s fiscal nightmare developed. But let’s show a separate chart for the burden of federal spending in the United States.

What’s remarkable is that the federal government and the Cayman Islands government have followed very similar paths to fiscal trouble. Indeed, Caymanian politicians have achieved the dubious distinction of increasing the burden of government spending at a faster rate than even Bush and Obama. No mean feat.

This data for the U.S. chart doesn’t include the burden of state and local government spending, so the Cayman Islands still has an advantage over the United States, but I’ll close with a prediction.

If the Cayman Islands adopts an income tax—regardless of whether they call it a community enhancement fee (to misquote Shakespeare, a rotting fish on the beach by any other name would still smell like garbage), it will be just a matter of time before the burden of government spending becomes even more onerous and Cayman loses its allure and drops from being one of the world’s 10-richest jurisdictions.

Which will be very sad since I’ll now have to find a different place to go when America suffers its Greek-style fiscal collapse.