Tag: fiscal policy

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

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

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

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

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

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

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

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

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

Three Lessons from the Tax Defeat in Kansas

Leftists don’t have many reasons to be cheerful.

Global economic developments keep demonstrating (over and over again) that big government and high taxes are not a recipe for prosperity. That can’t be very encouraging for them.

They also can’t be very happy about the Obama presidency. Yes, he was one of them, and he was able to impose a lot of his agenda in his first two years. But that experiment with bigger government produced very dismal results. And it also was a political disaster for the left since Republicans won landslide elections in 2010 and 2014 (you could also argue that Trump’s election in 2016 was a repudiation of Obama and the left, though I think it was more a rejection of the status quo).

But there is one piece of good news for my statist friends. The tax cuts in Kansas have been partially repealed. The New York Times is overjoyed by this development.

The Republican Legislature and much of Kansas has finally turned on Gov. Sam Brownback in his disastrous five-year experiment to prove the Republicans’ “trickle down” fantasy can work in real life — that huge tax cuts magically result in economic growth and more, not less, revenue. …state lawmakers who once abetted the Brownback budgeting folly passed a two-year, $1.2 billion tax increase this week to begin repairing the damage. …It will take years for Kansas to recover.

And you won’t be surprised to learn that Paul Krugman also is pleased.

The Five Most Important Takeaways from Trump’s Budget

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

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

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

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

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

 

Paul Krugman on Pump-Priming and Trump

New York Times columnist Paul Krugman recently chided President Trump for imagining he invented the metaphor of “priming the pump” during an Economist interview. Yet Krugman, like Trump, buys into the premise that budget deficits really do “stimulate” total spending or “aggregate demand” which is commonly measured by growth of Nominal GDP (NGDP).

Economic booms and busts clearly have huge effects on budget deficits, but where is the evidence that deficits and surpluses have their own separate (“exogenous”) effect on NGDP? 

To isolate cause and effect, we have to take out the “endogenous” effects that ups and downs in the economy have on taxes and spending. That is why the Congressional Budget Office (CBO)estimates budget deficits or surpluses (divided by GDP) without automatic stabilizers, which has traditionally been called the “cyclically-adjusted” budget. I will label it the “C-A Deficit” for short.  

CA Deficit and NGDP

The red line in the graph shows the CBO’s Cyclically-Adjusted (C-A) deficit or surplus as a share of GDP. The blue line shows the percentage growth in Nominal GDP (NGDP). 

From 1965 to 2016, the C-A Deficit averaged -2.7% of GDP, and growth of nominal GDP averaged 6.6%.

Contrary to 1960s Keynesian orthodoxy, the graph and table reveal no connection between the size of cyclically-adjusted deficits or surpluses and the rate of growth of aggregate demand (NGDP).  From 1991 to 2001, for example, the C-A Budget swings from an average deficit to a sizable surplus with essentially no change in the pace of NGDP growth. 

There is no measurable or even visible connection between larger CA-Deficits and faster NGDP growth in 2009-2012, nor between budget surpluses and slower NGDP growth in 1998-2000.  For more than 50 years, our experience has frequently been the opposite of what demand-side fiscalism predicts. This is not just a short-term phenomenon.

Supporters of BATs and VATs are wrong about trade and taxes

My crusade against the border-adjustable tax (BAT) continues.

In a column co-authored with Veronique de Rugy of Mercatus, I explain in today’s Wall Street Journal why Republicans should drop this prospective source of new tax revenue.

…this should be an opportune time for major tax cuts to boost American growth and competitiveness. But much of the reform energy is being dissipated in a counterproductive fight over the “border adjustment” tax proposed by House Republicans. …Republican tax plans normally receive overwhelming support from the business community. But the border-adjustment tax has created deep divisions. Proponents claim border adjustability is not protectionist because it would automatically push up the value of the dollar, neutralizing the effect on trade. Importers don’t have much faith in this theory and oppose the GOP plan.

Much of the column is designed to debunk the absurd notion that a BAT is needed to offset some mythical advantage that other nations supposedly enjoy because of their value-added taxes.

Here’s what supporters claim.

Proponents of the border-adjustment tax also are using a dodgy sales pitch, saying that their plan will get rid of a “Made in America Tax.” The claim is that VATs give foreign companies an advantage. Say a German company exports a product to the U.S. It doesn’t pay the American corporate income tax, and it receives a rebate on its German VAT payments. But an American company exporting to Germany has to pay both—it’s subject to the U.S. corporate income tax and then pays the German VAT on the product when it is sold.

Sounds persuasive, at least until you look at both sides of the equation.

When the German company sells to customers in the U.S., it is subject to the German corporate income tax. The competing American firm selling domestically pays the U.S. corporate income tax. Neither is hit with a VAT. In other words, a level playing field.

Here’s a visual depiction of how the current system works. I include the possibility that that German products sold in America may also get hit by the US corporate income tax (if the German company have a US subsidiary, for instance). What’s most important, though, is that neither American-produced goods and services nor German-produced goods and services are hit by a VAT.

Six Sobering Charts about America’s Grim Future from CBO’s New Report on the Long-Run Fiscal Outlook

I sometimes feel like a broken record about entitlement programs. How many times, after all, can I point out that America is on a path to become a decrepit European-style welfare state because of a combination of demographic changes and poorly designed entitlement programs?

But I can’t help myself. I feel like I’m watching a surreal version of Titanic where the captain and crew know in advance that the ship will hit the iceberg, yet they’re still allowing passengers to board and still planning the same route. And in this dystopian version of the movie, the tickets actually warn the passengers that tragedy will strike, but most of them don’t bother to read the fine print because they are distracted by the promise of fancy buffets and free drinks.

We now have the book version of this grim movie. It’s called The 2017 Long-Term Budget Outlook and it was just released today by the Congressional Budget Office.

If you’re a fiscal policy wonk, it’s an exciting publication. If you’re a normal human being, it’s a turgid collection of depressing data.

But maybe, just maybe, the data is so depressing that both the electorate and politicians will wake up and realize something needs to change.

I’ve selected six charts and images from the new CBO report, all of which highlight America’s grim fiscal future.

The first chart simply shows where we are right now and where we will be in 30 years if policy is left on autopilot. The most important takeaway is that the burden of government spending is going to increase significantly.

The United Kingdom and the Benefits of Spending Restraint

When I debate one of my leftist friends about deficits, it’s often a strange experience because none of us actually care that much about red ink.

I’m motivated instead by a desire to shrink the burden of government spending, so I argue for spending restraint rather than tax hikes that would “feed the beast.”

And folks on the left want bigger government, so they argue for tax hikes to enable more spending and redistribution.

I feel that I have an advantage in these debates, though, because I share my table of nations that have achieved great results when nominal spending grows by less than 2 percent per year.

The table shows that nations practicing spending restraint for multi-year periods reduce the problem of excessive government and also address the symptom of red ink.

I then ask my leftist buddies to please share their table showing nations that got good results from tax increases. And the response is…awkward silence, followed by attempts to change the subject. I often think you can even hear crickets chirping in the background.

I point this out because I now have another nation to add to my collection.

From the start of last decade up through the 2009-2010 fiscal year, government spending in the United Kingdom grew by 7.1 percent annually, far faster than the growth of the economy’s productive sector. As a result, an ever-greater share of the private economy was being diverted to politicians and bureaucrats.

Beginning with the 2010-2011 fiscal year, however, officials started complying with my Golden Rule and outlays since then have grown by an average of 1.6 percent per year.

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