One of the most remarkable developments in the world of fiscal policy is that even left-leaning international bureaucracies are beginning to embrace spending caps as the only effective and successful rule for fiscal policy.
The International Monetary Fund is infamous because senior officials relentlessly advocate for tax hikes, but the professional economists at the organization have concluded in two separate studies (see here and here) that expenditure limits produce good results.
Likewise, the political appointees at the Organization for Economic Cooperation and Development generally push a pro-tax increase agenda, but professional economists at the Paris-based bureaucracy also have produced studies (see here and here) showing that spending caps are the only approach that leads to good results.
Heck, even the European Central Bank has jumped into the issue with a study that reaches the same conclusion.
This doesn’t mean balanced budget requirements are bad, by the way, but the evidence shows that they aren’t very effective since they allow lots of spending when the economy is expanding (and thus generating tax revenue). But when the economy goes into recession (causing a drop in tax revenue), politicians impose tax hikes in hopes of propping up their previous spending commitments.
With a spending cap, by contrast, fiscal policy is very stable. Politicians know from one year to the next that they can increase spending by some modest amount. They don’t like the fact that they can’t approve big spending increases in the years when the economy is expanding, but that’s offset by the fact that they don’t have to cut spending when there’s a recession and revenues are falling.
From the perspective of taxpayers and the economy, the benefit of a spending cap (assuming it is well designed so that it satisfies Mitchell’s Golden Rule) is that annual budgetary increases are lower than the long-run average growth of the private sector.
And nations that have followed such a policy have achieved very good results. The burden of government spending shrinks as a share of economic output, which naturally also leads to less red ink relative to the size of the private economy.
But it’s difficult to maintain spending discipline for multi-year periods. In most cases, governments that adopt good policy eventually capitulate to pressure from interest groups and start allowing the budget to expand too quickly.
That’s why the ideal policy is to make a spending cap part of a nation’s constitution.
That’s what happened in Switzerland early last decade thanks to a voter referendum. And that’s what has been part of Hong Kong’s Basic Law since it was approved back in 1990.
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