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International Experience with Fiscal Rules

Preceding chapters explained the need for federal budget discipline, outlined how fiscal rules might help achieve it, and analyzed the political dynamics behind the dire federal debt outlook.

To recap, the federal budget deficit is projected to rise to above 5 percent of GDP by 2022, even with benign economic forecasts.[1] Federal debt held by the public is already at its highest level (at 78 percent of GDP) since just after World War II. Congressional Budget Office projections show rapid federal debt increases as a share of GDP over the coming decades, primarily due to rising entitlement expenditure as the population ages.[2] Economists agree that fiscal consolidation – including reform of these programs or tax rises – will be necessary to stabilize or lower the debt-to-GDP ratio.[3]

Can we learn anything from other countries about how fiscal rules could help get debt-to-GDP back on a downward path?

Ninety-six countries have utilized fiscal rules –  defined as “a long-lasting constraint on fiscal policy through numerical limits on budgetary aggregates” – in the past three decades.[4] Countries have experimented with spending, revenue, deficit and debt targets and ceilings, with varying degrees of stringency, different escape clauses, rules applying to either budget plans or hard outcomes, and exemptions for various types of spending and revenue. Reaching generalized conclusions about whether rules per se are effective, or which particular aspects of rules are successful, is therefore difficult.[5]

Individual country case-studies are more instructive. This chapter therefore analyzes the experience of Chile, Switzerland, the U.K. and Sweden with formal fiscal rules. All have sought to lower debt-to-GDP levels or reduce budget deficits in the past two decades.

None experienced challenges completely analogous to the U.S. today. Switzerland implemented a constitutional “debt brake” after a period of rapidly increasing debt, but with accumulated debt levels much lower than the U.S. currently faces. The UK and Sweden adopted fiscal rules to reduce swollen budget deficits following banking crises and the lock-in restraint, whereas the U.S. is still running large structural deficits in benign conditions. More importantly, long term imbalance in the U.S. is driven by spiraling costs of entitlement programs brought about by population aging. This unprecedented challenge is faced by most western economies and throws up different economic and political challenges than reducing debt-to-GDP ratios in the aftermath of one-off crises.

Nevertheless, the experience of these countries can provide general lessons for effective fiscal rule design given the current U.S. debt outlook.


Economists have written glowingly about Chile’s fiscal rule, which appeared to reduce debt levels while allowing flexibility during downturns.[6]

In 2000, the Chilean government voluntarily adopted a structural balanced budget rule. This aimed to achieve a cyclically-adjusted budget surplus of one percent of GDP each year. This target was lowered to half a percent in 2007 and straight structural balance in 2009, after gross debt was virtually eliminated.[7]

A committee of economic experts estimate potential GDP each year. A separate committee assess copper prices (which strongly affect the public finances) relative to their trends. These analyses are combined to estimate annual government revenues were the economy at full potential. This determines the maximum spending level allowed in budget plans for the year ahead. In other words, planned spending is capped at an estimate of cyclically-adjusted tax revenues.

Unlike a strict balanced budget rule, the budget balance fluctuates over the economic cycle with revenues acting as an automatic stabilizer. Debt acts as a shock absorber to economic fluctuations. The government runs a deficit when revenues are below potential and a surplus if the economy is regarded as “overheating” with unsustainable growth. Provided economic potential is accurately estimated, this ensures the budget balances over the business cycle. Economic growth means the debt-to-GDP ratio gradually falls in the medium-term.

Accurate estimates of the country’s economic potential are crucial to the rule working. Chile’s independent committees help mitigate against politicization and over-optimistic estimates of economic potential to justify higher spending. Given this independence, the Chilean fiscal rule applies no sanctions or future adjustment to spending plans if within a year structural balance is breached.[8]

The Chilean fiscal rule was initially adopted voluntarily, before being formalized into law in 2006. How has it performed? Between 2000 and 2007, the IMF estimates Chile ran an average budget surplus of 2.8 percent of GDP, with an average structural balance of 0.6 percent of GDP.[9] General government gross debt fell from 13 percent of GDP in 2000 to 4 percent of GDP in 2007, and net debt swung from 3 percent to minus 13 percent of GDP. Chile’s sovereign debt rating improved. Even the announcement of the rule in 2000 improved Chile’s creditworthiness.[10] Importantly, public spending fluctuated much less than in previous decades and GDP volatility declined substantially.[11]

The framework’s virtues really became apparent before the financial crisis. Then President Michele Bachelet was under pressure to increase government spending given sustained strong GDP growth and a high world price of copper. Yet the government resisted, with the independent committees judging most of the strong budget performance as cyclical.[12]. In 2007, Chile ran a budget surplus as large as 7.9 percent of GDP.

This conservatism proved prescient. By 2009 the budget had swung to a 4.2 percent deficit as the global recession hit. General government debt increased again, but Chile had been so prudent prior to the crash that even today gross and net government debt stand at 24 percent and 1 percent of GDP respectively.[13]

The limits of the framework have been exposed in the post-crisis period, however. From 2009 through 2011, the rule was temporarily abandoned, as the government cited extraordinary circumstances following the global recession.[14] No sanctions or commitments to a future tightening of policy were made, and the country ran structural deficits during this time (as shown in Figure 1).

Figure 1: Chile General Government Fiscal Balance

Source: IMF World Economic Outlook, April 2018.

Having returned to structural balance in 2012, the period since has seen sustained failure to meet the rule too, in part because “potential GDP” is difficult to calculate. Chile raised its corporate income tax rate from 17 to 20 percent under President Sebastián Piñera in 2011, and further to 27 percent under President Bachelet, with the intention to raise revenues for education and social spending.[15] But during this period of higher taxes and steep spending increases (overall spending has increased by 1.9 percentage points of GDP since 2011), annual real GDP growth underwhelmed expectations. Gross government debt has therefore near-doubled between 2013 and 2018, and net debt drifted back into positive territory, despite the pick-up in the global economy.

Potential GDP is inherently difficult to assess, particularly when major supply-side policy change occurs. Calculating “potential revenues” requires accurate assessment of: a) the health of the economy in real time, b) the “output gap” – i.e. how far the economy is away from its potential, c) how moving to potential affects revenues. All are uncertain and difficult to calculate.

Faced with slower-than-expected growth, President Piñera downgraded the rule’s  stringency to a 1 percent of GDP structural deficit target by 2014. President Bachelet then diluted it further, targeting a structural deficit trajectory (aiming for it to fall by 0.25 percent of GDP per year). Despite a recent pick-up in Chile’s growth rate, which has reduced the overall deficit, the IMF believes the country will still run a 2.4 percent of GDP structural deficit in 2018. Last, Standard & Poor’s downgraded Chile’s credit rating.[16]

The new government under President Sebastián Piñera has now pledged to return to structural balance over a six to eight-year period.[17] But breaches and continual adjustments to the framework have undermined its credibility.[18] Chilean economic commentators and analysts have called for the Fiscal Council (which has overseen the independent committees since 2013) to be granted more binding powers.

Chile’s experience then highlights strengths and weaknesses of structural rules based upon potential tax revenues. When potential GDP is estimated accurately, a structural balance rule delivers counter-cyclical policy (the basic correlation between Chile’s budget surplus and real GDP growth since 2000 is 0.67, see Figure 2), and a falling debt-to-GDP ratio. But potential GDP is difficult to estimate. Over-optimism can lead to unforeseen borrowing which, absent correction, raises debt-to-GDP levels.

Chile’s rule proved effective in the build-up to the crisis. But it has proven less enduring since. Absent a constitutional underpinning, political will is required to ensure rules are not abandoned or diluted and in the post-crisis period, Chile’s framework has been relaxed. This may have been initially because the structural balance rule only allowed revenues, and not spending, to fluctuate with the business cycle. When crises hit, as after 2009, social protection spending tends to rise. But under Chile’s rule other spending must be cut to allow for this. This absence of spending-side automatic stabilizers may have contributed to the political willingness to temporarily abandon the rule, ultimately undermining its credibility.

In Chile’s case, with low debt levels, allowing bygones to be bygones and temporarily abandoning the rule might not have major consequences, but such mistakes could be problematic for a country such as the U.S. with already high levels of debt.

Figure 2. Chile’s Counter-Cyclical Fiscal Policy

Source: IMF World Economic Outlook, April 2018

Swiss Debt Brake

Proponents of fiscal rules often hold up Switzerland as an exemplar.

Through the 1990s the Swiss national government ran sustained budget deficits, with gross government debt increasing from 34 percent of GDP in 1990 to 55 percent of GDP, and net debt rise from 13 percent of GDP to 34 percent.[19] Widespread concern saw the so-called Swiss “debt brake” approved in a referendum by 85 percent of voters in 2001, applying in the country’s constitution from 2003 onwards.[20]

The debt brake requires structural balanced budgets annually. Annual federal spending is capped at an estimate of tax revenues multiplied by a business cycle adjustment factor (trend real GDP growth divided by expected GDP growth for the year).[21] This means spending levels stay relatively independent of the near-term state of the economy and are stabilized around a smoothed revenue trend.

This rule should be counter-cyclical by construction. When real GDP growth is expected to be below trend growth, the spending cap exceeds revenues. When real GDP growth for the year is expected to be above trend growth, the spending cap falls below revenues. Over the long-run, the overall budget should balance, and hence the debt-to-GDP ratio should fall with economic growth.

This sounds similar to the Chilean rule. But the Swiss fiscal framework differs in key respects.

First, the Swiss Federal Department of Finance uses backward-looking trends in real GDP growth in calculating planned spending caps. Spending caps are therefore much more formulaic and predicated on hard data and near-term forecasts, rather speculative estimates of economic potential. This eliminates ambiguity and a potential sources of bias (though not entirely – the Swiss government admits there has been a bias error towards surpluses in application so far). By incorporating backward-looking data though, the Swiss rule ensures balance is achieved in the long-run, although it is possible it could result in near-term structural imbalance, if the potential growth rate were to change from its historic trend.

Second, certain expenditures highly sensitive to the health of the economy, such as unemployment insurance, are excluded from the rule and spending cap altogether, as are social security expenditures (though the latter is bound by its own spending targets).[22] Automatic stabilizers therefore operate for both spending and revenue.

Third, the Swiss framework incorporates mechanisms to deal with outcomes differing from planned structural balance. Deviations in actual outcomes from plans are chalked up as debits or credits in a “compensating account,” which must be adjusted for in future budgeting. Once debits exceed 6 percent of government spending, the excess must be eliminated in the next three budget cycles through cutting spending. Whereas in Chile there are no consequences for deviations from forecasts, in Switzerland deviations are factored into future policy to ensure the budget really does balance over time.

Finally, there is an escape clause for exceptional circumstances, if a qualified majority in both houses of the Swiss parliament approves the exceptional spending. Yet even these emergency measures are “debited” to a special “amortization account,” and must be compensated for within six years of the exceptional spending.

This rule practically guarantees a decline in the debt-to-GDP ratio over time, unless social security spending—which sits outside of it with its own rules—were to be increased significantly. In Switzerland’s case, the rule also helps tame government size. Since some tax rates are constitutionally restricted (with change requiring approval of a majority of voters in a majority of cantons), structural balance is largely achieved through controlling expenditure.

How has the debt brake performed since 2003? Switzerland has run an average overall surplus of 0.2 percent per year since then. This is practically identical to the IMF’s estimate of the average structural balance, showing that broadly a balanced budget has been achieved, with a slight surplus bias. As a result, after peaking in 2004, government net debt-to-GDP has more than halved (see Figure 3 – from 46 percent to 22 percent in 2018).[23] During this period, Swiss fiscal policy has been moderately counter-cyclical (with a correlation of 0.2).

The Swiss debt brake has largely worked as intended. Its constitutional backing, underpinned by the democratic mandate, gives the rule more authority and permanence than rules passed through ordinary legislation. It is simple, transparent and formulaic, adjusting over time to deviations from plans, making it robust to unforeseen events. It cannot be manipulated by continued overoptimistic assumptions about trend growth.

Yet as with all fiscal rules, it is difficult to answer whether the rule is most important, or the supporting institutions and public support which generated it in the first place. Switzerland relies heavily on voter initiatives and referenda in fiscal decisions, has a strongly decentralized federalized system, and effective fiscal rules at the cantonal level. It is worth noting too that the country has a strong and open financial system, providing clear signals for when deficits and debt are not sustainable.

The rule has also not been yet tested by a major crisis. In the longer-term, the exclusion of social security from the scope of the rules is likely to put upward pressure on government debt (as in most Western countries facing aging populations) absent continuation of separate rules to rein in that spending growth, or constitutional changes to tax rate limits.

Critics regularly contend that the rule is too restrictive, not allowing enough counter-cyclical discretion to deal with crises and limiting the scope for productive public investment. But the example of the UK’s experience with rules that exclude investment expenditure and the frequency of tinkering with fiscal rules in Chile, the UK and Sweden, suggests that there might be some meaningful trade-off in sticking to transparent and simple frameworks, at the expense of limiting flexibility.

Figure 3. Switzerland Government Net Debt

Percent of GDP

Source: IMF World Economic Outlook, April 2018.

United Kingdom’s Ever-Changing Fiscal Rules

The phrase “rules are made to be broken” could describe the U.K.’s fiscal experience over the past two decades.

Between 1998 and 2007, the Labour government operated a “golden rule” which only allowed borrowing for investment over the economic cycle. This was supplemented with a “sustainable investment rule” which said the net debt-to-GDP ratio should be kept below 40 percent.[24] By 2007 these rules had been completely discredited. The Financial Times wrote of its annual survey of economists: “Almost none use the chancellor’s fiscal rules any more as an indication of the health of the public finances.”[25]

The government used creative accounting to meet the “golden rule.” Consumption expenditure was re-defined as investment spending. The government’s growth forecasts, which underpinned the fiscal rules, proved continually overoptimistic about tax revenues. The methodology used to calculate cumulative budget surpluses for non-investment spending was changed and, according to the Institute for Fiscal Studies, “the estimated start date for the economic cycle was moved by two years at precisely the point at which, without this change, the government looked on course to break rather than meet the golden rule.”[26]

The financial crisis led to a complete abandonment of this framework, as debt-to-GDP soared when the recession hit. Reassessments from the IMF found potential GDP had previously been grossly overestimated. The U.K. is now believed to have entered the crisis running a 5.2 percent of GDP structural deficit in 2007.[27] Adding to that a discretionary “stimulus” package, the U.K.’s structural deficit soared to near 9 percent of GDP in 2009. Net debt rose from 37 to 68 percent of GDP between 2007 and 2010.

The incoming Conservative government recognized the unsustainability of this fiscal stance. It adopted two new rules in June 2010 as part of a “Fiscal Mandate” to reduce the deficit slowly over the five-year parliamentary term, and to get the debt-to-GDP ratio back falling by its end. These had no legal standing, but it was thought not meeting them would result in large political costs given the salience of the government finances in public debate.

The first rule said the government would eliminate the structural deficit, excluding investment spending, “within five years.” The second, a firmer rule, pledged that the net debt-to-GDP ratio would be back falling by 2015. The government planned a deficit reduction package of tax increases and spending restraint to hit these targets given growth and revenue forecasts. They created an independent Office for Budget Responsibility to oversee forecasting and assessments of compliance with the rules.[28]

These rules, ultimately, were abandoned. In 2011, the Office for Budget Responsibility revised down their estimate of the economy’s potential capacity, revising up their estimate of the level of the structural deficit. The government did not adjust its tax or spending plans, pushing back the timeline for achieving structural balance. In the end, the structural deficit was only halved over the period it was supposed to be eliminated (see Figure 5), and even now is not forecast to move into surplus until 2018/19.[29]

The net debt rule was also abandoned when it became clear it would bind. Though the net debt-to-GDP did begin falling from the end of the parliamentary term, the headline figure gave a false impression of long-term fiscal sustainability as the government improved the debt position through one-off asset sales.

Though the rules were abandoned, they were not completely useless. They kept focus on the need for deficit reduction. The primary reason for failure to meet targets was due to unexpectedly weak productivity growth, and hence tax revenue shortfalls. This led both borrowing to be significantly higher than planned. But despite huge political pressure to jettison fiscal consolidation and spend more, the government actually delivered marginally lower nominal spending at the end of the Parliament than originally planned (£757.1 billion in 2014/15, compared with plans for £757.5 billion).

The main problem with the plan itself was a decision to ring-fence large areas from restraint, including healthcare and the state pension (where spending was increased).[31] This not only meant major cuts had to be made in unprotected departments, but some of the longer-term liabilities associated with an aging population were worsened.[32]

A new framework was adopted in 2015 to “finish the job” of near-term fiscal repair. The aim was to close the remainder of the budget deficit and deliver an overall surplus by 2020. From there, a legally-binding surplus rule was planned, mandating an overall budget surplus every year, except when the economy encountered a negative shock (defined as when annual real GDP growth fell, or was forecast to fall, below 1 percent). The government argued that sustained overall surpluses were necessary to get the debt-to-GDP ratio down to historic levels over the long-term, giving the headwinds of an aging population and likelihood of recessions.

This proposed rule was criticized by economists for being simultaneously both too stringent and too lenient. It could have resulted in large within-year spending cuts to spending if growth forecasts proved over-optimistic, making it very pro-cyclical at times, and would have required targeting a large surplus to account for forecasting uncertainties. Yet when growth fell below the 1 percent threshold, the rule gave the government carte blanche to deviate from the target and decide when to return to it.

Again, this framework was abandoned before it ever bound. After the Brexit vote, the government pushed back the date for targeting a surplus, and now promises one by the mid-2020s. The electorate appear fatigued by years of “deficit reduction,” and demands for increased spending proliferate, despite the tax burden rising to its highest level in 49 years.[33] The debt-to-GDP ratio is expected to fall only modestly over the coming half-decade (see Figure 4 below), assuming benign conditions. But with the headwinds of an aging population to come, British government debt levels are still highly elevated relative to historic norms and projected to rise substantially on unchanged policies in future.[34]

Figure 4: UK Government Debt-to-GDP levels

Source: IMF World Economic Outlook, April 2018

The U.K.’s experience with fiscal rules is therefore an unhappy one. Absent constitutional constraints or independent assessment, politicians used creative accounting and over-optimistic forecasts to circumvent rules. Annual deficit targets proved difficult to plan for or hit given fluctuations of revenues, and structural consolidation plans were thrown off-course by changing estimates of the productive potential of the economy. The U.K. government has continually promised future restraint through tough rules but then ignored failures to hit deadlines.

One political economy lesson appears to be that fiscal repair should be undertaken while there is political and electoral buy-in. Promises to be responsible sometime in the future are virtually certain to be abandoned as circumstances change and political will subsides. In the U.K., there were no consequences for failing to hit targets. This is in stark contrast to Switzerland where spending caps are largely based on past data or near-term forecasts, and deviations from targets are worked into future budgets.


Sweden reduced an extraordinarily high budget deficit in the 1990s and set a fiscal stance to ensure its debt-to-GDP ratio fell over the longer term, albeit from a lower debt-to-GDP level than faced by the U.S. today.

In the early 1990s, Sweden faced a severe banking crisis, which saw banks recapitalized, the unemployment rate increase from 2 to 11 percent, and three consecutive years of falling GDP.[35] The budget deficit soared, as Figure 5 shows, to just under 11 percent of GDP by 1993.[36]

Figure 5: Sweden Budget Balance, 1980-2023

Source: IMF World Economic Outlook

A political consensus developed that the deficits were unsustainable and substantial fiscal consolidation was required. Halting debt accumulation became a priority in 1993 for the Liberal-Conservative government and then the Social Democrats in 1994. Two deficit reductions attempts were made through 1992 and 1993, with more significant efforts delivered between 1995 and 1997. The aim of the 1995 program was to stabilize the debt-to-GDP ratio by 1996 and balance the overall budget two years’ later. Both were achieved, with a 0.8 percent of GDP surplus by 1998.[37]

It is beyond this chapter to detail the deficit reduction program. Economists have debated why the budget deficit fell so rapidly, with some crediting other factors, including an accommodative monetary policy stance, strong international economic growth and supply-side reforms of the tax system, competition policy and public services.

But the crisis did create a climate conducive to developing a fiscal framework for Sweden’s subsequent smooth downward path of debt as a proportion of GDP. This began with the National Medium-Term Budgetary framework enacted in 1997-2000, and then was formalized into fiscal rules.

Today, Sweden’s fiscal framework is somewhat complex. But its outcomes stand out among advanced western economies. Between 1998 and 2018, Sweden averaged a general government surplus of 0.6 percent of GDP per year. Gross debt has fallen from 66 percent to 38 percent of GDP, and net debt from 51 percent to just 7 percent (see Figure 6 below).[38] The country was running budget surpluses prior to the financial crisis, meaning that even the 2008 crash resulted in very modest deficits.

Figure 6: Swedish General Government Gross and Net Debt, 1994-2023 (outturns and projections)

Source: IMF World Economic Outlook, April 2018

Thecurrent framework has built up in piecemeal fashion.[39] The main component is a “surplus target.” Until recently, the central government was committed to run an average budget surplus of 1 percent of GDP across the economic cycle (since relaxed to 0.33 percent of GDP).[40] As the U.K. example showed though, any rule that relies on estimates of the highly uncertain economic cycle is open to circumvention by politicians.

The framework guards against this using two indicators to assess whether the target is likely to be met.

First, each year a forecast of the structural budget balance is calculated and compared to the surplus target.[41] If the government believes it will not hit its structural surplus target annually, it must explain the deviation and outline how it intends to return to target, with plans incorporated into the next budget.[42] There are no sanctions or automatic adjustments if the target is forecast to be missed. In fact, in theory there is maximum flexibility for discretionary deviations in any year. The hope though is that clear and transparent analysis of the public finance position will cause politicians to pay a political cost though for not being able to justify these deviations.

This evaluation is also supplemented with a backward-looking calculation of the budget balance across the previous eight years, as a proxy for whether the rule is being delivered across the cycle. Again, any systematic deviations from the rule are highlighted, with suggestions for spending or tax decisions to adjust accordingly.

Absent systematic mistakes over assessments, this surplus rule ensures the debt-to-GDP ratio falls over time. The level of the surplus target is reviewed every 8 years too, allowing governments to reassess what is needed to ensure sustainable debt-to-GDP ratios given changes to demographics and the outlook for the federal finances.

To hit this surplus target, Sweden operates a rolling “expenditure ceiling” covering all central government and old-age spending except for debt interest payments. This ceiling applies for spending in each of the next three years, protecting against governments permanently increasing spending after temporarily strong tax revenues. Flexibility for unforeseen events is granted through a “budget margin” of up to 3 percent of forecast spending for three years ahead.[43] But combined with the surplus target, the ceiling effectively caps total tax revenues and prevents situations where taxes must be increased to account for insufficient control of expenditure.

A Fiscal Policy Council staffed overwhelmingly by academic economists was created in 2007 to oversee and assess whether the surplus rule and expenditure ceiling are being met, to evaluate economic forecasts, assess the justification for deviations from targets, and to set out what return to target is appropriate.

A “debt anchor” will be added in 2019, with a benchmark target for gross debt of 35 per cent of GDP. If actual debt deviates more than 5 percentage points from this benchmark, the government must write to Parliament outlining how they will deal with it. If this is due to the surplus target not being hit, then the surplus target should be revised up in the next period.[44]

Overall, the framework appears to haven been effective. Sweden has almost eradicated its net debt (as Figure 6 shows). It is in a strong fiscal position given future demographic challenges. The real question is whether these outcomes are due to rule design and implementation, or the political consensus for fiscal conservatism borne out of the 1990s crisis.

Some anecdotal evidence suggests the latter is important. In 2013 and 2014, opposition parties began undermining informal budgetary procedures. By 2015, the Social-Democrat government was calling for a relaxation of the surplus target. Finance minister Magdalena Andersson explained that it “was never meant to last forever.”[45] The surplus target was reduced to 0.33 percent of GDP, a reasonable move given low debt levels, but still showing the framework’s malleability. Absent a constitutional underpinning, one could imagine future governments deciding to dilute the target further.

Sweden’s overall target is more constrictive than the rules in Switzerland or Chile, but it allows far greater discretion and flexibility year-to-year in practice. This has advantages – it means, for example, that fiscal policy can be adjusted for unforeseen events. But it also makes a consensus behind meeting the rules incredibly important, and the recent changes suggests the rule is less secure than in Switzerland.

As the UK example shows, too, the technocratic Fiscal Policy Council is important to underpin the integrity of the framework, given the difficulty of estimating the business cycle and hence structural deficits. Sweden has appeared to be lucky so far in its outcomes, but the Chilean experience shows estimating structural balance is difficult to track accurately, making it hard to assess whether a surplus is consistent with the target within-year.

Lessons for devising a U.S. fiscal rule.

The experiences of Chile, Switzerland, Sweden and the U.K. provide some interesting lessons for fiscal rule design for the U.S. today.

  1. Political will is needed to achieve fiscal discipline and sustain rules. The examples of Chile and the U.K. show that governments often abandon or circumvent rules when they bind, particularly absent constitutional underpinning. Well-designed rules, with buy-in, can improve the functioning of a disciplined fiscal policy, providing cover for politicians to make tough budget decisions and resist pressure to increase spending substantially in cyclical upturns. But the desire for fiscal discipline is a pre-requisite.
  2. Rules must have provisions to deal with recessions or slower-than-expected growth. Inflexible rules, such as strict deficit targets or balanced budget rules, tend to be abandoned, revised or suspended in difficult circumstances. If constraints are too tight, rules will not prove politically durable. What one needs is a rule where the overall budget balance can fluctuate with the business cycle, but which balances budgets or runs surpluses over the long-run, and has pathways or institutions which help return to balance after temporary deviations from the rule.
  3. 3. The ultimate aim of a fiscal rule should be to keep the debt-to-GDP ratio at sustainable levels in the long-term. What a sustainable debt-to-GDP level means is discussed in more detail in Chapter X (Ed Dolan’s chapter).Given one cannot directly target or control a debt-to-GDP level, intermediate targets and controls on spending, revenues and ultimately budget balances are necessary over long-periods to keep debt at sustainable levels.
  4. Falling debt-to-GDP is all but guaranteed by some form of “structural balance” rule. Provided that the nature of the business cycle is accurately estimated, structural balance can be achieved by capping annual spending either to a cyclically-adjusted trend in revenues or to an estimate of revenues if the economy was operating at full potential, as in Switzerland and Chile respectively. The former ensures the effects of balanced budgets are delivered in the long-term but may be less counter-cyclical in any given year, whereas the latter’s effectiveness is determined by how accurate estimates of the productive potential of the economy are. To guard against over-optimistic prospects for the economy, one can either set up fiscal councils or independent committees to undertake or evaluate forecasts and economic potential on behalf of the government, or try to assess trend growth and revenues using historic data and shorter-term forecasts.
  5. Fiscal rules should be neutral between revenues and spending, and should work to affect the budget balance, not the size of government. Expenditure caps or ceilings, as seen in Switzerland and Sweden, have seemed most effective in delivering the structural balance which restrains the growth of debt. But that does not mean that governments should be restricted in what tax rates they can set over time by the fiscal rule itself. To command consensus, a fiscal rule must be neutral between tax revenues and spending. To prevent governments from running up irresponsible spending increases before demanding major tax hikes, the Chilean and Swiss fiscal rules in effect force the government to first raise structural tax revenues in order to facilitate higher expenditure ceilings.
  6. A spending cap should be as broad as possible to minimize creative accounting and ensure debt sustainability. Rules which exclude certain forms of expenditure, such as investment spending, have seemed prone to “gaming” by politicians. With the major driver of future imbalance being rising demands on entitlement spending, it makes sense to include old-age related expenditure within a rule, such that politicians are forced into considering reforms to these programs as their fiscal consequences begin to bite. The strongest argument for exclusion from spending caps are the cyclical components of social expenditure, which tend to rise during recessions. Absent flexibility with these, downturns force governments to cut non-cyclical expenditure in order to cover this extra social expenditure. The Chilean example suggests that this rebalancing leads to political pressure to abandon the rule.
  7. Any rule should not allow bygones to be bygones. Deviations in outcomes relative to the rule should not be ignored, but instead incorporated into future budgeting plans. The absence of consequences for missed targets creates an unhealthy political dynamic, incentivizing either continual over-optimism or leading to rules that fail to deliver fiscal sustainability. This is a particular concern for the U.S. federal government, where debt levels are already very high by historic standards.
  8. Other restraints may be necessary to prevent current politicians worsening long-term budget outcomes. Structural balanced budget rules do not restrict politicians today worsening the long-term fiscal imbalance by making entitlements more generous for future generations. This is a concern if the political consensus around fiscal discipline is expected to change. Therefore, restrictions that prevent new entitlement promises in future years would be beneficial. Some countries, such as Switzerland, exclude social security spending from its primary fiscal rule and subject it to its own rules. In the absence of this approach, rules could be designed requiring future entitlement promises to be worked into budget provisions today through compensating tax or spending adjustments.
  9. There should be a clear but limited escape clauses for genuine emergency situations. Otherwise there is a risk that the legislation will be abandoned entirely if difficult circumstances arise. Some economists have proposed, for example, the relaxation of fiscal rules when the central bank’s interest rate target hits the nominal bound of zero (when, they claim, the effectiveness of monetary policy is more questionable.) But it is better that temporary suspensions require a high-threshold vote, and the framework should ensure a well-acknowledged pathway back to achieving structural balance.
  10. The best way to obtain credibility for a fiscal rule is to get to the stage where it binds. As the U.K. example shows, preaching fiscal discipline like St Augustine “Lord give me fiscal discipline, but not yet!” is not credible. Pushing targets for achieving balance further into the future is especially dangerous given the risk of a changed political consensus and new economic downturns. In the U.S., an initial discretionary program to reduce the structural deficit will be necessary before any structural balance can be delivered. The evidence from other countries suggests that this should be delivered relatively swiftly when the political will arises.

[1] Congressional Budget Office, The Budget and Economic Outlook: 2018 to 2028, April 9, 2018.[2] Congressional Budget Office, The 2018 Long-Term Budget Outlook, June 26, 2018.

[3] IGM Economic Experts Panel, Taxes and Mandatory Spending, October 25, 2016.

[4] Victor Lledó et al., “Fiscal Rules at a Glance,” International Monetary Fund, March 2017.

[5] Alberto Alesina, “Fiscal Adjustments – Lessons from Recent History,” ECOFIN meeting, April 15, 2010.

[6] Jeffrey Frankel, “A Solution to Fiscal Procyclicality: The Structural Budget Institutions Pioneered by Chile,” National Bureau of Economic Research Working Paper no. 16945, April 2011.

[7] In the remainder of this chapter, I will highlight the path of gross and net debt in each individual country example. According to the IMF, “Gross debt consists of all liabilities that require payment or payments of interest and/or principal by the debtor to the creditor at a date or dates in the future. This includes debt liabilities in the form of SDRs, currency and deposits, debt securities, loans, insurance, pensions and standardized guarantee schemes, and other accounts payable.” Net on the other hand is “calculated as gross debt minus financial assets corresponding to debt instruments. These financial assets are: monetary gold and SDRs, currency and deposits, debt securities, loans, insurance, pension, and standardized guarantee schemes, and other accounts receivable.”

[8] Charles Wyplosz, “Fiscal Rules: Theoretical Issues and Historical Experiences,” National Bureau of Economic Research Working Paper no. 17884, March 2012.

[9] Data from IMF World Economic Outlook Database, April 2018.

[10] Guillermo Le Fort, “Structural Fiscal Policies to Target in the Chilean Experience,” Latin American Debt Management Specialists, April 2006.

[11] Jeffrey Frankel, “A Solution to Fiscal Procyclicality: The Structural Budget Institutions Pioneered by Chile,” National Bureau of Economic Research Working Paper no. 16945, April 2011, p. 7.

[12] Data from IMF World Economic Outlook Database, October 2017.

[13] Data from IMF World Economic Outlook Database, October 2017.

[14] Marina Halac and Pierre Yared, “Fiscal Rules and Discretion under Self-Enforcement,” NBER Working Paper No. 23919, October 2017.

[15] KPMG, “Corporate Tax Rates Table,” undated.

[16] Gram Slattery, “S&P downgrades Chile sovereign debt for first time in decades,” Reuters, July 13, 2017.



[19] IMF World Economic Outlook, April 2018.

[20] For a full description of the Swiss debt brake see, Alain Geier, “The Debt brake – the Swiss fiscal rule at the federal level,” Working Paper of the FFA no. 15, February 2011.

[21] For a fuller description, see John Merrifield and Barry Poulson, Can the Debt Growth Be Stopped: Rules-Based Policy Options for Addressing The Federal Fiscal Crisis, (Lanham, MD: Lexington Books, 2016).

[22] John Merrifield and Barry Poulson, Can the Debt Growth Be Stopped: Rules-Based Policy Options for Addressing The Federal Fiscal Crisis, (Lanham, MD: Lexington Books, 2016).

[23] IMF World Economic Outlook, April 2018.

[24] Robert Chote et al., “The fiscal rules and policy framework,” The IFS Green Budget, January 2009, pp. 81-112.

[25] “Cut spending to reduce borrowing,”Financial Times, January 2, 2007.

[26] Robert Chote et al., “The fiscal rules and policy framework,” The IFS Green Budget, January 2009, pp. 81-112.

[27] IMF, World Economic Outlook, April 2018.

[28] HM Treasury, Budget 2010, June 2010, p. 1-2.

[29] This is on the UK Office for Budget Responsibility’s calculations. The IMF still believes the UK will be running a structural deficit right through to 2023.

[30] U.K. Office for Budget Responsibility, Historical forecasts database, September 12, 2017.

[31] For more details read Ryan Bourne, “And they call it austerity,” Chapter 4 Taxation, Government Spending and Economic Growth, Institute of Economic Affairs.

[32] For more details on the UK’s longer term fiscal challenge, read Office for Budget Responsibility, “Fiscal Sustainability Report – July 2018,”

[33] Taxpayers’ Alliance, “Highest tax burden this year since 1969-70,” 23 July, 2018

[34] Office for Budget Responsibility, “Fiscal Sustainability Report – July 2018,”

[35]  Martin Floden, “Fiscal consolidation in Sweden: A role model?” September 25, 2012.

[36]  IMF, World Economic Outlook, April 2018.

[37] The Swedish Macroeconomic Policy Framework, Lars Calmfors

[38] Data comes from “General government net debt” and “General government gross debt,” IMF World Economic Outlook, April 2018.

[39] Government Offices of Sweden Ministry of Finance, “The Swedish Fiscal Policy Framework,” 2017/18:207, April 12, 2018.

[40] This began as a 2 percent surplus target but was reduced downwards to 1 percent following changes to EU regulations about the portion of the old-age pension system counting towards private saving.

classified some parts of the pension system as belonging to the private sector.

[41] In reality, due to the asymmetric nature of business cycles, ensuring that the surplus target is hit requires the government to target a structural surplus above the target in boom times. For more information, see FÖRDJUPNING, “A new surplus target,” the Swedish Economy August 2016.

[42] Notes from the Swedish National Institute of Economic Research suggest that this should occur “at a rate corresponding to the automatic strengthening of structural net lending that normally occurs in the absence of active fiscal policy decisions.” That means that discretionary efforts to reduce structural borrowing should occur at the same rate as cyclical borrowing would usually fall as an economy recovers.

[43] The applied budgeting margin is for at least 1 per cent of capped expenditure in the current budget year, 1.5 per cent for following year, 2 per cent the next year, and at least 3 per cent for three years ahead.

[44] For a discussion of other potential drivers in changes in the gross debt-to-GDP ratio, see: FÖRDJUPNING, “A new surplus target,” the Swedish Economy August 2016.



Bourne – Heartland Chapter – 2nd Draft

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