The success of new fiscal rules will depend upon their effectiveness in promoting economic stability and economic growth. There are several ways in which the proposed MP rule will promote these objectives, and the dynamic simulation model used in this analysis is designed to capture these effects (Merrifield and Poulson 2016b, 2017).
The MP rule provides for increased expenditures in economic recessions to sustain spending growth at or close to the spending cap. The rule allows for deficit spending and borrowing to finance those deficits in periods of recession. The limits on borrowing and deficit spending are imposed by the deficit/debt brake.
Expenditures from the capital investment fund are countercyclical. In years of recession and revenue shortfall, expenditures from the capital investment fund would assure more stable investment spending over the business cycle. The argument for this countercyclical investment expenditure is not the Keynesian rationale for investment spending to stimulate aggregate demand during a recession. Rather, the economics literature suggests that countercyclical investment spending will improve efficiency and economic growth. In periods of recession, there is likely to be slack and underutilized capacity in the construction industry. Increased expenditures for construction will benefit from the bargains available in that industry, resulting in better quality construction at a lower cost. Because the proposed fiscal rule allows for deficit spending and borrowing to finance those deficits in periods of recession, it is especially important to impose limits on borrowing by limiting capital investment spending, and by including interest as part of the expenditures subject to the expenditure limit.
Higher economic growth results from several provisions in the proposed rules. By constraining federal expenditures, a smaller share of resources is transferred from the private to the public sector. The capital investment fund will restore these expenditures to a high priority in the federal budget and promote higher economic growth. The MP rule provides that when the spending cap generates surplus revenue, a portion of the surplus revenue is offset by reductions in the marginal tax rate. This reduction in tax burdens will also stimulate economic growth.
Higher economic growth will facilitate the attainment of each of the objectives in imposing new fiscal rules. A higher rate of growth in output will achieve a tolerable level of debt/GDP faster. With federal spending growth limited to population growth plus inflation, a higher rate of growth in income will decrease federal spending as a share of income faster. As income increases at a faster rate, this will generate more rapid growth in revenue and increase the surplus revenue above the spending limit. That will allow more revenue to be allocated to the emergency and capital investment funds. The nation will be better prepared for military emergency, natural disasters, and financial crises. The nation will also be better able to fund the backlog on infrastructure investment projects.