The Swiss debt brake has enabled Switzerland to pursue a policy of fiscal consolidation to reduce deficits and achieve a sustainable fiscal policy. The Swiss debt brake imposes an expenditure limit that is cyclically adjusted based on the relationship between trend output and actual output. When trend output exceeds actual output, the adjustment factor increases the spending cap, and when trend output is less than actual output, the adjustment factor decreases the spending cap. In the long run, the spending cap will tend to follow the growth rate of trend output. This expenditure cap is similar to state tax and expenditure limits tied to income growth.
The proposed Merrifield Poulson (MP) rule would impose a deficit/debt brake that is similar to the Swiss debt brake (Merrifield and Poulson 2016a, 2017, 2018). The MP rule would impose a more stringent limit on the growth of government expenditures in the U.S. and differs in other important ways from the Swiss debt brake. A deficit/debt brake would be combined with other fiscal rules to achieve multiple objectives. The combination of fiscal rules comprising the MP rule are designed to achieve fiscal consolidation, economic stability, and economic growth.
A new fiscal rule should be designed and implemented to address the unique fiscal challenges faced in the U.S. The survey of fiscal consolidation requirements conducted by the OECD reveals that the U.S. is among a small group of profligate countries that must undertake a major fiscal consolidation in coming years to achieve a sustainable fiscal policy. The major challenge will be the unprecedented deficits and debt that have accumulated over the past decade, and that are projected to continue under current laws for the foreseeable future. There is now a broad consensus that these deficits and debt exceed a tolerable level and that U.S. fiscal policy is on an unsustainable path. New fiscal rules are needed to reduce deficits and debt below tolerance levels and to put the nation’s fiscal policies on a sustainable path. Only a stringent limit on expenditures will meet this fiscal consolidation requirement.
The new MP rule we propose for the U.S. imposes a deficit/debt brake on expenditures. We set a tolerance level for deficits equal to 3% of GDP, and as the deficit level approaches that level, the deficit brake places a more stringent limit on spending. We set a tolerance level for debt equal to 60% of GDP. As the debt level approaches that limit, the debt brake imposes a more stringent limit on the growth in spending. With deficit or debt levels near the tolerance levels, either or both the deficit and debt brakes lower the cap on discretionary general fund spending growth.
The MP rule imposes a cap on the growth in federal spending based on the growth in population plus inflation. The precedent for this spending limit is tax and expenditures limits enacted in some U.S. states. A spending limit based on population growth plus inflation has proven to be the most effective constraint on growth in government spending. Our analysis of state tax and expenditure limits reveals that expenditure limits based on population growth plus inflation impose a more stringent limit on expenditures than alternative spending limits linked to income growth (Merrifield and Poulson, 2014). In the long term expenditures will grow less rapidly than the growth in income. This will enable the U.S. to reduce the debt to GDP ratio to a sustainable level in the long term for several reasons. The slower rate of spending growth will result in reduced deficits and debt accumulation over time. As government spending increases less rapidly relative to the growth in the private sector, this phenomenon will promote higher rates of economic growth. Decreases in the ratio of debt to GDP reflect both the reduced growth in government spending and the higher rate of economic growth. When combined with a budget stabilization fund, this type of spending limit has also proven to be effective in stabilizing budgets over the business cycle.
Imposing the MP rule in the U.S. will be a formidable challenge, requiring a significantly lower trajectory of spending than that projected under current law. Implementing the MP rule for fiscal consolidation will require a careful consideration of how the spending cap is imposed on different components of the national budget.