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The United States faces a considerable challenge to achieve fiscal consolidation. With debt in excess of $20 trillion, and a debt/GDP ratio in excess of 100%, the U.S. has emerged as one of the major debtor countries in the OECD. To follow the guidelines set for OECD countries, fiscal consolidation would require the U.S. to reduce the debt/GDP ratio below 60%. Fiscal consolidation must be achieved while satisfying traditional objectives of fiscal policy to stabilizing the economy over the business cycle, objectives incorporated in the Employment Act of 1946, i.e. full employment and price stability.

It is clear that the U.S. cannot achieve this fiscal consolidation under current fiscal rules; the deficits and debt projected under current law are unsustainable. For half a century current fiscal rules have failed to halt deficit spending and the accumulation of debt. Fiscal policies have been biased toward short run stimulus, and as a result the country has virtually abandoned long run fiscal stabilization.

The new fiscal rules for the U.S. proposed in this study, the MP fiscal rules, follow the precedent set in other OECD countries that have successfully enacted fiscal rules to achieve fiscal consolidation and stabilization in the long term (Merrifield and Poulson 2016b, 2017). The most successful of these is the Swiss debt brake that has served as a model for new fiscal rules adopted in the European Community and in other OECD countries. The new fiscal rules we propose are also modeled after the Swiss debt brake, however, there are key differences in the deficit/debt brake that we propose.

The common elements between our proposed fiscal rules and the Swiss debt brake are debt reduction relying on a deficit brake and a debt brake to limit expenditures growth. Our proposed rules combine a deficit and debt brake, with a deficit tolerance level at 3% of GDP, and a debt tolerance level at 60% of GDP. As either or both deficits or debt near the tolerance levels, braking lowers the cap on discretionary spending growth. The spending cap is a multiple of population growth plus inflation. Our research on tax and expenditure limits at the state level shows that this is the least volatile, plausible grounds for a spending growth cap (Merrifield and Poulson 2014).

Our deficit/debt brake is complemented by other fiscal rules. An emergency fund provides for stabilization over the business cycle, and for other emergencies such as natural disasters and military conflict. A capital investment fund is introduced to prioritize infrastructure investments essential for long term economic growth.

Our deficit/debt brake is designed for the unique institutions in the U.S. economy. It is important to contrast the proposed MP fiscal rules, with other fiscal rules proposed for the U.S. We propose a combination of interrelated fiscal rules designed to achieve multiple targets, including a deficit/GDP ratio, and a debt/GDP ratio. After some debt reduction occurs, the proposed rules approximate a cyclically balanced budget, with surpluses in periods of economic expansion offsetting deficits in periods of economic contraction. Critics will argue that such a complex set of rules will be difficult to enact and to implement. We maintain that this combination of fiscal rules is a prerequisite to fiscal stabilization in the U.S. over the long term.

DOWNLOAD: The Merrifield Poulson (MP) Rule

The Merrifield Poulson (MP) Rules

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