Academic journal article Independent Review

Swedish and Swiss Fiscal-Rule Outcomes Contain Key Lessons for the United States

Academic journal article Independent Review

Swedish and Swiss Fiscal-Rule Outcomes Contain Key Lessons for the United States

Article excerpt

Recent U.S. fiscal policy has created deficits and accumulated debt at an unprecedented rate. In contrast, during the same period a number of other economically advanced countries have pursued policies that have reduced deficits and the ratio of debt to gross domestic product (GDP) (Alesina and Ardagna 1998, 2010, 2013; Gobbin and Van Aarle 2001). In these countries, a key factor has been the adoption of new fiscal rules (Organization for Economic Cooperation and Development 2012, 2014). Some of these rules set limits on deficits and debt levels, and others require greater transparency and accountability for fiscal policies. The specific limits typically require structural balance aimed at preventing the accumulation of debt over the business cycle while providing exceptions for extraordinary or emergency expenditures. The most stringent new rules mandate a budget surplus over the business cycle to reduce the debt-to-GDP ratio in the medium term so that pension and health plans can be funded in the long term. Some countries have been able to significantly reduce government spending as a share of GDP and in some cases also to reduce tax burdens (Organization for Economic Cooperation and Development 2012,2014).

The Organization for Economic Cooperation and Development (OECD) countries that have launched the new era of fiscal rules have done so to impose fiscal discipline, stabilize budgets, and accelerate economic growth (OECD 2014). But the growing belief that expansion of government is responsible for long-term widening of the variance of economic growth rates in European countries and the United States (for a survey of this literature, see Bergh and Henrekson 2011) is the more fundamental reason for increased interest in improved fiscal discipline. Andreas Bergh and Magnus Henrekson (2011) estimated that, with government size equal to total taxes or expenditure relative to GDP, a 10 percentage point rise in government size lowers the annual growth rate by 0.5 to 1 percent.

In this study, we assess fiscal consolidation and fiscal rules in Switzerland and Sweden, arguably the most effective fiscal rules in OECD countries. The Swiss debt brake continues to have a broad consensus of support in both the government and the electorate. However, support for Sweden's expenditure limit appears to be eroding, and criticism focuses on both the design and implementation of the expenditure limit. The experience in these two countries provides important fiscal-rule design and implementation lessons for other countries, including the United States.

A Public-Choice Framework

The public-choice literature provides several explanations for a deficit bias and high levels of expenditure and taxation in fiscal policy (Persson and Tabellini 2000). A deficit bias exists if over the long run the debt-to-GDP ratio rises, as has occurred in many high-deficit/debt countries (Bohn 1998; Wyplosz 2005, 2012).

Common-Pool Problems

Intra- and intertemporal common-pool problems (Wyplosz 2012) underlie democratic societies' deficit bias. The "common pool" is the revenue generated by a given tax base. The principal-agent theory in public-choice economics identifies several problems that could lead to a deficit bias as elected officials, or the agents, represent the principals, or the taxpaying citizens. In the absence of an ex ante spending cap or coordinated decision making, the principal-agent problem and prisoner's dilemma circumstances yield fiscal outcomes other than the social optimum (Buchanan and Wagner 1977; Mueller 2003; Wagner 2012). The key underlying dynamic is that independent self-denial in a commons is not reciprocated. So elected officials increase spending because other elected officials are not constrained from doing so. Fiscal rules can be designed to escape this prisoner's dilemma by requiring agreement on a budget constraint at the outset of the budget process. If a deficit bias exists only because of a coordination problem, we expect that elected officials would have an incentive to voluntarily design and implement such a fiscal rule. …

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