The Right Way to Balance the Budget
December 30, 2010
The federal debt is at its highest level since the aftermath of World War II -- and it's projected to rise further, says Andrew G. Biggs, resident scholar, Kevin Hassett, director of economic policy studies, and Matt Jensen, research assistant, at the American Enterprise Institute. Stabilizing debt levels would require an immediate and permanent 23 percent increase in all federal tax revenues or equivalent cuts in government expenditures, according to Congressional Budget Office forecasts.
In new research Biggs, et al., analyzed the history of fiscal consolidations in 21 countries of the Organization for Economic Cooperation and Development over 37 years. If the United States were to copy past consolidations that succeeded, what would it do?
This is an important question, because failed consolidations are more the rule than the exception:
- To be blunt, countries in fiscal trouble generally get there by making years of concessions to their left wing, and their fiscal consolidations tend to make too many as well.
- As a result, successful consolidations are rare: In only around one-fifth of cases do countries reduce their debt-to-GDP ratios by the relatively modest sum of 4.5 percentage points three years following the beginning of a consolidation.
- Finland from 1996 to 1998 and the United Kingdom in 1997 are two examples of successful consolidations.
The data also clearly indicate that successful attempts to balance budgets rely almost entirely on reduced government expenditures, while unsuccessful ones rely heavily on tax increases. On average, the typical unsuccessful consolidation consisted of 53 percent tax increases and 47 percent spending cuts. By contrast, the typical successful fiscal consolidation consisted, on average, of 85 percent spending cuts.
Any attempt to address the federal government's budget shortfall that relies on less than 85 percent spending cuts runs too large a risk of failure. The experience of so many other countries shows that it's crucial for the U.S. to get this right.
Source: Andrew G. Biggs, Kevin Hassett and Matt Jensen, "The Right Way to Balance the Budget," Wall Street Journal, December 29, 2010.
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