Over the summer, I mentioned a few times the work of Alberto Alesina and Silvia Ardagna, who looked at 21 OECD countries and 107 efforts to reduce their debt between 1970 and 2007. They found that spending cuts are more effective than tax increases at reducing a country’s debt-to-GDP ratio.
Building on Alesina and Ardagna’s work, AEI scholars Andrew Biggs, Kevin Hassett, and Matthew Jensen looked at some 100 instances in which countries took steps to address their budget gaps. Their findings were consistent with Alesina and Ardagna’s:
Countries that addressed their budget shortfalls through reduced spending were far more likely to reduce their debt than countries whose budget-balancing strategies depended upon higher taxes.
The typical unsuccessful fiscal consolidation consisted of 53 percent tax increases and 47 percent spending cuts. By contrast, the typical successful fiscal consolidation consisted of 85 percent spending cuts. These results are consistent with a large body of peer-reviewed research.
Now, a new book by the IMF called Chipping Away at Our Debt, edited by Paulo Mauro, looks at 66 instances of fiscal adjustments in Canada, France, the United States, Japan, Germany, and Italy. The key findings are in many ways consistent with the works highlighted above. For instance:
- Successful fiscal adjustments were grounded in structural reforms. Such reforms include welfare reforms as well as comprehensive expenditure review in the context of repositioning the role of the state (think Canada and Germany).
- Plans that avoided structural reforms failed to meet their targets.
- Successful plans were often grounded in real budget cuts.
- Expenditure cuts didn’t materialize to the extent initially envisioned.
- Revenue-based plans without well-specified tax-policy measures — a majority of the revenue-based cases — failed.
Other really interesting findings were:
- Ambitious plans tend to produce more adjustments than modest ones.
- Ambitious plans aren’t associated with more frequent changes in government (in other words, ambitious fiscal adjustment plans aren’t penalized by voters).
- In the case of successful adjustments, revenue often surpassed expectations
- Deviations of economic growth from initial expectations is key factor underlying a fiscal adjustment’s ability to meet its target.
- Public support is key to achieving successful fiscal adjustment.
Interestingly, this book provides an alternative perspective on the traditional literature on large, revenue-based fiscal adjustments. The case studies highlighted in this book show that while successful fiscal adjustments tend to bring in more revenue ex-post than expected (by 1 percent of potential GDP), few were actually intended as revenue-based adjustments. The instances of revenue over-performance in the book fall into two types: unexpected economic growth, and introductions of temporary revenue measures to offset the difficulties in implementing expenditure cuts. However, the book concludes that unintended revenue increases ultimately proved to be of a temporary nature.
They also stress the importance of realistic (rather than rosy) growth projections, citing among other examples the Clinton administration’s 1993–1998 realistic growth outlook, which tended to reinforce the support in Congress and in the public for reforms. The need for realistic/prudent macroeconomic assumptions, they explain, is going to be even more important going forward considering the greater and usual level of economic uncertainty.
Thanks to Tyler Cowen for giving me this book.