Can Spending Caps Constrain the Size of Government?

by Veronique de Rugy

In the Wall Street Journal, Dan Mitchell reports on the spending caps Swiss voters imposed on their central government back in 2001:

The reform, called a “debt brake” in Switzerland, has been very successful. Before the law went into effect in 2003, government spending was expanding by an average of 4.3% per year. Since then it’s increased by only 2.6% annually.

The Swiss debt brake does not require a balanced budget in the traditional sense. Tax receipts, as we know from the American experience, tend to increase rapidly when the economy is doing well and fall off when the economy stumbles. To smooth out the ups and downs, Switzerland’s debt brake limits spending growth to average revenue increases over a multiyear period (as calculated by the Swiss Federal Department of Finance).

This feature appeals to Keynesians, who like deficit spending when the economy stumbles and tax revenues dip. But it appeals to proponents of good fiscal policy, because politicians aren’t able to boost spending when the economy is doing well and the Treasury is flush with cash.

Equally important, it is very difficult for politicians to increase the spending cap by raising taxes. Maximum rates for most national taxes in Switzerland are constitutionally set (such as by an 11.5% income tax, an 8% value-added tax and an 8.5% corporate tax). The rates can only be changed by a double-majority referendum, which means a majority of voters in a majority of cantons would have to agree.

Needless to say, that’s not very likely. History shows the Swiss are more likely to approve tax cuts than tax increases.

Switzerland’s spending cap has helped the country avoid the fiscal crisis affecting so many other European nations. Annual central government spending today is less than 20% of gross domestic product, and total spending by all levels of government is about 34% of GDP. That’s a decline from 36% when the debt brake took effect.

This may not sound impressive, but it’s remarkable considering how the burden of government has jumped in most other developed nations. In the U.S., total government spending has jumped to 41% of GDP from 36% during the same time period, according to the Organization for Economic Cooperation and Development.

The spending cap has been an effective debt brake. Between 2005 and 2010, when debt levels in the average euro-zone nation jumped to 85% of GDP from 70%, Switzerland’s overall government debt declined to 40% of GDP from 53%. Debt is now down to 36.5% of GDP.

This is impressive.

The question now is, Since the spending cap doesn’t cover most social programs, how will Swiss finances hold up when their baby-boomers retire? Unfortunately, this design flaw is a common feature to most spending cap laws (think cut, cap and balance which excluded most entitlement programs and security).

That being said, in the case of the United States I don’t how these caps alone could truly control the explosion in entitlement spending, even if they were applied to the entire budget. Once the pressure becomes too strong and the spending explodes due to large number of people retiring and signing up for Medicare, lawmakers will have an incentive to increase the caps or do away with them all together. Unless we can credibly tie their hands, I doubt that the caps would achieve very much. Then if that’s the case, caps are no substitutes to reforming entitlement programs. 

Mitchell’s piece here.

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