European Fiscal Agreements Show that Balanced Budget Rules Mean Higher Taxes, not Smaller Government

I have many frustrations in my life, and near the top of the list is the conservative fixation about balancing the budget.

This view is very misguided. Red ink isn’t good, but the fiscal problem in America (as well as Europe, Japan, etc) is that the public sector is too big. Milton Friedman was right when he wrote, “I would rather have government spend one trillion dollars with a deficit of a half a trillion dollars than have government spend two trillion dollars with no deficit.”

To put it in simple terms, government spending is the disease and deficits and debt are the symptoms.

But even that analogy is inadequate. When politicians focus on borrowing rather than spending, it opens a door allowing the left to argue that tax increases are a solution.

Yet we know from historical experience that higher taxes encourage more spending and slow economic growth, and the combination of those two factors leads to more red ink.

Consider, for example, the experience in Europe. Beginning about 20 years ago with the adoption of the Maastricht Treaty, all members of the European Union agreed to limit annual budget deficits to 3 percent of GDP and total national debt to 60 percent of GDP.

And what happened after these rules were instituted? Well, according to data from the OECD, government got bigger, the tax burden rose, and there was more red ink.

Heck, the Europeans are in the middle of a fiscal crisis, so their rules to limit deficits and debt obviously haven’t been very successful.

Seems like maybe it’s time for them to realize that the problem is too much spending. But, no, that would make too much sense.

Amazingly, but not surprisingly, the Europeans now want to double-down on their failed policies by imposing, as part of a new fiscal pact, even more rules to supposedly control deficits and debt.

The EU Observer reports that: “Countries must introduce a ‘debt brake’ into their constitutions or at an “equivalent” legal level, requiring balanced budgets, which are defined as not exceeding deficits of 0.5 percent of GDP.” Furthermore, another EU Observer report says that “rules will have to include automatic correction mechanisms.” Knowing the mindset of the Euro-crats, this probably means automatic tax increases.

The obvious problem, of course, is that the Europeans have adopted the wrong measuring stick. When they talk about a “golden rule,” they mean limits on deficits and debt. Instead, they should be following Mitchell’s Golden Rule, which requires that government spending grow slower than the private economy.

This video is less than six minutes, but it provides all the key arguments about why the goal should be smaller government rather than fiscal balance.

Last but not least, it’s worth noting that Europe’s new fiscal agreement (assuming it ever gets implemented) is bound to fail. In part, this is because they are targeting red ink, which is the wrong variable.

But it’s also because the supposed enforcement mechanisms won’t work. The tentative pact assumes that European Commission bureaucrats in Brussels somehow will impose fiscal discipline.

To be more specific, a report in the EU Observer says: “The European Commission will carry a big stick: it will look at national budgets before national MPs and make demands.” Does anyone believe this will have any impact on Italian politicians?

And another story in the EU Observer notes: “Under the proposals, almost all fiscal policy-making would be taken out of the hands of national assemblies and delivered up to European civil servants.” Good luck with that. Does anyone think Spanish parliamentarians will cede budget authority to Brussels?

This is why I stand by my original arguments that bailouts won’t work and that a tough-love policy of benign neglect is the only feasible solution.

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