Given my concern about the negative effects of excessive government spending, as well as my concerns about the consequences of ever-growing government (higher taxes, higher debt, inflation), I’m always very interested to learn about the effectiveness – or failure – of different fiscal rules around the world.

• I’ve praised the Swiss “Debt Brake” for controlling government spending.
• I’ve panned the European Union’s “Maastricht Criteria” for being ineffective.
• I’ve lauded Colorado’s TABOR for controlling spending in a blue state.
• I’ve explained why balanced-budget requirements have a poor track record.

Let’s look at some new research on fiscal rules.

The International Monetary Fund has a new working paper, authored by Julien Acalin, Leonardo Martinez, and Francisco Roch.

They looked at the effect of fiscal rules with “robust correction mechanisms.”

Here’s their description of such rules in six nations (click to enlarge).

I’m curious why Switzerland was not included since it has a “clawback” requirement when spending exceeds its spending cap.

But let’s set that aside and look at what the authors discovered.

The importance of fiscal rules has been re-emphasized after COVID-19 pushed public debt to historically high levels… This paper contributes to the literature by showing that well-designed fiscal rules have been effective in mitigating fiscal risk, measured by sovereign bond spreads… In particular, we focus on one fiscal rule feature that could improve compliance and thus the performance of fiscal rules: Robust correction mechanisms, which specify automatic corrective actions when fiscal targets are breached, including pre-specified fiscal measures. …In our empirical section, we…identify the effects of introducing fiscal rules with robust correction mechanisms (FRRC) on sovereign spreads. We find that FRRC trigger a median spread reduction of about 25 percent, or 75 basis points for the average economy in our sample, over one year.

Sounds like good news.

The existence of robust correction mechanism (i.e., rules that can’t easily be evaded) seems effective, at least when looking at what happens to interest rates on government debt.

But I’m more concerned about whether rules limit the growth of government. So I went to the IMF’s database, pulled out the numbers for the six nations, and looked at the burden of government spending over the past 20 years.

I marked the years when the fiscal rules were introduced and was disappointed to see that there was not a reduction in the burden of government spending in most of the nations.

To be sure, perhaps government would have grown even faster if the rules did no exist, so I’m not arguing the rules are a failure.

I’m merely observing that government generally did not shrink.

Indeed, if you dig into the data, the burden of government in most of the nations actually got worse following the rule.

And this shows the main problem with fiscal rules that are pegged to debt levels. Simply stated, they are not effective if politicians have the option to raise taxes.

Here are two tables showing what happened to spending burdens and tax burdens in the xis countries.

The only countries that have improved are Cyprus (which was emerging from a fiscal crisis) and Costa Rica. And their tax burdens were basically unchanged.

The nations with the worst outcomes all had significant tax increases.

In the grand scheme of things, it is true that there is less likelihood of a debt crisis if a government opts for tax-financed expansions of government rather than debt-financed expansions of government. But long-run effect on growth will be similarly negative.

P.S. Interestingly, there have been several IMF-published studies (here, here, and here) showing the spending limits are the only effective fiscal rule.