Why are governments failing to balance taxes and spending?

Why are governments failing to balance taxes and spending?

By Chris Worthington

The European crisis is lurching from bad to worse with Italy and Spain joining Greece, Ireland and Portugal in a state of fiscal emergency.

At the same time, United States Republicans are trying to engineer their own crisis by refusing to increase the US Treasury's authority to increase debt to pay for spending.

Balancing tax and spending is the most basic task of governing and yet time and again governments fail miserably to do so. It now seems that default and austerity is as inevitable as death and (ever-higher) taxes.

Am I exaggerating?

The governments capable of consistently running a balanced budget are a dwindling few.

Matters will get worse, not better, over the next 30 years as ageing populations expand the costs of health and superannuation promises while eroding the tax base.

It may not be this year, but Greece is seemingly the future for much of Europe, the United States and Japan.

Of course, these countries are all democracies. As H.L. Mencken once noted: "Democracy is the theory that the common people know what they want and deserve to get it good and hard." So sharing the blame with the politicians are the voters who time and again reward the policy plan of spend now and pay later.

Let's look at Greece in detail: Greece is completely insolvent and no realistic assessment would argue anything but. Greece is in this mess because the Government used EU membership, and the kudos associated with it, to borrow cheaply for more than a decade and used that money to fund a massive expansion in the public payroll.

Now the money is being cut off and Greece has to cut all those jobs and raise taxes. But it turns out it can't raise taxes - its tax department is somewhere between incompetent and corrupt. (There is an object lesson in here for those who think that government debt is nearly risk-free because governments retain the ultimate power to tax.)

And so the Greeks are marching on the streets protesting the cruel caprices of reality, that borrowers won't lend to people who can't repay. This is about as productive as protesting against gravity or the changes of the season.

The credit crisis, or global finance, is not to "blame" for the fiscal crises unfolding. Recessions are inevitable - prudent governments run surpluses and reduce debt in the good times. The Greeks and their ilk have been tottering on the edge of the cliff for some time.

Most people accept the philosophy behind the role of governments in modern society - market outcomes are sometimes inefficient or inequitable and governments can address this. But fewer seem willing to accept that governments also fail us "good and hard", despite the frequent reminders.

We're all familiar with how often political (or any social) bodies end up dysfunctional. This would be true even if their incentives to perform weren't badly flawed (with the focus on short-term electoral cycles) and governing didn't require cobbling together a voting coalition of disparate interests.

The solution is institutional design that limits governments' ability to do the public harm. We already have the precedent for such an institution in independent central banks.

History has shown that the government of the day can't be trusted with direct control over the printing presses, because the temptation to prime the economy in election years (even if inflation inevitably results) is too much.

Controlling inflation requires credibility, something governments lack, so we've turned monetary control over to an institution that has a single goal (stable inflation), a long-term focus and can build and defend its credibility.

I propose that a similar institution is required to ensure that budgets are balanced (on average). We need an independent body that has the power to assess and reject budget plans that are not consistent with long-term solvency.

Balanced budget amendments have been tried (largely unsuccessfully) in American states. But the problem is that these rules are normally heavily stacked in the political right's favour - often by making it near impossible to raise taxes. They are also too rigid to allow for the fact that the budget position should vary with the cycle so as not to accentuate slumps and booms.

So the ideal "fiscal authority" would have power to choose a level of fiscal stimulus consistent with the economic cycle. It would also have a politically neutral approach to balancing the budget - if the government of the day is unable to propose a balanced plan, then all spending should be frozen in nominal terms and each year taxes raised by 0.5 per cent across the board, until the fiscal authority reaches its target budget position.

On a limited scale, New Zealand already devolves some fiscal responsibility to semi-autonomous bodies. Pharmac acts as a check on rising drug costs and ACC adjusts its levies regularly to ensure that its liabilities will remain funded.

Luckily New Zealand governments have shown over the last 20 years a reasonable capacity to run a tight fiscal ship regardless of the party in charge. Few policy proposals are made these days without some explanation of how it would be paid for over the medium term.

But even in New Zealand we continue to have explicit (superannuation) and implicit (public healthcare) liabilities where it is clear that higher taxes or spending cuts will be needed over the next 20 years. No politician is yet willing to commit to a path for addressing this reality.

It seems far better to put in place additional protection against fiscal recklessness now when we don't need it, than need it and not have it at some later date.

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Christopher Worthington is a senior economist at Gareth Morgan Investments
This article was first published in the NZ Herald.

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27 Comments

"An independent body".....doh

Is this guy for real or just taking the piss......maybe Goofy's panel of experts could do the two jobs....He certainly understands eff all about how govts operate.

The only way some cultures get round to running balanced budgets with smaller govt, is the Greek way!

"Fiscal recklessness"....is the Kiwi way, especially when Labour are wrecking the place.

Personally I think in the last 20 odd years the RB has done a good job in controlling inflation despite Pollies like HC.......So I cant see why they cant do more and better...lets face it letting Pollies do it is obviously a disaster of mega proportions so we are starting at the bottom.

regards

Totally agree.....expand the RB's portfolio.....

regards

Chris, good article....democracy is the problem...let's be honest - there are a lot of dumb people out there and they all get to vote...democracy is "government for the rabble, by the rabble"...as a result we have people who have trouble making a rational decision with the same voting power as our most talented people (e.g. scientists, businesspeople, judges etc..)...the solution is a meritocratic system where our most talented people have a higher weighting for their vote...that way we'll get less perverse outcomes from our politicians...and throw in 100% inheritance taxes too....all this sometime next week would be good :)

A meritocratic system is what the US has attempted to have and what has happened there is the "merits" have seen to themselves very well........this is the last thing we want IMHO.

regards

The US is far from a meritocracy...it was close to a meritocracy at the beginning with the founding fathers...but now can be classed as a plutocracy - you only have to have a look at their outrageous income and wealth inequality charts to see that...

Ah no the meaning of meritocracy in the case of the country formally known as the United States of America pre 1933 was about anyone could strive to get ahead on reasonably equal terms with anyone else in other words not as much of a class system well that in my opinion was the theory. The democracy bit was the system used for the ability to vote for the representatives of states etc etc...

However the USA was first and foremost foundered as a REPUBLIC...

  

Brilliant idea, but only for a season.

History has proven that in the end almost all regulatory bodies became captured.

We are addicted to:

- democracy,

- growth,

- spending,

- political inactivity,

- etc.

thusany such proposal is not gonna happen.

Yeah the current tax rate is still, way too low. They should have changed it to 100% ages ago.

"let's be honest - there are a lot of dumb people out there and they all get to vote...democracy is "government for the rabble, by the rabble".

Not only are there too many dumb people (they usually breed more prolifically) but too many others are intellectually lazy. 

 What a great economic strategy PM !

“Politicians can’t be trusted with money”

That’s absolutely correct. They spend taxpayer’s money on overseas workforces and at the same time spend billions fighting drugs, crime and building more prisons.

...and while we're at it, let's not let them manage anything:

http://www.nzherald.co.nz/nz/news/article.cfm?c_id=1&objectid=10739701

Like this was going to end any differently?

Three cheers Ian.

Judging by the number of comments it is not apparent to most the destructive nature of this persons blinkered writing.

I would invite the author and readers to watch this video infull to help form strong opinions on the topic.

http://www.youtube.com/watch?v=_dmPchuXIXQ

What a load. You just have to read what American presidents have written on the subject.

Before the Federal Reserve:

I believe that banking institutions are more dangerous to our liberties than standing armies. If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks and corporations that will grow up around [the banks] will deprive the people of all property until their children wake-up homeless on the continent their fathers conquered. The issuing power should be taken from the banks and restored to the people, to whom it properly belongs. Thomas Jefferson.

After the Federal Reserve:

I am a most unhappy man. I have unwittingly ruined my country. A great industrial nation is controlled by its system of credit. Our system of credit is concentrated. The growth of the nation, therefore, and all our activities are in the hands of a few men. We have come to be one of the worst ruled, one of the most completely controlled and dominated Governments in the civilized world no longer a Government by free opinion, no longer a Government by conviction and the vote of the majority, but a Government by the opinion and duress of a small group of dominant men. -Woodrow Wilson

Not sure which viewpoint we are supposed to subscribe to, but Wilson was perhaps being a bit pessimistic there - for such a hopeless basket case, the US did not do too badly after his time.  Leap forward all you like with all the reasons you hate the US, but the numbers of people trying to get into and out of it, even now, tell their own story.

The basic point here is that there are dangers in "Government by free opinion, conviction and the vote of the majority" - given that the vote of the majority is so often in favour of whichever candidate promises to spend most of somebody else's money on them, regardless of the longer term consequences. 

However, there are also dangers in Government by people who think they know better then we do, what's in our own best interest. If a wrong-headed decision has to be made about how my life and money are to be managed, I'd rather it were made by me ...

Ms de Meanour I appreciate your comments and can only agree that there are dangers in those who think they know more. Seldom in history have the rich (educated), applied support to the poor without their own self interest at heart.

It is therefore upto the majority of dumb (people like me), people to stand tall together and fight for our right to live as 'free' men and woman. Free to make our own mistakes and successes and direction in life.

Without a united democracy the rich and powerful have always sought ways to enslave the people.

To the bold statement  'politicians cannot be trusted with our money'. I answer that having a 'select' group of bankers and economists run our fiscal direction would be like handing humanity over to Lucifer.

Given the persistent failure of economists and economic theory to make accurate predictions about the future, what would you rather have? Politicians in charge of setting economic policy and subject to electoral scrutiny every 3-4 years, or a bunch of semi-autonomous bodies made up of so-called ‘experts’ (read economists) not subject to electoral scrutiny, and who decide such things?

I know who I would rather have, and it’s certainly not a bunch of semi-autonomous theorists’ pontificating in the backrooms of power about the way the world will be.  

I was impressed to read one economic's noble laureate’s self-reflection on the failure of economists to predict the GFC, and what this taught about the discipline and its shortcomings. It was refreshing to read such a candid and open piece of analysis and reflection on the field quite frankly, and by a genuine leader of it.  I can’t say I’ve seen any New Zealand economist publicly front to that failure in NZ yet. Well none that I’m aware of anyway. All we seem to get from our lot is a relentless from on high, I’m right and know everything, and you’re all dumbasses for not doing what I say.

More acknowledgement by economists of their field’s shortcomings and their capacity to get things wrong would be good in my view. The introduction of an economic uncertainty principal into economic modelling and commentary would be helpful as well. Somewhat like confidence scores.

I agree.  The economic profession doesn't have a good record of prediction or distinguishing between cyclical v structural revenue changes.  It has serious theoretical problems (as Steve Keen points out). It has been the willing but duplicious hand maiden to the wealth grab/privitisation under Thatcher/Reagan/4th Labour Government on/Pinochet etc etc. It has anti-democracy tendencies.

An interesting recent Treasury paper on the issue (thanks to BH for telling us about it) Making fiscal policy more stabilising in the next upturn Challenges and policy options by Anne-Marie Brook looks at a much wider range of options than this proposed unelected gang of whoevers running the country.  

Other (better?, democratic) options include increasing the range of matters reported on under the Public Finance Act to include better assessments of measures in terms of fiscal stability, setting a medium term spending/GDP target, or having a stabilisation fund.

Interstingly the paper shows that given the information and assessments provided by Treasury and others, Cullen was making the right decisions at the time.  The problem was that a cyclical revenue increase was misinterpreted (by Treasury) as a strucutral increase. The result was that at least from 2005, and including Bill English's "great" policies central government has been running (and continues to run) pro-cyclical economic policy. 

Why would a "independent" body dominated by economists do any better?

 

Does it all come back to the old saying that power corrupts?  Maybe the only solution would be to require all change to be subject to referenda. Don't the Swiss do this.  They seem pretty stable and successful.  In these days of online connectivity it should be relatively easy and inexpensive to achieve.  The ultimate form of democracy.  I bet our politicians would fight it tooth and nail; and wouldn't that reveal their true nature and motives.

Wouldn't that just result in short term knee jerk changes? and what about the 20% plus who don't have internet access?

And how has the country been run for the past 50 years, and how did we get into this mess.

As I said the only example we of this is Switzerland which probably has the most stable ecconomy and governance in the world; and has had this for centuries.

Re internet access for the 20% - libraries, councils, govt offices could be easily configured to provide this service.  What % of eligible voters vote anyway.  (however I would hate to see a democratic process gerymandered in any way)

 Chris - a part from parliament, regional/ local council most of these politicians in Switzerland are involved in the(ir) daily running of businesses in the real economy, while here in New Zealand they spend their time in all sorts of “activities”.

It creates a better understand, a more diverse and better standard in economic matters -  just a different culture.

That sounds far better. Far more grounded in the everyday reality of the country, not the rareified, BS, culture in Wellington that we are saddled with.

I wonder if the the Swiss political system gave rise to the culture or vice versa?  I wonder what sort of crisis in Switzerland gave rise to their political system?  I should find some reference material to learn more.

Chris - It is a bloody long story. Link below  is a good description of Switzerland – my birth country for 43 years.

 

 http://en.wikipedia.org/wiki/Switzerland#Education_and_science

An aeroplane was about to crash; there were 5 passengers on board, but only 4 parachutes.

The first passenger said, "I am President Obama, the chosen one. The world needs me, I can't afford to die." So he took the first parachute and left the aircraft..
The second passenger, Hone Harawira, said, "I am the leader of the Mana party in Aotearoa and I am the smartest Maori in New Zealand history, so New Zealand's people don't want me to die." He took the second parachute and jumped out of the aircraft.
The third passenger, Russell Norman, said, "I'm the leader of the NZ Greens and the nation needs my guidance and my boyfriend would miss me." So he grabbed the parachute next to him and jumped
The fourth passenger, ex-PM Jim Bolger, said to the fifth passenger, a 10-year-old schoolgirl, "I have lived a full life, and served my country the best I could. I will sacrifice my life and let you have the last parachute."
The little girl said, "That's okay, Mr. Bolger. There's a parachute left for you. NZ’s smartest Maori took my schoolbag!"

Russell Norman jumped without a parachute saying " Greens are usually on a high "