Putting the Brakes on Government Spending: Debt Ceiling and Debt Brake

Large budget deficits and high public-sector spending and debt have been pervasive features of modern economies, including in the United States and Switzerland. Employing a debt brake has proven effective at limiting spending, though it is no silver bullet.

So, what happens when a government hits its debt limit—or runs a surplus?

Switzerland: Budget Surplus

A so-called luxury problem: The Swiss government has been running a surplus. After high deficits from 1992 to 2002, average government spending has been around $1.3 billion less (nearly 2 percent of total spending) than the budgeted amount since 2003.

In 2017, the Swiss government may run a federal budget surplus of nearly $513 million. 

It was in 2003 that the Swiss implemented the “debt brake” (Schuldenbremse)—which sets a limit on expenditures, whether during times of recession or economic boom. Since then, the Swiss federal government has lowered its gross debt from roughly $130 billion to around $104 billion.

The Swiss parliament is now considering relaxing the debt brake rules, and commissioned a panel of experts—four professors and one former state financial administrator—to present suggestions on how to proceed. Parliamentarians had visions of allocating at least part of any future surplus for additional expenses in following years.

The commissioned experts, however, presented different suggestions, the main one being that the debt brake rules should remain in place for the foreseeable future. The group pointed out that future surpluses are sure to be significantly lower than in the past: Sinking interest rates and reduced inflation cannot be expected to continue endlessly, and they could even reverse. Furthermore, the panel cautioned, lifting spending caps for future years could act as an incentive to set the budget needlessly high.

Instead, the panel suggests: lower taxes! Budget surpluses, the panel says, are a strong indicator that tax revenues have been too high.

The Swiss government has already slowed down spending growth in some areas in order to offset higher costs for roads, pensions, security, and migrants from Africa and the Middle East. Even so, the Swiss government projects a small—$104 million—budget surplus in 2018. No word yet on tax cuts.

Background

During the 1990s, large budget deficits in all three levels of government led to a large increase in public debt. The increasing debt was highly unpopular among the public, and the Federal Council and parliament worked out a mechanism, the debt brake, to limit government spending.

A debt brake is an expenditure-based rule that limits spending—except on social security—in accordance with revenues and a business-cycle adjustment factor. The Swiss debt brake is a countercyclical expenditure rule that allows deficit spending during economically weak periods and limits spending more tightly during economically strong periods. The goal is to achieve a stable revenue-to-spending ratio. The rules, adopted in 2003, have led to a budget that tends toward surpluses or balance (For detailed information, see this excellent article by Daniel J. Mitchell (YL 2003).

The debt brake required a change in the Swiss constitution, which voters approved easily with a majority of nearly 85 percent. After some delays, the Swiss debt brake has been working more or less as intended, slowing down the growth of public debt which currently stands at 36 percent of GDP. If public spending deviates from the set limit, the difference is credited or debited to an adjustment account and has to be balanced out in one of the following years. Critical for continued success of the debt brake is that revenue estimates must be close to structural revenue. Furthermore, since a spending limit is not a silver bullet, and its effectiveness requires commitment to fiscal responsibility, the debt brake must continue to enjoy a certain respect by politicians.

The United States: Hitting the Debt Ceiling?

The United States has had a debt limit, known as the debt ceiling, since 1917. According to the U.S. Treasury, the debt limit “is the total amount of money that the United States government is authorized to borrow to meet its existing legal obligations, including Social Security and Medicare benefits, military salaries, interest on the national debt, tax refunds, and other payments.”

This ceiling is rarely firm: Since 1960, Congress has raised, temporarily extended, or revised the definition of the debt limit 78 times, and since 1917, the country has hit the debt ceiling only once, in 1979.

As of early September 2017, the debt ceiling had not been raised, and time was running out: “The X date” was to hit sometime in early to mid-October. The “X date” is the first day on which the Treasury would not have enough money to pay all the bills that are due. The Bipartisan Policy Center calculated that, absent a raised debt ceiling, the Treasury would lack $80 billion in October—meaning that 23 percent of bills would go unpaid that month.

With this X date in mind, Treasury Secretary Steven Mnuchin had sent a letter to Congress on July 28, saying it is “critical” for Congress to extend the debt limit by September 29.

On September 6, President Trump “shocked Republicans” by making a surprise deal with congressional Democrats to raise the debt ceiling, thereby avoiding a government shutdown—for now. The deal expires on December 15.

The situation remains as clear as it is harrowing: Without another increase or suspension of the debt limit in December, the Treasury will, again, lack legal authority to resume borrowing. And, since the government spends more than it takes in, it has to borrow.

Conservatives in Congress are calling for any debt limit hike to be paired with serious spending reforms. Debates over where to cut spending, and by how much, often show Republicans and Democrats at odds.

Budget showdowns? Government shutdown? Those potential battles are still looming.

U.S. in a Dire Situation

The total public debt is at more than $20 trillion (105 percent of GDP), with fast-growing deficits and even larger unfunded liabilities.

Congress last raised the debt ceiling in November 2015 as part of the Bipartisan Budget Act (BBA), known as the Obama–Boehner budget deal.

U.S. government debt exceeds the amount that the U.S. economy produces in goods and services as measured by annual GDP. Debt is growing rapidly, primarily driven by spending on health care and old-age entitlement programs, including Medicare, Medicaid, Social Security and the Affordable Care Act (“Obamacare”).

A spending limit can enshrine fiscal commitment and facilitate enforcement. But only when lawmakers have a staunch commitment to changing budgetary policy can a spending limit, or its enforcement, be sustained. As with most any laws or reforms, political will is indispensable for success.

Other Methods for Establishing Effective Expenditure Limits in the U.S.

The Penny PlanHouse Budget Committee Member Mark Sanford (R–SC) and Senate Budget Committee Chairman Mike Enzi (R–WY) introduced the “Penny Plan,” which would implement an aggregate spending cap beginning in 2017 and would cut one penny from every dollar the federal government spends.

The Penny Plan would impose a spending cap of $3.6 trillion for total noninterest outlays, less 1 percent for 2017. For each following year through 2021, outlays would be capped at the previous year’s level (not including net interest payments), less 1 percent. Starting in FY 2022, total spending would be capped at 18 percent of GDP, which is in line with the historical average.

The Maximizing America’s Prosperity (MAP) Act.  Introduced by Representative Kevin Brady (R–TX), the MAP Act is focused on the key drivers of spending and debt in the U.S. (unsustainable health care and retirement programs), and would cap federal non-interest spending as a percentage of full-employment GDP (or potential GDP for cyclical adjustment). Lawmakers would be able to spend more during periods when the economy is weak, and deficits incurred to smooth out business cycles would be offset with surplus revenues when the economy is near full employment.

The Business Cycle Balanced Budget AmendmentThe Business Cycle Balanced Budget Amendment, introduced by Representative Justin Amash (R–MI) would cap federal non-interest spending based on the average annual revenue collected over the three prior years, adjusted for inflation and population. Congress would need to pass implementing legislation to carry out the necessary spending changes determined by the spending cap. The expected motivator for politicians to stick with the lower spending is public humiliation for breaching the spending caps.

The Merrifield/Poulson (MP) RuleThe MP rule, named after researchers John Merrifield and Barry Poulson, would limit all federal spending with automatic enforcement sequestration, except for interest, Social Security, and Medicare Part A.

A second-layer debt and deficit brake would include all spending, except interest, and is expected to exert indirect pressure on entitlement spending by squeezing other parts of the budget more tightly. The spending limit would be adjusted upwards with population growth and inflation, similar to Colorado’s Taxpayers Bill of Rights (TABOR), which is recognized as one of the most effective budget limits in the U.S.The second-layer debt brake follows the Swiss model for achieving countercyclical budget balance.

A debt brake is not an automatic cure-all for fiscal woes—but for countries that have implemented it, it has worked better than having no debt brake at all.

 

Additional Reading

Trump Bypasses Republicans to Strike Deal on Debt Limit and Harvey Aid, New York Times

Trump’s surprise deal shakes up fall agenda, The Hill

2017 Debt Limit Analysis, Bipartisan Policy Center

Why raising the debt ceiling won’t be easy, CBS News

What the chaos looks like if Congress fails to raise debt ceiling by October, CNN Money

Even the OECD Now Admits Spending Caps Are the only Effective Way of Restraining Government, 2015, by Daniel J. Mitchell

How the Swiss “Debt Brake” Tamed Government, by Daniel J. Mitchell (YL 2003)

2017 Debt Limit Should Trigger Spending Limit—with Enforcement, by Romina Boccia (YL 2016)

State and Local Spending: Do Tax and Expenditure Limits Work?

Analysis of the Bipartisan Budget Act of 2015

Causes of the U.S. Government’s Unsustainable Spending

Trump’s 2017 Debit Limit Price, If Any, Remains Unclear

John D. Merrifield and Barry W. Poulson, Can the Debt Growth Be Stopped? Rules-Based Policy Options for Addressing the Federal Fiscal Crisis (Lanham, MD: Lexington Books, 2016).

A Growing Consensus for Spending Caps and the MAP Act, 2015, by Daniel J. Mitchell