Constitution / Economy / Fiscal policy / Politics

Swiss-tested, Keynes-approved: Switzerland’s debt brake as a model for the U.S.

By Will Portman

Critics of a balanced budget amendment (BBA), such as the Center on Budget and Policy Priorities (CBPP), argue that a BBA would “mandate perverse actions in the face of recessions” and thus “aggravate recessions.” And they’ve got a point — at least about a BBA that would mandate that the budget be balanced each fiscal year.

During economic downturns, revenue tends to decrease as GDP declines, and spending tends to increase as demand for programs like Unemployment Insurance and the Supplemental Nutrition Assistance Program rises. Additionally, cutting spending and/or increasing taxes in a bad economy can exacerbate and prolong poor economic conditions. For these reasons, even from a fiscal hawk’s perspective, it can make sense to run a deficit during a recession, so long as the deficit spending is paid for when the economy improves.

The BBA proposal that failed to pass the House and Senate in fall 2011 states that “total outlays for any fiscal year shall not exceed total receipts for that fiscal year, unless three-fifths of the whole number of each House of Congress shall provide by law for a specific excess of outlays over receipts by a rollcall vote.”

If this proposal were to become a constitutional amendment, one of two things would happen: either the federal government would be forced to cut spending and/or raise taxes during recessions, which would be counterproductive in terms of restoring economic growth, or Congress would simply get in the habit of approving deficit spending by supermajorities, rendering a BBA essentially useless in terms of correcting the country’s long-term fiscal imbalances.

A simple, Swiss-inspired tweak in last year’s BBA legislation would remedy this problem, though, providing for long-term fiscal balance but also for deficit spending during economic downturns.

Switzerland has developed a fiscal rule that requires a balanced budget, but not necessarily over the course of a fiscal year. Rather, the Swiss debt brake ensures that the country’s budget is balanced over the course of a business cycle, allowing for deficit spending during economic downturns so long as the government runs surpluses during economic booms to pay off any debt incurred.

According to the Center for a Responsible Federal Budget (CRFB), the Swiss debt brake states that “each year, the budget must be in balance, adjusted for economic conditions. They do this adjustment by multiplying expenditures by a cyclical factor (the ratio of trend real GDP to expected real GDP) thus either allowing for deficits during recessions or forcing lawmakers to have surpluses during booms.”

How it works is that the government passes a balanced budget each year. But if the economy does worse than expected (meaning that revenues would likely decline and mandatory spending would likely increase relative to projections), the government run a deficit, perhaps even pursuing Keynesian expansionary fiscal policies as a way to stimulate economic growth. If the economy does better than expected (meaning that revenues would likely increase and mandatory spending would likely decrease relative to projections), the government is obligated to use the surplus it incurs to pay for previous or future deficit spending.

This is a simple, elegant answer to the strongest argument against a BBA: that it would be “a fiscal straitjacket that would prevent government from being able to respond to economic downturns.” And while the Swiss debt brake does grant the government greater flexibility, it also removes subjectivity from the decision to allow for deficit spending, and requires that all deficit spending eventually be paid for. As the CRFB put it, the Swiss have “designed a budget rule that neatly walks the tightrope between too rigid and too soft.”

The Swiss debt brake has been in effect for a little over a decade. Switzerland ran up large deficits during the 1990s, but today, with many European countries on the verge of debt crises and Greece in the middle of one, Switzerland’s budget is balanced and its borrowing costs are among the lowest in the world. The Swiss government went so far as to cancel two bond auctions last year because it didn’t have any borrowing needs.

Policymakers in the U.S. would be wise to use Switzerland’s debt brake as a model for an American BBA. The Swiss debt brake controls long-term deficits just as well as the recently proposed American BBA, but in requiring balanced budgets over the course of the business cycle rather than every fiscal year, it accommodates economic fluctuations rather than working against them.