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Transparency & Sustainability in Government


Fiscal imbalance is important because, at some point, government’s lenders are going to stop rolling over debt or start charging higher interest rates. There is also a point at which markets will lose confidence. Since these tipping points are multivariate, and dependent on a sum of human decisions, Miron argues it would be wise to get a grip on fiscal imbalances sooner than later.

Miron looks at national debt and deficit through the years and notes they are no indication of the size, scope, or financial health of a country. In the United States, “The apparent improvement in the debt from the 1960s onward masks a gradual but consistent increase in unfunded liabilities that exceeded the reduction in explicit liabilities. Thus, fiscal balance was getting worse despite the fall in the debt.” Many policies, including pensions and debt, shift funding off into the future. “Fiscal imbalances typically imply large redistributions across generations with future generations facing substantially higher taxes to pay for the retirement and health benefits of existing retirees.”

Using the latest data, Miron calculated fiscal imbalances. In 2012, the fiscal imbalance in the United States was 5.4 percent of GDP using the Congressional Budget Office’s (CBO’s) baseline projections. Using the CBO’s alternative projections, which realistically assume policies will continue to be modified as they have been, as with adjustments for inflation, the fiscal imbalance is 9.0 percent of GDP. In 2010, Greece came off worst of all with a fiscal imbalance of 17.8 percent of GDP. Not far behind it were presumably healthy countries like the United Kingdom (13.7) and Germany (13.9). To illustrate what that means, Miron says taxes in the United States would have to increase 25.5 percent to close the baseline imbalance and 50.3 percent to satisfy the alternative imbalance.

Miron says there are three ways to mitigate fiscal imbalance. The first is to grow the tax base. Governments have innumerable options for doing this, and at the top of the list are multiple options for deregulation. But this tack will only put a dent in the imbalance. Another challenge for this route is the delusional way in which governments typically overestimate growth rates in economic forecasts. Economic development incentives are drops in the bucket and flashes in the pan. They will not address structural budgetary shortcomings unless, by becoming ongoing, they exacerbate the shortcomings to pay for themselves.

As the Laffer curve indicates, raising taxes will help government grow revenue up to a point. Increases in low tax rates will generally garner more revenue for government. But as rates get higher, people move with their feet, are motivated to seek out shelters and other forms of evasion, or simply lose interest in productive activities once they’re not worth the effort. Miron says, “My own hunch is that [achieving balance solely by tax increases] is close to impossible in the United States and utterly impossible in Europe.” He adds many European countries are “already on the wrong side of the Laffer curve.”

The third method of closing the gap between revenues and expenditures would be reducing the latter. Some programs, like criminal justice and national defense, run up a deficit, but they are generally agreed-upon proper roles of government. Other programs, like the highway fund and Social Security, would actually have a negative impact on the economy if their funding were to be cut. But many programs either harm or have a minimal impact on productivity and growth. “The list of productivity-damaging programs is long and varied, but the expenditure accounted for by many of these programs is trivial relative to the magnitude of fiscal imbalance (e.g., agricultural subsidies or the Export-Import Bank). Thus, even killing off dozens or hundreds of such programs would not make a noticeable difference.”

Miron argues, “A substantial reduction in fiscal imbalance is therefore likely to require significant cuts in Medicare, Medicaid, and Obamacare. While these programs can have efficiency benefits under some conditions, their main impact is to redistribute resources rather than promote economic efficiency.” They’re prime targets because they comprise large portions of GDP, with Medicare estimated to rise to almost 10 percent of GDP by 2089. Problems with the programs include economic distortions caused by taxation and redistribution and adverse incentives for hiring and saving. A politically unpopular way to fix this would, of course, be to increase copayments and deductibles.

Calculating fiscal imbalance requires a bit of calculus. It is not simply a measure of expenditures minus revenues, or the annual cumulations thereof. Fiscal imbalance takes into consideration the current financial position and how much programs, unmitigated or under recent strategies of adjustment, will grow and how fast. A fair assessment requires an evaluation of all programs, down to a point of diminishing returns, each program having its own rate of growth. It also has to account for debt service, with best estimates of interest and rates of inflation. Since fiscal imbalance is a tool of economists and not politicians, it does not enjoy the luxury of, for example, feigning solvency by assuming pension assets can grow at the same rate as high-risk, high-turnover investments in the same portfolio.

Miron concludes, “The fundamental economic reality implied by fiscal imbalances is that the ‘rich’ economies are not as rich as they would like to believe; they are planning far more expenditure than they can afford. Recognizing this fact sooner rather than later does not eliminate the problem, but it allows for more balanced, rational, and ultimately less costly adjustments.”

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