The Golden Rule of Government Spending

What Is the Golden Rule of Government Spending?

The golden rule, as it pertains to fiscal policy, stipulates that a government must only borrow in order to invest, and not to finance existing spending. In other words, the government should borrow money only to fund investments that will benefit future generations, while current spending must be covered and funded by existing or new taxes.

Key Takeaways

  • The "Golden Rule" of government spending is a fiscal policy stating that a government should only increase borrowing in order to invest in projects that will pay off in the future.
  • Under the Rule, existing obligations and expenditures are to be financed through taxation, and not issuing new sovereign debt.
  • The Golden Rule has been applied in several European and Asian countries, however, the U.S. does not follow such a standard and often grows its sovereign debt to finance ongoing expenses.

Understanding the "Golden Rule"

The "golden rule" term originates from ancient writings, and can be found in the New Testament, the Talmud, and the Koran. Each has a story that teaches the golden rule: Do unto others as you would have them do unto you. In fiscal policy, the golden rule seeks to protect future generations from being overburdened by debt by limiting borrowed money only to investments, and not to weigh on future generations for the benefit of current expenditures.

This golden rule in fiscal policy has been successfully implemented in many countries. Although its particular application varies from country to country, the basic premise of spending less than what the government takes in is always at its foundation. In most countries that have adopted the rule, a change in their constitution was required to ensure its proper application. Countries that have applied some form of the golden rule have experienced a reduction in deficits as a share of gross domestic product (GDP), after many years of deep deficit spending.

Global Applications of the Golden Rule

Switzerland instituted a debt brake that restricts government spending to the projected average revenue for the current business cycle. Switzerland has managed to keep its spending growth to less than 2% per year since 2004. Meanwhile, it has been able to increase economic output at a faster rate than its spending.

Germany applied a similar debt brake, which managed to reduce spending growth to below 0.2% between 2003 and 2007, creating a budget surplus. Canada, New Zealand, and Sweden tried the same experiment at various times, which turned deficits into surpluses. The European Union has embarked on its own variation of the golden rule, requiring all countries whose debts are higher than 55% of GDP to reduce their structural deficit to 0.5% of GDP or less.

No Golden Rule for the United States

The United States has yet to codify any golden rule that would require a spending cap, although there have been numerous attempts by lawmakers to do so. The U.S. Constitution does not require a balanced budget, nor does it impose any limits on spending or issuance of sovereign debt.

The budget surpluses under President Clinton in the 1990s were a result of temporary policies that included tax increases and some spending reductions. In 1985, Congress passed the Gramm-Rudmann-Hollings bill, which specified annual deficit targets that, if missed, would trigger an automatic sequestration process. The Supreme Court ruled the law was unconstitutional, and so it was abandoned.

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