The 3 percent rule

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Over on Cato-at-Liberty, Chris Edwards proposes a new rule for US public spending – that its growth should be limited, by law, to a maximum of three percent a year (roughly equivalent to inflation plus population growth). That seems a reasonable goal, he says, and could gain broad centrist support.

It is easy to see the appeal: if UK public spending had only grown by 3 percent a year since 2000, we would currently be spending £470bn rather than £697bn a year. That ‘saving’ of £227bn would wipe out the budget deficit with enough left over to abolish VAT (not that this would necessarily be the priority). The graph below shows how things might have been.

But how about projecting the 3 percent rule forward? The graph below assumes that the coalition government meets it spending targets up until 2015-16, and that public spending grows by only three percent a year thereafter. Based on project nominal GDP growth of 5 percent a year, spending would decline from 48 percent of GDP now, to 37 percent in 2020, and then 31 percent in 2030.

 

Now, that might be a much slower rate of progress than many of us would like. But it does show that – in the long run – you don’t need to do anything all that dramatic in order to significantly reduce the share of the economy consumed by the state. All you need is a long-term commitment to fiscal responsibility, and the discipline to stick to it.

Edwards also flags up a couple of additional benefits of the 3 percent rule: (1) “one advantage of an annual growth cap is that it would lock-in any spending cuts that are made, and thus spending would be ratcheted downwards” and (2) “A fixed percent cap would also encourage policymakers to support a low-inflation policy by the Fed because the lower was inflation, the higher the budget limit in constant dollar terms.”

It gets my vote.