August 8, 2011

Most Fiscal Reforms Fail to Lower Debt-to-GDP Ratio

Key materials

The United States is not the first nation to wrestle with large and unsustainable national debt. Economists have identified a number of other instances in which wealthy, industrialized nations have taken on dangerous levels of national debt and have attempted reform. The bad news, as this week’s chart by Mercatus Research Fellow Matthew Mitchell demonstrates, is that the large majority of these reforms failed. The good news, illustrated in Mitchell’s recently published review of the literature, is that we have much to learn from the experiences of others.

Mitchell reviews the findings of Harvard economists Alberto Alesina and Silvia Ardagna. Using data from 21 wealthy nations, covering nearly 40 years, they identified 107 separate instances of attempted fiscal reform. After controlling for a number of other factors, they found a striking pattern: in those instances in which reform failed to lower debt-to-GDP ratios, the reforms had concentrated on large revenue increases and only modest spending reductions. In contrast, in those instances where reforms succeeded in lowering debt-to-GDP ratios, the researchers found that governments had pursued large spending reductions and modest revenue reductions.

Mitchell shows that a number of other researchers have confirmed that reforms that focus on spending cuts are far more likely to be successful than those that focus on revenue increases. He also demonstrates the consequences of failing to heed history’s lessons.