The political color of budget responsibility

In an article published in the New York Times of 26 October, Alan Rappeport notes that the US federal deficit will exceed USD 1 trillion in 2020. The deficit has grown for four consecutive years, despite the economy is booming. According to the editorialist, the Trump administration would have strayed from the path of orthodox fiscal policies characteristic of conservative republican ideology.

But is it really true that moderation and fiscal responsibility are prerogatives of the republican tradition? Several observations would seem to disprove the thesis: the debt-to-GDP ratio increased during the administrations of Reagan and the Bushes, while it decreased in the era of Carter and Clinton. It will be true that debt grew during the Obama administration, but it is also true that the administration found itself managing a recession of exceptional depth and persistence.

In our study we show that, since the second post-war period, the debt-to-GDP ratio has increased in periods of republican administrations more than it has been in periods of democratic administrations. And the same is true for a group of 24 OECD countries.

Analyzing precisely how the political color of governments is associated with different fiscal policies is not easy, due to multiple contextual factors influencing fiscal policy. Our study takes them into consideration. First of all, we recognize the fact that, systematically, governments that inherit a bumpy budget try to reduce debt. Secondly, we consider the effect of demographic trends and, above all, macroeconomic conditions (unemployment rate or other indicators of the phase of the economic cycle). Finally, let us consider the effect of war conflicts, which are important for the United States. Our results should be read "with these conditions being equal".

The United States

In the US case, our estimates indicate that the transition from a Republican presidency to a Democratic one is associated on average with an average federal debt reduction (relative to GDP) of 1.8 percent per year. We also find that democratic administrations are more likely to tax and promote public spending. Another interesting fact that emerges from the study is that democratic administrations put in place more aggressive counter-cyclical fiscal policies to stimulate the economy during a recession, even pushing for debt when necessary. More precisely, when the unemployment rate is at least four percentage points above the average level, the democratic administrations are more inclined to expand the debt than the Republican ones. However, in average conditions, the opposite occurs.

Figure 1

Figure 1 shows the evolution of the debt-GDP ratio observed in reality and the color of US administrations. The dashed lines compare reality with hypothetical scenarios in which the political color of the administration is opposite to that of each period. For example, in the 1980s, the debt-to-GDP ratio increased from 32 to 62 per cent under the presidencies of Ronald Reagan and George Bush the father. With hypothetical democratic administrations, the increase would have been much more contained, from 32 to 40 percent. There are no major differences in the debt promoted by the Obama administration with respect to a hypothetical Republican government. The explanation lies in the 2008 recession combined with the fact that democratic administrations adopt more robust countercyclical policies.

The Italian case

For the other 24 OECD countries, the analysis is complicated by the presence of coalition governments whose classification in terms of political color (right and left) is difficult. Nevertheless, the results confirm US evidence. The right-most governments within each country are more likely to expand public debt than social-democratic governments. The latter are more inclined to finance public spending policies and to impose higher taxes. The results are particularly clear in countries with a majority electoral system, where there is a clear alternation between left and right oriented governments.

Italy is not an exception. The analysis of the governments of the First Republic is overshadowed by the presence of a long series of coalition executives mostly led by Christian Democrats. It is easier to analyze the economic policy of the governments of the Second Republic when there is a clear alternation between left and right governments (except the technical governments of Lamberto Dini and Mario Monti which we exclude from the analysis). It is also necessary to have sufficiently long periods of political continuity to evaluate the effect of a certain government (for example, the first Berlusconi government lasted just nine months).

During the Ulivo governments of the second half of the nineties (1996-2001) the debt-to-GDP ratio decreased substantially, from 119 to 109 per cent. Despite the favorable economic situation, the decline in debt slowed down with the Berlusconi governments of the 2000-2006 period, when the ratio settled at around 107 percent. The government of the Union between 2006 and spring 2008 led to a further contraction of the debt up to 104 per cent, which was followed by a new surge under the fourth Berlusconi government (2008-2011). The debt then fell slightly under the governments of Matteo Renzi and Paolo Gentiloni, before recording a new increase during 2018 after the establishment of the government supported by the 5-star League and Movement. It is too early to assess the effects of the PD-M5s government.

As surprising as they are in the rhetoric of political debate, these results are in line with the political-economic theory proposed in our studies.

We take for granted (in line with empirical evidence) that conservative governments are less interested in welfare and in the production of public goods. This explains the preference for lower taxation (in favor of private consumption) and for containing public spending. At the same time, these governments are less interested in financing future public spending and for this reason they are more inclined to borrow. The reason is not a lack of empathy towards future generations, but the awareness that they will be able to adjust their budgets by cutting back on social spending. To the conservative lobbyist Grover Norquist, a supporter of the strategy "starve the beast"(Starving the beast) is attributed the statement:" My goal is to cut the government in half in twenty-five years, to reduce it to the size in which we can drown it in the bathtub ".

Populism and fiscal irresponsibility

In line with Norquist's claim, our argument requires that governments and voters recognize the existence of an intertemporal budget constraint. That is to say, that today's debt has a cost for future generations. The recognition of the report has for years been part of the political discourse of European social democratic governments. However, the recent success of populist political movements, both left and right, is leading to a loss of attention to the principle of fiscal responsibility. The trend is favored by low interest rates, which facilitates the financing of public debt at limited costs in the short term.

However, the evidence continues to suggest that high levels of indebtedness are not the solution to the problem of growth (think of Japan, Greece or Italy itself). In addition, Western countries should think about how to tackle the most difficult phase of the demographic transition that will bring further indebtedness and an increase in the demand for essential public services (such as health care).

In this historical context, listening to the sirens of populism risks starving not so much the beast as the future generations.

A version of this article was published in English on VoxEu.