Government spending has exceeded tax revenue in every year this century. A series of deficits¹ ensued, culminating in a debt of $2.7 billion. This state of affairs led the Government in 2015 to create the Fiscal Responsibility Panel, an advisory group, to provide guidance on ways of reducing the debt burden² to 80 per cent.

To date, there has been no meaningful reduction in the debt burden or a time frame to reach the target. The debt burden stands at 245 per cent ($2.7 billion/$1.1 million).

Further and more worrisome, Budget Statement 2020 formalised the move away from austerity. By austerity, I mean the process of eliminating the gap between what the Government is spending and what it raises in tax revenue.

According to the Budget Statement, the new policy would rely on economic growth to increase tax revenue to the point where revenue surpassed spending, thereby giving the Government the space to begin the chore of paying down the $2.7 billion debt. This new policy, otherwise known as “kicking the can down the road”, lacked a commitment to debt reduction.

Even before the pandemic, the move away from austerity was a high-risk strategy. For the strategy to work, the economy would need to grow, in nominal terms, at more than 4 per cent for a decade³, notwithstanding that this feat had not been achieved since before the previous recession in 2008. Further, there was little in the Government’s stimulus package that could promote growth of more than 4 per cent.

But economic life is fraught with uncertainty. Macroeconomic forecasting, in particular, relies on many assumptions about the many moving parts within the economy as well as in the rest of the world. The likelihood of making a bad forecast is high.

Consider the difficulty of making a microeconomic prediction about the next “big thing”. When thinking about this century’s “big things”, few predicted the rise of Apple, Google, Facebook, Amazon or the Great Recession. Given the size of the debt, the assumption that no deliberative debt-reduction policy was necessary was naïve. It would be like a mortgagor not having a budget plan — relying on a hustle here and there to cover the monthly commitment to the lender.

Further, consider that since 2006 policymakers have made two major fiscal policy errors.

The first: despite years of the strongest recorded economic growth, government spending raced ahead of tax revenue. The result was an acceleration of the growth in debt from 30 per cent in 2006, to 40 per cent in 2007, to 74 per cent in 2008, to 100 per cent in 2009¹¹ when the Great Recession’s effect started to bite.

By that time, the Government’s fiscal discipline had vanished into a maze of capital-project overruns. Policymakers suffered from the same problem as Tom Wadson’s turkeys: the turkeys thought that because Tom had been caring for them in the run-up to Christmas, that trend would continue into January.

Similarly, for policymakers, they assumed that the trend of unprecedented economic growth would continue indefinitely and magically cover any overspending. More than ten years later, the economy has yet to return to its pre-recession growth path. The past is a poor indicator of what is to come.

The second fiscal-policy error in 2019, while not dramatic in terms of the acceleration of debt, witnessed a tepid withdrawal from austerity, which was solidified in 2020. In addition to the turkey problem, hubris can explain some of why governments engage in overspending. The belief that both past performance was within their control and that future performance is within their control is the Achilles’ heel of policymakers.

Consider that most, if not all, of the growth we have experienced since 1992 is the result of international business; more specifically, reinsurance. And that reinsurance grew largely because of a series of natural disasters over which we had no control.

Bottom line: the growth we have experienced since 1992 has more to do with luck than acumen or skill.

Debt is particularly sensitive to economic conditions. Small changes in economic conditions drastically change a country’s debt burden. For example, within a year, our debt will exceed $3 billion and tax revenue is likely to fall by one quarter to about $750 million. As a result, our debt burden could increase from 245 per cent to 400 per cent — an acceleration away from the target of 80 per cent set by the FRP.

Hopefully, the message is clear: austerity is the only rational post-pandemic fiscal policy for the Government to pursue for the foreseeable future. But not all austerities are created equal. For simplicity’s sake, and building on the research of the late Alberto Alesina¹², let’s consider two varieties: tax-based austerity (TB) and expenditure-based austerity (EB). TB eliminates deficits by increasing tax revenues as opposed to reducing government spending. Most people don’t want higher taxes, despite the local tax burden — the ratio of tax revenue to gross domestic product — being low relative to other islands and offshore financial centres.

Alesina’s research, which is based on case studies of 16 OECD¹³ countries’ austerity plans, suggests that increasing taxes slows economic growth in both the short and medium term. In other words, if Bermuda’s economy functions like the average OECD economy, then TB is likely to extend the 2020 recession to 2025.

On the other hand, EB eliminates deficits by reducing government spending. The same study suggests that, from a growth perspective, cutting government spending is preferred because the recessionary effect is milder in the short term and almost non-existent in the medium term. Again, we are assuming that the local economy functions like the average OECD economy.

A possible cause of EB’s milder impact on growth is that cuts in spending signal to entrepreneurs — the capitalist class of job creators — that the Government is serious about getting a handle on its spending and therefore higher taxes, the bane of entrepreneurs, are less likely. In short, EB signals a return to fiscal discipline. This signal from the Government is a confidence boost for the job-creating class. Policymakers may assume that voters prefer TB to EB. The evidence from the OECD study does not support this view.

When applying this notion to the local economy, one possible explanation could be that higher taxes will anger a wider constituency than EB, which would mostly affect unionised, politically connected government workers who number about 7,000 — roughly 20 per cent of the electorate. TB will negatively impact the entire electorate, including the government workers who managed to keep their jobs and pay packages intact.

Further, from the electorate’s perspective, not all government spending is the same. Current spending on salaries, rent, financial assistance, travel, etc, affect voter attitudes differently than spending on capital projects or infrastructure. It would appear that taxpayers find the latter more palatable.

Post-Covid fiscal policy will, out of necessity, lean heavily on austerity. This necessity is borne not just out of the debt being large or that it is folly to rely on economic growth to solve the problem, but because of the nature of globalisation.

The global economy is a highly interconnected and therefore complex system riddled with uncertainties. It is more akin to ecology, about which we know very little, than physics, about which we know quite a bit.

So at the macroeconomic level, let us accept that it is not possible to predict the global economy’s path. And let local economic policy reflect this uncertainty and not be duped by periods of prosperity as Tom Wadson’s turkeys are before Christmas.

¹A deficit is the difference between government spending (G) and tax revenue (T) in any given year:

(G - T). A positive deficit is a surplus. Debt, on the other hand, is the sum of previous deficits: ?_ (t=1)^n (G - T).

²Debt burden: measured as the ratio of debt-to-tax revenue.

³Percentage changes in tax revenue tend to match percentage changes in nominal or current GDP more closely than real GDP. Ordinarily, economic growth is defined as a positive percentage change in real or constant dollar GDP.

¹¹Debt in 2005 = $152m. Debt in 2006 = $198m. Debt in 2007 = $278m. Debt in 2008 = $483m. Debt in 2009 = $969m.

¹²Alberto Alesina et al., What Do We Know about the Effects of Austerity?, AEA Papers and Proceedings 2018, 108: 524-530.

¹³Organisation for Economic Co-operation and Development: a group of 37 countries that consider themselves democratic and market-based. Collectively, they account for about one half of the global economy.

• Craig Simmons is senior economics lecturer at the Bermuda College

• To view Craig Simmons’s briefing note on the impact of the Covid-19 pandemic on Bermuda’s economy, click on the PDF link under “Related Media”