January 2013
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Thompson’s Rule to Balance the Federal Budget

Gresham’s Law, “bad money drives out good money (from circulation)”

Economists though the years have had simple economic rules that they attach their names to. There is:

CATO Scholar Dan Mitchell’s Golden Rule: “Good fiscal policy exists when the private sector grows faster than the public sector, while fiscal ruin is inevitable if government spending grows faster than the productive part of the economy.”

Okun’s Law when unemployment falls by 1%, GNP rises by 3%.

Gresham’s law “Bad money drives out good”

And so forth.

One of the debates that will intensify when the fiat currencies collapse around the world is how to keep federal governments around the world from exploiting their positions of power over the people. By this I mean running up the debt and creating invisible taxation in the form of inflation on the people.

Hopefully we will have competing currencies from private banks and this will not be a big issue, when money is based on hard precious metals it is very difficult for government s to run deficits, but if some countries remain on fiat money there is a way to discipline them, call it Thompson’s Rule.

It is relatively simple:

1. Restrict federal spending to a percentage amount. Here in the USA because we have income, payroll and corporate taxes but no value added tax (VAT) we have historically collected around 18% of the GDP in federal revenues. This has varied little since WWII with the exception of today and the late 40s. Other countries will have to evaluate this percentage on a country by country basis but keep in mind for ever 10% of government created the economy loses 0.5% to 1.0% in GDP growth per year. This adds up over time very quickly.

Currently politicians have a powerful incentive to create inflation to buy votes. By using the invisible inflation tax politicians can blame capitalist and rich people for rising prices.

2. Subtract two years from the budget year. 2013 – 2 = 2011. 18% of the nominal 2011 GDP.


18% of the 2011 GDP is $15.075 trillion x (0.18) = $2.7135 trillion. Current tax receipts are $2.671 trillion with the resulting deficit of 42.5 billion. Quite a difference from the trillion dollar deficits we are currently running.

Let’s check a few years to make sure this works.

2000 GDP was $9.951 trillion x 0.18 = $1.79 trillion in spending for 2002. Taxes collected in 2002 $1.859 trillion for a modest surplus.

1990 GDP was $5.800 trillion x 0.18 = $1.04 trillion in spending for 1992. Taxes collected in 2002 $1.148 trillion for a modest surplus.

1980 GDP was $2.788 trillion x 0.18 = $502 billion in spending for 1992. Taxes collected in 2002 $617.4 billion for a modest surplus.

Most years tax collections are predictable, but when they are not if the federal government has already accumulated funds collected during good years running budget deficits for brief periods will not be as politically or economically damaging to a nation.

Most years there will be a surplus. Only in bad economic times like today will there be a deficit. If the federal government is forced to run a surplus in the good economic times then deficit spending will not be such a politically and economically traumatic event in the bad years. This is how a federal government is supposed to operate, evening out the business cycle.

A couple of more advantages to this system is if greedy politicians want to spend money to buy votes they are forced to pass legislation that grows the economy. The less the economy grows the less they have to spend.

Second this forces greedy politicians to look at the hidden inflation tax as a negative not a positive like today. If the value of 2011 money is diluted by inflation the politicians will have less to spend to buy votes. This is the reverse of the system we have today where politicians have every incentive to create inflation as a hidden tax on the gullible public.

I would argue that this is better than a balanced budget amendment. With a balanced budget amendment what is to stop politicians from passing a VAT and increasing spending to 25% or 30% of the GDP?


Politicians will win that battle every time.

This system is simple and incentivizes politicians to control inflation and pass legislation that encourages economic growth.

If other economists want to steal this idea they are more than welcome.

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