Debt Brakes and Austerity: When Fiscal Rules Ignore Returns

Debt Brakes and Austerity: When Fiscal Rules Ignore Returns

Thomas R. Ullmann

2025-06-29

Abstract

For two decades the public-debt-to-GDP ratio has dominated fiscal debate. While an ever-rising debt stock can threaten solvency, Germany and the United Kingdom show that "fixing the debt" through rigid debt brakes or sweeping spending cuts can hobble long-run growth thus counter intuitively increase the debt-to-GDP ratio. This article tracks the origins and macroeconomic fallout of Germany's constitutional Schuldenbremse and the United Kingdom's post-2010 austerity programme closing with an outline of a return-on-investment (ROI) golden rule 2.0, inspired by the Swedish model, that aligns borrowing with long-run prosperity in the air of a Keynesian approach.

The Debt Obsession

Since the 1980s the median advanced economy has seen gross public debt climb from roughly 40% to above 100% of GDP. Each crisis,Latin America in the 1980s, the euro debt crisis in 2010, the pandemic in 2020, triggered fresh warnings of an imminent debt spiral. Politicians and tabloids routinely liken the state to a household that must "tighten its belt" when its credit card bill grows. The usual desperate reaction is to look at cutting investment in order to reduce short-term borrowing.

However nations are not households. They outlive any individual lender, issue safe assets demanded by the private sector, and most critically have policy levers that influence national income, the very denominator of the debt ratio. Advanced economies typically borrow in their own currency, giving them greater flexibility over debt management and monetary policy (though this aspect is more complex in currency unions like the eurozone). A government that cuts growth-enhancing spending to hit an arbitrary deficit ceiling may end up with a higher debt ratio because GDP shrinks, thus tax revenues and/or crime rates push up the cost of policing from under-skilled impoverished neighbourhoods.

Fiscal discipline is necessary, but the right metric is required in order for it not to be self defeating. Debt-to-GDP is one such metric that leads to economic folly. An alternative return on investment (ROI) method will be outlined in this article.

The German and UK cases provide a cautionary tale against rules that ignore the quality of spending and the long-run return on public capital.

Germany's Schuldenbremse (Debt Brake)

Origins

The 2009 debt-brake amendment, passed in the wake of the global financial crisis, capped the Federal structural deficit at 0.35% of GDP and required individual Länder (states in US English) to balance their budgets entirely[1]. Proponents argued that hard constitutional limits would anchor expectations, prevent a repeat of 1990s deficit overruns, and protect future generations from "debt mountains". Escape clauses exist for natural disasters and severe recessions, but claw-back rules force rapid consolidation once the emergency ends.

This amendment ensured that its reversal would require a two-thirds majority vote to reverse. In a country of coalition governments this would prove immensely difficult to reverse, even when evidently harmful.

The Investment Gap and Growth Drag

Between 2010 and 2019 gross public investment averaged 2.0% of GDP, roughly one-third below the OECD mean. The Kommunalpanel reports a maintenance backlog of €450~billion, equivalent to the annual economic output of the Netherlands. Econometric work by the Kiel Institute suggests that every additional one-percentage-point of public-investment-to-GDP lifts potential output by 0.6% after three years and 1.0% after ten[2]. By 2024 the IMF estimated Germany's potential output to be about 1% below a counterfactual without the brake—a permanent hit of roughly €40~billion per year in lost income and tax revenue.

Infrastructure and Social Costs

Some 'concrete' examples illustrate both the physical and economic damage,

• Transport In September 2024, Dresden's Carola Bridge partially collapsed just minutes after a tram had crossed, severing a key Elbe crossing and disrupting tram lines, district heating, and river navigation. Emergency demolition took 47 hours, but the full replacement is not expected before 2030. Initial cleanup alone cost up to €7 million, with the total financial burden projected to reach several hundred million euros[3]. Nationwide, Germany faces a bridge maintenance crisis: as of 2023, around 8,000 motorway bridges and 3,000 other long-distance road bridges require renovation, while approximately 50% of the 60,000 municipal bridges are in poor condition[3]. The federal audit office warns that current renovation efforts are falling short, with only 69 of 280 planned bridge projects completed in 2024, and estimates that €2.1 billion will be needed for 2026 renovations alone given the state the bridges have been left in. Improved upkeep could have reduced overall expenditure long-term.
• Digital communications Only 15% of German households had fibre connections in 2023, ranking 34th out of 38 OECD members[4]. Firms report broadband bottlenecks as the second-largest barrier to scaling AI applications.
• Energy Grid expansion has averaged 450~km per year, far below the 1,400~km required to hit the 2030 renewables target. Delays already add an estimated €4~billion per year in redispatch costs ultimately borne by households[5].
• Law enforcement A decade of staff and training cuts saved the Länder barely €1 billion a year, yet the knock-on jump in violent-crime losses and overtime now costs about €4 billion annually—turning the headline "savings" into a net fiscal loss[3].
• Military readiness Skimming defence below NATO's 2 % goal saved roughly €15 billion per year through the 2010s, but today Berlin must cover a €100 billion special fund for urgent kit and a €67 billion base-repair backlog— these initial funds will require substantial top ups obliterating earlier savings[6].

The debt brake was supposed to protect the young from a legacy of debt; it now risks saddling them with a legacy of crumbling assets and lower real wages. Moreover, the drag of economic growth hits the state's tax receipts either lowering investment or putting further pressure on future governments to borrow, contrary to intentions the debt-to-GDP zealots had in the first place.

Germany - cumulative municipal investment backlog, 2000-2024. The dotted marker (2009) highlights the introduction of the constitutional debt brake. After a decade of near-flat backlog, deferred maintenance accelerated sharply—trebling between 2016 and 2024 and reaching roughly €450 billion, equivalent to the annual output of the Netherlands.[7]

Austerity in the United Kingdom

The Deficit-Reduction Programme, 2010-2019

"I want this Government to carry out Britain's unavoidable deficit-reduction plan in a way that tries to strengthen and unite our country… Today, our national debt stands at £770 billion and within five years it is set to reach £1.4 trillion… The interest alone could be around £70 billion a year."-Prime minister David Cameron, 2010

Faced with a post-crisis deficit above 10% of GDP, the 2010 coalition government pledged to "balance the current budget" within five years. The Treasury mapped out discretionary cuts worth 7.9% of GDP, four-fifths on the spending side[8]. Local government grants fell 26%, capital spending dipped 30% in real terms, and welfare reforms shaved 1.5% off household disposable income for the bottom quintile.

Hidden Costs: Crime, Health, and Human Capital

In a similar vein to Germany, British Austerity has stunted the economy and destabilised society in a way immensely difficult to reverse. Just a few examples include,

• Public safety Police numbers dropped by 20,000. A panel study by Machin (2020) attributes one-third of the subsequent rise in violent crime to reduced force size, imposing external costs of roughly £4~billion per year.
• Health NHS spending grew at only half its historic rate. Under-investment is linked to 130,000 excess deaths (2012-2019) and record waiting lists[9]. Ill health and sickness absence already drain about £100~billion a year in lost productivity and benefits—far more than the roughly £10~billion a year saved by squeezing the NHS, turning a short-term saving into a long-term economic loss.
• Infrastructure and social care shortfalls In England, the National Audit Office warned in 2023 that almost 7 000 school buildings require major rebuilding or refurbishment, with some at risk of sudden structural failure. [10] Local-government insolvencies have become routine: Woking (2023) and Birmingham (2024) both issued section 114 notices after debt-fuelled property bets soured.[11], [12] Meanwhile the King's Fund estimates that real-terms spending on adult social care fell 12 % between 2010 and 2019, contributing to a record 165 000 staff vacancies and spill-over delays in the NHS.[13] Each example shows how headline "savings" create downstream liabilities that eclipse the original cuts.
• Macro impact The Office for Budget Responsibility judges that austerity reduced the level of GDP by 2.5% by 2018—a cumulative loss of £350~billion[14]. Ironically, debt/GDP in 2019 was still higher than projected in 2010 because slower growth offset deficit gains.

David Cameron did actually achieve his deficit reduction by 2015, as evidenced by the slow down in the growth of debt/GDP.

While the UK pursued austerity after 2010, stimulus-oriented countries like the US, Canada, and Sweden experienced stronger cumulative GDP growth from 2008 to 2025 thus supporting the argument that austerity may have constrained long-term recovery. [15]

A Smarter Metric: The Golden Rule 2.0

The original Golden Rule of public finance refers to a fiscal principle that distinguishes between current (consumption) spending and investment (capital) spending. It was most prominently used by the UK Treasury in the late 1990s and early 2000s, under Chancellor Gordon Brown.[16] The original incarnation of the golden rule was focused on the use of debt only in investment and not to fund current spending.

Instead of limiting government borrowing by an arbitrary debt/GDP ratio or reducing the deficit by an arbitrary amount a more meaningful approach is to consider a return on investment (ROI) methodology that underpins the golden rule 2.0.

This can be laid out making a number of assumptions on potential inflation rates alongside spending saved from, for example, increased GDP leading to increased tax revenue or reduced crime rate from initiatives engaging communities.

The assumptions made here are for simplicity. With a decent grasp on forecasting, variance could be calculated in order to understand the risk of the investment.

Additionally, a return on investment will often be time delayed, say from construction times, or from educational projects feeding into a more skilled workforce.

Ultimately the fundamental tenet of the golden rule 2.0 is a positive ROI though depending on the project a higher lower bound may be sought .

A general ROI Framework

In this section a concise layout of the methodology is given. It will forgo descriptions of risk analysis and ignore the details over the change in spending saved \(\Delta S_t\), and extra tax revenues \(\Delta T_t\) which themselves will be functions of time.

Assuming a flat end-of-year payment \(L\), the outstanding balance after \(t\) payments is,\[ D_t \;=\; k(1+i)^{t} \;-\; L\,\frac{(1+i)^{t}-1}{i} \]

The first term is the original principal compounded by the interest \(i\), the second term subtracts the value of repayments already made.

To ensure the debt is fully paid off by year \(N\), we impose \(D_N = 0\). Solving for \(L\) gives the familiar annuity formula,\[ L = k\,\frac{i}{1-(1+i)^{-N}}. \]

In other words, \(L\) is the constant nominal repayment that retires the loan exactly in year \(N\).

Each year's cash outflow is \(L\). To express that flow in real (inflation-adjusted) terms, divide by the CPI growth factor:\[ \text{Real debt service in year }t:\qquad DS^{\text{real}}_t = \frac{L}{(1+\pi)^{t}} \]

Putting it together, costs and benefits

Return on investment (ROI).

Thence, investments should only be considered when \(\text{ROI} > 0\). There are various additional complexities that will need to be accounted for, such as the cost/benefit of one project can influence another.

Break-even window

The year in which a project's cumulative net benefit turns positive ("break-even") is crucial for fiscal sustainability and political feasibility. Projects that repay society within one or two electoral cycles tend to face lower appropriation risk and enjoy stronger public support, while those with very long payback horizons require robust justification (inter-generational equity, climate resilience, etc.) and careful discount-rate treatment [17], [18], [19], [20].

These break-even windows will restrict the expected ROI for a project. Examples of how this affects the lower bound of ROI will be given in the following section.

Indicative break-even windows found in the applied-economics and policy literature. Ranges vary with country context, discount-rate assumptions, and project execution risk.

Policy Implications

• Golden Rule 2.0. Capital projects are approved only when the real-term ROI is positive, above the ROI given by the break-even window, and within a defined margin of error; day-to-day outlays must still be financed from current revenue. Similar notions are discussed in the UK's treasury's text yet rarely followed. [17], [25].
• The "ring-fenced investment corridor used in Sweden's fiscal framework [26] is the closest model to the golden rule 2.0.
• Additionally costs, including the cost of borrowing, must take into account other projects running in parallel, as well as their risks.
• Independent audit. A non-partisan fiscal council certifies key parameters \((i,\pi,\rho,\Delta T_t,\Delta S_t)\) and publishes stress-tests under higher-rate or lower-benefit scenarios.
• Ex-post learning. Five-year look-back studies compare realised versus forecast ROI, updating appraisal rules (similar to what is practiced by the UK National Audit Office and the Netherlands CPB) [27], [28].
• Break-even horizon discipline. Except for climate-adaptation and early-childhood programmes, projects with a discounted break-even point beyond 15 years trigger an automatic "justify-or-defer" review [21]. This will decide the lower bound for ROI.
• Transparency dashboard. All certified ROI models and post-completion reviews are published in machine-readable form; Germany's new Infrastrukturatlas offers a workable template [29].

Illustrative case study, a high-speed rail link

The following is a simplified example based on real world numbers on how a project may be assessed for viability assuming it was paid for through borrowing.

Loan terms Nominal rate \(i = 3\%\); horizon \(N = 20\) years; annual repayment \(L \approx \text{€ }0.672~\text{billion}\)

Economic impact Real GDP rises permanently by 0.2,%, worth €8~billion per year in 2025 prices. With a 40,% tax share, \(\Delta T_t = \text{€ }3.2\) billion. Road-wear savings add \(\Delta S_t = \text{€ }0.4\) billion, for a constant real benefit of €3.6 billion from year 3 onwards.

Discounting assumptions Expected inflation \(\pi = 2.0\%\); real social discount \(\rho = 1.5\%\).

Real present value of costs/benefits, \[ PV_{\text{costs}} = \sum_{t=1}^{20}\! \frac{L}{\bigl[(1+\pi)(1+\rho)\bigr]^{t}} \approx \text{€ }9.7~\text{billion} , PV_{\text{benefits}} = \sum_{t=3}^{20}\! \frac{3.6}{(1+\rho)^{t}} \approx \text{€ }54.4~\text{billion} \]

Return on investment, \[ \text{ROI} = \frac{54.4 - 9.7}{9.7} \approx 4.6 \]

An illustration of the above example when different values of \(\Delta S_t\) are used to reduce or increase the ROI and the effects on the break-even point. Even in the case of an ROI=0.5 the break even point is 25 years. Shaded regions indicate ±1 standard deviation assuming 5-10% uncertainty in estimated costs and benefits, in line with public project forecasting guidelines [25]. If the project is delayed by \(n\) years this will delay the break-even window by the same number.

Inflation sensitivity

If inflation were 0.5 percentage points higher (\(\pi = 2.5\%\)) while the nominal loan rate stayed at 3 %, the real cost of the fixed repayments falls slightly and \[ \text{ROI}_{\pi=2.5\%} \approx 5.0, \]

underlining that the rule naturally permits more borrowing when real borrowing costs are low.

Are any countries doing this already?

The closest real-world analogue to the framework proposed here is Sweden's dual fiscal rule. Since the mid-1990s the Swedish parliament has combined an overall surplus target with an "investment rule" that permits additional borrowing for projects judged to raise long-term productivity [26]. An independent Fiscal Policy Council publishes retrospective evaluations and the parliament receives an annual investment envelope, so the idea of separating capital from current spending is well established. Even so, Swedish practice still relies on political negotiation to fix the size of that envelope and does not apply a hard, project-level return-on-investment (ROI) hurdle at the approval stage.

Other countries pursue pragmatic variants of the same logic without formal ROI gates. Japan has sustained a gross debt ratio above 250 % of GDP for more than a decade, pairing large-scale public-works programmes with aggressive monetary easing to keep service costs low [30]. Canada operates an informal "debt-service-ratio'' ceiling that caps interest outlays at roughly ten per cent of revenues yet still finances an ambitious green-transition portfolio [31]. The United States crossed 120 % of GDP in 2020, but the Infrastructure Investment and Jobs Act (2021) and the CHIPS and Science Act (2022) channel new borrowing into productivity-enhancing assets, with impact analyses carried out by federal agencies rather than by an independent fiscal council [32].

Sweden therefore demonstrates that separating investment borrowing from day-to-day budgeting is politically and administratively feasible, while Japan, Canada and the United States show that markets will tolerate high headline debt if investors believe the spending lifts future growth.

What sets the Golden Rule 2.0 apart is the requirement that every project clear a quantified, real-terms ROI test before any debt is issued, that the aggregate borrowing limit is automatically equal to the present-value cost of all certified projects, and that five-year look-back studies feed realised data into the next appraisal cycle. By tying borrowing capacity directly to forecast earnings and by publishing all models and stress tests, the corridor turns today's patchwork of discretionary judgement into a self-adjusting, transparent, and ultimately more credible fiscal discipline mechanism. Fiscal discipline should not be about debt avoidance.

Bottom line: Return on investment driven fiscal discipline

Both Germany and the United Kingdom pursued fiscal virtue by focusing solely on reducing deficit spending. A debt brake that crowds out investment and an austerity drive that slashes productive capacity share the same flaw: they treat all borrowing as if it were consumption. These countries are illustrative, but they are not alone in leaving economic potential unfulfilled through debt avoidance.

Instead, a smarter framework distinguishes between debt that finances future growth and debt that merely shifts today's bill to tomorrow. By embedding ROI logic into fiscal rules, governments can preserve discipline while still investing in the assets, physical, human, and digital, that underpin long-run prosperity and stability.

This is not a call to fiscal recklessness. An ROI approach does not sanction infinite spending; it endorses a form of smart Keynesianism. Rate shocks, project overruns, and macro-volatility must be priced in ex ante, and only investments that clear a risk-adjusted hurdle should proceed. Mismanaged projects can still trigger debt spirals: poorly spent borrowing drives up financing costs while yielding little in return. That is why this methodology bears fruit only when investments are rigorously audited and informed by ex-post learning.

Yet the evidence shows that the greater hazard often lies in paralysis, refusing to borrow for projects whose social return is clear. Under-investment depresses growth, erodes the tax base, and, by an ugly irony, forces future governments to shoulder a larger debt burden to cover the revenue shortfall.

Sound public finance therefore demands neither blanket austerity nor open-ended borrowing, but a willingness to invest where yields outweigh the costs.

[1] Reuters, "Explainer: Is reform of Germany's debt brake on the cards?" Accessed: Jun. 29, 2025. [Online]. Available: https://www.reuters.com/world/europe/is-reform-germanys-debt-brake-cards-2024-11-12/

[2] Kiel Institute, "Economic outlook Q4/2024." Accessed: Jun. 29, 2025. [Online]. Available: https://www.ifw-kiel.de/fileadmin/Dateiverwaltung/IfW-Publications/fis-import/ac7c79e1-3a8f-4345-b191-65d074f2d140-KKB_120_2024-Q4_Deutschland_EN_.pdf

[3] Global Highways, "Germany's crumbling roads costing billions." Accessed: Jun. 29, 2025. [Online]. Available: https://www.globalhighways.com/news/germanys-crumbling-roads-costing-billions

[4] OECD, "Fibre and 5G expand their footprint across the OECD." Accessed: Jun. 29, 2025. [Online]. Available: https://www.oecd.org/en/data/insights/statistical-releases/2025/05/fibre-and-5g-continue-to-expand-their-footprint

[5] Clean Energy Wire, "Germany's aim for 80% renewables in electricity by 2030 is well within reach." Accessed: Jun. 29, 2025. [Online]. Available: https://www.cleanenergywire.org/news/germanys-aim-80-percent-renewables-electricity-2030-well-within-reach-minister

[6] Reuters, "German chief of defence orders swift expansion of warfare capabilities." Accessed: Jun. 29, 2025. [Online]. Available: https://www.reuters.com/business/aerospace-defense/german-chief-defence-orders-swift-expansion-warfare-capabilities-2025-05-25/

[7] KfW Research, "Kommunalpanel 2024 - Ergebnisse im Überblick." Accessed: Jun. 29, 2025. [Online]. Available: https://www.kfw.de/KfW-Konzern/KfW-Research/Kommunalpanel

[8] Wikipedia contributors, "United kingdom government austerity programme." Accessed: Jun. 29, 2025. [Online]. Available: https://en.wikipedia.org/wiki/United_Kingdom_government_austerity_programme

[9] LSE Inequalities Blog, "The cost of austerity: How spending cuts led to 190,000 excess deaths." Accessed: Jun. 29, 2025. [Online]. Available: https://blogs.lse.ac.uk/inequalities/2024/06/19/the-cost-of-austerity-how-spending-cuts-led-to-190000-excess-deaths/

[10] National Audit Office, "Condition of school buildings," HC 954, 2023.

[11] BBC News, "Woking council effectively bankrupt after £1.2 bn debt." Accessed: Jun. 29, 2025. [Online]. Available: https://www.bbc.co.uk/news/uk-england-surrey-65824859

[12] The Guardian, "Birmingham city council declares effective bankruptcy." Accessed: Jun. 29, 2025. [Online]. Available: https://www.theguardian.com/uk-news/2024/sep/05/birmingham-city-council-bankruptcy

[13] The King's Fund, "Adult social care funding and workforce pressures." Accessed: Jun. 29, 2025. [Online]. Available: https://www.kingsfund.org.uk/projects/adult-social-care-funding-and-workforce-pressures

[14] Office for Budget Responsibility, "Public investment and potential output." Accessed: Jun. 29, 2025. [Online]. Available: https://obr.uk/public-investment-and-potential-output/

[15] International Monetary Fund, "World economic outlook database." Accessed: Jun. 29, 2025. [Online]. Available: https://www.imf.org/en/Publications/WEO

[16] M. Larch and A. Turrini, "The EU's stability and growth pact: Best practices for fiscal policy rules?" European Commission, European Economy — Economic Papers 408, 2009. Accessed: Jun. 29, 2025. [Online]. Available: https://ec.europa.eu/economy_finance/publications/pages/publication15482_en.pdf

[17] HM Treasury, The green book: Central government guidance on appraisal and evaluation. London, 2023. Accessed: Jun. 29, 2025. [Online]. Available: https://www.gov.uk/government/publications/the-green-book

[18] World Bank, Public investment management assessment (PIMA): framework. Washington DC, 2021.

[19] N. Stern, The economics of climate change: The stern review. Cambridge University Press, 2006.

[20] J. J. Heckman, "Skill formation and the economics of investing in disadvantaged children," Science, vol. 312, no. 5782, pp. 1900-1902, 2006.

[21] Organisation for Economic Co-operation and Development, Cost-benefit analysis and the environment. Paris, 2020.

[22] A. E. Boardman, D. H. Greenberg, A. R. Vining, and D. L. Weimer, Cost-benefit analysis: Concepts and practice, 5th ed. Cambridge University Press, 2018.

[23] International Energy Agency, World energy investment 2023. Paris, 2023.

[24] Intergovernmental Panel on Climate Change, "Climate change 2022: Impacts, adaptation and vulnerability," IPCC, Geneva, Sixth Assessment Report, Working Group II, 2022.

[25] B. Flyvbjerg, "Survival of the unfittest: Why the worst infrastructure gets built—and what we can do about it," Oxford Review of Economic Policy, vol. 25, no. 3, pp. 344-367, 2009.

[26] Swedish Fiscal Policy Council, "The Swedish fiscal framework and public investment," Stockholm, 2022.

[27] UK National Audit Office, "Lessons learned: Delivering major projects," HC 33, 2021.

[28] CPB Netherlands Bureau for Economic Policy Analysis, Cost-benefit analysis in practice. The Hague, 2019.

[29] Federal Ministry for Digital and Transport, "Infrastrukturatlas 2024," Berlin, 2024.

[30] International Monetary Fund, "World economic outlook database: japan." Accessed: Jun. 29, 2025. [Online]. Available: https://www.imf.org/en/Publications/WEO/weo-database/2025/JPN

[31] Parliamentary Budget Officer, "Fiscal sustainability report." Accessed: Jun. 29, 2025. [Online]. Available: https://www.pbo-dpb.gc.ca/en/blog/news/RP-2324-034--fiscal-sustainability-report--rapport-viabilite-financiere

[32] US Congressional Budget Office, "Budget and economic outlook: 2024 to 2034." Accessed: Jun. 29, 2025. [Online]. Available: https://www.cbo.gov/publication/60054