The Antidote To Fiscal Crisis Is Cutting Government Spending And Not Raising Taxes

From the Bloomberg article, "U.K. Takes Medicine, Greece Turns Doctor Away" by Kevin Hassett:

The antidote to fiscal crisis is fiscal consolidation, a dramatic change in spending and tax policy that reduces the indebtedness of a nation. Such consolidations have relied on varying degrees of tax increases and spending reductions. Some have successfully reduced debt, some haven’t. The data tell a clear story: What works is cutting government spending. [emphasis added]

A series of influential papers by Harvard University economist Alberto Alesina and various co-authors found decisive evidence that successful consolidations rely almost exclusively on spending reductions, while unsuccessful consolidations seek to close 50 percent or more of the gap with tax increases.

Cutting Is Key

A recent study by the International Monetary Fund supports the principle that cuts, particularly to entitlement programs, are key.

Also see my earlier blog post on this topic, "History Shows Cutting Spending And Taxes Spurs Economic Growth."

New Economic Research Finds Tax Cuts And Not Stimulus Spending Promote Economic Growth

From "Why the Spending Stimulus Failed: New economic research shows why lower tax rates do far more to spur growth." by Michael Boskin in the Wall Street Journal:

economic theory, history and statistical studies reveal that more taxes and spending are more likely to harm than help the economy. Those who demand spending control and oppose tax hikes hold the intellectual high ground.[Emphahsis Added].
***Macroeconomics since Keynes has incorporated the effects of longer time horizons, expectations about future incomes and policies, and incentives (including marginal tax rates) on economic decisions.***based on the best economic evidence, we should reject increased spending and increased taxes.

If anything, we should lower marginal effective corporate and personal tax rates further (for example, along the lines suggested by the bipartisan deficit commission's Erskine Bowles and Alan Simpson). We should quickly enact an enforceable gradual phase-down of the spending explosion of recent years.

Read the complete Wall Street Journal article here.

Increasing The Top Tax Rate Does Not Increase Tax Revenues: Lowering The Top Tax Rate Increases Tax Revenues

From The Wall Street Journal, "There's No Escaping Hauser's Law: Tax revenues as a share of GDP have averaged just under 19%, whether tax rates are cut or raised. Better to cut rates and get 19% of a larger pie" by W. Kurt Hauser:

Over the past six decades, tax revenues as a percentage of GDP have averaged just under 19% regardless of the top marginal personal income tax rate. The top marginal rate has been as high as 92% (1952-53) and as low as 28% (1988-90). This observation was first reported in an op-ed I wrote for this newspaper in March 1993. A wit later dubbed this "Hauser's Law."


***On average, GDP has grown at a faster pace in the several quarters after taxes are lowered than the several quarters before the tax reductions. In the six quarters prior to the May 2003 Bush tax cuts, GDP grew at an average annual quarterly rate of 1.8%. In the six quarters following the tax cuts, GDP grew at an average annual quarterly rate of 3.8%. Yet taxes as a share of GDP have remained within a relatively narrow range as a percent of GDP in the entire post-World War II period. 

Read the complete Hauser piece here.

Reducing the deficit and debt will not be as easy as passing legislation to increase taxes.

As Hauser describes in his article and as known from other economic research, raising the tax rate produces lower than expected tax revenues and also lowers future GDP. People shift their actions to reduce tax payments, increase tax deductions and generate more tax free income from tax free investments. Higher tax rates lower the rate of capital investment, which reduces future GDP and taxable income.

The Bowles-Simpson draft deficit reduction plan envisions tax revenue rising to 21 percent of GDP. As Hauser notes, 19 percent of GDP is the norm as tax rates rise and fall over the last six decades.

The only way to substantially increase tax revenues is through strong economic growth and strong economic growth is more likely in a low top marginal income tax environment.

The US is unlikely to solve its deficit problems through higher tax rates. The US will find itself needing to make substantial cuts to its spending programs in order to get its fiscal house in order. Simultaneously it will need to lower tax rates to spur economic growth.

Cutting government programs and government spending while lowering top tax rates will not be an easy sell for politicians, but it is the right way to eliminate the deficit and increase GDP growth.

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• Economic View: Taxing the Rich: It's All Relative (nytimes.com)
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3 Possible Future US Economic Scenarios Highlighted By Dallas Fed Bank Economists

Economists at the Federal Reserve Bank Of Dallas highlight three general scenarios that the US economy could follow in these unusually uncertain economic times.

From "Oh, the Places We’ll Go: Three Scenarios for Economic Trajectory" by Tyler Atkinson and David Luttrell:

The recent recession proved to be one of the largest setbacks to U.S. output and the largest contraction in employment in the post–World War II era. After starting strong, the subsequent recovery has begun to show signs of slowing down, with second quarter 2010 real gross domestic product (GDP) growing at a revised 1.6 percent annualized rate. While the recovery has exhibited an overall growth rate that would be acceptable during normal periods of growth in the business cycle, one would expect more robust growth at the current phase of recovery given the magnitude of the recession. In fact, stronger growth is required if the U.S. economy is to return to its prerecession path of output growth (Chart 1).

While the economic outlook is unusually uncertain, there are three general scenarios that the economy could follow.

Read the Atkinson and Lutrell's complete article about the trajectory of US growth here.

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History Shows Cutting Spending And Taxes Spurs Economic Growth

From The Wall Street Journal article, "Tax Cuts vs. 'Stimulus': The Evidence Is In: A review of over 200 fiscal adjustments in 21 countries shows that spending discipline and tax cuts are the best ways to spur economic growth." by Harvard Economics Professor Alberto Alesina:

Politicians argue for increased stimulus spending, as opposed to spending cuts, on the grounds that it would speed up economic recovery. This argument might have it exactly backward. Indeed, history shows that cutting spending in order to reduce deficits may be the key to promoting economic recovery.

***

Economic history shows that even large adjustments in fiscal policy, if based on well-targeted spending cuts, have often led to expansions, not recessions. Fiscal adjustments based on higher taxes, on the other hand, have generally been recessionary.

***

The evidence from the last 40 years suggests that spending increases meant to stimulate the economy and tax increases meant to reduce deficits are unlikely to achieve their goals. The opposite combination might.

Read the complete article here. If the entire article is not available, try this link.

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Germany's Economic Growth Without Stimulus Is 6 Times Greater Than US With Stimulus

From The Beacon Blog, "Macroeconomic Policy, European-Style" by Randall Holcombe:

Figures announced this week show that in the second quarter the US economy grew at a 1.6% annual rate. Economic growth in the 16-nation euro zone was 3.9%. That includes Greece, Spain, and Portugal, who are part of that 16-nation group. Germany, by itself, grew at a 9% annual rate.
Is the Obama stimulus package working? One way to judge is to compare US economic growth with economic growth in Germany, where Chancellor Merkel has rejected deficit spending for stimulus as fiscally irresponsible.

Read the complete Beacon blog post here.

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