Tax Hikes Lead To Recession, Spending Cuts Lead To Recovery
Albert Alesnia, a professor of political economics at Harvard, has an interesting article at City Journal exploring a study he and colleagues conducted into the two different types of deficit reduction: Spending cuts and tax hikes.
The conclusion? Tax hikes push economies into deeper, more prolonged recessions. Spending cuts, on the other hand, push economies toward recovery.
In 2011, the International Monetary Fund identified episodes from 1980 to 2005 in which 17 developed countries had aggressively reduced deficits. The IMF classified each episode as either “expenditure-based” or “tax-based,” depending on whether the government had mainly cut spending or hiked taxes. When Carlo Favero, Francesco Giavazzi, and I studied the results, it turned out that the two kinds of deficit reduction had starkly different effects: cutting spending resulted in very small, short-lived—if any—recessions, and raising taxes resulted in prolonged recessions.
We weren’t the first people to distinguish between the two kinds of deficit-cutting, of course. In the past, such critics as Paul Krugman, Christina Romer, and some economists at the IMF have responded that the two approaches don’t have different results. When an economy performs well after government spending cuts, they say, it’s actually because the business cycle has picked up, or else because the government’s monetary policy happened to be more expansionary at the time. But my colleagues and I took both factors into account in our research, carefully analyzing the business cycle and monetary policy in relation to each fiscal episode, and concluded that the difference between expenditure-based and tax-based actions remained.
In this age of “stimulus spending” we seem to have forgotten that government spending is not free. The money the government spends doesn’t just appear out of thin air. The government cannot spend anything without first taking something away from someone else. Even when the government borrows, we’re essentially spending the tax dollars of future Americans that haven’t yet been collected.
The idea that government could take money from someone and then spend that money to stimulate the economy is ludicrous. Which is why deficit reduction through spending cuts helps the economy. Government is a burden, and while we all agree that a civilized society must have some level of government, excessive government hurts our ability to prosper.
Tags: deficit, national debt, spending
