July 14, 2011


Yes, You Really Can Cut Your Way to Prosperity: The literature is clear: spending cuts, not tax increases, are more likely to succeed in reducing deficits and debt and are more friendly to economic growth. (Andrew Biggs and Matthew Jensen, July 14, 2011, The American)

In fact, one of the least contested points in the fiscal consolidation literature is that reduced transfer payments correlate with more successful fiscal consolidations and higher economic growth. And the United States’ fiscal problem is, essentially, an entitlements issue. Without rising entitlement costs, the federal budget would be more or less in balance over the long term. It’s as if the United States is ripe for a consolidation. Entitlement problems are easiest to fix, and that’s what we’ve got.

The academic debate over fiscal consolidations and economic growth concerns whether the positive "expectational effects" of fiscal consolidations—that is, the increased consumer and investor confidence generated by the belief that adverse fiscal outcomes have been avoided down the road—outweigh the short-term negative Keynesian effects of reduced government spending. Entitlement reform, however, would generate new confidence in the near term while the contractionary reductions to actual spending would not occur for years to come. For instance, many Social Security reform plans raise the retirement age, but all do so over the space of many years, and the effects are gradual. This combination is ideal in our current times of high unemployment and low growth.

This fact is particularly salient given that the Democratic congressional leadership—in particular, House minority leader Nancy Pelosi—has argued for no cuts to Social Security or Medicare. This implies that the long-term fiscal gap would be filled almost entirely by new revenues or draconian cuts to the military and discretionary spending. The academic literature suggests that a consolidation based on raising tax rates or cutting government investment would be practically doomed to failure.

Rather than focus on any given number—be it 85 percent, or 100 percent, or something else—policy makers should heed the broad lessons of the fiscal consolidation literature: that spending cuts, not tax increases, are more likely to succeed in reducing deficits and debt and are more friendly to economic growth; that the larger the debt we need to reduce, the larger the role for spending cuts; and that the most effective spending cuts are in transfer payments, such as entitlement programs, not in areas such as government investment.

...is whether the GOP is really unwilling to buy those entitlement reforms at the cost of some pretty trivial tax hikes.

Posted by at July 14, 2011 6:05 AM

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