Guest Columnist Veronique De Rugy:
Senior Research Fellow at Mercatus Center at George Mason University
A version of this commentary appeared in The Washington Examiner
Recently the president announced that he would be holding firm on his demand for $1.6 trillion in new tax revenue from the rich as part of any deal he would make to address the “fiscal cliff” and our debt problem. In theory, the president promises some spending cuts. That’s what he calls the “balanced approach,” and it is a recipe for disaster because it will both fail to address our debt problem and hurt the economy.
Over the years, many economists have looked at what other countries facing our current debt problems have done. A review of the academic literature on this issue shows that successful debt reduction measures are mostly made of spending cuts rather than a mix of spending cuts and tax increases. For instance, in a new paper, “The Design of Fiscal Adjustments,” Harvard economists Alberto Alesina and Silvia Ardagna provide yet new more evidence that fiscal consolidation based mostly on the spending side are more likely to lead to a permanent and long-lasting reduction in debt-to-GDP.
Second, successful reforms cut in two areas: social transfers (entitlements in the American context) and the size and pay of the government workforce. If you think about it, this makes sense. These are the types of spending cuts that prove a country is serious about getting its fiscal house in order, because they take on two of the biggest special interests in any country — government employees and seniors.
As Kevin Hassett and Andrew Biggs of the American Enterprise Institute have shown, a staggering eight of every 10 attempts by countries to reduce their debt-to-GDP ratios are failures. This means that even in a time of crisis (or especially in a time of crisis), lawmakers prefer politics over solid, pro-growth policy. Countries experiencing fiscal trouble generally get there through years of catering to interest groups and constituencies that favor spending (on both sides of the political aisle), and their fiscal adjustments tend to make too many of these same mistakes. The United States seems poised to do the same.
What is the impact of spending cuts or tax increases on the economy? First, agreement among economists on the impact of budget cuts on growth is far from being settled. However, a few lessons have emerged. Fiscal adjustments achieved through spending cuts rather than tax increases are less recessionary than those achieved through tax increases. Alesina and Ardagna’s research also reveals that private investment tends to react more positively to spending-based adjustments. Thus, they argue that spending cuts are more sustainable and effective in reducing debt and raising economic growth; thus expansionary fiscal policy becomes possible again.
Second, tax cuts are more expansionary than spending increases in the case of a fiscal stimulus. The work of former Obama Council of Economic Advisers Chairwoman Christina Romer and her economist husband, David Romer, shows, for instance, that increasing taxes by 1 percent of GDP for deficit-reduction purposes leads to a 3 percent reduction in GDP. Third, research from the International Monetary Fund in particular finds that fiscal adjustment based mostly on tax increases will hurt the economy the most.
The bottom line is that Obama’s “balanced approach” more closely resembles the historic failures — the fiscal adjustments that don’t successfully reduce a nation’s debt-to-GDP ratio. What’s more, history reveals that the balanced approach generally results in tax increases but rarely delivers on the spending cuts. That’s unfortunate, considering that if the government could actually collect $1.6 trillion over 10 years from tax increases, this amount still wouldn’t be enough to fill in the projected $6 trillion cumulative deficit over the period.
Moreover, as Obama himself once said, a tax increase will likely hurt the economy — and hence should be avoided, especially in this weak economy.
Here’s to hoping that Congress will give spending cuts a chance.
ON THE ECONOMY: LET’S LYNCH THE LANDLORD
By John Dunham:
Managing Partner, John Dunham & Associates
“The Landlord’s here to visit, they’re blasting disco down below. Sez, ‘I’m doubling up the rent, cos the building’s condemned. You’re gonna help me buy City Hall.’ But we can, you know we can. But we can, you know we can. Let’s lynch the landlord man.”
So intone the 1980s punk band Dead Kennedys in their debut album.
Unable to impose its will through Congress – in fact unable to pass any bills – the Obama administration is acting like the country’s landlord, imposing its will through more and more “house rules,” fees, and well, just general grumpiness. At the same time, more and more mayors, governors and other executives on both the right and the left are imposing restrictions on everything from owning pets, to drinking soft drinks, to having medical procedures. Its as if executives across the political spectrum believe that they have been granted a divine right to rule their subjects as if they were a medieval monarch.
The Wall Street Journal, in a recent editorial suggests that the ending of the political season is going to unleash a regulatory flood upon the American public. (Here Comes the Regulatory Flood, Wall Street Journal, November 23, 2012) If the Journal is correct, and I think it is, the country is about to undergo something akin to the Spanish Inquisition without as much bloodshed. As an economist, it is not the so called Fiscal Cliff that worries me, but the Regulatory Tsunami.
According to the Journal, federal regulators will impose their wrath upon industries that make up the majority of the country’s economic activity. These include health care, where hundreds of rules contemplated in the Affordable Care Act have not even been written yet, financial services where only a third of the nearly 400 rules imposed by the Dodd-Frank act have been finalized, to energy which will likely face the wrath of an administration that is tyrannically hostile to everything outside of wind power and ethanol made from sawgrass.
On top of this, there seems to be no end to the plethora of social regulations being imposed by state and local executives. Now that smoking tobacco is basically illegal anywhere outside of – well outside – we can expect alcohol, food (call it salt, sugar, fat, carbs, gluten, or whatever you want but its food), entertainment and anything else that people enjoy to come under attack. Only gaming (which is a state controlled industry) and for some reason marijuana, seem to be held harmless in the current environment.
We can expect that the right to communications will also continue to be eroded as institutions like the United Nations attempt to gain sovereignty over the internet, and freedom of movement will continue to be restricted.
If what appears to be in the cards comes to pass, the one thing that I guess we should be happy about is that John Kennedy is no longer President. If that were the case we might have to worry about an executive order re-imposing the droit du seigneur or right of the lord, to take the virginity of his serfs’ daughters prior to marriage.
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