An interesting article on balancing the budget ran in Monday’s Times: “Politicians Can’t Agree on Debt? Well, Neither Can Economists.” Reporter Binyamin Applebaum writes that “Economists agree that federal borrowing must be reduced, but they do not agree about the proper mix of tax increases and spending cuts.” Both ways of reducing the deficit have economic costs, but it is difficult to quantify and compare those costs. Which produces greater pain, tax increases or spending cuts? I found this argument convincing:
Both approaches cause immediate economic pain, but the dominant school of economic theory predicts that tax increases should be somewhat less painful to the nation’s economy. A $100 spending cut reduces economic activity by $100, while an equivalent tax hike will be paid partly from savings, so that spending is reduced by a smaller amount.
Several studies have found the opposite, however — that tax increases inflict greater harm on the economy than spending cuts. It’s hard to tell how much conflict really exists among economists; after all, until recently, media coverage of global warming emphasized that there were two schools of thought on the subject, and falsely claimed that intelligent people disagreed. (In reality, nearly all mainstream scientists agree that man-made global warming is occurring; only a handful of fringe figures remain skeptical.) That said, one of the studies Applebaum cites was conducted by the IMF, a respected institution (albeit one based on free-market principles) that can’t be accused of shilling for the Republicans.
It’s very possible that tax increases do more “harm” to the economy than spending cuts. However, I don’t believe that automatically makes spending cuts the more desirable remedy. Decreased economic activity is indeed one measure of a nation’s well-being, but it is not the only one. Not all economic activity is good: I would rather see the GDP decrease because fewer millionaires are splurging on yachts and BMWs than see it increase because Wall Street has invented another shady mortgage product. The economy was humming along before the 2008 financial crisis, but it’s hard to argue that the country was healthier or better off because people were buying houses they couldn’t afford. The classic example of “negative” economic activity is the drug trade: Yes, it brings in money, but at what cost? (New York Magazine ran a provocative piece suggesting that Texas’ booming economy is largely fueled by the cross-border drug trafficking, which puts money in the pockets of home-buying and service-consuming residents.)
This paragraph of the Times article stood out to me:
The monetary fund study reported that a 1 percent fiscal consolidation achieved primarily through tax increases reduced economic activity by 1.3 percent over two years, while an identical consolidation driven primarily by spending cuts reduced activity by 0.3 percent.
Those percentages are straightforward, but not so straightforward are the conclusions we should draw from the study. Spending cuts seem to be the obvious choice, as they slow the economy by only 0.3 percent, but consider how those spending cuts are achieved. Slicing government programs rarely has an effect on the wealthy; after all, no one is considering eliminating things like tax-sheltered health savings accounts or the home mortgage deduction (after all, Republicans would call that a tax increase!), both of which disproportionally benefit the well-off. Spending cuts mean cuts to programs like Medicaid, food stamps and welfare that help people at or near the poverty level.
It seems to me that these cuts have a smaller impact on the economy than tax increases because the poor have little choice but to spend money on food and medicine. I imagine that most people who receive less money in food stamps make up the difference not by relying on soup kitchens or food pantries but by dipping into savings, relying on credit cards or finding a second job. Thus, the same amount of economic activity (food buying, medical bills) occurs; the only thing that has changed is the source of funding. It looks as if the government is spending less, but in reality the cost has simply been shifted onto those citizens least able to afford it. The Treasury may accumulate less debt, but ironically. individuals may be forced to accumulate more. Given that fiscal conservatives love comparing the government unfavorably to a family who can’t exceed its budget by borrowing or increasing its “national debt” (when in reality families do so all the time by racking up Visa debts or taking out payday loans), it’s interesting that proponents of spending cuts tend to overlook this. In addition, I wonder how much long-term damage such shifts in spending do to the economy. A mother who raids her savings account to buy cereal and milk is not saving for her children’s education or for potential emergencies. If she is out of money when her car breaks down, she might lose the job if she can no longer make the commute, and that will increase unemployment. If she has no money to pay for a trip to the emergency room, the hospital will end up writing off the bills as charity care, which won’t help the economy either.
I’d rather opt for tax increases, especially those which fall most heavily on the well-heeled (those corporate jet write-offs Obama loves to talk about come to mind, but so do the ridiculously low rates at which capital gains and other investment income are taxed), than spread the pain around with ill-advised tax cuts. There is always the argument that higher taxes squelch job creation, but that reasoning sounds more like woe-is-me whining from the business community than a rational fear. Companies are sitting on record piles of cash, yet job creation does not seem to be a priority. Raising taxes for hedge fund managers is unlikely to prevent the local plumbing company from hiring another worker. At the end of the day, I would rather see the top ten percent of Americans pay higher taxes, even if it does dampen economic activity, than shred the social safety net.
. . . So Well Read. . . 