Should we use spending cuts or tax increases to reduce the government’s budget deficit? New research suggests it depends on how much we like recessions:
This paper studies whether fiscal corrections cause large output losses. We find that it matters crucially how the fiscal correction occurs. Adjustments based upon spending cuts are much less costly in terms of output losses than tax-based ones. Spending-based adjustments have been associated with mild and short-lived recessions, in many cases with no recession at all. Tax-based adjustments have been associated with prolonged and deep recessions.
Sadly, the choice between spending cuts/tax increases has become a partisan political issue with each party choosing their preferred method rather than focusing on the empirical evidence of what would be most effective. Reducing the deficit will likely require a mixed approach, of course, but the decision of how much of each we use should be guided by values that liberals, conservatives, and libertarians can all agree to. In this we could learn from Hippocrates:
The physician must be able to tell the antecedents, know the present, and foretell the future – must mediate these things, and have two special objects in view with regard to disease, namely, to do good or to do no harm.
Replace “disease” with “deficit” and you have a wise suggestion for how to approach the problem. While we are not always sure what will “do good” we have a better idea of how “to do no harm.” Since recessions tend to hurt the poor and working classes even more than spending cuts, solutions that do not lead to prolonged and deep recessions should be preferred.
(Via: Greg Mankiw)
