Wednesday, June 29, 2011

Cutting Spending is Not Better Policy Than Raising Taxes

Why Michael Boskin is Wrong, Again

Earlier The Dismal Political Economist commented on a WSJ op/ed piece by former Bush economist Michael Boskin who provided five, count em, five lessons for deficit busters.  His first recommendation, cut spending $5 for every $1 in tax increases.

To justify his positon Mr. Boskin said

In a comprehensive study of post-World War II fiscal consolidations in developed economies published last year by the National Bureau of Economic Research, economists Alberto Alesina and Silvia Ardagna conclude that successful deficit reduction averaged $5 to $6 in spending cuts for every $1 of tax hikes. Higher taxes more often led to recession.

To spare readers the agony of plowing through the technical aspect of the study cited by Mr. Boskin, The Dismal Political Economist did not provide a review of that study.  Now we do have an analysis by the Congressional Research Service which concludes the following about a study that is part of the intellectual basis of Conservative policy on deficit reduction.

The International Monetary Fund, however, correcting problems they perceived in the Alesina and Ardagna study, found spending cuts to be contractionary, consistent with mainstream views. Moreover, while the IMF found cuts in spending to have smaller effects than tax increases, those effects were generally ascribed to offsetting monetary policy which was more significant with spending cuts than tax increases.

The findings in the Alesina and Ardagna study that successful debt reductions were associated with higher growth when spending cuts were used was based on 9 observations out of 107 instances of deficit reduction, or less than 10% of the sample. In addition, most of the countries where debt reductions were successful were at or close to full employment, while the United States remains well below full employment, raising questions as to whether this evidence is applicable to current U.S. conditions. Thus, both methodologic l questions and questions of applicability to current circumstances can be raised for the Alesina and Ardagna, and similar, studies.

So the world order in Economics is now back where it should be.  Cutting spending is highly contractionary, and the policy of huge cuts in spending relative to raising taxes to cut the deficit is again determined to be bogus economic policy, just as economic theory says it should be.

Furthermore, instead of stimulating the economy, as Conservatives would have you believe, cutting spending is going to reduce growth and employment in the economy just as economic theory says it would.  From the above study.

The claim based on the evidence of Alesina and Ardagna (and similar studies) that policies traditionally viewed as contractionary, such as cutting spending, will increase growth in the shortrun in the United States, can be questioned on at least two grounds. First, when a methodology that looks to intentions was used to select instances of deficit reduction, as in the IMF study, the empirical results were consistent with traditional fiscal policy. Second, the deficit reductions in the Alesina and Ardagna study that were successful by the authors’ measures were associated with economies generally above, or close to, full employment in most cases. The United States is still operating considerably below potential output.

Why is this important?  Well the Paul Ryan Budget Plan passed by the House was based on the assumption that huge cuts in federal spending would immediately create hundreds of thousands of jobs. It  Creates nearly 1 million new private-sector jobs next yearAnd both Republicans and Democrats are currently negotiating huge spending cuts to cut the deficit, and they believe in part that this will result in a stronger economy.  The above cited study is just additional support for the argument that it won't, that

Will this information slow the race to contract the economy by massive cuts in government spending?  Well no, the issue for Democrats is trying to appease Republicans, the issue for Conservatives  is Political Philosophy, not the economic well being of the country.


  1. I was with you till the last sentence. Do you seriously believe the issue for Republicans (and that's who's involved here, not conservatives) is political philosophy? The issue is political advantage, at whatever expense to the well-being of the country.

  2. I agree that political advantage is the intermediate goal, with the final goal being enacting a ideologically based economic policy.

    So we may be saying the same thing.