Cut Government Spending to Grow the Economy!


Over at National Review's The Corner, Reason columnist and Mercatus economist Veronique de Rugy points to more work from Alberto Alesina, Carlo Favero, and Francesco Giavazzi about the relative merits of cutting spending versus raising taxes as a means of reducing debt-to-GDP ratios. Alesina, Favero, and Giavazzi write:

Fiscal adjustments based upon spending cuts are much less costly in terms of output losses than tax based ones. In particular, spending-based adjustments have been associated with mild and short-lived recessions, in many cases with no recession at all.Instead, tax-based adjustments have been followed but prolonged and deep recessions. 

De Rugy comments:

Another interesting finding in the Alesina/Giaviani paper is the correlation between spending cuts and business confidence. They find that "business confidence (unlike consumer confidence) picks up immediately after an expenditure-based adjustments." They are going to look more into this question in order to determine whether there is a direct causation or simply an interesting correlation.

Why? Because businesses seem to respond to the idea that the government is getting its house in order, which means less volatility in the political arena, less threat of new taxes (hard to estimate) and new regulations. Reducing regime uncertainty is something that governments can always do regardless of the business cycle or macroeconomic trends.

Surely even the Obama administration's most ardent supporters must be asking themselves whether constant interventions into the economy may have prolonged the recovery rather than hastened it.

Related: How Regime Uncertainty is Killing Businesses.