Thursday, December 30, 2010

AEI scholars' research: taxes vs. spending cuts

OMB Chart
Excerpts published at

An editorial grabbed my attention recently.  Titled, "The Right Way to Balance the Budget" the piece was published on page A13 of the Wall Street Journal on December 29th. 
Three scholars from the American Enterprise Institute (AEI) collaborated on the aforementioned article.  They examined the likelihood of success coming from three choices we have to address our deficits and the national debt.

The choices of course are: tax increases, spending cuts, or a combination of both.

AEI website: Andrew Biggs
AEI website: Kevin Hassett
Two PhD economists, Andrew Biggs (London School of Economics) and Kevin Hassett (University of Pennsylvania) and economic research analyst Matt Jensen, argue their case by building on the prior work of two Harvard economists: Albert Alesina and Silvia Ardagna.

Messrs. Biggs, Hassett and Jensen conclude the primary way to fix our fiscal predicament is singular in nature -- cut government spending.  Period.  (Although they'd hasten to add that the type of spending cuts implemented does matter).  According to their thesis, the notion of raising taxes, or even using a combination of tax raises and spending cuts -- will not work. 

The case for cutting federal (and state) government spending has been simple -- increasing revenues for the government without statutory spending restraints, will only result in continued spending because historically, government reverts to its spendthrift ways when it is not legally shackled to do otherwise.

Remember, we had a balanced federal budget as recently as 1998 and ran surpluses for a few years but Congress and the Executive branch of government failed to continue a fiscally responsible path, so here we are in 2010 facing a 14 Trillion dollar monster.

No wonder many Americans believe that neither Congress, or any President can be trusted to remain fiscally responsible.  So, what about the experience of other industrialized, debt-laden countries?  Here's the verdict from the AEI authors who analyzed the history of debt consolidations attempted in 21 nations over the course of 37 years...

The authors assert, "...the typical unsuccessful consolidation relied on 53% tax increases and 47% spending cuts."  

Some observers predict that this is precisely the sort of compromise (i.e. arriving at a closely weighted mix of tax increases and spending cuts) which will be hatched by pols in Washington trying to tackle our own debt problem (or appear as though they are).

Biggs-Hassett-Jensen conclude that nations achieve fiscal balance only after applying austerity measures which include a minimum 85% reduction in spending cuts.  In other words, no more than 15% of the total solution, comes from tax increases.  They also hold that nations achieve these cuts primarily by responsible reduction of social transfer payments.

Surprised?  We have to significantly reduce spending now to avoid much more devastating pain later, because nations don't tax their way to solvency.