The Facts about Spending Cuts, the Debt and Gross Domestic Product

Veronique de Rugy, a senior research fellow at the Mercatus Centre at George Mason University, discusses the facts and myths surrounding spending cuts, the debt and gross domestic product (GDP).

Myth 1: You cannot reduce the deficit to an appropriate level without also raising taxes.

Fact 1: Spending cuts are the most effective way to reduce the debt-to-GDP ratio.

Harvard's Alberto Alesina and Silvia Ardagna examined 107 efforts to reduce the debt in 21 Organization for Economic Cooperation and Development nations between 1970 and 2007; their findings suggest that tax cuts are more expansionary than spending increases in the cases of a fiscal stimulus.

Also, they found that spending cuts are a more effective way to reduce the debt-to-GDP ratio.

Myth 2: Lawmakers facing economic catastrophe forget about politics and adopt measures that address genuine fiscal issues.

Fact 2: Politicians rarely put politics aside.

A recent paper by Andrew Biggs, Kevin Hassett and Matthew Jensen of the American Enterprise Institute shows that even in a time of crisis (or especially in a time of crisis), lawmakers tend to adopt policies for the sake of politics.

Countries in fiscal trouble generally got there through years of catering to interest groups and pro-spending constituencies (on both sides of the political aisle), and their fiscal adjustments tend to make too many of the same mistakes

Myth 3: The US has had higher debt-to-GDP ratios before so we shouldn't worry now.

Fact 3: We should worry the debt-to-GDP ratio actually underestimates the size of the government's real liabilities.

History appears to be reassuring, since several advanced countries have had debt-to-GDP ratios much higher than the one we have now without defaulting, so why should we worry?

Two main reasons: First, while the US debt is big now, it's only going to get bigger in the coming years. Second, the debt-to-GDP ratio actually underestimates the scale of the US debt problem because of intra-governmental debt, unaccounted liabilities and unfunded liabilities.

Source: Veronique de Rugy, The Facts about Spending Cuts, the Debt and the GDP, Reason Magazine, July 29, 2011.

For text: http://reason.com/archives/2011/07/29/the-facts-about-spending-cuts

For more on Tax and Spending Issues: http://www.ncpa.org/sub/dpd/index.php?Article_Category=25

First published by the National Center for Policy Analysis, United States

FMF Policy Bulletin/ 09 August 2011

FMF Policy Bulletin

Policy Bulletin

Publish date: 18 August 2011
Views: 515

FMF Policy Bulletin, Monetary Policy,

The views expressed in the article are the author’s and are not necessarily shared by the members of the Foundation. This article may be republished without prior consent but with acknowledgement to the author.

Share this article

Help FMF promote the rule of law, personal liberty, and economic freedom become an individual member / donor HERE ... become a corporate member / donor HERE