JONATHAN CHAIT AUGUST 9, 2011
Eric Cantor is circulating a memo to House Republicans urging them to hang tough on their absolute opposition to any deficit reduction plan that includes higher revenue. He includes a little bit of apparent ballast to support his position:
Raising taxes in this economy will only make it harder for working families and the very small businesses we are counting on to create jobs and get our economy going.
But don’t take my word for it; here is what two Harvard economists concluded in a 2009 study about the various approaches to closing budget deficits, “For fiscal adjustments we show that spending cuts are much more effective than tax increases in stabilizing the debt and avoiding economic downturns. In fact, we uncover several episodes in which spending cuts adopted to reduce deficits have been associated with economic expansions rather than recessions.”
I'm gratified to see the House republicans invoking the Ivy League elites with such reverence. There are, however, several problems here. First, the paper in question jumbles together economies facing a liquidity trap with those that don't, as Paul Krugman has argued:
First, the whole stimulus debate is supposed to be about what happens when interest rates are up against the zero bound. Everything is different if the central bank is busy adjusting rates in response to conditions, and may well raise rates to offset the effects of any fiscal expansion. Yet the Alesina-Ardagna analysis doesn’t make that distinction; Japan in the 90s, which was up against the zero bound, is treated the same as a batch of countries in the 70s and 80s, when interest rates were quite high.
Second, they use a statistical method to identify fiscal expansions — trying to identify large changes in the structural balance. But how well does that technique work? When I want to think about Japan, I go to the work of Adam Posen, who tells me that Japan’s only really serious stimulus plan came in 1995. So I turn to the appendix table in Alesina/Ardagna, and find that 1995 isn’t there — whereas 2005 and 2007, which I’ve never heard of as stimulus years, are.
So to put it bluntly, I’m not much persuaded by a paper that doesn’t even identify the one clear example we have in the postwar period of large Keynesian stimulus in a zero-rate environment.
Another problem, and this is kind of intuitive, is that the appropriate mix of spending cuts and higher revenue is obviously connected with what the levels are in the first place. In a country where taxes consumed 60% of GDP and spending consumed 70%, you would obviously want to focus your attention on spending cuts. It's relevant, then, that the United States is a very low-tax country:
But let's ignore those objections. Forget about the paper's flaws, and forget about the fact that it takes no account of the existing tax levels in the countries involved. As Mike Konczal has pointed out, the conservative attempts to extrapolate from Alesian and Ardagna an appropriate ratio of revenue to spending in fiscal consolidations all wind up concluding that cuts should account for about 83% of the deficit reduction. That's about equal to the deal that Obama and Boehner agreed on, and that House Republicans refused to sign. Cantor is advocating a paper that advocates for exactly the kind of bargain he killed.
The truth is, there is no serious economic support, anywhere, for the Republican position that deficit reduction must consist of 100% spending cuts, or that no deficit reduction is better than deficit reduction with any revenue component. Fred Barnes argues in the Weekly Standard that Obama was silly to demand revenue because "For Republicans, not raising taxes is foundational, primal." He meant this, of course, in a positive sense. A primal belief is not a belief that relies upon empirical support.