The Kindest Cuts

[Valin]

City Journal:

 

Shrinking spending reduces deficits without harming the economy—unlike tax hikes.

Alberto Alesina

Autumn 2012

 

Should debt-ridden and economically struggling Western governments be doing everything possible to reduce their deficits? The debate over that question has become increasingly confusing—not only in Europe, where the matter is particularly urgent, but in the United States, too. Those in favor of immediate deficit reduction argue that it is a necessary precondition of economic growth. Today’s deficits become tomorrow’s debt, they say, and too much debt can bring fiscal crises, including government defaults. Markets, worried about solvency, will require high interest rates on government bonds, making it more costly for countries to service their debts. Defaults could cause banks holding government bonds to collapse, possibly leading to another financial meltdown. There can be no sustained growth, say the deficit hawks, unless we start balancing our books.

 

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The deficit debate is often misleading, however, because it tends to ignore a huge difference between the two kinds of deficit reduction. The evidence speaks loud and clear: when governments reduce deficits by raising taxes, they are indeed likely to witness deep, prolonged recessions. But when governments attack deficits by cutting spending, the results are very different.

 

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Cutting spending isn’t easy, of course, because the recipients of government subsidies and benefits—public employees, early retirees, large companies getting expensive favors, local governments with no fiscal discipline, and on and on—are well represented in the political arena, while taxpayers are not. Nevertheless, the conventional wisdom that fiscally prudent governments will invariably suffer electoral losses seems to be wrong. In a recent paper, Dorian Carloni, Giampaolo Lecce, and I show that even governments that have drastically slashed spending haven’t systematically lost office in the elections that followed. Sometimes—though not always—voters do understand the need to retrench, rewarding governments that ignore the lobbies’ pleas, especially when those governments speak clearly to voters and are fair in how they cut spending.

 

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