How to Grow Out of the Deficit
October 4, 2010
As Washington debates the fate of the 2001 and 2003 tax cuts, many lawmakers have fallen into a logical trap of their own making. Although they recognize that tax increases hurt the economy, they argue that our huge deficit requires Congress to raise revenue through a tax hike, says Edward P. Lazear, a professor at Stanford University's Graduate School of Business and a Hoover Institution fellow.
This argument rests on the flawed premise that we can reduce the deficit only by increasing taxes, as if high levels of spending are a given. Not so.
To reduce spending and reignite growth, this Congress or its successor should take two actions, says Lazear.
- Cut the level of spending that has been increased so dramatically since 2008.
- Institute an "inflation-minus-one" rule to constrain future spending increases.
Even if President Obama succeeds at lowering the deficit to 4 percent of gross domestic product (GDP) by 2013, our public-debt-to-GDP ratio will still be dangerously high, at over 70 percent, or nearly twice what it was during the Bush years. As economists Carmen Reinhart and Kenneth Rogoff have shown, such high debt-to-GDP ratios are associated with low growth.
In order to return to the healthier spending ratios of the past two decades, Congress should do the following:
- Enact a budget that brings spending for fiscal year 2012 at least half way back to where it was in 2008.
- Begin limiting future spending according to an inflation-minus-one rule.
If this policy was enacted it would take three or four more years to get to a balanced budget. And if an aggressive Congress cuts spending even faster than the limit imposed, those additional cuts would be baked into future budgets, says Lazear.
Source: Edward P. Lazear, "How to Grow Out of the Deficit," Wall Street Journal, September 27, 2010.
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