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

August 5, 2011

Veronique de Rugy, a senior research fellow at the Mercatus Center 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: We have 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 our 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 our debt problem because of intragovernmental 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

 

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