"Almost a decade after the onset of the global financial crisis, national debt in advanced economies remains near its highest level since World War II, averaging 104 percent of GDP. In Japan, the ratio is 240 percent and in Greece almost 185 percent. In Italy and Portugal, debt exceeds 120 percent of GDP. Without measures either to cut spending or increase revenue, the situation will only get worse. As central banks abandon the extraordinary monetary measures they adopted to battle the crisis, interest rates will inevitably rise from historic lows. That means interest payments will eat up a growing share of government spending, leaving less money to deliver public services or take steps to ensure long-term economic growth, such as investing in infrastructure and education. ...
"Which policies are more likely to result in a lower ratio of debt to GDP? A number of papers have addressed this question since at least the early 1990s (Alesina and Ardagna 2013 summarizes the early literature). We decided to take another look at the issue using new methodology and a much richer set of data covering 16 of the 35 countries belonging to the Organisation for Economic Co-operation and Development between 1981 and 2014, including Canada, Japan, the United States, and most of Europe, excluding postcommunist nations. Our analysis focused on some 3,500 policy changes geared toward reducing deficits either by raising taxes or by cutting spending. ...
"More specifically, we found that on average, expenditure-based plans were associated with very small downturns in growth: a plan worth 1 percent of GDP implied a loss of about half a percentage point relative to the average GDP growth of the country. The loss in output typically lasted less than two years. Moreover, if an expenditure-based plan was launched during a period of economic growth, the output costs were zero, on average. This means that some expenditure-based fiscal plans were associated with small downturns, while others were associated with almost immediate surges in growth, a phenomenon sometimes known as “expansionary austerity” that was first identified by Giavazzi and Pagano (1990). By contrast, tax-based fiscal corrections were associated with large and long-lasting recessions. A tax-based plan amounting to 1 percent of GDP was followed, on average, by a 2 percent decline in GDP relative to its pre-austerity path. This large recessionary effect tends to last several years.
"Our second finding is that reductions in entitlement programs and other government transfers were less harmful to growth than tax increases. Such cuts were accompanied by mild and short-lived economic downturns, probably because taxpayers perceived them as permanent and so expected that the taxes needed to fund the programs would be lower in the future. Thus, the data suggest that reforms of social security rules aimed at reducing government spending are more like normal spending cuts than tax increases. Because social security reforms tend to be persistent, especially in countries with aging populations, they entail some of the smallest costs in terms of lost output.In more detailed analysis, the authors consider various explanations and compare them to the data. For example, the advantages of cutting debt/GDP ratios with spending, rather than taxes, don't seem to be associated with corresponding changes in monetary policy, exchange rates, or simultaneous packages of other economic reforms. The big difference seems to be that tackling the debt/GDP ratio with spending based tools is associated with a rise in private investment, while tacking it with tax increases is not.
I'm not someone who agonizes over finding short-term ways to cut budget deficits. But it does seem to me that the US economy has evolved in an uncomfortable direction of making future promises without providing financing for them, including not just government programs like Social Security and Medicare, but a number of private pensions as well. I'd like to see discussion of reforms that would either explicitly scale back on these future promises, or identify a stream of funds to finance them, or some combination of both.
