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InsiderOnline Blog: September 2010

Spending Cuts Are Good for the Economy

Reducing budget deficits by cutting government spending has a stronger record of economic stimulus than either reducing the deficit with tax increases or increasing government spending. That’s what Harvard economists Albert Alesina and Silvia Ardagna have found in their recent research. They examined 107 instances of large reductions (at least 1.5 percent in one year) in budget deficits as well as 91 instances of large increases (over 1.5 percent in one year) in budget deficits over the past 40 years.

They found that when an economy expands following deficit reduction, spending cuts were the largest part of the adjustment. At the same time, when recessions followed deficit reduction, tax increases were the predominant policy. The authors also found that when budget deficits increased, tax cuts had a more expansionary impact on the economy than spending increases.

Writing in the Wall Street Journal, Alesina points to the reason for these findings: Spending cuts “signal that tax increases will not occur in the future, or that if they do they will be smaller. A credible plan to reduce government outlays significantly changes expectations of future tax liabilities. This, in turn, shifts people’s behavior. Consumers and especially investors are more willing to spend if they expect that spending and taxes will remain limited over a sustained period of time.”

Posted on 09/15/10 03:12 PM by Alex Adrianson

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