The current administration and Congress seem to have had one prescription for everything that ails us: spend more. Most of us know intuitively that the so-called stimulus was a gigantic waste of money we’ll be paying off for years to come.
Now, Harvard political economist Alberto Alesina has looked at 200 financial adjustments in Europe and found that cutting taxes and reigning in spending are the best ways to stimulate economic growth.
Alesina notes in the Wall Street Journal:
In Europe today, the risk of a renewed recession comes not from the spending cuts that some governments have enacted, but from a sovereign debt overhang and multiple bank failures. July's stress tests were not reassuring because they didn't test the exposure of European banks to sovereign debt; had they done so, many banks would have failed. Those banks remain a threat to the European economy.
In the U.S., meanwhile, recent stimulus packages have proven that the "multiplier"—the effect on GDP per one dollar of increased government spending—is small. Stimulus spending also means that tax increases are coming in the future; such increases will further threaten economic growth.
Alesina found that in around 40 years in European countries it was spending cuts and tax cuts that lead to economic growth, while tax increases more often led to a downturn. Here’s the part I want Congress to read very carefully:
How can spending cuts be expansionary? First, they 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.
On the other hand, fiscal adjustments based on tax increases reduce consumers' disposable income and reduce incentives for productivity.