Wednesday, November 28, 2012

A thought on the policy consequences of fiscal talk

We talk about taxes in terms of rates. We talk about spending in terms of levels.

There's good reason for that of course, since those are the units of the policy decisions.

But what are the implications of this way of talking about fiscal policy? It's going to bias people into thinking "spending is out of control". As a result of inflation, population growth, and economic growth, the levels of both revenue and outlays are going to be continually increasing, even if the role of government in the economy stays exactly the same. The same is true of revenues, of course. But that's the point - nobody talks about tax policy in terms of revenue levels (unless they want to just flash big numbers). They talk about it in terms of tax rates. When tax rates have stayed steady but spending levels have increased, it's very hard to make the argument that we need to raise taxes.

There's also a credibility argument to it. Spending is going to keep increasing no matter what. Any effort to balance budgets by pulling back on spending - even if it helps to reduce deficits - will always look like it has failed, since all the opposition has to do is wait a little while and let it keep creeping up.

Tax cuts have no such (apparent) credibility problem. When Congress cuts tax rates they're cut. Tax cutters look like they keep their promises, even if the government actually collects more revenue over time (for the same reasons they spend more money over time).


  1. I think the credibility problem is more that expense-cutters aren't really committing to anything. The budget is made through an AFAICT ad hoc process each year. So year to year, we can tell if taxes are still on track or have now deviated. We can't do the same for expenses because there is no "track" on which they are. We could solve that though by pinning the expenditures to a percentage of NGDP. Congress could just say: "From now on, we are spending 20% of NGDP each year." Then, when they decide to spend more or less money, they have to go before the floor and say: "We want to raise/lower our expenditures by X percentage points of GDP." In other words, there can be some sort of credibility.

    1. This is a good point. I agree with much of Daniel's thoughts here but think it misses the difference in spending vs taxes even when considered on the same basis. While both have been increasing nominally over time (as expected), spending has been trending up as a % of GDP more than taxes, even if one excludes the effects of a "depressed" economy. Surely my point of view is biased to some degree, but I have a hard time envisioning spending dropping below 20% of GDP anytime in the foreseeable future (regardless of political party in charge).

  2. Daniel are you dead? I've never seen you go this long without a new post.


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