Deficit Reduction Can Proceed Concurrently With Economic Stimulation

Editor's Note: The following article is by a Nobel Prize winning economist. He's right about deficit reduction as far as he goes. However, some taxes can be raised without affecting recovery from the recession so that recovery and deficit reduction could proceed concurrently. For instance a Financial Transactions Tax (FTT) would not affect the recovery since it targets primarily the rich. For too long we've swallowed the myth that the rich create jobs so we cannot tax them. But that's simply not true. The rich are putting their money into financial transactions that have nothing to do with the Main Street economy. And we've swallowed the myth that additional taxes have to affect the middle class and the poor. But it ain't necessarily so. Additional taxes properly targeted can serve to definancialize the economy which would be a good thing.

 

Additional revenue sources from targeted taxes will not only pay for government programs that actually do provide jobs and stimulate the economy, but will contribute to deficit reduction. Also to be considered is a Value Added or VAT tax. Although this is considered regressive by some economists, the regressive features can be easily alleviated, and its virtues are that it is not easily evaded and would be a significant revenue source in order to correct the chronic underfunding of the federal government brought about by Reagan and Bush tax cuts for the wealthy. This holds for states too which are also in dire financial straits. The trick is to properly target revenue sources that don't detract from the economic recovery while bringing down the deficit at the same time or at least holding it steady.

 

Published on Thursday, March 11, 2010 by The Capital Times (Wisconsin)

The Dangers of Deficit Reduction

by Joseph E. Stiglitz

NEW YORK - A wave of fiscal austerity is rushing over Europe and America. The magnitude of budget deficits -- like the magnitude of the downturn -- has taken many by surprise. But despite protests by yesterday's proponents of deregulation, who would like the government to remain passive, most economists believe that government spending has made a difference, helping to avert another Great Depression.

Most economists also agree that it is a mistake to look at only one side of a balance sheet (whether for the public or private sector). One has to look not only at what a country or firm owes, but also at its assets. This should help answer those financial-sector hawks who are raising alarms about government spending. After all, even deficit hawks acknowledge that we should be focusing not on today's deficit, but on the long-term national debt. Spending, especially on investments in education, technology and infrastructure, can actually lead to lower long-term deficits.

Faster growth and returns on public investment yield higher tax revenues, and a 5 to 6 percent return is more than enough to offset temporary increases in the national debt. A social cost-benefit analysis (taking into account impacts other than on the budget) makes such expenditures, even when debt-financed, even more attractive.

Finally, most economists agree that, apart from these considerations, the appropriate size of a deficit depends in part on the state of the economy. A weaker economy calls for a larger deficit, and the appropriate size of the deficit in the face of a recession depends on the precise circumstances.

It is here that economists disagree. Forecasting is always difficult, but especially so in troubled times. What has happened is (fortunately) not an everyday occurrence; it would be foolish to look at past recoveries to predict this one.

In America, for instance, bad debt and foreclosures are at levels not seen for three-quarters of a century; the decline in credit in 2009 was the largest since 1942. Comparisons to the Great Depression are also deceptive, because the economy today is so different in so many ways.

Yet, even with large deficits, economic growth in the U.S. and Europe is anemic, and forecasts of private-sector growth suggest that in the absence of continued government support, there is risk of continued stagnation -- of growth too weak to return unemployment to normal levels anytime soon.

The risks are asymmetric: If these forecasts are wrong, and there is a more robust recovery, then, of course, expenditures can be cut back and/or taxes increased. But if these forecasts are right, then a premature "exit" from deficit spending risks pushing the economy back into recession.

As the global economy returns to growth, governments should, of course, have plans on the drawing board to raise taxes and cut expenditures. The right balance will inevitably be a subject of dispute. Principles like "it is better to tax bad things than good things" might suggest imposing environmental taxes.

The financial sector has imposed huge externalities on the rest of society. America's financial industry polluted the world with toxic mortgages, and, in line with the well established "polluter pays" principle, taxes should be imposed on it. Besides, well-designed taxes on the financial sector might help alleviate problems caused by excessive leverage and banks that are too big to fail. Taxes on speculative activity might encourage banks to focus greater attention on performing their key societal role of providing credit.

Over the longer term, most economists agree that governments, especially in advanced industrial countries with aging populations, should be concerned about the sustainability of their policies. But we must be wary of deficit fetishism. Deficits to finance wars or giveaways to the financial sector (as happened on a massive scale in the U.S.) lead to liabilities without corresponding assets, imposing a burden on future generations. But high-return public investments that more than pay for themselves can actually improve the well-being of future generations, and it would be doubly foolish to burden them with debts from unproductive spending and then cut back on productive investments.

These are questions for a later day -- at least in many countries, prospects of a robust recovery are, at best, a year or two away. For now, the economics is clear: Reducing government spending is a risk not worth taking.

© 2010 Madison.com

Joseph E. Stiglitz is University Professor at Columbia University. Among many books, he is the author of Globalization and Its Discontents. He received the Nobel Prize in Economics in 2001 for research on the economics of information. He is the co-author, with Linda Bilmes, of The Three Trillion Dollar War: The True Costs of the Iraq Conflict.  His most recent book is Free Fall: America, Free Markets, and the Sinking of the World Economy.