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Manual The Means to Prosperity: Fiscal Policy Reconsidered

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Taxes should be set based not on spending levels but on macroeconomic conditions, and deficit financing has no effect on interest rates. Some politicians have invoked those positions to suggest that the government need not worry about debt at all. This goes too far. When the economy is held back by lack of demand during a downturn, modern monetary theory gives similar answers to those provided by more mainstream Keynesian theory—that is, that more spending or lower taxes will have little effect on interest rates.

But the modern monetarist approach is a poor guide to policy in normal economic times, when it would prescribe large tax hikes to control inflation—not exactly the policy its advocates highlight. According to the best projections, the United States is on course to exceed these figures over the next 30 years. Although the U. Trying to make this situation sustainable without adjusting fiscal policy or raising interest rates, as recommended by some advocates of modern monetary theory, is a recipe for hyperinflation.

There is a widely held misconception that the deficit has risen primarily because government programs have grown more generous. Not so. Deficits have ballooned because a series of tax cuts have dramatically reduced government revenue below past projections and historical levels. The tax cuts passed by Presidents George W. Bush and Donald Trump totaled three percent of GDP—much more than the projected increases in entitlement spending over the next 30 years. Those cuts meant that in , the federal government took in revenue equivalent to just 16 percent of GDP, the lowest level in half a century, except for a few brief periods in the aftermath of recessions.

As things stand, however, the Congressional Budget Office projects that revenue over the next five years will continue to average less than 17 percent of GDP, a percentage point lower than under President Ronald Reagan. Over time, economic growth means more people earn higher incomes, adjusted for inflation, and so more people pay higher tax rates. More serious than leading to inadequate revenue is the way that tax cuts in the last 25 years have misallocated resources. They have worsened income inequality and, at best, have done very little for economic growth.

Look abroad, and it becomes obvious that the United States has more of a revenue problem than an entitlement problem. That is because the United States brings in the fifth-lowest total revenue as a share of GDP among those 35 countries. The idea that higher spending, particularly on entitlements, is to blame for rising deficits stems from a combination of faulty numbers and faulty analysis.

Total U.

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Social Security and Medicare spending are set to rise by more than this over the coming decades, but that rise will be at least partially offset by other spending reductions and will do less to increase the deficit in terms of present value, which accounts for the current value of future spending and borrowing, than the tax cuts passed in the last two and a half decades.

Entitlement costs have risen not because the programs have become more generous but largely because the population as a whole has aged, a fact that is mostly the result of falling birthrates. That is not making government spending more generous to the elderly, and there is no reason why retirees should bear most of the burden of lower birthrates. One might argue that the rise in entitlement spending caused by longer life spans represents an increase in the generosity of Social Security and Medicare, since people are collecting benefits for a longer period of time.

But that is the wrong way to look at it. By , the standard retirement age for Social Security will complete its rise from 65 to 67, reducing the time that most people will collect benefits. Many lower-income Americans, moreover, are dying younger than they used to. That disturbing trend means that poorer retirees are collecting less in Social Security payments than before.

Tax lever of fiscal policy - Aggregate demand and aggregate supply - Macroeconomics - Khan Academy

Over the last 30 years, the cost of both a day in a hospital and a year in college has risen by a factor of more than relative to the price of a television set. At a more abstract level, rising inequality also pushes up the cost of achieving any given policy goal. Most people acknowledge that the government has some role to play in redistributing income, even though they disagree on how large that role should be. For any given amount of redistribution, more inequality means more spending.

Large mismatches between revenue and spending will have to be fixed at some point.

All else being equal, it would be better to do so before the amounts involved get out of hand. Even setting aside these macroeconomic considerations, politicians should remember that running budget deficits does not replace the need to raise revenue or cut spending; it merely defers it. Sooner or later, government spending has to be paid for.

How Washington Should End Its Debt Obsession

It is hard to budget rationally and decide what expenditures and tax cuts are worthwhile when one obfuscates the ultimate cost of these policies. The right budget strategy must balance several competing considerations: it should get as close as possible to the most economically efficient policy while remaining understandable and politically sustainable. The optimal policy from an economic standpoint would be to gradually phase in spending cuts or tax increases at a rate that would prevent perpetual growth in the national debt as a share of the economy but would avoid doing serious harm to economic demand along the way.

Such an approach, however, would be complicated and difficult to understand.


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A requirement that the federal government balance its budget or begin paying down the debt is easier to grasp but would impose far more deficit reduction than the economy needs or could bear. Such measures are also politically unsustainable.

The Means to Prosperity

Even if policymakers passed such legislation tomorrow, they could not bind their successors to it. Clinton oversaw four balanced budgets and bequeathed a declining national debt to Bush, but a decade after Clinton left office, the debt was higher than when he arrived. A simple approach to fiscal policy that would prove understandable, sustainable, and economically reasonable would be to focus on important investments but do no harm. In short, when you are in a hole, stop digging.

That means that instead of passing unfunded legislation, Congress should pay for new measures with either spending cuts or extra revenues, except during recessions, when fiscal stimulus will be essential given the increased constraints on monetary policy now.


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This approach would provide a ready way to prioritize: if something is truly worth doing, it should be worth paying for. Such a course would also strike a reasonable balance between the harms of extra debt and the harms of deficit reduction. The deficit would continue climbing to unprecedented levels. But no longer would the United States be pursuing the reckless fiscal policies of the last two years, which, if continued, would add even more debt, even faster, while driving up inequality and failing to support growth.

A lot of details would need to be worked out. This book fills this gap.


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It delivers a keen assessment of the role and scope of current fiscal policy. New contributions and critical reviews of state of the art research analyze fiscal policy in terms of viability, potency, consequences and sustainability, and also shed light on its relation to economic and political ideas. The authors believe that the legacy of the last fiscal revolution has been an excessively negative view of deficits and debt, and believe that this volume will contribute to open a dialogue on fiscal issues, and bring back a more balanced view of fiscal policy.

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With contributions from leading authorities including Barbara Bergmann, Jeffrey Frankel and David Colander, this is a major new contribution to the field. Passar bra ihop. Ladda ned. A fiscal expansion entails a decrease in government saving. Lower saving means, in turn, that the country will either invest less in new plants and equipment or increase the amount that it borrows from abroad, both of which lead to unpleasant consequences in the long term.

Fiscal policy also changes the burden of future taxes. When the government runs an expansionary fiscal policy, it adds to its stock of debt. Because the government will have to pay interest on this debt or repay it in future years, expansionary fiscal policy today imposes an additional burden on future taxpayers. Just as the government can use taxes to transfer income between different classes, it can run surpluses or deficits in order to transfer income between different generations. Some economists have argued that this effect of fiscal policy on future taxes will lead consumers to change their saving.

Recognizing that a tax cut today means higher taxes in the future, the argument goes, people will simply save the value of the tax cut they receive now in order to pay those future taxes. The extreme of this argument, known as Ricardian equivalence, holds that tax cuts will have no effect on national saving because changes in private saving will exactly offset changes in government saving.

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If these economists were right, then my earlier statement that budget deficits crowd out private investment would be wrong. But if consumers decide to spend some of the extra disposable income they receive from a tax cut because they are myopic about future tax payments, for example , then Ricardian equivalence will not hold; a tax cut will lower national saving and raise aggregate demand. In addition to its effect on aggregate demand and saving, fiscal policy also affects the economy by changing incentives. Taxing an activity tends to discourage that activity.

By reducing the level of taxation, or even by keeping the level the same but reducing marginal tax rates and reducing allowed deductions, the government can increase output. Incentive effects of taxes also play a role on the demand side. Policies such as investment tax credits, for example, can greatly influence the demand for capital goods. The greatest obstacle to proper use of fiscal policy—both for its ability to stabilize fluctuations in the short run and for its long-run effect on the natural rate of output—is that changes in fiscal policy are necessarily bundled with other changes that please or displease various constituencies.

The same is true for a tax cut for some favored constituency.