Is cutting government deficit necessary economically? If so, why?
Also, what does the Austrian school say about how to make these cuts? I am assuming as the private sector grows? What about unemployment etc … ?
Thanks 
Nothing is “necessary” “economically”. Can you refine your question? What are you really asking?
Let’s assume that the government is running a balanced budget with zero debt and that it has only one tax, a flat income tax of 25%. Let’s assume further in saying that this hypothetical government cuts the income tax in half, so that the tax burden is now 12.5% on every individual. Let’s also assume that this tax cut increases economic growth by 1% per year (a 10% reduction in corporate taxes have shown to increase economic growth by 1.1%, so this isn’t a very farfetched number). An increase in economic growth by 1% per year would mean that real tax revenues would also increase by an additional 1% per year, since real income (what is being taxed) would be increasing. Thus, given a long enough time period, the tax cut that initially produced a budget deficit would produce a budget surplus (assuming spending is fixed in real dollars), while simultaneously improving the standards of living.
So an increase in the budget deficit could, theoretically, in the long run, produce a budget surplus and better standards of living, but ONLY if the budget deficit is increased due to lower tax rates, which spur economic growth.
It has been alleged that cutting government debt only makes sense when “servicing” it (paying bond holders their due interests) reaches a certain threshold. This varies according to whoever’s talking: 5% of the GDP, 10% of the budget etc. Take Japan and Spain. Japan has an enormous debt but can afford to “service” it because Japanese bonds pay very low interests and its economy is relatively stable, meaning tax revenues are also relatively stable. Spain has a much inferior debt but (despite fictious AAA Moody’s rating) her bonds pay much higher interests than Japan’s. Also the Spanish economy is facing turbulent times meaning tax revenues won’t be as stable as Japan’s. This way you can say that Japan can afford to be heavily in debt while Spain needs to take measure to reduce debt (or to be more precise, the amount of her GDP/budget going into debt “servicing”) despite being in a much better nominal situation.
Having said that I think you will find that the recipe most Austrian-schooled economists and analysts advocate is pretty much the same: run a budget surplus and use the surplus to repay the debt. It’s also interesting to note that the same people advocate tax cuts: the loss of revenues will be made up by cutting expenses as much as possible. These cuts in turn will generate real world economic growth, helping us to run a surplus. While on paper this is a very sound plan, recent experience has taught us that in the present social-democratic framework this is absolutely impossible. A government running this program is sure not to last one year in office. Don’t believe me? Try booking a flight to France right now. The French are rioting like savages because the Sarkozy government has proposed raising age requirements for government pensions by two years. Imagine what would people do if some “free stuff” was taken away all of a sudden. We may all laugh at the “land-burning Communist peasants” and their antics but this is a shape of things to come. very slowly governments all over the West have reached the conclusion they need to cut budget deficits damn right now because their economies aren’t going to recover anytime soon. In fact tax revenues, despite continous nominal GDP growth, tax revenues have been slowly but steadily declining all over Europe despite much tighter controls.
While we may approve of debt-cutting measures an old saying goes somewhat like this “there’s an ocean between saying and doing”. Especially in a democratic system.
Kakugo, if the French government took serious steps toward freezing spending and cutting taxes, it could balance its own budget rather easily. For example, each 10% reduction in corporate taxes has been estimate to increase GDP growth by 1.1%, while it also has been estimated that reductions in corporate taxes are practically revenue neutral because the revenue that isn’t captured via corporate taxes will be captured by other taxes (e.g. capital gains, income, sales). So if France completely eliminated its corporate tax rate, it would increase economic growth significantly while barely reducing tax revenues, if at all. In the long run, tax revenues would increase enough to balance the budget.
Furthermore, I believe that any government could win the support of its citizenry if it took radical steps toward reducing tax rates. Imagine if the French government eliminated corporate tax rates and cut the income tax by half across the board. Nobody will riot if they pay less to the government, while the increased economic growth as a result of the tax cuts would gradually increase real tax revenues over the long run. Moreover, I believe that such a drastic tax cut could accompany some spending cuts, as the anger from the spending cuts would be more than offset from the joy of paying less taxes.
For example, in the US, if payroll taxes were cut in half, that would amount to a giant tax cut on both working Americans and businesses. The vast majority of the American public wouldn’t complain if these tax cuts would be accompanied by cuts in agricultural subsidies, transfer payments to foreign governments, a reduction in the length of unemployment benefits, an increase in the minimum age for Social Security and Medicare, etc.
Krazy kaju, so what you are saying is that all that is required to deal with a deficit is to simply not increase government spending too much?
That’s more or less the same as what I believe.
What I wonder is what happens if you neither raise taxes at all nor increase spending too much. A while ago, I started to believe that this alone is sufficient to deal with a deficit.
Kaju, while I agree completely with your ideas as usual there’s a divide between theory and practice.
First of all, cutting taxation to increase economic growth takes time. Three years? Five years? That’s way too much for politicians and interests groups: they need to turn the boat around damn right now. The present economical catastrophe is proof enough of this. Already six months after the mortgage time bomb exploded politicians and bankers were already declaring “mission accomplished”. Remember the “Max Power Way” from The Simpsons? “It’s the wrong way, just faster”. Couldn’t have put it better myself.
Second of all, remember people much prefer having “free stuff” than paying less taxes. This springs partly from a sense of schadenfreude: people gaining more than me will be worse off than me. They will be forced to share their wealth. Paying taxes myself is a small price to pay to see them robbed at the point of a gun. Also you have to remember people really believe in “markets failure”: they much prefer paying more taxes to see “services” handled by the State than paying less taxes and having to deal with the free market. The State is seen as “fairer” than the private sector. Just ask any European who he/she’d like to handle his/her pension. Or look at this recent Japanese poll (by Shinhodo 2001):
* Prime Minister Kan Naoto has said it would be best to create a society in which people can live with peace of mind, even if people are asked to bear a (tax) burden to a certain extent. What do you think?
High welfare / High tax burden state: 22.2%
Medium welfare / Medium tax burden state: 60.4%
Low welfare / Low tax burden state: 8.8%
Don’t know: 8.6%
That says it all.