The Kindest Cuts

Shrinking spending reduces deficits without harming the economy—unlike tax hikes.

Should debt-ridden and economically struggling Western governments be doing everything possible to reduce their deficits? The debate over that question has become increasingly confusing—not only in Europe, where the matter is particularly urgent, but in the United States, too. Those in favor of immediate deficit reduction argue that it is a necessary precondition of economic growth. Today’s deficits become tomorrow’s debt, they say, and too much debt can bring fiscal crises, including government defaults. Markets, worried about solvency, will require high interest rates on government bonds, making it more costly for countries to service their debts. Defaults could cause banks holding government bonds to collapse, possibly leading to another financial meltdown. There can be no sustained growth, say the deficit hawks, unless we start balancing our books.
Their opponents agree that we should eventually rein in deficits—but right now, when economies worldwide are weak, is the wrong time. To shrink a deficit, this argument goes, you need to raise taxes or to cut spending. Taking either of those steps reduces aggregate demand, making an already faltering economy sputter and sink into serious recession. The all-important debt-to-GDP ratio swells because GDP growth slows more than the measures taken reduce debt. Therefore the approach is self-defeating. Governments should instead continue to run deficits and paper them over with borrowed money, waiting to balance their budgets until economies get stronger.

Read more: http://www.city-journal.org/2012/22_4_spending-cuts.html