In the run-up to this weekend’s G-8 summit at Camp David, journalists have unfavorably compared European “austerity” with Barack Obama’s economic policies.
European spending cuts, the argument goes, have hurt people and are arousing political opposition, while Obama’s proposals to keep federal spending at 24 percent of gross domestic product indefinitely are likely to succeed.
Evil Republican spending cuts, in contrast, would deny the economy needed stimulus and wreak havoc on ordinary people.
But the facts undermine the storyline. Veronique de Rugy of the Mercatus Center at George Mason University took a look at what “austerity” in Europe actually means.
What she found is that government spending has increased or not appreciably declined in Britain, France, Italy, Spain and Germany. The only significant spending reductions are in Greece, where the bond market cut off funding.
In the other countries, the big adjustment has been an increase in tax rates. European “austerity” is an attempt to reduce government budget deficits largely by increasing taxes and only to a small extent by reining in spending.
Which, when you come to think about it, is the policy not of House Republicans — who actually passed a budget — but of Barack Obama.
Over the past three years, Obama has pursued the goal of higher tax rates as relentlessly as Captain Ahab pursued the great white whale.
Never mind that by some measures the United States, even with the “Bush tax cuts,” already has the most progressive tax system in advanced economies. About 40 percent of federal income tax revenues come from the top 1 percent.
And we know from experience that when top rates are increased above Bill Clinton’s 39.6 percent, the intake is always less than projected. Since World War II, federal revenues have never risen much over 20 percent of gross domestic product, whether the top rate was 28 percent or 91 percent.
The reason is that when rates get high enough, investors’ animal spirits (John Maynard Keynes’ term) are directed less at increasing productivity and creating wealth and more at avoiding taxes. And without increased productivity, you don’t get robust economic growth — which hurts everyone.
There’s another problem. High tax rates mean a volatile revenue stream, as California Gov. Jerry Brown is finding out. When times are bad, revenues dry up just when government needs money. California’s budget deficit has zoomed from $9 billion to $16 billion in a few months.
Barack Obama doesn’t seem to care about these things. In the 2008 campaign, ABC News’ Charlie Gibson asked him whether he would increase the capital gains tax rate even if it meant reducing government revenue, as has happened in the past.
Yes, Obama said, “for purposes of fairness.” He wants to take away money from people who have earned it even if government gets less to spend.
Obama argues that government spending can generate growth. But money spent propping up state and local public employee unions and funding supposedly shovel-ready projects — major features of his 2009 stimulus package — didn’t do much for the economy.
In contrast, Obama’s former chief economist Christina Romer and her husband David Romer, in a 2010 academic paper, wrote that “exogenous” tax increases, like letting the “Bush tax cuts” expire after the recession is over, are “highly contractionary.”
“Our estimates suggest that a tax increase of 1 percent of GDP reduces output over the next three years by 3 percent,” the Romers wrote. “The effect is highly significant.”
Higher taxes are the prime ingredient of European austerity. The danger is that with sluggish growth revenues will languish and the bond market will shut down, as in Greece. Then spending gets cut with a meat cleaver, not a scalpel.
House Budget Chairman Paul Ryan understands this. House Democrats’ “balanced approach” — with tax rate increases — “just means let’s start European austerity right now,” he told The Washington Examiner last week.
Ryan’s budget, which passed the House, would cut tax rates but would also eliminate tax preferences. Many high earners would end up paying more. But because they wouldn’t face higher rates on the next dollar they earn, there would be no incentive to seek tax shelters.
You can find Democrats who agree with this approach, though they’d differ with Ryan on details. But they won’t speak up as long as their leader keeps pursuing that great white whale.
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