Here’s a pop quiz for macroeconomic students from Economist’s View on how to deal with the deficit.
Mark Thoma suggests the following exam question:
You are in charge of your nation’s fiscal policy giving you full control of both government expenditures and taxes. Due to past decisions, wars, recessions, and some very unfortunate disasters you find yourself with a large government debt. In response, you should
- increase government spending
- decrease government spending
- do nothing
- increase taxes
- decrease taxes
Mark has some other possible answers that you may find amusing, but I didn’t want to make the exam too hard. Let’s see if we can figure out what the correct answer must be by ruling out the items that don’t seem to work.
(a) Increase government spending. OK, that’s obviously not the right answer. So now we already have a one in four chance of getting it right!
(b) Decrease government spending. Steve Slivinski and Chris Edwards at the Cato Institute have proposed $62 billion in spending cuts (hat tip: Economist’s View). But implementing these would require admitting that such measures as the energy bill and the President’s education initiative were a mistake. All of these items originally went into the budget because this spending was perceived to be beneficial, and unquestionably the legislation conferred political gains. Cutting any of these categories entails even greater political costs.
(c) Do nothing. That’s sometimes a good strategy, and it’s the one piece of advice economists could give that actually might be followed. The Skeptical Optimist argues that we can just grow our way out of the situation. But this only works if the rate of growth of government spending can be held below the rate of growth of the economy. Federal expenditures rose from 18.4% of GDP in 2000 to a projected 20.1% for 2005. Growing our way out of the federal debt burden requires some fundamental changes in Washington along the lines discussed in point (b), and runs into the same obstacles we encountered with that answer.
(d) Increase taxes. Both Democrats and Republicans see this as political suicide.
(e) Decrease taxes. There may be good arguments for trying to keep tax rates low (for example, see Mallory Factor or John Tamny). But it’s a rather rare scholar who would claim that cutting the federal tax rate from current values would actually increase total tax revenues, or that the Bush tax cuts achieved that result. Certainly it’s hard to see the great economic boom of which some speak in the current numbers. Real GDP over the last year has grown at an average annual rate of 3.6%– nice growth, but actually below average for an economic expansion. Personal saving has recently plunged into negative territory, which hardly supports the claim that existing tax cuts have spurred the saving that will set the stage for rapid future growth.
Hmm, those seem to be all the possibilities. All right, class, here’s a hint on how to answer multiple choice questions. If you think you’ve ruled out every one of the indicated answers, go back over your analysis. One of the options that you thought wouldn’t work has to be the correct answer.