Tuesday, February 07, 2006

The US Budget plan

The Washington Post has a fairly decent summary of the financial fiction that is the US budget plan. The simple truth is that tax cuts are the easy part of a small government fiscal agenda. This administration has proven very capable of cutting taxes but has failed comprehensively on the more important challenge of controlling spending, which has risen drastically over the President's period in office. While the new budget is supposed to herald a new austerity it does so only by comparison with the profligacy of the President's earlier years. Even if such fictions as the clampdown on tax evasion do realise significant gains in revenue (as reported in the link above Goldman Sachs don't buy these figures) the reality is that the US will be in deficit for some time to come.

The simple truth is that spending is somewhat like calories - where it comes from is only so important. This can be summed up by the Ricardian Equivalence theorem, proposed by Robert Barro, which argues that the choice of financing spending with borrowing or taxation is equivalent; people know they will have to pay eventually.

Of course there are differences, taxation tends to cause unpleasant changes in marginal incentives to work, save, report your earnings accurately or stay in the country but deficits have their own set of unique, micro, harms in their inexorable effects on interest rates and inflation. However, in lieu of a complete analysis of the size of these harms, it seems sensible to assume that in the aggregate there are increasing harms for each additional dollar borrowed or saved, as taxation moves along the Laffer Curve and cumulative deficits increase as a portion of GDP. As the US has been borrowing a lot recently it is likely to become an increasingly damaging option and may even lead to the kind of financial reckoning that would have everyone forget Iraq as the Bush legacy.

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