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Does raising taxes and increasing spending aid economic recovery?

By Rachel Alexander
web posted November 4, 2002

As the election approaches, many politicians are ominously warning that the only way to revive the economy is to raise taxes, insisting that any opponent who dares say they will not raise taxes is being irresponsible in order to get votes, and will eventually see the folly of their ways once elected and raise taxes. There is also talk of the necessity of new spending, in order to "stimulate" the economy. Yet after these declarations, there is a deafening silence - no in-depth analysis is offered explaining precisely how raising taxes and increasing spending will help the economy. Why? Most politicians don't understand macroeconomics; they fail to grasp the correlation between cause and effect in this area. Over and over again, when an economy eventually improves, no matter when it recovers relative to government tinkering, liberal politicians inevitably state that it was because of the increases in spending and taxes.

Instead of comprehensively explaining how their macroeconomic plan will work, leaders like Tom Daschle throw around meaningless phrases like "long term economic recovery strategy," and "short term economic stimulus bill," hoping that the media and most voters will be deterred from further investigation by the important-sounding and esoteric nature of the phrases.


Daschle

Liberals like Daschle don't understand what started the recession in the first place. It wasn't because of tax breaks or not enough spending - it was because of government tinkering that was trying to "fix" the economy, particularly interest rates. The government lowered interest rates, allowing more and more shaky investments, and when those lucrative investments started to fail, the economy could no longer sustain them all. Of course, what needs to happen is to let those investments fail, without government interference, and perhaps investors will learn in the future not to make unwise investments.

Unfortunately, the government always insists on intervening, and instead of pointing out that maybe the investors should have been more careful, the government starts meddling with the interest rates once again, which only prolongs the recession, as we learned in the 1930's. Now why would you want to lower the interest rates again, when that was what precipitated the inflationary credit expansion in the first place? Of course, liberals like Daschle confuse the cause with the solution - they believe that Roosevelt's policies in the 1930's helped end the Depression, rather than prolong it.

Arguments that spending must be increased to stimulate the economy are flawed. Keynesian economics, which teaches that additional government spending will solve the problem of overproduction when consumers aren't spending as much, is flawed because government spending hurts long-term growth. Pumping money into the economy to save businesses - that probably should have gone under - does little to sustain growth and in fact inhibits it, by taking money (in the form of new or higher taxes) from consumers and investors who could have been using that money to invest instead for the long term. And taxing an activity reduces the level of that activity and destroys incentives to work. Instead of raising taxes in order to increase spending, why not allow people to keep their money, resulting in more savings and investment? Regardless, where is the evidence that government spending is more profitable for the economy than individual saving and investment? Noticeably, Daschle doesn't cite any studies demonstrating this. A Cato Institute study found that every $1 increase in spending actually costs $1.40 because of compliance costs and inefficiencies in the system. And increasing spending is what leads government into budget crises, since spending always seems to outpace tax revenues.

Arguments for tax increases instead of tax breaks are equally flawed. Reagan's tax cuts, which came on the heels of the economic recession of the 1970's, resulted in the longest peacetime expansion in the history of the U.S. They didn't worsen the recession into a depression. Contrary to Keynesian economics, which holds that cutting taxes increases inflation and does little for growth, the opposite happened. Tax receipts grew 20 percent faster in the 1980's era of tax cuts than they did during the 1990's era of tax increases. Of course, the deficit increased under Reagan, but that was because the liberals in Congress refused to cut spending on their pet social programs, in return for compromising on the approval of Reagan's defense programs, even after they had promised they would.

Next time a politician insists that it is necessary to raise taxes and increase spending through their important sounding "comprehensive plan for economic growth," but fails to explain how it will actually work, be suspicious that even they do not understand it.

Rachel Alexander is the editor of Intellectual Conservative. Resources from the Ludwig von Mises Institute were relied upon for this article.

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