Cuts Better Than Spending
Our results suggest that tax cuts are more expansionary than spending increases in the cases of a fiscal stimulus. Based upon these correlations we would argue that the current stimulus package in the US is too much tilted in the direction of spending rather than tax cuts. For fiscal adjustments we show that spending cuts are much more effective than tax increases in stabilizing the debt and avoiding economic downturns. In fact, we uncover several episodes in which spending cuts adopted to reduce deficits have been associated with economic expansions rather than recessions. We also investigate which components of taxes and spending affect the economy more in these large episodes and we try uncover channels running through private consumption and/or investment.
The irreducible bottom line is that the government is a burden and a drag on the economy. In some contexts, it’s worth the cost, but when it comes to affecting the economy, we’re better off lightening the burden — whether we’re talking the United States or Rhode Island. (And that’s not even getting into regulations and mandates.)