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David Shreve's op-ed column on the fiscal cliff
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CHARLOTTESVILLE--Recent deliberations on the "fiscal cliff" make one thing very clear: Too many lawmakers have become wedded to too many myths about tax policy and economic history. To ensure that the current policy struggle doesn't deflect us from a return to widespread prosperity and full employment, we should look clearly at the record and puncture these myths forcefully. There are at least two key lessons:
Tax increases can much more readily stimulate a capitalist economy than tax cuts. While the effects of both are dependent upon how budgets are adjusted in their wake, for a stimulus, increases must only be spent; tax cuts must be coupled with additional deficit spending of equal magnitude. Put another way, to have any stimulus effect
If, instead, we insist on maintaining the prevailing posture (no change in the existing deficit, surplus, or balance), and offset tax cuts with budget cuts, we will depress economic activity. It does matter, of course, how these tax cuts are focused, for if wealthier citizens receive the largest share (in the absence of companion deficit spending), the economy-depressing effect is that much more profound.
And since the payroll tax is the only federal tax of significant enough size to become the object of a major cut focused on the not-so-wealthy, there is really very little opportunity to do anything with fiscally neutral federal tax cuts than depress economic activity in a significant way. Even more remarkable than our blindness to this phenomenon on the federal level--where deficit spending is a readily available tool--is our lunatic embrace of state level tax cuts as stimulus, where deficits are much more circumscribed--legally and politically.
While we are fortunate, therefore, to have had additional deficit spending alongside every recent federal tax cut--the real stimulus here--repeated application of this combination has also diminished the dollar-for-dollar power of fiscal policy and deficit spending. As Keynes explained it in 1936, the power of deficit spending stems from the way it augments the general power of wise monetary policy and progressive fiscal policy. It becomes a necessary force, in special circumstances, only when interest rates are kept too high and fiscal policy is insufficiently progressive.
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