Don't Fear Spending Cuts

Daniel Henninger in the WSJ against those who believe Armageddon coming from the piddly Sequester spending cut. It seems this Harvard Prof. believes spending cuts are much more important than tax increases to get economies back on their feet. 

Mr. Alesina has identified the alternative. His, and others', work the past decade with how struggling economies revive suggests that the Obama spend-more solution is the opposite of what the U.S. should be doing.

There is general agreement on at least two things about the current U.S. economy. It is emerging from the deepest recession since the Great Depression, and its debt level is unsustainable. The path back to stronger growth, argues Mr. Alesina, is a combination of significant, permanent cuts in public spending and relatively small tax increases, if any.

This view isn't born of "right-wing" ideology. Mr. Alesina is an Italian, as are many of his co-authors. As Europeans, Mr. Alesina and his colleagues were forced to confront the biggest challenge facing Western economies the past 40 years. Europe rose from the ashes of war, but how would it rise from the ashes of debt, as benevolent postwar spending programs outstripped revenue?

Mr. Alesina and his colleagues wanted to answer the most basic question: What works?

They sought the answer (which they published in an August 2012 paper on "fiscal consolidations" for the National Bureau of Economic Research) by analyzing an International Monetary Fund history of all the fiscal plans that 17 OECD governments enacted between 1978 and 2009, including the U.S., Canada and Japan. Together, these countries tried everything to grow—raise spending, cut spending, raise taxes or cut them, in endless combinations. What helped?

"Adjustments based upon spending cuts," the economists concluded, "are much less costly in terms of output losses than tax-based ones. Spending-based adjustments"—that is, cuts—"have been associated with mild and short-lived recessions, in many cases with no recession at all. Tax-based adjustments"—tax increases—"have been associated with prolonged and deep recessions."

The debate over "failed austerity" is misleading because it emphasizes spending cuts but rarely mentions tax increases. "Austerity" plans, the Alesina studies suggest, fail to revive growth when they too heavily rely on raising taxes on income and capital—as across Europe and now in the U.S.

There is no magic ride back to prosperity. The Alesina team is describing the least-bad antidote for the long-term poison of destructive national debt. Fiscal plans based on large, permanent spending cuts are associated with renewed growth more than any alternative policy mix that has been tried. Indeed, spending cuts without big tax increases look to be the only thing that really works. The leading example the past 15 years is . . . Canada. And just an observation: The Dow proceeded to its high after the sequester happened. The cuts were the first credible step in rebuilding private-sector confidence.