If the objective is to reduce fiscal deficits, would it be better to hike taxes or cut public expenditure?

- "The euro-zone countries and the United Kingdom have undertaken to quickly reduce their fiscal deficits. Would it be better i f they did so primarily via a tax hike or via a cut in government expenditure?"
- "To answer this question, we must in our view start off from two observations:
· the reduction in fiscal deficits will seriously affect growth, unless households consume more; in the usual literature about Ricardian neutrality, this requires that only cuts in government expenditure are used; there is then a fall in expectations of future taxes and a rise in
consumption. In practice, the choices can be more complex: spending cuts that would give rise to precautionary savings must be avoided (reduction in the generosity of pension schemes and health insurance); and the same goes for tax hikes that would reduce consumption (VAT, welfare contributions paid by wage earners);
· the main problem for the European economy is the high level of structural unemployment and the sluggishness of potential growth. It is thus important to avoid tax hikes that would discourage employment (welfare contributions) or investment (welfare contributions, taxes on company earnings) in countries where companies have financial problems."
- "We are then left with the following approaches to reduce fiscal deficits:
· a higher taxation of unearned income, which is primarily saved;
· a reduction in nonessential welfare transfers (for example coverage of less serious diseases, whereas coverage for serious health risks must be maintained to prevent precautionary savings);
· higher taxes on inheritance, which would reduce the savings rate;
· raising the retirement age, which reduces the incentive to save."
Natixis Flash Economics 364 20100715

No comments:

Post a Comment