I'm fascinated that there's still a debate on the question of whether the best way to help the economy in the long run is by higher taxes on the rich plus government stimulus versus austerity and lower taxes. You would think that with so many governments around the world trying one policy or the other for the past hundred years we would have an unambiguous track record to inform us. One of those approaches - stimulus versus austerity - must be better than the other, right?

Instead of clarity, I see proponents of government spending and higher taxes cite the Clinton administration as a time when higher tax rates coincided with a booming economy and a more balanced budget. Proponents of austerity point to Estonia's recent success in belt-tightening. Where's my clarity, damn it?

I declare a link war!
In the comments, give me links to support one argument or the other with historical examples. Keep your comments brief, please, with just a summary of the link. I'll compile them and declare a winner.

My bias going into this is that the best approach to stimulus versus austerity depends on whatever else is happening in the economy. If you have a dotcom boom happening, you can probably raise taxes with impunity and balance the budget too. If not, perhaps the austerity thing makes more sense. That's my starting point. I'd like you to change my mind.

Link on!

[Update: This link will be hard to beat. Thanks to Kuvuplan for that.]

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Sep 13, 2012

In the case of Spain, the country's government has decided to refocus on austerity (for many reasons) before the economy could afford to begin repayment. In America, if we had decided to go full-bore austerity after bailing out banks, but before bailing out the auto industry, we might not have realized a profit from AIG as the damage from a failed auto industry could have pulled down the rest of the economy as well.


For Greece, they seem to have a credit card problem. Instead of using debt to buy productive capital that strengthens their economy, they seem to have purchased the equivalent of plasma TVs.

+10 Rank Up Rank Down
Sep 13, 2012
@ rambis is absolutely correct about the broken window fallacy.

@yonibak and others mention Krugman's articles on the failure of European austerity measures. However, this analysis ignores a very simple fact. Even though they are claiming to implement 'severe austerity' measures, many countries didn't cut spending at all (and none did so significantly). This were also frequently tax increases at the same time.

If you don't actually cut spending, don't blame 'austerity' for not working.


Sep 13, 2012
Austerity is for the boom times to pay down the deficit, its time to spend when we are hurting.

The Reagan and Bush Administrations actually trumpeted increasing the deficit as a good thing, using the money for military, unfunded wars and tax cuts. Since 1980 deficit spending went up during Republican Administrations and down during the Clinton Administration - see the graph:

Now obstructionist Republicans suddenly have religion about deficit spending.

Arguments against austerity include the Great Depression, and more recently Ireland and Greece where austerity is choking them. In the U.S. the anemic attempt at spending to spur the economy in the beginning in 2008 was not sufficient to make a difference. 1/3 of the stimulus was in the form of tax cuts. We needed to do much more and still do.

Here are my supporting links to an article and an interview with Nobel prize winning Paul Krugman:
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Sep 13, 2012
Government spending is not the solution as proven by the "Stagflation" experienced during 1970s. Increases in government spending and poor business environment led to declining productivity (GDP), out of control inflation, and high unemployment. Long-held Keynsian beliefs were debunked. How quickly we forget.

Recession of 1970s: http://en.wikipedia.org/wiki/Global_stagflation_of_the_1970s

Definition of Stagflation: http://www.economywatch.com/inflation/stagflation/1970s.html
Sep 13, 2012

Thank you for not only providing us with an unusually (from you) intelligent comment, not only providing us with more supporting links than we needed but managing to avoid your usual hate speech.
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Sep 13, 2012
Nobel Prize winning economist Paul Krugman has been pushing for more government spending for the past year & points to Europe over the past 3 years having disastrous consequences of their austerity.

If you have an NY Times subscription you can acces all of his columns here:

Here's the latest from his blog:

To me it seems like high taxes & high spending neutralize each other because you are putting money in & taking it out. Same with austerity & tax cuts. In both cases you are just shifting money around from one economic class to another. Republicans usually talk about the need for tax cuts to stimulate the economy & create jobs. Then when it comes to spending the important thing is the deficit.
Sep 13, 2012
Scott, the reason you're confused, is that you're trying to understand macroeconomics, but you've completely left out monetary policy (in the US: the Fed). The question is whether the economy is "below potential", suffering from a "lack of demand", or not. If it is, like now, then more demand stimulus will be very helpful. (On the other hand, economies in better equilibrium are hurt, rather than helped, by "more stimulus".) But you can get that EITHER with the fiscal government spending more, OR with the Fed printing more money. In fact, the ideal would be austerity in the fiscal government, plus very loose monetary policy.

But everybody (like you) forgets monetary policy. So the only alternatives you can imagine are austerity which cuts government spending (and would reduce demand, a terrible idea in the current depressed economy), or else higher taxes (which would also harm the economy) and more spending (which would raise the long-term debt).

You have the wrong tool for the job. The real answer is that the Fed has made huge mistakes in these last few years. And you're trying to fix a Fed monetary mistake, by somehow playing with fiscal policy choices. No wonder you have a hard time seeing a historical correlation.

More details at Market Monetarism:
and at the brilliant Scott Sumner's "Money Illusion" econ blog:

[Do you have a link that describes a country that followed your prescription of austerity plus loose monetary policy and made it work? -- Scott]
Sep 13, 2012
Scott, you start from a terrible assumption.
The cure for a recession is LOWER taxes and HIGHER spending.
Eliminate payroll taxes on BOTH employee and employer.
Get money into the hands of private businesses. Yes, that would make some people rich. Would you continue on our current path to prevent some people from getting rich?
To avoid becoming the next Greece do we choose to become the next Japan?
There is no financial crisis so deep that a sufficiently large tax cut (and/or) spending increase cannot deal with it.
Read (for free) The Seven Deadly Innocent Frauds. http://moslereconomics.com/2009/12/10/7-deadly-innocent-frauds/

[Do you have a link that shows any country tried lower taxes and higher spending and made it work? -- Scott]
Sep 13, 2012
I forgot to add that the TAX BURDEN of the Scandinavian countries is also among the world's highest (as one of those links proves).
+2 Rank Up Rank Down
Sep 13, 2012
Most prominent and most recent example is double dip recession in the United Kingdom:


Compare the recovery of the Obama years in the US with the non-recovery of the UK:


The double-dip recession in the UK concides with the austerity measures of the Tory government:


The policy of austerity of the Tories has been criticized even by the International Montary Fund:


Here is a choice quote:

"Recovery has stalled. Post-crisis repair and rebalancing of the UK economy is likely to be more prolonged than initially envisaged. Confidence is weak and uncertainty is high. Looking ahead, the economy is expected to grow modestly, but with current policy settings the pace will be insufficient to absorb significant slack in the economy, raising the risk of a permanent loss of productive capacity."

It turns out that history repeats. In 1929, the first Labour Prime Minister Ramsay MacDonald bought into cutting to balance the budget. Soon after the UK was the in the thick of the Great Depression, and MacDonald is widely denounced on the Left as a traitor of leftist values:


While we're on the UK, I'll note as an aside that social disorder and unemployment reached record levels in the Thatcher years (low taxes on the rich):


There's a number of competing theories on the causes of the Great Depression. But whatever your opinion is, there's a few facts that's undeniable. There's the recession of 1938 in the USA, coinciding with cuts in the budget in 1937:


The conservative economists have their "theories", but so does every theology. Look at a graph of the GDP per capita of the USA, which accelerates as soon as the Keynesian stimulus from rearmament comes into play:


The effect is even more prominent in the case of Germany, where Germany, despite its crippling depression of the Weimar years, managed to quickly bounce back to full employment and almost managed to produce enough machinery and supply enough soldiers to defeat half the world combined. I assume I don't need to give a link backing this up.

Finally, take the Scandinavian economies, which have among the highest GDPs per capita even though their welfare spending per capita is among the highest:


[No one doubts you can temporarily goose GDP through massive government spending. That's obvious. The trick is doing that and reducing government debt at the same time, or even in the long run. Did anyone do both? -- Scott]
Sep 13, 2012

A country is not a household. A country is immortal. The number-value of debt is less meaningful for an immortal entity than for one that will likely only have fifty or sixty productive years in which to pay back borrowed resources.

So, if a country, say, Elbonia, goes into debt in order to finance necessary projects (banks, roads, healthcare, whatever Elbonians need), then Elbonia can pay off that debt over the course of the next infinite number of years.

Hopefully, these debt-financed investments will yield a healthier, stronger, more productive population which can then dedicate a portion of their booming economy to paying back loans.

Or, they could be austere in their spending. Which would very likely lead to a shortage of necessary goods and services which would leave the population less able to engage in productive activities.

[Greece and Spain are immortal. Why do they have a debt problem? Is it purely psychological? -- Scott]
Sep 13, 2012
"The figure near the bottom shows a positive correlation between governments that cut spending and slower GDP growth."

That's a pretty obvious statement. The result occurs for the same reason as the statement that a person who spends a lot of money using credit cards has more stuff - at that moment. Debt financing always works great --- for a while. The issue is lower taxes versus government spending. Obviously, if a government chooses between lower and higher spending, with taxes unchanged, GDP will be higher with the higher spending, however that doesn't accommodate for the future issue of how to service that debt.

[Interest on the debt in the U.S. has gone down substantially even as debt increased because interest rates are low. In an environment of dropping interest rates apparently you can have your cake and eat it too. -- Scott]
Sep 13, 2012

The figure near the bottom shows a positive correlation between governments that cut spending and slower GDP growth.
Sep 13, 2012
I don't have a link, just a comment.

To get a boom in the economy or a rapid improvement in employment gains, you need companies taking greedy risks to grow their businesses. This is most likely to happen when consumers are spending their money and making decisions on what they want to buy or finance. However, companies don't take inordinate risk in dealing with government contracts, they just bid and staff up to meet their needs. They try to lobby the government and get favorable contracts, whilst providing the minimum service to continue those contracts, and mix in lobbying to ensure they are. The government assistance provided directly to the public is used on items like groceries, debt servicing, and generally doesn't result in much durable good production. However, if companies ramp up hiring, which they will do when consumers are spending more money (due to lower taxes), more durable goods are purchased and the greed of companies competing will increase employment further and start a self-perpetuating cycle that will only be broken when consumers have overstretched themselves from a debt standpoint (excluding other world events) and scale down. In effect, lower taxes and lower government spending increases the money multiplier effect in the economy, which causes an outsized gain for the same nominal spending of dollars. A non-regulated boom bust cycle can be very healthy to the nation as it plays a constant game of survivor so that only the businesses with the best models or most productive work-forces will survive, which independent of outside intervention, will raise the standard of living vs. the alternative.

Obviously there is a link out there that says roughly the same as my comment, however, I didn't feel like searching to find it.
Sep 13, 2012
Also, the stimulus was an investment. We're in the black (as a nation) from the money invested in AIG. Not all debt is terrifying. Some of it yields a worthwhile outcome. Like a house (if you like houses) or an education (if you want one). Or, sometimes, as in the case with the AIG stimulus investment, more money.

Sep 13, 2012
The whole concept of increased government spending *with* higher taxes has never made sense to me. It confuses/conflates the "stimulus" with the deficit/debt issue. We currently have both issues, but the solutions to these 2 problems are not the same

Higher taxes might reduce the deficit, but it also *removes* money from the economy. Even accepting the Keynesian theory of the idea that a stimulus will "add" demand to the economy., the taking of extra taxes will reduce funds available in the private economy, which is what we are trying to stimulate.
Sep 13, 2012
Iceland dominated austerity (by refusing it and holding bankers accountable) and other European nations tried to implement similar (not identical, similar) plans that look promising for their economies. From May 2012.

Sep 13, 2012

OK. Went to the link. Read the parable. Makes a very good point. But its applicable to govt spending only to the point that govt spending is corrupt/wasteful/worse than what the taxpayer would have spent it on. I would definitely like to keep my $15,000 but, speaking from a benefit-to-society point of view its possible that the govt would spend it better than I would. Anyone want to take up that point?
+8 Rank Up Rank Down
Sep 13, 2012
The Broken Window Fallacy: The very short summary is that revenues from taxes would be used in other ways to stimulate the economy.

Sep 13, 2012
Sorry to pile on with another comment that isn't what you asked for, Scott, but I would like to know why, as of right now, the blog page is showing 3 comments yet when I view those comments I see only 2.
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