Paul L. Caron

Wednesday, November 24, 2010

Mankiw: The Blur Between Spending and Taxes

New York Times op-ed, The Blur Between Spending and Taxes, by N. Gregory Mankiw ((Harvard University, Department of Economics):

Should the government cut spending or raise taxes to deal with its long-term fiscal imbalance? As President Obama’s deficit commission rolls out its final report in the coming weeks, this issue will most likely divide the political right and left. But, in many ways, the question is the wrong one. The distinction between spending and taxation is often murky and sometimes meaningless.

(Hat Tip: Elliott Manning.)

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Maknkiw sounds like a Mugwamp.

Posted by: Shag from Brookline | Nov 24, 2010 5:04:36 AM

Professor Mankiw believes, as the majority of mainstream economists, that the tax revenue is the main source for financing government spending, or in other words that the only way to finance (or fund) the deficit spending is through the issue of non-interest debt (currency) or sold interest earning bonds, so any increase in the level of government spending beyond of its tax revenues will produce deficit, which in turn will have implications in the short and long run. In the short run, in order to cover the excess of spending, the government will have to issue debt (currency or bonds). However, despite the government can run temporarily deficit, in the long run the “structural (permanent) deficit” must be avoided or better yet it should be eliminated. Otherwise, the past and current increase in government spending would mean, in the future as Mankiw argues, “higher taxes or lower benefits” for the whole population.
In such vision the government deficit represents a burden for our next generations; therefore, it is an imperative to balance the government fiscal accounts. However, his concern does not have any historical or practical foundations for several reasons. First, as professor L. Randall Wray points out “this view [mainstream economists view] completely misunderstands the nature of government spending, taxing, deficits, and bond sales (…) permanent consolidated government deficits are the theoretical and practical norm in a modern economy”. In fact, the US economy is running deficits at least in the last 20 year (with some exceptions in the Clinton term) and the economy is not broken! The reason is simple: When a country, like United States, has a monetary sovereign in a context of flexible exchange rates, the deficit does not represent a major problem, at least up to reach the level of full employment; on the contrary, an increase in the level of deficit means an increase in the level of private wealth thus an increase in the level of employment and output. Finally, in a modern monetary economy “the government spending is always financed through creation of fiat money”. Indeed, the US economy, like other modern economies, operates using fiat money. When the government is sovereign in its own currency and can face his liabilities the emission of money operates as social relationship of assets and liabilities in balance sheets among firms, banks and government.

Posted by: Alejandro Garay | Dec 7, 2010 10:26:16 AM