Harvard takes on Princeton (II)

Harvard's Alesina

“Way back in 2010, when everybody in Washington seemed determined to anoint Representative Paul Ryan as the ultimate Serious, Honest Conservative, I pronounced him a flimflam man. Even then, his proposals were obviously fraudulent: huge cuts in aid to the poor, but even bigger tax cuts for the rich, with all the assertions of fiscal responsibility resting on claims that he would raise trillions of dollars by closing tax loopholes. . . Since then, his budgets have gotten even flimflammier. . .

“[L]et’s turn to the serious proposals. . . the one released by Senate Democrats[, b]y comparison with the Ryan plan, . . . is a very reasonable plan indeed.”

--Paul Krugman, New York Times

As the title indicates, this is our second time going to Harvard to answer Paul Krugman, the Nobel prizewinning Princeton economist. Our thanks to Daniel Henninger, who in the Wall Street Journal, has grabbed onto the work of Harvard economist Alberto Alesina.

Henninger calls Alesina “the last economist that Democrats want to deal with” at a time the country is gaining sympathy for spending cuts. He notes that Democrats have long believed in the 1931 Keynesian multiplier (“spend your way to prosperity”; Paul Krugman), saying no president believes in it more than Obama.

Alesina contrarily argues for a combination of significant, permanent cuts in public spending and small tax increases, if any. His views come after Alesina and his colleagues analyzed the International Monetary Fund history of all fiscal plans enacted by 17 OECD governments--including the U.S., Canada and Japan--between 1978 and 2009. Together, these countries tried everything to grow the economy—raise spending, cut spending, raise taxes or cut them, in endless combinations.

Alesina and company concluded:

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

Alesina says the European debate over "failed austerity" is misleading because it emphasizes the spending cuts but rarely refers to tax increases. In truth, "austerity" plans fail to revive growth when they too heavily rely on raising taxes—in Europe or in the U.S.

The studies found that fiscal plans based on large, permanent spending cuts lead to renewed growth more than any alternative policy mix tried. Canada is the leading example the past 15 years. Henninger adds that in the U.S., the Dow reached its all-time high after the sequester happened. Weren’t the cuts the first credible step in rebuilding private-sector confidence?

The Patty Murray Senate budget: A $975 billion spending cut and a $975 billion tax increase. The Paul Ryan House budget: $4.6 trillion of spending cuts and no new taxes beyond the fiscal-cliff increases.

Henninger concludes the Murray budget would be a disaster, while the Ryan budget is the way to go, if Harvard’s Alesina is right.