November 9, 2010

The Negative Consequences of Government Expenditure

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The U.S. national debt currently stands at 62 percent of GDP—its highest level since WWII. Under plausible assumptions, this ratio will rise to at least 80 percent and possibly 185 percent of GDP by 2035 and continue increasing thereafter. As the debt ratio increases, the country’s creditors will demand higher and higher interest rates to continue financing this debt. This means even larger deficits and ultimately a U.S. default.

Both macroeconomic and microeconomic perspectives suggest that tax increases cannot address the debt problem because higher taxes mean slower economic growth, reducing the scope for increased tax revenue. If tax increases cannot restore fiscal balance, the United States must slow the path of expenditure, starting with reforming entitlement spending, to avoid fiscal Armageddon. Expenditure cuts can simultaneously improve fiscal balance while enhancing economic growth.