September 17, 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 United States’s creditors will demand higher and higher interest rates to continue financing this debt. This means ever-larger deficits and ultimately a U.S. default. The United States can try to avoid this fate by raising taxes, but that approach faces both political and economic obstacles. Raising taxes is rarely popular with either voters or politicians, especially in a weak economy. Both macroeconomic and microeconomic perspectives, moreover, suggest that taxes slow economic growth, thereby limiting the scope for revenue gains. If tax increases cannot restore fiscal balance, then the United States must slow the path of expenditure to avoid fiscal Armageddon.