Simple solution for deficits

A heated debate rages in most countries: where should governments cut spending? where and how shall taxes be increased or introduced? Most commentators reject the lawnmower method as too crude. This would mean that all spending and/or taxes are adjusted by the same amount, without any exception. As everybody benefits from certain spending measures every expenditure has a natural constituency that fights tooth and nail to preserve that spending. People in favor of the lawnmower are therefore thin on the ground. In addition, no one wants to be branded 'cruel or inconsiderate' or (in academia) a simpleton. Much better to dream up elaborate - and complicated - schemes that hurt no one but miraculously slay the deficit dragon.

But is the lawnmower method really so crude? Cutting spending by 5 per cent and increasing taxes by 5 per cent cannot really be called brutal. After all, a few years ago everyone got perfectly by on an income that was, on average, about 10 per cent lower than it is today.

Introducing new taxes such as VAT or carbon taxes create just more red tape and are a dead weight on enterprise and future employment. They do nothing to reduce spending - and that is what got most countries into the deficit mess in the first place.

Tax Burden: the limit may be close

The steady rise in the share of government spending since the early 1970s was a trend that was inexorably moving towards a level that was bound to create tremendous tensions. No longer would it be possible to bribe and pay off various segments of the voters and thus paper over conflicting aspirations in the various parts of the population. It is mathematically impossible for the state to command more than 100% of GDP and breaking point is reached at a much lower level. High tax levels will ultimately sap the willingness to work in those individuals milked by the state for the benefit of the lazy. They may then throw in the towel and happily consume what they have already earned. Why should a well-off professionals or entrepreneurs who have done well and are in mid-life continue to work hard just for the privilege of having half of their income confiscated? In reality his tax burden is much higher as the remaining half is also subjected to additional taxes and fees – above all VAT levied by the government. Once a large part of the producers of wealth starts to live a rentier’s life the whole edifice of the welfare state – and even government – would stand on exceedingly shaky ground.

Orderly reduction of debt levels is feasible

Irwin Stelzer should gloat a bit less (Wall Street Journal), there is no reason why the debt mountain cannot be reduced in an orderly fashion. Of course, what has been built over several decades can only be reduced in a slow and systematic way. This means that the 'freebies' distributed by the politicians will have to be withdrawn. But people survived without them in the past and with leadership and good will they will survive perfectly well. The army of 'invalids' living on state benefits in Britain for example has swollen dramatically since the early 1980s (yes, it started under the 'Iron' Lady!).

Unfortunately the economic debate is dominated by those seeking to profit from the implosion of the economies in (Southern) Europe and those trying to make their living by serving them. This unhealthy symbiotic relationship between Investors (especially Hedge Funds) and their 'advisors' in sell-side investment banks means that they are only happy if there is 'volatility' in the markets, the more the better for their business (and out-sized profits at the expense of the wider investment public and the taxpayers in general).

A few numbers to illustrate the feasibility of an orderly return to stable fiscal regimes: Greece with about Euro 300 billion in debt has to pay around 15 billion in interest with an interest rate around 5 per cent. To bring debt down to a more reasonable 150 billion over a period of 30 years would mean a net repayment of 5 billion. This total of 20 billion Euros distributed over a population of 11 million may appear to be a heavy burden but it is only 6 per cent of GDP. Now we all know that spending is more fun than saving but to say that this is not possible is not a statement of fact.

The will may be lacking but like in personal life, is it really too much to cut spending by 6 per cent? At least some part of this money goes to internal creditors who will spend the money and thus stimulate the economy. Money does not disappear in a black hole! Repayment will also mean that interest rates will be on a downward trajectory or remain low. And repayment of foreign creditors will allow them to spend more and stimulate the whole European Economy.

Controlled inflation - solution to debt overhang?

We try to keep economics out of our blog but sometimes we just cannot resist the temptation. The reason why there is a slowly-rising tide of calls for allowing a 'controlled' rise in inflation seems to be that politicians and technocrats seem to see no chance in reversing - or even stopping - the tendency for public (and private) debt to grow. Naturally, reversing a trend that has been going on for the better part of nearly four decades is not achievable in a year or two. So the only way to reduce total indebtedness would be a painful adjustment process lasting many years - much longer than the election cycle in any western democracy. But this is not to say that it would be impossible and it is doubtful whether relying on inflation would mean that the adjustment burden is shared more equally between all groups of the population. One should also not forget that in a closed economy the citizens owe the debt to themselves in aggregate. The problem is that the debtors and the creditors are different people and therefore repayment of the debt means that the debtors carry the adjustment burden.