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More on How Certain Spending Cuts Can Be Like Tax Increases

1 min readBy: Gerald Prante

Yesterday, I made the comment that there are some fiscal policies that would technically qualify as “spending cuts,” but which have similar effects as an increase in marginal tax rateThe marginal tax rate is the amount of additional tax paid for every additional dollar earned as income. The average tax rate is the total tax paid divided by total income earned. A 10 percent marginal tax rate means that 10 cents of every next dollar earned would be taken as tax. s (i.e. distortive). Is every spending cut like a taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. increase? No. But when a spending item is tied to some economic activity (like many taxes are), changes in policy can have similar effects as changes in tax policy.

Take for example the suggestion made by some that Medicare should be means-tested (at least in-part). As noted supply-side economist Steve Entin explains here, such a policy would be in effect an implicit tax, even though it would technically be classified as a spending cut. Alan Reynolds makes the same point here when referencing a work by Jagadeesh Gokhale and Lawrence Kotlikoff. See also Greg Mankiw.

As one can see, saying that some spending cut has similar effects as a tax increase is not derived from some big government worldview. In fact, it is derived from the core principle of economics (one that is emphasized by supply-side economists): incentives matter.