More on How Certain Spending Cuts Can Be Like Tax Increases

August 26, 2009

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 rates (i.e. distortive). Is every spending cut like a tax 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.

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