The Arithmetic of Government Spending Cuts

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Economists like to use calculus whenever possible to assure themselves that they are really scientists. This article shows that simple arithmetic can help us to understand the important debates that are going on everywhere about the means by which deficits can be reduced. The most common mistake is to assume that cutting $100 in spending will reduce budget deficits by $100. The mistake is to ignore the affect that a cut in government spending has on tax revenue. When government cuts spending GDP falls, and tax revenues decline with it. The argument in this article is very similar to one that Keynes used with the example of the Banana Paradox. He used this very simple problem to show that increases in the savings rate will cause GDP and employment to fall unless the additional savings are used to fund an equal amount of investment.

Ironically, the same people who advocate spending cuts to decrease deficits are also fond of cutting taxes. In this case they argue that tax cuts will increase government revenue by stimulating the economy. There is no empirical evidence to support the claim that tax cuts stimulate the economy enough to compensate for lost revenue.