Wednesday, December 8, 2010

One lesson from the tax cuts deal in the U.S.

The recent agreement on tax cuts in the U.S. has generated a heated reaction. There are different readings about the economic and political consequences of the agreement (Mark Thoma provides a nice summary of some of the reactions).

The deal represents a very interesting political agreement between the Obama administration and the Republicans. Obama concedes by maintaining all the "temporary" tax cuts of the Bush administration, even for individuals earning above $250,000 and the Republicans decide to ignore their campaign statements that reducing the deficit should be a priority.

The outcome becomes an additional fiscal policy stimulus in the form of tax cuts and, obviously, a higher projected deficit for the coming years. I am very sympathetic to the idea of using again fiscal policy as much as possible to bring the economy back to potential, so there is an element of good news in the announcement (although maybe the agreed policies are not the best, spending might still be a more powerful fiscal policy tool to deal with the current circumstances).

But beyond the economic consequences of the announced tax cuts, there is one clear lesson from this experience: reducing budget deficits in the U.S. will be a challenging task. And if the plan requires increasing taxes then you need to wait until there is a real crisis of confidence and this crisis leads serves as a wake up call to politicians. Given what we have seen this week, finding a balance between short-term goals and long-term sustainability and making difficult decisions to reduce budget deficits will require substantial changes in the way politics and policy are done in the U.S.

Antonio Fatás

on December 08, 2010 |   Edit