James Pethokoukis

Politics and policy from inside Washington

The way out of (national) debt

June 15, 2010

National Review’s Stephen Spruiell makes the following point:

Italy (debt-to-GDP: 118 percent) has put together an austerity package that relies mostly spending cuts to do the heavy lifting. Portugal (debt-to-GDP: 86 percent) has put together an austerity package that relies mostly on tax increases. Because Italy is cutting spending instead of raising taxes, it has better economic growth prospects, and will bring down its level of indebtedness more quickly, than Portugal. That markets believe this is reflected in CDS spreads of 189 basis points for Italy, compared with 289 points for Portugal.

Me: Traditional fiscal austerity (higher taxes and less spending) has a poor track record because higher taxes are a growth killer. The way heavily indebted nations escape their fiscal traps is either through inflation or higher growth or default. The US should take Door #2 while also cutting spending.

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