Josh Barro writes
The United States has tremendous available fiscal capacity, as demonstrated by significantly higher tax burdens in most other first-world countries. The real risk of elevated spending is that we’ll adopt a permanently higher level of taxation.
That is a risk, but not a catastrophic one. While there is a link between government spending and economic growth, it is not as strong as conservatives like to believe. For example, Mueller and Stratmann find that a one percentage point rise in government spending as a share of GDP will tend to reduce annual GDP growth by a bit under one-twentieth of a percentage point.
I think Josh’s points are well and good but they present an opportunity for me to make another point.
To spend may be to tax but taxing and spending are not the same thing. There are many reasons why but an important one is the effect on economic growth.
For a lot of reasons it makes a lot more sense to think that increased government spending will slow economic growth over the long run than increased taxes.
That is, suppose that the government raised taxes and used them to fund a truly profit seeking sovereign wealth fund. This is probably not possible in diverse democracy like the US but for either ethnically homogenous countries or non-democracies it might be possible.
In that case taxes go up, but government consumption does not go up. It makes a lot of sense to think that GDP growth might actually increase under this scenario.
Higher tax rates might very well cause people to work harder as more are pushed into poverty. The taxes are then extracted and put into investment which increases the size of the capital stock, further spurring growth. Even if those capital investments spill out into other countries that will drive down the value of the nations currency and drive up the output of the high productivity tradables sector.
You may have noticed by now that some countries have more or less done this.
Yet, what works for sovereign wealth also works for deficit reduction. Paying down the deficit by raising taxes may very well increase economic growth through the same mechanisms.
Moreover, increasing government spending through debt might slow down the long term growth rate of the economy even if no taxes were raised.
Lastly in my view not enough studies control for the fact that high tax jurisdictions are often high regulation, high union, high occupational licensing and restrictive on immigration. All of these factors are likely to be fairly important.