The economic fallacy in austerity economics

Austerity economics argues that restoration of economic growth requires fiscal stabilisation - usually, from a position of fiscal deficits, this means reducing fiscal deficits. This can be done by either cutting spending (including the cost of debt servicing) or increasing taxes. Both are influenced by the rate and quality of changes in GDP.

As austerity policies came in during 'stage 2' of the GFC, they almost always involved - large spending cuts, minimal tax hikes (in some places - the UK is an example) taxes were actually reduced, and various monetary measures to reduce interest rates and so the cost of servicing government debt. There are generally no narratives that explain why the centre of gravity of fiscal policy was so regressive - why the changes tended to push far more of a load onto state spending than upon the revenue side.

As would be expected, the effects were to cut effective demand, and quickly economic forecasts were revised downwards, with lower tax revenue accompanying lower GDP levels and high spending (for example as unemployment rose), and this increased the forecasts for fiscal deficits. In general, whilst one can expect this outcome to have been clear from the modelling made when the original austerity forecasts were made, these were massaged to give better outcomes, and then this proved hard to continue as GDP slowed.

Given this, is it clear that $1 for $1 transfers from rich to poor will increase effective demand. In Australia, removal of the effective 'flat tax' of 15% charged on contributions to superannuation funds in a way that increased income tax revenues by, say, $10 bn, and reductions of proposed spending cuts by the same amount would increase effective demand, slow unemployment gains and in a series of second-round effects reduce the forecast, and actual, fiscal deficits. In the old Keynesian language, with unemployment above the minimal level variations in the marginal propensity to consume will (in any decent macro model) have such effects.

But, what is happening? In Australia, neither the ALP nor the Coalition are offering the population a vote on tax increases. Like old issues such as immigration and the death penalty, if such policies are not in the manifesto of a party that can be elected to govern, you cannot vote for them.

But has the ALP been cunning? Instead of tax hikes, ex Treasurer Swan talks about adjustments to the taxation of contributions to superannuation funds for those with high incomes, about changes to the conditions that allow negative gearing, and taxation of mineral companies. Unless the Treasury has been completely bought by its political masters, such policy changes, which can be said not to be income tax hikes, must have positive effects on the forecasts for the fiscal position, and upon the real economy.

Which takes us back to the lack of a narrative as to why, when all those people sat around tables in those EU capitals now implementing austerity policies, these issues were not discussed enough for them to become part of the historical narrative. Of maybe this has been written up somewhere?

4/2/2015