I can't argue that an increase in taxes will not have negative consequences for the economy... [but] it's what you do with the money that matters. What I can argue is that the benefits from using the tax dollars for things such as health care, infrastructure, or other important objectives provides benefits that exceed the costs from increasing taxes, including any reduction in output. Thus, when the economy is in a state where there are highly beneficial government projects waiting in the wings and taxes that can be increased without causing substantial costs, i.e. if the benefits exceed the costs, then deficits should not be an obstacle to putting those projects in place. Focusing solely on the cost side - whether the economy will slow at all as the result of the tax increase - without focusing on the benefits from what is done with the increased tax collections misses an important part of the equation.Mark is right, of course, that really we need to make guesses about both the costs and the benefits when assessing any possible change to fiscal policy. I therefore completely agree that the deficit should not be an impediment to additional spending, when that additional spending is deemed to be of reasonably positive social value.
That is why I would oppose deficit reduction for the sake of deficit reduction presently. What are the benefits from decreasing the deficit? There do not appear to be large gains from the usual channel, i.e. from lowered interest rates and less crowding out since interest rates have been insensitive to deficits recently, and there's no evidence that growth would be strongly affected... Thus, reducing the deficit brings no great benefit presently, has large potential costs, and for me is easy to oppose on that basis. And going in the other direction the costs and benefits are reversed. There are lots of beneficial things we could do with more revenue, and though increasing taxes would have costs, it's unlikely those costs would be large enough to offset the expected benefits if we are careful to limit the spending to projects that are expected to produce a high return.
I'd like to think a little more about one of the points that Mark made, however: that there are very limited gains to deficit reduction right now because interest rates have been insensitive to the size of the deficit in recent years. He may be completely right about this... but I haven't seen enough evidence to convince me of that quite yet. Interest rates have indeed been surprisingly low in recent years, given the US's large budget deficits, but this doesn't mean that the deficit hasn't increased them above where they would otherwise have been. So call me agnostic on the issue.
But there's one other possible side-effect of deficit reduction that also makes me reluctant to dismiss the beneficial effects of deficit reduction so quickly. This is an admittedly fuzzy notion that I have, with little empirical evidence to support it, so please feel free to fire away at it... but I have the sense that deficits are one type of signal to businesses about the way government is being run, and thus an input into the formation of business confidence.
Large structural deficits (or at least large deficits that aren't falling) tell businesses that (a) the federal government is having a problem keeping its economic house in order, and (b) that future tax increases are likely. Both of these messages could tend to make businesses less confident about the future, and thus less inclined to undertake as much long-term investment spending.
Investment spending has been surprisingly low for several years now. What's the explanation? Certainly it's not overly high interest rates. I suspect that at least part of the explanation is that businesses have been less confident about the future than they were, say, a decade ago. Furthermore, I think it's possible that at least part of that loss in confidence has to do with the signal that large and uncontrolled structural deficits have sent about the nation's economic stewardship. Furthermore, it's very easy to guess that taxes are going to have to be raised sometime soon. The uncertainty about exactly which taxes will be raised, by how much, and when, adds another element of doubt and insecurity to long-term business planning.
Okay, maybe it's a crazy theory. But I'm not quite ready to dismiss the benefits of deficit reduction. We might not be very good at measuring them, but that doesn't mean that they're there.
Now, all that said, I still stand by my earlier statement that I don't think the deficit should be an impediment to sensible additional spending. But I do think that we need to consider the subtle impact that large structural deficits might have on the nation's economic performance.