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Working Paper #10-13

October 24, 2013

Europe’s Fiscal Crisis Revealed: In-Depth Analysis of Spending, Austerity, and Growth

By , , , , , , , , and

NOTE: A newer report and data compendium are now available.

Edited by Salim Furth

Preface

Derrick Morgan

Why would your time be well spent reading this special report on detailed economic data from Europe over the past half-dozen years?  It is very simple: Washington must learn from Europe’s mistakes, or be doomed to repeat them.

Those who favor ever-increasing spending and loathe smaller government prefer to call any measures to reduce deficits “austerity.” The word itself has the unmistakably negative connotation of the miserly uncle who is furious that somewhere, just maybe, someone is having a good time. These proponents of perpetual deficits and unfunded entitlement programs love to portray proponents of restrained government as killjoys who will lead a nation to ruin because of their obsession. It is to their advantage to lump together the data from tax increases with spending cuts, using the poor results from the former to tar the later.

This report examines closely what the governments in Europe actually did, with precise technical descriptions and analysis. Some reduced spending, others increased taxes, and some pursued a combination of the two to right their fiscal imbalance. Interestingly, the data reveal that the governments did not always follow through with their plans as originally envisioned. 

This report demonstrates that not all methods of fiscal restraint were equal: increasing taxes was more damaging to the economy and less effective in reducing deficits than spending cuts. The effective way to shrink deficits – reducing spending – leads to stronger economic growth over time, while the counterproductive way – tax increases – leads to slower economic growth and lingering ill-effects, with less deficit reduction than advertised. 

As the United States faces a flood of annual fiscal deficits and a tsunami of unfunded future liabilities, at some point our policymakers will have to take more of the people’s money or spend less.  Thanks to this report, policymakers can refer to unambiguous data. And to those who complain it is not possible to close our annual and long-term structural deficits by focusing on spending, The Heritage Foundation has shown one way in the study Saving the American Dream

Instinctively, conservatives understand the incentive effects of austerity done poorly; we reject tax hikes, particularly during times of slow growth. Increasing government spending may temporarily boost the quarterly GDP numbers, but only to the long-term detriment of the private sector, the real creator of prosperity. (The private sector knows spending today means higher taxes tomorrow and capital flows to government bonds instead of the productive private sector.) It is the fiscal equivalent of eating your seed corn to spend borrowed money today.  Evidence marshaled in the following pages is clear: When the time for addressing deficits comes—and it will—we need to reduce spending, not raise taxes.  We must learn from Europe’s mistakes, not repeat them.

*****

In its present version as a Center for Data Analysis Working Paper this report is available for download in a PDF format, and the accompanying dataset is available as a Microsoft Excel file. The report will be updated with feedback received at the Heritage Foundation’s October 25th event, “Austerity, Spending, and Growth: A Symposium,” and published as a Heritage Foundation Special Report.

 

 

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