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Noah Smith

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Conservatives Shouldn't Fear the Fiscal Cliff

Posted: 12/18/2012 4:39 pm

There has been much hand-wringing among commentators and policymakers of all stripes over the looming "fiscal cliff," which threatens to hike taxes and cut spending if a less dramatic budget plan cannot be agreed upon soon. The worry is that the sharp policy changes, especially the tax hikes, will slam GDP growth, sending us into another recession.

Now, there may be good reason to fear this outcome. But conservatives should be much more sanguine about it than others. Why? Because according to a central tenet of conservative economics, the fiscal cliff is not going to be a big deal. I'm talking about the principle known as "Ricardian equivalence."

A brief primer for those who never took a graduate economics class (you lucky devils!): Ricardian equivalence is a fancy term for the idea that the timing of taxes doesn't matter for the economy. This notion was thought up by Harvard economist Robert Barro (who was too humble to attach his own name to the result). It works like this: Suppose the government borrows a billion dollars today. Well, people know that the government will eventually have to pay that billion dollars back. So they know that at some point -- maybe not today, maybe not tomorrow, but someday -- taxes are going up. And because people think about the future, not just the present, they take those future taxes into account when making their economic decisions -- decisions about investment, consumption, hiring, and working. In Barro's model, people are so forward-looking that it just doesn't matter when you tax people. In fact, deficit spending is exactly the same as a tax today!

Ricardian equivalence has become a pillar of conservative thinking about economic policy. When President Obama was preparing the 2009 "stimulus" bill, a number of economists -- including Robert Barro himself -- took to the editorial pages to vigorously protest. Deficit spending, they argued, couldn't boost the economy, because people would expect future taxes to pay for today's spending, and would cut back accordingly, exactly canceling out the "stimulus."

By the same logic, conservatives shouldn't be worrying about the fiscal cliff. Yes, taxes will go up if we go over the cliff. But according to Ricardian equivalence, people have known all along that this would have to happen at some point, and they have been planning accordingly. Barro's theory says that the tax hikes of the fiscal cliff actually happened back when the government started borrowing money in the first place. When Ronald Reagan boosted defense spending in the 1980s, he was actually raising (future) taxes. When George W. Bush cut taxes in 2001, he wasn't actually cutting taxes at all; he was simply pushing the taxes into the future. Ricardian equivalence says people have been planning for the fiscal cliff for the last three decades. So it should be no big deal.

Now, some conservatives will point out that the tax hikes of the fiscal cliff don't exactly match the kind of taxes in Barro's model. Real taxes -- for example, income taxes -- are "distortionary", meaning that they discourage people from working and therefore hurt the economy (Barro's famous paper assumes no such distortions). So the fiscal cliff could still have some negative effects. But even these should be vastly reduced by the power of forward-looking expectations. American workers and businesspeople know that America tends to raise money through income taxes. So even if the fiscal cliff causes distortions, the logic of the conservative economics paradigm says that people have been planning for those distortions for a long, long time.

Now, of course, Ricardian equivalence itself might be wrong. In fact, many economists believe that expectations don't actually cancel out much of the effect of taxes and spending. These economists, loosely referred to as "Keynesians," believe that fiscal stimulus does work, and that the fiscal cliff is in fact a big danger. But conservatives have generally rejected Keynesian ideas in recent decades, especially since the 2009 recession. So while many people still have good reason to fear the fiscal cliff, conservatives should be far less concerned. (I am, of course, far from the first to point this out; Menzie Chinn of the University of Wisconsin has been making this argument for a while now.)

So if this is true, then why have conservatives made such a public fuss about the cliff? Part of it is politics, of course. But part of it is the simple logic of debate and "dialectic" in a modern open society. Conservatives are pushing hard against tax hikes because they are afraid of even higher tax hikes should they cede any rhetorical ground. They're probably not really scared, but they're acting as if they are, because to fail to take an extreme anti-tax position will just embolden liberals.

In other words, the fight over the fiscal cliff might just be an elaborate form of political kabuki theater. Conservatives, if they believe their own economic doctrine, are probably not actually losing any sleep.

 
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