The Washington Post

IMF: Budget cuts hurt growth a lot. But tax increases barely matter.

IMF managing director Christine Lagarde (Bloomberg)

A new study (pdf) by the International Monetary Fund raises a further warning flag for fiscal cliff negotiators in the U.S. In what it bills as the first-ever study of its kind, the fund analyzed decades of data on the world’s major industrialized countries to estimate how changes in government spending or revenue affect economic output.

The news isn’t good. Given current circumstances, with a U.S. economy that is growing but still trying to make up lost ground from the 2008 crisis, a one dollar change in government spending could knock as much as $1.80 in output from the economy – what fund researchers called a “statistically significant…and sizeable" outcome.

One brighter spot that could also influence negotiators: the growth impact of a tax hike is estimated to be negligible. The list of measures that automatically become law absent an agreement include both spending reductions and tax increases. While the spending cuts would comprise a heavy drag on growth, the fund paper suggests that a one percent rise in tax revenue would knock just 0.1 percent from gross domestic product.

Overall, however, the paper reinforces what has become the IMF’s recent mantra on cutting government deficits: in a recovery that remains vulnerable, slower is better: “When feasible a more gradual fiscal…consolidation is likely to prove preferable to an approach that aims at ‘getting it over quickly.’”

The size of the so-called “fiscal multiplier” is key to assessing how the tax and spending changes approaching under the fiscal cliff will hit the broader economy. Fiscal multipliers have been an intense subject of research at the fund in recent years, as austerity measures in places like Greece have seemed to undermine growth so deeply they become counterproductive.

The fund said that what makes today’s study unique is that it correlates spending and tax impacts to whether a country is operating near or well below capacity – in economic parlance, the size of the “output gap.” Following the sharp downturn in 2008, most developed nations are still struggling to recover.

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