Spending Cuts or Higher Taxes: Is This Really A Question?

Did we learn nothing as children? When we wanted to go to the candy store to buy ourselves whatever $10 worth of candy could get us, we did. When our allowance dropped down to $5 and the jumbo candy bag was $7, we spent a little less that week and saved the rest for our next allowance.  This is called a spending cut because the need to pay for something else has caused us to decrease our current expenses. This makes sense right? So why are European countries favoring higher taxes rather than spending cuts to cover their budget deficits?

Europe will probably be facing another recession this year and their overall economy is expected to contract in 2013. Many countries are trying to avoid this by simply increasing taxes. The truth is this is not the recommended method and has actually proven to be ineffective in generating more revenue. Great Britain’s 50% top marginal income tax rate has actually reduced tax revue by as much as 5% this year, according the Wall Street Journal. Any idea why? Because those in the top marginal income tax rate did not get there by being careless about their money! When the taxes increase, citizens will simply shift their incomes and affairs into a more appropriate situation in a less tax burdensome country. So, the country either loses its population, and tax revenue, or they come up with a better way to handle the budget deficit.

As we know, higher taxes typically hurt new business and, at times, are a dangerous beginning to inflation; but they do offer a positive value that, I believe, most politicians enjoy: a short term fix. France and Greece are due to hold election this spring so both of them are looking for that sort of solution before dealing with the real problem at hand. Their plan is to increase taxes to start paying for the budget deficit, show positive signs of diminishing debt, and get reelected based on how “good” of a job they’re doing. These “excuses” are why Europe will face another recession this year and see their economy contract next year. They’re not fixing the problem; they’re delaying it with temporary ineffective solutions.

Positive signs of the right track are coming though. Portugal is looking to decrease their deficit by a plan of 70% spending cuts and 30% tax increases. Ireland, on the same token, looks to have two thirds of their deficit recovered by spending cuts and one third by higher taxes, which is the typical allocation. Unfortunately, as mentioned before, France, Greece, and Italy all look to balance their budget with tax revenue as the main contributor.

We’ll see what happens in the coming months as we watch the strategies of Portugal and Ireland as compared with France, Greece and Italy. Who will choose the best strategy? Who will save the most money? And who will eventually be able to afford their jumbo bag of candy the following week?