Posted by: Dirk | January 21, 2013

Rising taxes in times of low demand

Tax revenue data from Eurostat was released lately, and this is the most interesting graph:

taxIn case of an economy with aggregate demand problems increasing tax rates is the opposite of what text books say, especially so if your economy is in the liquidity trap. Don’t get me wrong: if the increase in taxes is the outcome of strong economic growth coupled with a progressive tax system (the higher your income, the higher your marginal tax rate) then there is no problem at all. A rising tax share would be a sign of success.

However, these years GDP is not growing strong and the increase in taxes does not help to expand aggregate demand. This leads us right to the economic crisis. Either we can expand demand through government spending, or we try to bring national debt ratios down by increasing taxes and cutting spending. Europe has chosen the latter, but the results are telling. Interest rates for Germany, which has reached a balanced budget, are basically zero for short run debt. The message of the bond market is clear: borrow more! That is a vote of confidence that can be exploited by policy makers, if ideology would not stand in the way.


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