The business community is generally behind efforts to reduce government deficits, especially in the US and UK. Yet at the same time, it is often said that deficit reduction alone is not enough. There has to be a strategy for positive business growth.
At first sight, there seems to be a paradox. Deficit reduction means cutting expenditure or raising taxes or both – any of which is bad for growth. However, in the longer term, deficit reduction is essential if growth is not to lead to inflation, which will in turn destroy growth.
In an effort to simplify the whole debate, here are the three main ways by which growth might, in theory, be encouraged – and the obstacles to their delivering that growth.
1 Maintain high government spending. This can be done only by raising taxes or by continuing to run the current huge deficits. Higher taxes simply reduce growth – even Keynes, the economist usually (mis)quoted by those who favour big state spending, said as much. Running up deficits is itself the problem, not the solution. It cannot go on forever. Apart from anything else, it is inefficient because government spending rarely goes to those sectors with the greatest potential for viable growth.
2 Cut taxes. This is the most effective way of stimulating growth, because the money released can be targeted at the most productive parts of the economy. In the longer term, intelligent tax cuts will produce growth that will increase government revenue, which will in turn reduce the deficit. The obvious problem with this is that it takes time: in the very short term, tax cuts will actually increase the deficit – unless accompanied by spending cuts which are politically and administratively difficult in a democracy.
3 Cut regulation. This could be done at the same time as either of the other two strategies, or on its own. It is the only strategy that does not increase the deficit in the short term. Indeed, it might reduce it immediately, since fewer rules out to mean fewer bureaucrats to enforce them. The downside is that for deregulation to make much of a difference to growth, it will have to be radical – and so far governments have been very reluctant to give up any of their power over business. We are not holding are breath.