Following the debt crisis of 2009-2010, Greece is currently undertaking a large fiscal adjustment. This adjustment can occur either by cutting spending or by increasing tax revenues. I present evidence from the successful experience of several European countries that went through similar adjustments to examine how the composition of the fiscal adjustment (cutting spending vs. increasing taxes) affects macroeconomic performance and the likelihood of reducing fiscal imbalances. The conclusion is that most successful adjustments typically rely much less on taxes than the proposed Greek fiscal adjustment and that Greece would benefit from lowering taxes and cutting spending even more. In addition, the experience of countries that undertook large fiscal adjustments suggests that governments cutting spending had no problem getting reelected as the improved economic performance helped them gain popularity.
This article has been written by Loukas Karabarbounis. The full article here.