Permanent cuts boost spending through expected future tax relief

Evidence

The same expectation-based mechanisms as before are on display in this later paper but are more fully specified. Thus, in the absence of any significant liquidity-constraint, “when spending cuts are perceived as permanent, consumers anticipate a reduction in the tax burden and a permanent increase in their lifetime disposable income.” This leads them to spend and invest more today because they perceive that “previously expected large tax increases will not be necessary in the future,” which is especially true at higher rates of taxation. When such policies are followed in periods of “fiscal stress,” the results are better because the signal that the cuts will be permanent is more credible. So, not only should we cut, we should cut when it hurts, in the slump, not the boom, and we should cut decisively. — Mark Blyth, Austerity, 465