Industrialized nations have almost always adopted a combination of [tax increases and spending cuts] to cut debt, according to an International Monetary Fund survey last year. The fund, which examined 30 instances dating to the 1980s, found that nations on average closed half the gap with tax increases and half with spending cuts.
Both approaches cause immediate economic pain, but the dominant school of economic theory predicts that tax increases should be somewhat less painful to the nationís economy. A $100 spending cut reduces economic activity by $100, while an equivalent tax hike will be paid partly from savings, so that spending is reduced by a smaller amount.
Recent studies, however, have found the opposite: Countries that rely primarily on spending cuts tend to experience less economic pain in the short term. Moreover, in some cases, the cuts seem to spur faster growth.
The monetary fund study reported that a 1 percent fiscal consolidation achieved primarily through tax increases reduced economic activity by 1.3 percent over two years, while an identical consolidation driven primarily by spending cuts reduced activity by 0.3 percent.
"It's coming to be accepted wisdom that itís better to have spending cuts than tax increases,"
said Alan Auerbach, an economics professor at the University of California, Berkeley.