Proof that raising taxes crashes economies

Osaka Castle by Highland 663 on WikiCommons

In 1997 when Japan increased its consumption tax from 3%-5% to pay for it's expensive stimulus programs it sent its recovering economy crashing. After nearly 20 years of stimulus Prime Minister Abe's plans finally began to pull Japan out of one of the longest economic ruts of any developed nation in recent history.

Then in April the consumption tax increased again from 5%-8% and their economy fell by 6.8% in the following quarter.

While it's presumed that Japan's economy will eventually grow back to the size it was before the tax increase it will never be as big as it could have been.

It's also interesting to note that previous to it's recent recovery Japan had built up the highest percentage of debt in the developed world in order to "stimulate" its economy. Building roads, ports, and other infrastructure projects, but their economy didn't recover for decades despite, or perhaps in part, because of all the spending which required tax increases and required the government to borrow money from it's citizens which they could have spent to improve the economy.

This isn't to say that governments can't spend money to improve the economy; better education, safer cities, infrastructure, and scientific research can all be a huge boon.

But only if done correctly, the problem is that spending isn't often done correctly.

Spending on education, for example, hasn't been tied to better outcomes in many cases because often additional spending isn't used on any real improvements.

Large sports stadiums and many massive transit projects have been shown to cost far more than the positive economic impact they have.


For the government to be most effective;

1-Spending must come quickly. That is the government essentially has to spend the capital faster than it would have been spent if they hadn't borrowed it from other places which spend it. Borrowed money after all isn't new money, its money taken from somewhere else.

2-What the government spends the money on matters.
Whatever the government buys should have a larger long term positive impact than the money they spent. Education, for example, is far superior in spending than bridges in developed economies, because we already have a lot of infrastructure so new infrastructure has very little impact (this picture would be different in Ethiopia where one of the biggest barriers to manufacturing is the difficulty they have trucking the goods out of the country). In addition certain aspects of scientific research which cost large amounts of money (building and equipment purchases) can also be good because we get benefits from these long after the jobs from spending the money go away.

3-Tax cuts won't be effective unless they encourage positive spending as well. If people and companies dump their tax cuts into safe investments which prevent this money from being spent quickly enough to benefit the economy, the result won't help the economy. Tax cuts, if used, have to be limited to the cuts that are the most likely to encourage spending and investment.

One tax cut I would have liked to have seen, and would still like to see is a break on all money earned in foreign countries, so as to bring that money back to the United States.


Finally
It's important to keep in mind that any short term gains from government spending must be balanced by the fact that this money has to be paid back, which reduces the amount of money the government has to spend later and forces taxes to remain high enough to pay this debt. So no matter where you fall increased debt should be bad in the long term.