Three Key Political Choices in Fiscal Squeeze and Their Consequences

As mentioned earlier, this book focuses particularly on three key political choices bound up with fiscal squeeze, namely the choice of tax hikes as against spending cuts, the choice of whether to deliver the pain in short sharp shocks or in a more gradual and long drawn-out way, and the choice of how to handle the political blame (central to Pierson's analysis), for example, by sharing or shifting decision-making powers or keeping control in the hands of individual parties or elected politicians.

Tax Hikes or Spending Cuts?

If cutting public spending is so hard and electorally dangerous for democratic politicians in the face of political and social pressures, as much of the literature about the alleged 'unstoppability' of public spending growth implies, why don't democracies always choose to tax their way out of fiscal difficulties? In Paul Pierson's classic study of 1980s welfare state retrenchment, one of the biggest contrasts between the Reagan and Thatcher administrations lay in the role of taxation. The Reagan Administration chose to cut taxes, thereby increasing the United States' budgetary deficit and putting extra pressure on federal government spending, while (as we show in Chapter Eight) the Thatcher Government ramped up taxes in a deep recession and later presided over a real-terms rise in tax revenue as a result of North Sea oilfields coming onstream and increased revenue from other sources stemming from economic recovery. And as we show in the next chapter, there are marked variations over the century in the relative weight placed on revenue increases as against spending cuts. Indeed, debate over how much fiscal correction should come from revenue increases and how much from spending cuts often runs hot in politics (as it did after both world wars, in the 1930s and again in the 2010s) and has been much discussed by economists, for example, in preferences expressed for 'spending-led adjustments' by economists such as Hideki Konishi (2006) or Alberto Alesina and Silvia Ardagna (2010) and bodies such as the International Monetary Fund (see IMF (2010) and Pete Devries et al. (2011)).

In political science, there is no clear-cut theory that directly explains how political parties and governments choose between tax hikes and spending cuts. There is an older literature on the political limits of taxation (for example, in the work of Colin Clark (1945)), but modern political science typically explains such choices as an outcome of broader electoral calculations or constraints. One well-established theory is the 'median voter theorem', originally developed by Duncan Black (1958), which assumes that voters on issues of economic policy will ordinarily be arrayed on a left-right spectrum and that political parties aiming for office will therefore compete in the centre ground for what they see as the median voter's preferences on taxing and spending. If that is how parties approach austerity decisions, it follows that median voters will, in effect, decide the balance between tax hikes and spending cuts, that the median voters themselves will experience the least austerity both on the tax side and the spending side (with greater pain being inflicted on the voters at either end of the spectrum, such as the comparatively wealthy and the comparatively poor), and that if they follow this electoral logic, parties of the left will not differ greatly from parties of the right in the austerity they enact.

However, the median voter theorem is by no means unchallenged as an account of how policy emerges from party competition, and different predictions about tax and spending policy on austerity can be drawn from different assumptions. Other theories focus on political tactics to shape preferences (by 'heresthetic' or other means) or on group pressures on political parties and government, in particular on how far concentrated groups, with high stakes in policy outcomes, may be able to press for policy choices from which they themselves receive concentrated benefits, paid for by diffusing the costs among less well-organized groups (Wilson 1980: 357-94). The family of group-based theories includes various accounts of 'capitalist democracy', aiming to explain how democracies are shaped by the interactions between states and markets, and includes Thomas Ferguson's (1994) 'investment theory of politics'. The 'investment theory' argues that what drives party policy preferences is not so much competition for centre-ground voters as the competing interests of the key backers and funders of different political parties and candidates. Applied to fiscal squeeze policies, such an approach would lead us to expect political parties to tailor tax and spending choices to fit the preferences of their key stakeholders, which might mean a bias towards favouring groups other than swing voters, for example in tax treatment of wealthy individuals or spending on services for the benefit of non-median voters.

Further, as we noted in earlier work (Hood, Heald, and Himaz 2014: 6), electoral punishment might be asymmetrical between parties of the right and left, in two different ways. Most straightforwardly, core voters of right-wing parties might be expected to punish those parties more severely for tax increases than for spending cuts, while core voters of left-wing parties might be expected to do the reverse, punishing those parties more severely for spending cuts rather than tax increases.

Against that is the so-called 'Nixon goes to China' phenomenon in politics, based on the famous 1972 rapprochement between the United States and China initiated by a Republican US president, Richard Nixon, who had previously maintained a strong anti-communist stance (Cukierman and Tommasi 1998). On that analogy, parties might be expected to experience less punishment from their core voters in going against those voters' preferences (if their core voters have nowhere else to go), suggesting that in some circumstances rightwing parties might experience less electoral punishment for tax rises than spending cuts, and vice versa for left-wing parties. As we shall show, our analysis here provides more support for the first type of 'punishment asymmetry' than the second.

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