Saturday, February 28, 2009

Crowding-out for Spending Increases but Not Tax Cuts?

Lori Montgomery plays Steno Sue for the GOP:

Republicans quickly attacked the document as a recipe for economic disaster, saying it would raise taxes on businesses and consumers in the middle of a recession in order to bankroll a massive government expansion. "The era of big government is back, and Democrats are asking you to pay for it," said House Minority Leader John A. Boehner (R-Ohio). "The administration's plan, I think, is a job killer, plain and simple." White House budget director Peter Orszag rejected that analysis, saying none of the tax increases would take effect until 2011. But some economists worry that even in 2011 the economy may be too fragile to absorb a tax increase. Meanwhile, some Democrats joined Republicans in complaining that the budget plan does not go far enough to narrow the yawning budget gap.

Dean Baker objects to this nonsense:

While no economists are identified with the view that President Obama's tax increases on the wealthy in 2011 will harm a fragile economy, the article does not discuss at all the economic impact of the cuts in spending that "some Democrats" and Republicans apparently favor. The multiplier for almost possible spending cuts would be considerably larger than the multiplier for the tax increases on the wealthy. Any economists who were concerned that tax increases in 2011 could harm a still weak economy would almost certainly be much more concerned about the prospect of spending cuts in that year.

OK – this is the standard Keynesian view but we are seeing a parade of folks on display at this blog who would tell you: (1) the multiplier for tax cuts is indeed high; and (2) increases in government spending completely crowd-out investment even during periods of unemployment. After all, the Treasury View is what must be taught to their graduate students. Of course, all real economists know the Treasury View does not hold when fiscal stimulus comes in the form of tax cuts for the rich – right?


Anonymous said...

Increase in military spending do crowd out other uses of the resources employed. Seymour Melamn and President Eisenhower both say that.

The product of the warfare state does nothing and takes resources from uses that should help citizens, like building bridges or levees.

Now deifcit spending only moves rich peoples' saving from "investments" to T Bills, which are the same effect as collecting the money from the wealthy as taxes only they keep the principal and get interest.

It goes both ways.

wellbasically said...

I'm not going to argue for crowding out... I just hope you're not claiming that because the crowding out crowd is wrong, the spend spend spend crowd is right.

Deficit spending however is just another form of investment. If you can claim that building a road from "A" to "B" will result in higher incomes for the people of "A", and so pay off the cost of the road and the interest in higher tax receipts down the years, then ok. However if it won't pay off, then you're going to have a tax increase to pay for it, and that's depressive to the economy.

If deficit spending for multipliers worked, why not just deficit spend $10 tril next year if it's going to multiply 1.5 according to the Mark Zandi quote machine. It's a perpetual motion machine.

Eleanor said...

The part of crowding out I don't understand is, how does government spending crowd out private spending, when the private sector has no interest at all in investing?

wellbasically said...

The story is that government spending soaks up the cash in the banking system, so private investors have to pay higher interest rates to borrow.

Will anyone ever write a history of mistaken ideas, one after the other? My guess is that "crowding out" was born because Keynesian stimulus spending didn't work as advertised and somebody had to come up with an explanation for its failure.

Will Hayes said...

wellbasically is wrong on at least her last point.

Keynes discussed crowding out extensively. The crowding out theory was the dominant economic theory before the 1930s. keynes argued that because the multiplier effect was roughly 4, government spending more than compensated for any crowing out effect and the serious threat of higher interest rates.

Current research pegs the multiplier effect at around .5 for government spending:

Lerner at Harvard pegs the multiplier at about .7 but the multiplier for venture capital spending at around 8. Nice gap. According to that research, every dollar the government spends actually costs us over seven dollars. That perpetual motion machine sucks.