Wednesday, May 12, 2010

Feldstein v. Thoma on Fiscal Policy and Aggregate Demand

I would have thought Martin Feldstein would better understand the Barro-Ricardian Equivalence proposition:

President Obama proposes to increase tax rates on high-income households while making the existing tax rates permanent for taxpayers below the top tax brackets. While the increase would hit only a relatively small fraction of all households, that group represents a large share of total taxes and of private spending. Raising their tax rates would be a substantial blow to overall spending and therefore to GDP growth.

While it is true that high-income households represent a large share of consumption, the issue is what is the marginal propensity to consume out of a change in disposable income created by a two-year increase in current tax obligations? For households who do not face borrower constraints and would therefore most likely behave in a fashion predicted by life cycle models of consumption, the impact on consumption demand would most likely be very modest at best. The Barro-Ricardian Equivalence proposition would go so far as to suggest that delaying a tax increase needed to restore long-run fiscal sustainability would have no effect on aggregate demand.

Fortunately Mark Thoma offers us this more reasoned assessment of the role of fiscal policy and aggregate demand:

Shifting the tax cuts to people who are more likely to spend the extra money rather than put it into savings would provide an even larger boost to the economy. It's also worth noting that if the worry is about the effect on the economy and the deficit, it would also be possible to allow the tax cuts to expire and then replace the missing demand with additional temporary government spending


r l love said...

The problem is: GLOBAL aggregate demand. Americans consume too much, not too little. Americans over-eat to the extent that they have created a diet-related disease epidemic (while over a billion people around the world are malnourished) and that has left the US less able to compete in the global marketplace due to health-care costs, and at a time when labor costs were already making the US economy less than competitive... And of course Americans consume far too much energy (especially considering what little they produce of any actual benefit). Wealth does not need to be redistributed from wealthy Americans to poor Americans, wealth needs to be redistributed from the global wealthy to the global poor.

Greece, and a long list of other second-tier nations are a good example of just how much downward pressure there is on wages and incomes, globally. The first-tier nations have managed to postpone some of their GDP contractions through a combination of increased gains from financial services, debt, and dubious asset appreciations, although the advanced nations are also dependent on exports to the second-tier nations. As the second-tier nations consume less though, which is unavoidable, nations such as Germany, Japan, and the US, will export less at a time when an increase in exports is their only hope of maintaining the anemic growth that currently exists.

What must occur is a concerted effort among the G20ish to stimulate the global economy through development loans. And the global intelligentsia must make it understood that the 'demographic dividend' is devaluing EVERYTHING THAT CREATES SUSTAINABLE GROWTH. I suppose though that things need to get somewhat worse before the global intelligentsia lets go of the linear thinking. Optimistically though, Mark Thoma did at least get the tax-increases-on-the-wealthy part correct.


Bruce Webb said...

I know the textbooks like to say all that spending is equivalent you have to wonder whether high end consumption has the same multiplier effect as low end. Or whether money spent on fine dining, high couture, jewelry, art just ends up in the hands of people who spend it on similar items with the ultimate beneficiaries being DeBeers, exporters of caviar and wine, owners of Carrera marble quarries, off shore casinos, and perhaps not least the Columbian drug cartels.

Other things being equal injecting money into a given economy should have reasonably equivalent effects. But billionaires and people on unemployment don't live in the same economy, money spent out of that unemployment check will almost always move upwards to it's final resting place (which may be Sam Walton's kids) but whatever multiplier effects are likely to show up in the form of wages and hence payroll taxes, where a billionaire purchasing that Picasso for $106 million not necessarily having any domestic multiplier at all.

Surely the real world incidence of actual spending should be taken into effect??

TheTrucker said...

For Blogger r l love:

Malthus was correct. The third world societies must learn to keep it in their pants if they are to have prosperity. Most of the problems are caused by the pursuit of economic rent by those of power. Organized religion and neoclassical economics based government are the two rent seeking wellsprings of poverty. I have no desire to give up my prosperity to enable the procreation of religious nut cases in or out of government. We are running short of air, water, and energy. But of people we have plenty.

This idea of taxing the rich to aid the poor is economic suicide unless the poor stop their breeding. Lyndon Johnson already made this mistake. He said "Poverty breeds poverty" but he did nothing to arrest the breeding. Feeding poverty is a lost cause if not done with an eye toward birth control. Giving people more money for having more kids is rather stupid.

For Bruce Web:

Imports and oil should be heavily taxed in the USA and the proceeds of these taxes directly redistributed to the PRODUCTIVE bottom of the economy. The same is done with taxes on the rich. That sort of taxation is a tax on accumulations of money. If such accumulations are not taxed then the common people will inevitably be enslaved by the overlords as they have been over the last 30 years of neoclassical trickle down lack of respect for environmental limits.

At this point government and the banking system have injected ten trillion bucks into the world economy and not yet reclaimed any of it with taxation. That is the size of the "national debt". A large amount of reclamation must take place to balance the economy between the producers and the overlords. The amount of money in the economy far exceeds the value of _REAL_ capital.

A recurring but passing though on this is the institutionalization of a 100% reserved banking system funded by an exchange of T-Bills for bank deposits.

If the rich are to ?earn? money they will be forced to invest it as opposed to being rewarded for loaning it to the people that protect their financial position. Meanwhile, government can still CREATE money in order to maintain a reasonable rate of inflation and offer real opportunity to those who want to be productive.

I would think that this sort of alteration plus the rent of natural resources would be more than adequate to maintain a viable (non imperialistic) government. Moves in this direction are not bad moves.