Tuesday, September 7, 2010

Orszag Fails Introductory Macro

Let’s leave aside the larger questions having to do with how and why the US economy got into the current bind—global imbalances, the political economy of investor hegemony, etc.—and look only at the immediate fiscal and employment effects. What’s wrong with Peter Orszag’s suggestion in today’s New York Times that the demands of the short run output gap and long run fiscal sustainability can be met by extending the Bush tax cuts for another two years, but written in disappearing ink, with a mandatory end after that?

Simple: he forgot the balanced budget multiplier. He could accomplish much more of the first goal without any cost to the second by proposing a different plan: end the tax cuts immediately while simultaneously appropriating an equivalent amount of money to a fund that could be spent on various public projects or simply rebated to the states to reduce their own program cuts. If he thinks two years is the magic timespan, he could write in two years’ worth of the revenue increases due to ending the tax breaks. The economics that every introductory students learns, and which is in fact unassailable, should tell him that the stimulative effect of an equal dose of higher taxes and higher spending is greater than the equivalent of reduced taxes and reduced spending. Of course, this difference is even greater in the case of the Bush tax cuts, which were overwhelmingly tilted toward high-income households with a much lower marginal propensity to consume. (And I leave out equity considerations, which are not supposed to infect macroeconomic analysis.)

Note to instructors: clip this op-ed and use it in class after you cover fiscal policy. See how many students can outsmart this former head of the CBO and OMB. I realize this is setting the bar a bit low, but they might still get a charge out of it.


ProGrowthLiberal said...

A temporary tax cut for the well to do who are not likely liquisity constrained! The life cycle model says most of this will be saved with very little aggregate demand impact. The Ricardian Equivalence extension of this model says all of it will be saved with zero aggregate demand impact.

Joe K said...

You say "... that every introductory student learns." I'm sure you meant to say '... that every introductory student (should be) is taught.'

Considering that most of the media appears confused on this point ( 'all the experts say you can't raise taxes during a recession'), I would say very few people actually learned the lesson.

media said...

i find alot of these a bit 'wack'. i prefer to see the actual numbers. i did hear that ending all cuts give the govt 232Billion/yr. if its only ended for those who make more than 250G (people like me) then the govt only gets 15% of that or about 30B. (if people would like some of these hard earned ducats which i fear will face increase taxes due to unjust entitlement spending (most of those people are not hereditary noble laureates) then i have access to several nigerian bank accounts which for a small processing fee/shipping and handling i am willling to give the atm cards to. like 50cent, i'm going to die before i can spend this sh-t which is tragic. )

one could look at what happens if one ends the cuts for 200G, etc.

i also havent seen any rebutal of the statement that 'small businesses' would be the most hurt. do people in small businesses make 250G in personal income? thats the gop talking point.

the same numbers issues apply to social security. p diamond i think and others have done the analyses, but the 'progressivity' of social security seems relatively minimal, especially when one adjusts for mortality. (perhaps high earners should reitre later; make that progressive too----or retire early, but then a low earner gets your job for a few years. that would also level out the issue of indexing benefits to wages.)

alot of this debate seems to rest on preserving status quo innumeracy, possibly because the numerate are all esconsed in CBO etc while the innumerate are at the glen beck rally or equivalent spouting off.

the best system one can describe in words.