Tuesday, December 30, 2008

Jeffrey Miron’s Preference for Ineffective Fiscal Policy

Jeffrey Miron claims:

Is a fiscal stimulus good policy? The answer is no if the stimulus consists of increased spending. The stimulus may be good policy, though, if it consists of lower taxes.

We will likely hear this slogan a lot from conservatives over the next few weeks. Miron’s argument against increasing spending goes something like this:

If the new spending is for projects that are beneficial for society overall, and if the private sector cannot or will not undertake these projects, then the expenditure is worthwhile independent of what it does to fight the recession. A standard example might be repair of the interstate highway system ... Even if certain components of the nation's spending are too low, nothing guarantees that new spending will be directed to these areas. Instead, experience suggests that much will be for repairing "bridges to nowhere," especially those located in the districts of influential legislators. The Keynesian argument for a spending stimulus does not, of course, assume this spending is for projects that have economic or social value. The theory, in fact, suggests that digging ditches and then filling them up is effective at stimulating the economy. This cannot make sense in the long run; government spending must be paid for with taxes, so it ultimately comes at the expense of private spending. Projects that do not make economic sense are then pure waste. Yet the history of government spending indicates the stimulus package will include countless zoos, aquariums, museums, parks and other pork barrel projects for which the private demand does not come close to justifying the investment. In many cases, these projects will persist for decades.

If Jeffrey Miron is worried that the new Administration is about to push for a bunch of pork barrel projects, maybe he should talk to Lawrence Summers. So let me address instead Miron’s faith in tax cuts as the cure for our lack of aggregate demand.

Tax cuts also stimulate demand via the standard Keynesian channels of increased disposable income for consumers

The underlying Keynesian premise for short-term fiscal stimulus is that we need to accelerate aggregate demand but eventually aggregate demand will be restored either through more consumption (public or private) or more investment. When Miron talks about government purchases crowding-out private spending, he is referring to the period known as the long-run and not the short-term concerns that will be the dominant macroeconomic theme for 2009. If one is a believer of propositions such as the life cycle model of consumption or the Barro-Ricardo equivalence proposition, one would dismiss out of hand this notion that we can accelerate aggregate demand by passing a tax cut today that will one day have to be financed by a tax surcharge. I should hasten to add there are a couple of ways of addressing this critique of tax cuts – one of which Miron hints at:

For those who advocate smaller government, the case for a tax cut is easier; short-run increases in the deficit are not a major concern if government should be smaller (and can eventually be reduced in size) in the long run. If the level of spending is too high, the U.S. can have its cake and eat it too: cut taxes now to improve efficiency and stimulate the economy and cut spending later to balance the budget.

Of course, this smaller government canard was a rational for the 1981 tax cut and almost every Republican call for tax cuts since. But even when the Republican Party dominated fiscal policy decision making, we never saw any significant reduction in the size of the government.

Some Keynesians would argue that the life cycle or Barro-Ricardo equivalence models of tax cuts and consumption ignore the fact that some households face borrowing constraints. On this score, Miron might consider what Philip Rucker reported yesterday:

President-elect Barack Obama’s economic stimulus plan will include an immediate tax cut for middle-class families

In other words, the plan is to give tax cuts to those who may indeed be facing borrowing constraints. I guess Miron might complain that President Obama intends to make these middle class tax cuts permanent by increasing taxes on the wealthy – who likely do not face borrowing constraints. But the redistribution of the tax burden is not likely to have much of a net effect on aggregate demand. Simply put – I do not see how Miron’s call for tax cuts will have as much bang for the buck in terms of accelerating aggregate demand as the set of fiscal proposals being advanced by the President-elect’s economic team.


TheTrucker said...

I am soooooooooooooooooooooooooo sick of the "tax cut" garbage that I could puke. It matters what or who is taxed and it matters what is done with the proceeds of the tax. Fiscal reality exists somewhere BETWEEN Keynes and Hayek.

I am very much enamored with the fundamentalism of Henry George as a counterbalance to Austrians and Marginalists (neoclassical nutters).
The Macro pretenses of the Marginalists are simply a means to bury the efficacy of taxation as applied to economic rent.

In addition, current trade realities and environmental concerns should also play a role in the shaping of fiscal policies. It is simply not just a macro argument when one speaks of fiscal policy. The Fed's tinkering with interest rates is much too blunt an instrument to address the real issues. And on the "fiscal" side an increase in the progressive nature of the income tax (which is primarily a tax on economic rent) is still lacking if we are concerned with government playing its proper role.

The carbon tax and rebate system is a marvelous example of the role that government should play in "steering" the economy. A possible example is a $25 a barrel excise tax on oil with every nickel of the proceeds used to create a quarterly "stimulus" shaped exactly like the stimulus we had early this year. Such a tax and rebate system will, in fact, stimulate the economy while making alternative fuels and more efficient autos more competitive. This is in the middle of macro and micro in that the government does not attempt to directly subsidize particular winners and losers. Whether electric cars or hybrids or ethanol or bidiesel or solar or wind. All of these efforts are given a competitive boost by increasing the price of gasoline while protecting the consumers.

This is also true for the "tariffs and corporate tax cuts" formula. This little jewel relies on competition to pass the tax savings through the corporations to the consumers. If there is no "monopoly problem" then the consumers receive a rebate of the tax just as they would have if the proceeds were distributed in the example of the tax on oil (or carbon vouchers or whatever). The other advantage is that a lower corporate tax encourages more business in this country as opposed to another. The combined effect of the tax shift from corporate income taxes to tariffs dramatically reduces capital flight and offshoring.

A tax is not just some monolithic macro move as is an interest rate cut at the Fed.

Anonymous said...

I also am sick of the "tax cuts" garbage.

I thought that Keynes's theory stated that during recessions, private parties retain their money instead of spending it (a wise choice individually but the aggregate effect was harmful). Tax cuts would just allow private parties to save/hoard more money, which seems to be the worst possible approach ! Not to mention the past 8 years of real world testing of his theory (did growth rates during the extremely short Bush "expansions" even reach the average growth rate under Clinton ?

On the subject of gas taxes, why not impose gas taxes to get the price of gas around $4 per gallon, accompanied by a tax credit (for people with incomes under the Social Security cap) to offset those higher taxes. There should be no net tax increase on people whose incomes are less than the Social Security cap but that price will change their gasoline usage ! The tax credit should be based on average miles driven to further encourage people to reduce their gasoline usage.

TheTrucker said...

The taxation of carbon/gasoline/oil and the granting of a tax credit is logistically difficult. It will easily be attacked by rightards as yet another example of government bloat.

Even if the proceeds of the tax are redistributed equally to all persons who have filed a tax form the conservation of gasoline would still take place and the subsidies to ethanol and biodiesel could be removed. This is a reduction in government bloat. The rebate system is simply much more "eloquent". For the righties it will reduce the size and complexity of government. And for those of us who believe in fairness, it obviates the pork barreling and favoritism practiced by the crooked politicians.

But no matter what is done the oil companies will enlist the commercial users of liquid fuels in an all out war on carbon fuels excise taxation. The truckers and the cab drivers will be used as the pawns in this game somewhat like "Joe the Plumber".

Although there are protections of owners such as the "fuel allowance" paid by shippers of long haul freight, at the margins more freight will by shipped by rail as opposed to truck. More people will opt for the "airport shuttle" as opposed to a cab. Each cabbie and each truck driver is not harmed significantly, but the cab and trucking companies are. It will be "Harry and Louise" all over again.

High school econ is the only real answer.