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.
