The position of Fraser Nelson and Guido Fawkes on deficits should hearten the left. Tax cuts are stimulative but spending rises even more so.
Keen blog readers will have been following the fascinating debate over deficit-findanced tax cuts between Danny Finkelstein on the one hand, and Fraser Nelson and Guido Fawkes on the other. The left should be heartened by the latter’s position.
Yesterday, Finkelstein, the fiscal hawk, wrote: “If the Tories were now to cut taxes immediately upon on entering office, what would happen? It would, erm, destabilise the economy, wouldn’t it.” Guido responded:
“bond traders understand that a growing economy supports their coupon payments, whereas a flat or contracting economy is a greater sovereign credit risk. A growing economy can afford to finance a budget deficit if necessary. An over-taxed, low to no growth economy can’t. High taxes, and Britain is a high tax economy after 13 years of Gordon, destabilise the foundations of a strong economy, driving enterprise into the ground or overseas. Guido remembers when this was ideologically core to Conservative thinking, it was when they won elections…
Today, the Fink replies:
“He is forced into that position by his view, cogently and frequently advanced, that tax cuts should always be proposed since they force the state to cut spending.”
But that’s not quite right. Guido does want tax cuts to be offset by spending reductions but, recognising that spending cuts are politically tricky, believes “in the realm of lesser evils” that deficit-financed tax cuts are stimulative. And he’s right – but spending rises are even better.
During the stimulus debate in the US, much was made of Congressional testimony by Mark Zandi, the Chief Economist of Moody’s Economy.com, an independent provider of economic analysis. In this updated report assessing ‘The Impact of the Recovery Act on Economic Growth‘, Zandi outlines the “bang for the buck” from different aspects of the US fiscal stimulus. While some tax cuts delivered increases in GDP beyond the amount pumped back into the economy, it shows that spending increases were the most efficient form of deficit spending.
The key to recovery is growth. Some tax cuts – like the Government’s VAT cuts or Obama’s tax rebates – can play a stimulative role. But as this independent study shows, government spending is the most efficient way to address the low aggregate demand that typifies the current recession.
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33 Responses to “Finking about stimulus”
Giles
I was actually a pretty big fan of the VAT cut as it was hard to save, like an income tax rebate might be. I’m glad that Guido thinks the income tax ideas of the liberal democrats would be stimulative. I am slightly surprised he thinks stimulation is what we need, when he is already worried about inflation. If people think inflation is about to happen, then they must think demand is bumping up against supply.
but perhaps the view is: you increase the supply potential of the economy by lifting these tax levels. but then you would also increase rates if you allowed your deficit to bloom , wouldn’t you?
On the nelson-fink debate, I suspect nelson is wrong, because fink is a seriously brainy guy. And has probably read the history; if you read N Lawson’s closely detailed account of 1979-89, you find that Mrs T was frequently very cautious, backed down a lot in the beginning, held back for silly political reasons from rational reforms. Nelson has a cartoonist idea of Mrs T. Read the history, I say.
I would not personally call for spending rises right now. I would rather deploy QE money in the real economy, ease some financing strains that are holding back some investments. We have a 13% deficit, and control over our own currency. One is a weakness, the other a strength….
Psi
Will –
no you are wrong, your economic understanding is stuck somewhere in the 1960s. To suggest that ALL spending increases are more economically effective than ALL tax cuts would have shown you to be ignorant 40 years ago but to do so now is inexcusable.
The report to which you refer is one about an American plan which spent money on particular projects and cut taxes in particular ways. Any spending project or tax cut will have a different multiplier effect.
For example it would be possible to spend a great deal of money laying tarmac over the entirety of Ross and Sutherland but the multiplier would be considerably less than 1 (probably very close to zero).
Where as if you were to spend that putting a heated extra runway at Gatwick (leaving aside environmental issues for the moment) with a high speed rail link from several London locations (Canary Wharf, London Bridge and Victoria for example) the multiplier would be higher.
If you were to spend the money improving literacy and skills in areas where those are particularly poor the multiplier would be higher still.
As to tax rises, again not all will have the same effect the effect of raising the tax free threshold would have a much larger multiplier (more stimulating) effect than the same amount of money spent on reducing the top rate.
@ David Coats
Do you understand Keynes? He advocated running up a deficit during falls in aggregate demand but then when growth returns you have to run large surpluses.
If you do understand this basis concept I assume you were equally critical of Gordon Brown for running deficits (or, very rarely, small surpluses) when he was chancellor and the economy was growing? He clearly should have been running huge surpluses given the level of deficits runs now.
Additionally Economic understanding as moved on considerably since the time of MacMillan, for example the huge QE process (based upon understandings derived from Friedman’s work). There would have been very little monetary stimulus if we did as you suggest and stop economics somewhere in the 1950s.
The Tory economic position may be laughable, but they seem to stack up quite well against the sort of criticism they receive from places like this. Perhaps intelligent comment is not what this blog exists for (feels rather like a site intended to preach nostalgia to the converted) then perhaps you should dump any pretence of being “evidence based.”
Mark
I’m not sure about Will Straw and Guido Fawkes discussing economics, it seems a bit like two Premiership footballers discussing Stoicism!
Anyway, for what it’s worth, you can’t view the spending in isolation. The money has to come from somewhere and the funding issue is critical for the UK.
As we see today the government is borrowing record amounts. As a result of today’s shocking borrowing news the spread on British debt is at the same level as Portugal, not a flattering comparison, we are supposed to be a G7 member, not an agrarian peripheral member of the Europe. Unlike the US, Britain does not have a reserve currency and its economy is far more dependent on one sector, finance to drive output.
Besides, analysis of the US economy does not always match the UK. But let’s assume it does, for the sake of argument. If so, then why is the government cutting back in the areas where spending at the margin delivers the biggest “bang for buck”? The FT’s Martin Wolf puts it better than me “the parts of public spending that sustain the long term health of the economy should not be sacrificed. Yet that’s exactly what the government is doing: net investment is being slashed from 3.5% of GDP in 2009/10 to 1.3% in 2013/14.” As usual, Gordon Brown is getting it all wrong.
Ellie Gellard
another good'un frm @leftfootfwd .Some tax cuts can stimulate economic growth,but Govt spending does it better. http://tinyurl.com/yhfoy83
Thomas Byrne
I actually agree with this piece, in that Guidos position is idiotic. (Re: Tax cuts funded by borrowing, but obviously not Left Foot Forwards conclusions.