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.
33 Responses to “Finking about stimulus”
Will Straw
Thanks for the comments. It’s a fascinating debate. A few replies:
David – Completely agree.
Giles – whether we need more spending rises right now is a different debate. I was just outlining that those who support deficit-financed tax cuts must not rule out deficit-financed spending increases.
Psi – You mischaracterise my argument. I didn’t claim that ALL spending rises would be more stimulative than tax rises. The chart I reproduced clearly shows that there are different multipliers. And you’re wrong about your example too: Who would doing the tarmacing and where would the tar come from? The money going to those workers and companies would trickle back into the economy so you would get a substantial mutliplier effect. The point is that there would be better ways to spend that money just as there are better ways to spend money than tax cuts. The central point of my argument was that if you conceded that deficit-financed tax cuts can help the recovery, you have to also accept that well targeted spending rises do the same.
Mark – I agree that the US numbers will, at the margin, be different but a similar exercise in the UK would yield similar results and show that both well targeted spending and tax cuts are stimulative – an argument that the right are keen to ignore. As to mine and Guido’s economic knowledge, he was a successful trader for a number of years so I do happen to respect his take on these matters. For my sins I covered economics in both my undergrad and graduate degrees before working on economic policy at the Treasury. So perhaps Guido and I are a bit Cantona and Mourinho discussing stoicism.
Mark
Will, sorry if that was personal but this is not yet the economists forum of the FT. Although a successful stint as a trader does not guarantee economic wisdom, although perhaps “Guido” had some clever insights, who knows.
Like I say, we can’t look at the UK’s spending in isolation, you must consider the funding question. The markets are keen to pick a new whipping boy, for appearances sake at least the UK needs to avoid giving speculators ammunition for an attack. This would be ruinous, we can’t discount the event.
So like I say above, there’s nothing wrong with targeted spending but the government is doing the opposite of what is necessary for long term growth. Spending on the NHS and other areas is “ring fenced” but net investment gets slashed, the reverse of the argument above. Now we get into another political debate but if there’s no economic growth in the future, we can’t fund the NHS as well. Spending should go to where it delivers the greatest gains at the margin but the government is doing to reverse. Indeed it looks like spending is being directed towards where it delivers marginal electoral gains, these are short term and cynical.
lee james brown
@leftfootfwd shows that best way to stimulate economy is by gov spending. http://tinyurl.com/yhfoy83 Treasury figures show the same.
Bearded Socialist
we’re not highly taxed, compared to other countries. Compared to somewhere where no one pays tax, only then are we highly taxed
David
“…you’re wrong about your example too: Who would doing the tarmacing and where would the tar come from? The money going to those workers and companies would trickle back into the economy so you would get a substantial mutliplier effect.”
Ah, the broken window fallacy rears its head again…