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”
Psi
Will –
Two quick issues:
Firstly “You mischaracterise my argument. I didn’t claim that ALL spending rises would be more stimulative than tax rises.”
I my have mischaracterised what you meant but not what you said. Your statement was infact:
“But as this independent study shows, government spending is the most efficient way to address the low aggregate demand”
I simply added one word all which highlighted how in your argument you were over simplifying the issue. I’m willing to accept you meant that you believe that generally government spending is more effective than tax cuts but perhaps you should be more open to the idea that the situation is more complicated than churning out statements that read like they have come from the Labour party of 1982. If your statements can be parodied be someone adding the word all in them once you argument needs refining.
Secondly in the spirit of accepting what you say may not actually be what you meant perhaps you would reconsider your answer:
“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.”
I did deliberately start with an example that even an A level student would easily see was ridiculous. Particularly the phrase “substantial” too me that would tend to imply a multiplier greater than 2. As anything with a multiplier less than unitary should be considered terrible.
Michael Burke
Will, an interesting piece.
You are right, goverment spending is more useful than tax cuts in promoting growth. And we don’t need to rely solely on the US example to prove it. The Treasury here has also demonstrated it. The Treasury Public Model 2002 shows that, in the first year, the ‘bang for buck’ from a tax cut is 0.3, compared to 1.1 for an increase in government spending. Better, both types of stimulus rise over time so that in year 3 the return is 0.9 for tax cuts and 1.4 for increased spending.
http://socialisteconomicbulletin.blogspot.com/2010/01/investment-not-cuts-by-michael-burke.html
Of course, the Treasury estimates, like Moody’s are just long-run averages, and in current conditions the multipliers are certain be higher.
Dave B
The NY Times had an interesting article on this:
“…Alberto Alesina and Silvia Ardagna have recently conducted a comprehensive analysis of the issue. In an October study, they looked at large changes in fiscal policy in 21 nations in the Organization for Economic Cooperation and Development. They identified 91 episodes since 1970 in which policy moved to stimulate the economy. They then compared the policy interventions that succeeded — that is, those that were actually followed by robust growth — with those that failed.
The results are striking. Successful stimulus relies almost entirely on cuts in business and income taxes. Failed stimulus relies mostly on increases in government spending.”
http://www.nytimes.com/2009/12/13/business/economy/13view.html
Ewan Watt
Do people on the left still claim that the New Deal saved the American economy? I had no idea.
But Will, would you not also say it depends on the value of stimulus you inject into the economy? For example, surely using a surplus – as Keynes advocated – would be a much more robust response to a downturn than financing spending through, well, printing money?
That’s my problem when some folks – I’m not necessarily referring to you in particular – claim that a fiscal stimulus is the answer to all our problems. Furthermore it could even be argued that the UK never had a fiscal stimulus because around 99% of the newly printed money was used to finance existing public spending. On the other hand the Germans actually had reserves – rather than a printing press – to stimulate growth. Funny that, because I’m sure the Germans are aware of what happens when you print money.
Personally I’d prefer the FN/Guido route, but like the United States, can we honestly claim that we’re stimulating the economy whilst destroying our own currency and frightening the hell out of bond traders? I’m also glad to see that some folks – incidentally, often on the right – have a better understanding of Keynes than the Left does. Keynes actually liked surpluses and noted that deficits were only necessary during a downturn. Can we really say that Labour are following Keynes here? One part of Keynes they may well be familiar with is causing inflation that cuts the deficis and attempts to fool the working man into believing that because he’s still in work he’s doing just fine. But as we’ve seen with Jimmy Carter, inflation also pushed the poor into a higher tax bracket – fiscal profligacy has its consequences and they usually hurt the most vulnerable, folks I would have hoped Labour would seek to protect.
Finally, rather than a fiscal stimulus what I’d prefer to see is a real, concerted attempt to sort our banks out. Given the non-existent interest rates it’s near enough impossible for some banks not to be making a profit right now, mainly because they’re failing to pass on these cuts to the taxpayer – that was what exacerbated the Great Depression, not a lack of stimulus. In fact, most banks are actually hiking their interest rates to consumers. Will, I know you’ve often highlighted that when cutting rates fail the only recourse is to enact a fiscal stimulus, right? But what happens when consumers and the population at large fail to get these cuts passed on?
Unfortunately it will be the bond market – rather than politicians – who decide when spending cuts have to start. That’s unless you’re advocating more QE?
Ewan Watt
“…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.”
Are we working on the basis that the road needs to be tarmacked or what? Or are we advocating digging a hole and refilling it for the sake of it?