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
Ewan –
If you read my example, (deliberatly ludicrus, to make it east to understand) I was suggesting tarmacking a distant area of Scotland (not even roads) where there would be no demand for the increase in tarmacked area and destroying the tourism industry. Will, apparently, thinks it will have a “substantial” multiplier effect, but I hope he has mis-stated his view on this. We’ll find out when he replies.
Ewan Watt
Psi – sorry mate, I wasn’t deliberately mocking your example – I was just looking for folks to try and defend how this often cited “stimulus” programme would actually aid the economy. Y’know, public works etc… We could also have referred to the broken window or throwing gold down a mine shaft, filling it up with concrete and giving unemployed folks pick axes…
I see plenty of this stuff in the US – the “stimulus” has been used to maintain airports or stations that nobody uses this anymore. How is that productive? And I would imagine that most of these studies that advocate a stimulus are based on the presumption that every dollar – or pound – is targeted. But when you spend almost $1tr, that’s just impossible.
marcus Aurelius
How’s that “No more boom and bust” thing workin’ out for ya?
Will Straw
I’m glad this has provoked such a good debate. And apologies for taking a while to come back. Some thoughts:
Mark – I didn’t take it personally at all but thanks for saying so – just a bit of light ribbing. Of course, you’re right, it would be disastrous if the bond markets stopped funding the deficit but we’re not there yet and the judgment of the 67 economists is that cutting in 2010-11 raises that risk.
David, Psi, Ewan – I’m not suggesting that the best policy would be to tarmac rural Scotland or to fill in holes for that matter, of course not. But there would be a multiplier higher than zero (and probably close to 1 given the raw materials and labour costs). Reading your earlier comment, I think we atually agree on different policies having different multipliers (the reason I reproduced that table). My contention was that, on average, well targeted spending projects will have higher multipliers than tax cuts. As Giles points out, this is particularly true when the savings rate is rising.
Josh – You’re priceless. To paraphrase: you can’t trust any economists apart from the ones I agree with”
Marcus – Giles Wilkes is good on why there is still a deflationary risk. See here: http://freethinkingeconomist.com/2010/02/16/ive-been-waiting-for-this-inflation/
Ewan – Agree with you on the banks but we can walk and chew gum, no?
Marcus Aurelius
I wouldn’t pay that much attention to state employed economists. Remember the 1981 budget, which turned conventional wisdom on its head by raising taxes sharply despite the fact that the economy was in a deep recession?
Many in the Treasury objected, as did 364 British economists who signed a celebrated letter predicting that the budget would condemn the economy to a prolonged depression.
The 364 economists were discredited when the budget led the way to the long economic upturn of the 1980s. Professor Sir Alan Walters’s critics had missed the reason to raise taxes – to allow interest rates to be cut sharply. Interest rates are a key driver of UK economic performance because of the huge amount of debt – including mortgage borrowings for houses – dependent on short-term interest rates.