I spent much of this week hoping that this horrible stimulus bill would not pass — that our president would prove sensible, would calm the Democratic hordes in the House and rewrite the bill in a way that would, you know, actually stimulate the economy. Instead, we are relying mostly on a Keynesian multiplier that may or may not happen (the idea that every government dollar spent will trigger more dollars spent). Much of it will not happen immediately, much of it is not terribly important (government building remodeling projects) and the tax cuts are small and one-off things.
This strikes me as a huge missed opportunity. Obama promised a tax cut to 95% of Americans. How about cutting a big chunk of the 25% tax bracket down to the lower 15% level? And the 28% down to the 25% level (or, heck 15% — a flat tax!)? This would immediately have put more money in the hands of middle-class Americans and broadly encouraged more work (in America, we rarely choose leisure when we make more money — kind of a strange phenomenon, but true). It would be easy to understand, systematic, and the government would not be picking winners. And it wouldn’t even involve tax cuts for the “rich,” which would be politically unpalatable.
As it is, the current stimulus brings to mind a dysfunctional couple that has struggled with debt in the past. It all comes crashing down around their ears. And so, they talk to each other about cutting back, doing without, living within their means. One party starts saving. But then the other looks around and decides to do something. Not a horrible impulse if it involves, like, getting a second job. But, alas, no. This partner decides that the bathroom needs remodeling. And goes out and spends big bucks on that — but not just that. Also an Oriental rug for the entry way, repaving a driveway that doesn’t need to be paved, new $400/yard designer wallpaper for the entire basement where no one goes, plus a shopping spree for clothes no one really likes, but since you’re spending money… I mean, yes, in theory, some of this could raise the price of the house when you eventually sell it, and some will make you feel better. If you feel better, you might, eventually, earn more money. But you’d think this particular partner had a major problem. And you would be right.
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Laura Vanderkam is the author of 168 Hours: You Have More Time Than You Think (Portfolio, 2010) and Grindhopping: Build a Rewarding Career without Paying Your Dues (McGraw-Hill, 2007). She is a member of USA Today's Board of Contributors, and her work has appeared in Reader's Digest, Scientific American, Wired, The American, Portfolio and other publications.
Write to her at lvanderkam at yahoo dot com.
Hey Laura,
I like your metaphor, the dysfunctional couple… but I think it is flawed. Government can’t be compared in this way to a family or a business. Government can pull a vast amount of resources and with them affect the economy. Families, during difficult time, should save. Government should NOT. This is not the time to balance the budget.
Now, regarding spending vs. tax cuts: obviously, I am not going to convince you that spending is better than tax cuts, nor I think you are going to embrance Paul Krugman’s view (forget for a moment that he is a liberal). But oh well, you’ve got to accept that the Novel prize in economics knows a great deal better than most of us.
So here Paul Krugman’s words: http://krugman.blogs.nytimes.com/2009/01/31/another-temporary-misunderstanding/
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Another temporary misunderstanding
Brad DeLong links to Megan McArdle saying something wrong about the effects of a temporary increase in government spending. But he fails to note that it’s not just wrong, it’s 180 degrees wrong: a temporary increase in government spending should have a larger impact on demand than a permanent increase, not a smaller impact.
And that’s actually an important point: one way to explain why government spending is better than tax cuts as a stimulus is to say that temporary tax cuts aren’t effective at increasing demand, but temporary spending increases are.
Here’s the logic (which follows directly from Milton Friedman’s permanent income hypothesis, by the way): suppose that the government introduces a new program that will cause it to spend $100 billion a year every year from now on. To pay for this, it will have to raise taxes by $100 billion a year, permanently — and if consumers take this into account, they might well cut their spending enough to offset the increase in government purchases.
But suppose the government introduces a one-time, $100 billion program to repair bridges over the next year. The government will have to issue debt to pay for this, and will have to service that debt, requiring higher taxes — say, $5 billion a year. That’s a much smaller impact on consumers’ future after-tax income than the permanent program. So much less of the spending rise will be offset by a fall in consumer demand. (I’m not considering the effect of the spending in raising income, which would probably cause consumer demand to rise rather than fall.)
So economic theory — Milton Friedman’s theory! — says that spending is a more effective form of stimulus than tax cuts.