Tax cuts help the economy more than spending in a recession
As we continue to debate the impact of the economic stimulus package passed in 2009, and subsequent “jobs bills,” we should look at what Barack Obama’s own economic advisor, Christina Romer, once noted about tax cuts as an effective tool to fight a downturn (emphasis mine):
Underlying the debate is a long-running argument about how much of a lift the government gets from spending more or taxing less. Keynesians argue that when the economy is distressed, a dollar spent by the government multiplies in value. It gives a worker income the private sector has failed to produce, which he spends, creating demand for goods and services.
Ms. Romer argued last year that this “multiplier” for government meant every dollar spent created about $1.50 worth of demand.
Some economists say that’s too high. Valerie Ramey of the University of California at San Diego, initially thinking as a Keynesian, developed doubts after sifting through historical examples. During the military build-ups of World War II, the Korean War and the Reagan era, a dollar spent added roughly a dollar of growth, she says. Although Ms. Ramey supported stimulus in 2009 because the economy was so weak, she doesn’t advocate more now. “We just don’t have enough evidence to prove that it’s good.”
Robert Barro, a Harvard economist, found even smaller multipliers: A government dollar spent creates about 80 cents worth of growth, or possibly less, he says. Government spending, he says, crowds out private sector spending that would otherwise be taking place.
Keynesians say other things were happening at the same time as military build-ups that muddy the results. During World War II, for instance, consumer goods were rationed and Americans were exhorted not to spend.
Economists who say Mr. Obama should have relied more on tax cuts cite research of an unlikely source: Ms. Romer, his adviser. In a study she and her husband, David Romer, conducted before she joined the administration, Ms. Romer found large multipliers from tax cuts, which she concluded “have very large and persistent positive output effects.” Tax increases, she also found, hurt growth.
Two things about this. The first being, why weren’t tax cuts, and I’m talking about real cuts in tax rates not meaningless tax credits, passed since they have have a postitive effect on the economy, as Romer notes?
Secondly, she points out that tax hikes hurt the economy, yet President Barack Obama and Democratic leaders in Congress are refusing to do anything about the expiration of the Bush tax cuts at the beginning of 2011, which will hit all taxpayers hard next year. But, ideology and demagoguery are more important that good economic policy.