Tax cuts, not bailouts

Topics: Regulation
29 Dec 2008

From: Ervan

Even many conservative economists are arguing the government should act
to prevent an over correction as leverage unwinds and spending
contracts. I remain skeptical, for reasons mostly already discussed.
But if action is necessary, then monetary policy and tax cuts (without
spending cuts) are to be preferred to new spending. The Democrats have
it wrong of course (with Obama not yet clearly committed).

Here are some excerpts from professional economists arguing against the
spending part of the bail out. Most of these links came via Mankiw's
blog (which Vince pointed out to me).


> The ad hoc aspect of the bailout created a precedent [...] It has
> become increasingly apparent that the market doesn’t know what to
> expect and that many financial institutions are sitting on the
> sidelines, waiting to see what regulators will do next. Regulatory
> uncertainty is stifling the ability of financial markets to engineer
> at least a partial recovery. [Cowan, 1]

> Such a reassesment indicates that countercyclical fiscal
> policy should focus on the automatic stabilizers rather
> than discretionary actions. [Taylor, 8]

Government spending is inherently wasteful:

> Tax cuts enable private individuals to make spending decisions about
> more of the money they earn, which would help spur recovery in several
> ways. Private individuals are likely to be more careful with their
> money than politicians. Private individuals stand to gain from good
> spending decisions and lose from bad spending decisions. By contrast,
> there seldom seems to be any effective consequences for politicians
> who squander other people's money [ CATO/Powell, 2, and many other
> goods reasons at this link]

Avoiding political torque on businesses:

> [regarding federal reserve policy to stimulate the economy ] The cash
> comes in the form of loans. It entails no new government enterprises,
> no government equity positions in private enterprises, no price fixing
> or other controls on the operation of individual businesses, and no
> government role in the allocation of capital across different
> activities. [ Lucas, 3]

Government waste from a different perspective:

> The moral of the story: If the government spends a fiscal stimulus
> package on goods and services without much public value (as in Case
> C), it could well stimulate the economy as measured by macroeconomic
> aggregates but leave the participants in the economy worse off
> [Mankiw, 4, the full article has a nice example of how this can
> happen ]

The macroeconomic evidence is not there for spending:

> My point is simple: it is very hard to find examples of successful
> fiscal stimulus driving an economic recovery. Ever. [ Cowan, again,
> in a different post, 5]

The macroeconomic evidence is there for tax cuts:

> conclude that the government spending multiplier is about one ...
> [another study finds 1.4] ... concludes that the tax multiplier is
> about three: A dollar of tax cuts raises GDP by about three dollars.
> [ Mankiw, 6, with numerous caveats about the quality of the data ]

Or maybe for sales tax cuts instead:

> Monetary policy can only a small further contribution. Income-tax
> rebates seem to have little support and would probably have relatively
> small effects within the year, with undesirable continuing effects in
> later years. We are enthusiastic about removing sales taxes for the
> year and perhaps somewhat longer, with a phaseout [7]
What I find curious about this one is that they mostly criticized rebate
checks, which are shown not to work, but didn't directly address a
longer term tax cut. A previous article argued that a tax cut is
preferred because consumers have an expectation of it lasting a while
and thus spend instead of save it.

There are certainly plenty of professional opinions in favor of a
spending bailout too, but it's not the obvious good idea it's made out
to be.

[1] Tyler Cowan,


[3] Robert Lucas, Nobel Laureate,

[4] Mankiw,

[5] Cowan,

[6] Mankiw,

[7] Woodward and Hall

[8] John Taylor,

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