lifestyle leader

What's the deal... with fiscal stimulus? That's the burning question that's on everyone's mind these days - yes, everyone. At least it should be, since most members of the G20 have committed to using some sort of fiscal policy measures to compensate for the increasingly futile efforts of central banks to stimulate the economy. Although most people don't care to know the details of this debate, it matters a great deal: somewhere down the line, you're going to get upset with the government for either a) raising your taxes to pay for wasteful spending commitments or b) raising your taxes/cutting benefits to pay for government deficits induced from earlier tax cuts.

This is why it matters whether our respective governments choose to implement direct government spending or issue tax cuts. We've debated this already, but so far the best summary of both sides of the argument that I've come across can be found on Mark Thoma's website. It's a long-ish article, so I'll provide the core points here:

Rather than compare the benefits of tax cuts vs. govt spending on "bang for buck" (govt spending will win because it adds more to GDP), the quoted article suggests that the two approaches should instead be assessed on 1) the value of increased spending (adv: tax cuts), and 2) the precision of timing (adv: govt spending).
The common argument is that "Unlike the consumer, the government does not reliably spend extra resources on valuable purchases." Examples are not hard to find (cough, Detroit), and politicians are notorious for building roads, bridges and roundabouts to nowhere. In short, there is more overall value in the aggregate decisions of market actors - this is why centrally planned economies fail miserably.

Unfortunately, during times of severe economic uncertainty, consumers are not spending at normal rates and the proceeds from tax cuts are liable to be squirreled away or used to pay down debts. For instance, some members of my office are expecting a lump sum of about $4,000 as a result of some recently-completed union negotiations. Based on my non-rigorous survey of my co-workers, I get the impression that a few are willing to blow it all on a spending spree but most are putting it towards credit cards, etc.

Second, although it's true that governments tend to be more wasteful than consumers, Thoma questions whether market actors are really directing their resources towards things of higher value: "Like purchasing stocks and houses in a bubble, things like that?" Equally, we find roads to nowhere built by the private sector: they lead to abandoned housing construction projects.

The big advantage for fiscal stimulus is that it can concentrate spending on large projects that will last well beyond the economic troubles - projects that may not otherwise have been implemented by the private sector due to market failure, lack of economies of scale, or what-have-you. The counter-argument is that, unlike the make-work projects of the New Deal era, building infrastructure requires much more specialization these days. You can't just hire a bunch of people with shovels. That means the spending will have a long lag-effect before it kicks in - perhaps too late.

It seems that for every good argument on one side, there is an equally good counter-argument on the other side. Tax cutters say that fiscal stimulus is just wasted through "leakage" and that it is difficult to turn off the money tap once it's opened. Fiscal spenders counter that tax cuts are also extremely difficult to reverse and that consumers may choose to spend money on goods made outside the country - a form of leakage on its own. So what to make of all this?

It seems that the best solution is to find creative ways to bring elements of both sides together, perhaps taking advantage of the benefits of both. One idea is to reduce value-added taxes on consumer products, but place an expiry date on the reduction to encourage spending now. Another, which Thoma suggests, is merely to break up a stimulus package into pieces, some of which involves targeted tax cuts and others which focus on projects with high social value.

Sounds good to me.

(First image: lmno4p.org; Second: markybaby.com)