Thursday, May 09, 2013

Odd "logic"

The NYT this morning (and echoed by the WP in Wonkblog) made the point that the "austerity" caused by the sequester's cuts of about 2% of the budget has started to have negative effects from slowing growth, to lower levels of employment, to perhaps even increased toenail fungus (although the last claim is not made explicitly).

The Times is pretty explicit in their claims -

"Hardly a day goes by when either government analysts or the macroeconomists and financial forecasters who advise investors and businesses do not report on the latest signs of economic growth — in housing, consumer spending, business investment. And then they add that things would be better but for the fiscal policy out of Washington. Tax increases and especially spending cuts, these critics say, take money from an economy that still needs some stimulus now, and is getting it only through the expansionary monetary policy of the Federal Reserve."   And they've got some pretty impressive support from all those economists in DC (whose livelihood depends on supporting government) and from folks on Wall Street like Moody's (that did such a great job in analyzing collateralized debt obligations and other fairy tales.

So let's review the logic of this claim.   The issue is whether increases in government spending actually improve answers for economic growth.

The question is if you take money from Peter to pay Paul or to build shovel ready projects or to increase the number of government employees or to loan it to dubious projects like Solyndra whether you get a multiplier effect - $1 becomes $2 as it flows through the economy.

An Alternative View by John Taylor based on policies which 
would reduce the size of government spending - i.e. what the 
Times does not like.
The economics evidence on this is exceedingly mixed.  The Keynesians argue that this kind of diversion helps the economy grow more quickly.   But the evidence is not on their side.   A number of re-evaluations of the policies of FDR suggest that his dithering actually impeded recovery.   The multipliers in the literature run from something like .6 to 1.5 for spending - which means that if you spend a dollar in the public sector the resultant benefit is either equal to 60¢ or $1.50.   My guess is that the 60¢ is more accurate the Keynesians would argue that it is closer to $1.50.

But there is another part of the equation and that relates to increasing taxes.   The recent tax increase(s) also have an effect on the economy.   Every wage earner had a 2% decrease in take home when the silly FICA reduction was not renewed.   At the same time, with the logic of redistribution, the highest income taxpayers are paying a bit more.   Most of the multipliers on tax revenue are negative - some significantly so.  So for example some estimates suggest that increasing some taxes will reduce growth by as much as 5:1 - that is a bit extreme but most economists suggest at least some negative effects from increasing taxes.   One could also make the case that deficit spending is just a future version of a tax increase and thereby has directionality close to those for tax increases (under you can pay me now or pay me later theory).

There is one other odd thing about this story.   Although none of the supporters of the position express it directly, they seem to be saying that dollars at the margin are more important.   If it was a good idea to improve tax equity (the claim made by the Obama administration in supporting the tax increases) but not to reduce spending - then one must conclude that that tiny percent of GDP is determinative on the direction of economic growth.   With all due respect, that sounds like just plain silly.

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