1/29/09

Where Does the Money Go?

In a recent post, Megan McArdle makes a strong argument for tax-cuts, as opposed to public spending, as a bigger part of the stimulus package. It's well worth reading, but the short version is that--beyond spending on so-called "shovel-ready" projects--"tax-cuts are better because they're faster." She concludes by continuing the campaign against Keynesian stimulus:
Though you wouldn't think it from the really quite shocking incivility emanating from the pro-stimulus side, the empirical evidence that this works in a large industrial economy like ours is basically nonexistant. The problem is, we have very, very few examples to test on: America during the Great Depression, and Japan in the 1990s. And neither America nor Japan managed to stimulate their way out of their troubles. You can argue--and many do--that this is because we, and they, didn't stimulate enough. That may be true. But unless you can forward test your theory, it's a just so story . . . as we just painfully found out about the "It was all the Fed's fault" narrative of the 1930s banking collapse.

What we've got, since Japan really never did emerge from its lost decade, is basically one fact: America entered World War II in a depression, and emerged from World War II without one. ...

But the amount of government borrowing during World War II was truly gargantuan--roughly half of GDP by 1943. All the relief dribbled out over the course of the Great Depression at best kept the Depression from being worse--unemployment was still in the double digits in the late 1930s. Moreover, much of the spending FDR did do was paid for by tax hikes, which cancel out the stimulative effect of the spending.
In his January 8 column, Paul Krugman explains why government spending can be more effective than tax-cuts:
...fiscal stimulus can sometimes have a “multiplier” effect: In addition to the direct effects of, say, investment in infrastructure on demand, there can be a further indirect effect as higher incomes lead to higher consumer spending. Standard estimates suggest that a dollar of public spending raises G.D.P. by around $1.50.
From Krugman's most recent column:
... it’s clear that when it comes to economic stimulus, public spending provides much more bang for the buck than tax cuts... because a large fraction of any tax cut will simply be saved.
The big question is, since the stimulus plan includes both tax-cuts and public spending, why was there not a single Republican vote? Matthew Yglesis has a theory.

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