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Feldstein on Fiscal Policy
Martin Feldstein, a proponent of the recent fiscal stimulus, said it didn't work.
Here are the facts. Tax rebates of $78 billion arrived in the second quarter of the year. The government's recent GDP figures show that the level of consumer outlays only rose by an extra $12 billion, or 15% of the lost revenue. The rest went into savings, including the paydown of debt....Although press stories emphasizing that the rebates induced additional consumer spending were technically correct, they missed the important point that the spending rise was very small in comparison to the size of the tax rebates.
It's a peculiar op-ed, however, as he then goes on to say:
The small rise in spending in response to these tax rebates is similar to what previous studies of one-time tax cuts found. It also corresponds to what both basic economic theory and common experience imply. Although someone who receives a permanent annual salary increase of $1,000 typically would increase his annual spending by an almost equally large amount, a $1,000 rise in wealth caused by a share price increase or a tax rebate would raise spending only gradually over a number of years.
Right. But a short-term tax cut is exactly what Feldstein called for in an earlier op-ed.
The poor effects of the Bush tax rebate as fiscal stimulus, however, let Feldstein now attack the Obama plan for a $1000 tax rebate. Nothing wrong with that - McCain has nothing better however - but what Feldstein doesn't say is that if you follow the logic of his two op-eds (and this is not something I would necessarily buy into) the conclusion should actually be that fiscal stimulus would work better if it ran through government spending.
Posted by Alex Tabarrok on August 7, 2008 at 08:58 AM in Economics | Permalink
Comments
A tax rebate is theoretically supposed to have a multiplier effect. How is that captured in the 12/78 number? Philosophically, I believe in tax rebates, however, from a mathematical standpoint, I have to believe a tax rebate would have to be of an optimal size to induce a multiplier effect. ie, bigger than the average American's credit card debt, so that they pay it off and have leftover a small amount that would persuade them to buy a larger expenditure, eating back into their debt.
Posted by: brainwarped at Aug 7, 2008 9:17:52 AM
I must admit that I used my check to stimulate the economy of Canada (Montreal, in particular) while on vacation. I guess I didn't do my part.
Posted by: matt at Aug 7, 2008 9:23:22 AM
Also, the 12/78 number doesn't have the counterfactual right: in the absence of stimulus, consumer spending may well have fallen (or risen).
Posted by: no at Aug 7, 2008 9:28:03 AM
So to summarize Feldstein:
1. "both basic economic theory and common experience imply" that a rebate isn't going to do much.
2. Nonetheless he supported the Bush rebate
3. He now opposes Obama's proposed rebate
Is it just possible that his positions reflect his political preferences rather than objective views of sound economic policy?
Posted by: Bernard Yomtov at Aug 7, 2008 9:32:50 AM
I'm sympathetic to Feldstein's argument, but I think he needs to answer the question "Compared to what?" We observe the world with the rebates and not the way the world would have been without the rebates.
Posted by: mcr at Aug 7, 2008 9:36:25 AM
feldstein seems to discount the long term positive, growth encouraging effects of a decrease in interest rates (caused by the increase in savings). not only do tax cuts increase consumer spending in the short run but they ultimately decrease interest rates and potentially increase investment (which could lead to long term increases in supply) and GDP growth. in fact, the allocation of money towards savings and investment gained from tax cuts could have more positive effects than a direct injection of the money immediately back into GDP.
Posted by: dana at Aug 7, 2008 10:16:34 AM
The point of a stimulus isn't to affect the economy. The point is to make it appear to a gullible, uninformed public that the government is doing something about the problem. Typically, around the time the stimulus hits the downturn has run its course and the economy starts improving, the the gullible, uninformed public thinks that its government is doing something.
Posted by: david at Aug 7, 2008 10:20:37 AM
Good post, Alex; I had the same confusion regarding Feldstein's op ed. And I agree with Bernard's comments, that Feldstein's support for the Paulson rebate, but opposition to the Obama one, seem suspicious.
But to follow up on Dana's point: Are we all Keynesians now, even at the Wall Street Journal? What is the deal with scolding people for paying down their credit card debt during an economic downturn? That's the responsible thing to do. Do you guys make fun of the "paradox of thrift" at GMU? We did at Hillsdale College...
Posted by: Bob Murphy at Aug 7, 2008 10:48:50 AM
Just to clarify, I thought the Bush stimulus was a gimmick too, but because:
(a) They should have cut spending by the same amount, otherwise they are borrowing money from the private sector in order to give money to the private sector,
and
(b) It would have a supply-side effect if they had cut marginal tax rates, not given an ex post rebate.
Posted by: Bob Murphy at Aug 7, 2008 10:51:15 AM
If we think the problem is underspending, I would propose that we give the money we borrow to state and local government. They are having to cut programs and wages to stave off the shortfalls in income tax revenues that the rich aren't paying this year because their incomes fell. The propensity to spend among households and governments doesn't have to rise - just not fall - to ensure that they money is spent. And since we're preserving existing programs rather than creating/expanding programs, the lags that usually pervert stimulus programs are less likely to be a dominating factor.
I say this reluctantly, given that had those programs not overexpanded during prior years, they wouldn't be having to contract now. E.g., California state spending expanded by double the rate of inflation and population growth over the last 4 years.
Posted by: Larry at Aug 7, 2008 10:59:51 AM
Philosophically, I think that whenever the government is running a debt, we are in tax rebate territory.
The hypothetical baseline should be balanced income and spending. Now sure, that opens the whole crazy world of stratagems to reach a more balanced budget, including the incredibly irrational but popular notion that the way to balance the budget is to run a debt so large no one else can run it higher.
I'm afraid the floppy 'Norquists' (to coin a group) spent and tax-cut us into this position, where no answer is a good one. We were NOT supposed to run up a higher national debt in the growth part of the business cycle. And now, in the down part, we are in a spot.
In terms of what to do now ... I'm sure the 'Grovers' don't care ... as long as their taxes are cut.
Posted by: odograph at Aug 7, 2008 11:00:50 AM
In this case, don't "we" want people to pay their mortgage?
Posted by: Andrew at Aug 7, 2008 11:11:48 AM
So we have a Democrat campaigning on a tax rebate - and Ronald Reagan's Chief Economic advisor arguing that arguing that the rebate won't improve the economy.
Can anyone tell me what planet I'm on?
Posted by: Greg at Aug 7, 2008 1:15:37 PM
Well, someone please tell me if I am missing something:
Money is simply something we trade in order to allocate a share of scarce of goods and services.
Taxation is simply how the government allocates scarce goods and services from other parts of the economy to the government.
The government may have given a "stimulus" rebate check, but since the government didn't actually reduce its own consumption of finite goods and services, there was no additional goods and services available for consumption or capital investment. The net effect was zero (although it might have redistributed resources from one area of the economy to another)
No tax cut or "stimulus" rebate will have any effect unless the government actually cuts spending (and hence, reduces its consumption of scarce goods and services).
It seems so simple to me... but obviously there are highly educated well-respected people who think that the stimulus works. Are they just influenced by ideology and political loyalty, or is there some big gap in my understand of how this stuff works (and can someone give a brief explanation, if so)?
The point of a stimulus isn't to affect the economy. The point is to make it appear to a gullible, uninformed public that the government is doing something about the problem. Typically, around the time the stimulus hits the downturn has run its course and the economy starts improving, the the gullible, uninformed public thinks that its government is doing something.
Yes, I understand that... but why do some well-respected experts also support the stimulus package? Not everyone who supports the stimulus package is part of the uninformed, gullible public.
I must admit that I used my check to stimulate the economy of Canada (Montreal, in particular) while on vacation. I guess I didn't do my part.
Since Canada is the largest trade partner of the U.S., and largest single foreign consumer of U.S. goods, you most certainly did your part.
Posted by: Rex Rhino at Aug 7, 2008 1:15:42 PM
I'm not too confused about the two op-ed pieces. While the first one argues that a tax rebate that would kick in with growing unemployment and end after--a sort of semi-permanent income shock--would keep people spending, the second op-ed argues that the one-off rebate (a temporary income shock) didn't do much... as anticipated. Both are perfectly consistent with the Permanent Income Hypothesis.
Posted by: Holger Siebrecht at Aug 7, 2008 1:42:46 PM
The questions of what about in the absence of the rebate is irrelevant. The point was to increase aggregate demand by a measure that would hopefully match, or be somewhat equal to, the cost of the stimulas program. People certainly got their checks in the mail, shown by the substantial increase in income, but they didn't spend their rebate check on consumer products as shown by the consumption figures.
Feldstein is easily doing a cost-benefit analysis of the stimulas package. How much did it cost? Was the implementation effective? Were the intended goals met satisfactorily? The bump in consumer spending we got from the stimulus checks most certainly helped, but it's another matter whether or not it was worth the cost of adding $78 billion to our long-term fiscal debt. The situation we have here today is very similar to the result of Carter's stimulus package: Incomes increase, but spending hardly does.
At least Feldstein has the courage to say a plan he backed was a failure. I have a feeling you won't see Jason Furman saying anything close to what Feldstein has written, especially when his candidate says America needs a second stimulus package.
Posted by: Lance at Aug 7, 2008 1:51:53 PM
Rex, is it clarifying to say that a rebate check generates a particular kind of deficit spending? The debt goes onto the Federal books, but the consumer gets to choose where the money goes.
That might work as a recession-curing stimulus in some circumstances but not others.
Posted by: odograph at Aug 7, 2008 2:03:13 PM
Thanks for this post - which I should have read before I offerred up my critique over at EconoSpeak. Economist Mom has weighed in with views on the short-run v. long-run impacts of fiscal stimulus which mirror my heresy accusation of Feldstein. This WSJ oped was not one of Marty's better ones!
Posted by: pgl at Aug 7, 2008 2:27:43 PM
Rex, it is important to identify how the government finances it's debt. If the government issues bonds which are then bought by say, China, then that is a direct infusion of money into our economy - courtesy of the People's Republic.
A less cynical was to look at it is to say the government borrows from future generations to create a stimulus in the present.
Posted by: MS at Aug 7, 2008 2:27:47 PM
Rex,
I think your analysis is far better than Feldstein's--his article is something I would have expected from Krugman. Just two points:
(1) Strictly speaking, government deficit spending is irrelevant only when Ricardian equivalence holds. In this case, the private sector perfectly offsets the government sector. E.g. if the government lowers taxes by $100 billion but maintains its own spending, then "total spending" remains the same because the private sector anticipates higher taxes in the future (if only to service the higher government debt), and so saves the entire $100 billion.
(2) The point I was making is that the way the money is returned to the private sector matters. Rather than giving a lump sum check, it would have made more sense for the government to lower marginal income tax rates (such that, in static terms, the total tax expenditure was the same). Obviously they didn't do this for political reasons, but it would have made more economic sense.
To give an extreme illustration going the other way: One might take your view and say, "It is irrelevant whether taxes are 0% or 100%; if the government seizes the entire GDP and spends it, total spending and employment are the same." But of course, nobody will work at 100% tax rate, and so GDP goes to zero in that case. The fallacy is to assume a fixed amount of goods and services, that is then divided between private and government sectors.
Posted by: Bob Murphy at Aug 7, 2008 2:42:43 PM
Has there EVER been compelling evidence that short-term stimulus can dramatically influence the economy?
Posted by: Matt Bandyk at Aug 7, 2008 3:16:46 PM
Bob Murphy:
(2) The point I was making is that the way the money is returned to the private sector matters. Rather than giving a lump sum check, it would have made more sense for the government to lower marginal income tax rates (such that, in static terms, the total tax expenditure was the same). Obviously they didn't do this for political reasons, but it would have made more economic sense.
If you did this more "sensible" reduction in marginal income tax rate, what's your forward strategy, exiting recession and heading toward recovery?
(I am assuming the debt, and debt service, as a percentage of GDP is high for you, as it is for me.)
Posted by: odograph at Aug 7, 2008 3:55:28 PM
All the debate before the rebate was passed over about how much get spent in six months. We now have about one a half months data. Isn't this a little early to be drawing any strong conclusion one way or the other?
Posted by: spencer at Aug 7, 2008 4:10:05 PM
Odograph asked:
[Bob, if] you did this more "sensible" reduction in marginal income tax rate, what's your forward strategy, exiting recession and heading toward recovery?
I'm saying it would be a temporarily lower marginal rate, with the cut being calibrated so that (in static terms if you want to be super careful) the estimated loss to the Treasury over the time length of the cut, would be exactly equal to the cost of the rebate.
So assuming people's incentives to produce are unaffected by tax rates, then it should be equivalent. But since people will actually produce more, it will in fact be better than just handing people a pile of money.
Now you're right, I think an even more sensible solution would be for (say) the government to cut the military budget* by $200 billion annually, and then cut taxes permanently (through marginal rate reductions) by that amount, calculated on a static basis.
But my point is, even if we're going to borrow and rebate, it makes more sense to give the money back through marginal rate reductions, rather than lump sum transfers.
* If you like the military budget, then pick some other area of government profligacy.
Posted by: Bob Murphy at Aug 7, 2008 5:25:59 PM
I basically worry about downward adjustment to tax rates because the baseline is so political. I'm sure that expiration of such a cut would be reported as "Hey, he wants to raise our taxes!"
The next question in my mind is if this sort of stimulus does prove to be inefficient, what does that do to the old arguments that we couldn't wait for infrastructure projects, because they couldn't be timely?
Make hay when the sun shines ... and maybe repair bridges when you've got to run a deficit anyway.
Posted by: odograph at Aug 7, 2008 7:23:48 PM
