Today's Wall Street Journal carries an op-ed by a Harvard political economist, Alberto Alesina, who looked at the relative worth of tax cuts and spending cuts vs. "stimulus" spending and tax increases in dealing with both economic recovery and deficits. If you're an Obama economic model believer, a liberal who trusts that the government can generate economic growth through extraction of cash from the economy redistributing it to favored projects and constituencies the results are not pretty.
In the U.S., meanwhile, recent stimulus packages have proven that the "multiplier"—the effect on GDP per one dollar of increased government spending—is small. Stimulus spending also means that tax increases are coming in the future; such increases will further threaten economic growth.
Economic history shows that even large adjustments in fiscal policy, if based on well-targeted spending cuts, have often led to expansions, not recessions. Fiscal adjustments based on higher taxes, on the other hand, have generally been recessionary...
The composition of fiscal adjustments is therefore critical. Based on what we know, the U.S. and Europe are currently at greater risk from increased stimulus spending than from gradual but credible spending cuts.
Europe seems to have learned the lessons of the past decades: In fact, all the countries currently adjusting their fiscal policy are focusing on spending cuts, not tax hikes. Yet fiscal policy in the U.S. will sooner or later imply higher taxes if spending is not soon reduced.
The evidence from the last 40 years suggests that spending increases meant to stimulate the economy and tax increases meant to reduce deficits are unlikely to achieve their goals. The opposite combination might.
Yesterday another Harvard economist, Robert Barro, hit concordant notes in another Wall Street Journal op-ed.
Now the Obama administration is considering whether to maintain the Bush tax cuts or let them expire. Unfortunately, little of the administration's analysis refers to incentives. Rather the discussion is mainly about whether the poor or the rich spend a greater fraction of added disposable income, whether the rich can afford to pay more taxes, and so on.
From the standpoint of incentives, the important point is that higher marginal tax rates harm the economy. For example, if all of the 2003 Bush tax cuts (which alone reduced the average marginal rate by two percentage points) were undone for 2011, I estimate that GDP growth for 2011-12 would be reduced by 1.1 percentage points...
My hope is that the administration will shift away from programs based on Keynesian reasoning and toward policies that emphasize favorable economic incentives. Extension of the full tax cuts of 2001-03 and a reduction in the period of eligibility for unemployment insurance would be good starts.
You know, some of those guys from Harvard are pretty smart. You'd think a guy from Harvard would know that, but unfortunately Mr. Obama's experience at America's oldest university was limited to its Law School.