Thursday, July 29, 2010

In American politics, stupidity is the name of the game

Washington Post editorial "In American politics, stupidity is the name of the game" (July 29th, 2010) offers shrill ignorance when making a backhanded comment concerning economics.

That could never happen here because the fairy tale of supply-side economics insists that taxes are always too high, especially on the rich.

The author was referring to various tax solutions to the deficit, though the topic is not what concerns Corrections here. What we wish to deal with is the snide sciolism that E.J. Dionne Jr. displays in his dismissal of "supply-side" economics. Corrections offers just such a "fairy-tale" story here, reiterating Harald Uhlig's recent American Economic Review article "Some Fiscal Calculus" (May 2010) (Corrections previously spoke about a working paper version here).

In his concise paper, Uhlig undertakes to understand the "multipliers" of tax cuts and government spending. He does so in a typical, non-Keynesian model, though his result is stronger in a Keynsian model. We replicate his figures using his code. In our case, the most important portion of his paper is displaying the benefits of a tax cut and government spending (both are advocated as stimulus measures, the former Mr. Dionne is criticizing).

The first figure we display, Figure 2 in Uhlig's paper, is of the multipliers calculated for either government spending and a tax cut (click to enlarge). As we see, initially government spending has a high multiplier, while a tax cut has a low. However, because the spending must be paid for with higher taxes in the future, government spending's multiplier drops over time. Tax cuts, because they encourage growth and reduce distortionary taxes, have a positive multiplier.

Figure 4 of Uhlig's paper offers the dynamics of debt and the tax rate's increase for a government spending stimulus, displaying the reason why stimulus is worse in the long run (increased taxes) (click to enlarge).

Figure 5 displays the dynamics of government spending and output in the very long run, indicating the massive long-run tradeoff to output for a short-run boost to today (click to enlarge).

Uhlig concludes with the finding that with government spending stimulus, $3.40 of output is lost eventually when we discount it back to the present day, while cutting taxes generates $1.70 in extra output, discounted back to today.

The Washington Post, as is its wont, is in need of a permanent Correction to its deep-seated love of taxation.

1 comment:

  1. In addition to this excellent quantitative analysis, for business people with longitudinal experiences making choices now, you know that all of this "stimulus" will be paid for by someone moving forward and that this will translate into increased taxation and personnel expenses moving forward (SSI matching etc). All reasons not to invest in the US now and rather to shift investments to environments who are not adopting foolish economic policies.