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249 IRET Congressional Advisory 1 (2009)

handle is hein.taxfoundation/iretcgadv0246 and id is 1 raw text is: INSTITUTE FOR RESEARCH ON THE ECONOMICS OF TAXATION IRET is a non-profit 501 (c)(3) economic policy research and educational organization devoted to informing the public about policies that will promote growth and efficient operation of the market economy. January 26, 2009 Advisory No. 249 STIMULUS OR BUST? President Obama and Congressional Democratic leaders are proposing a two-year, $825 billion economic stimulus. That is on top of the vast sums already being spent in the financial bail-out packages. This is an immense program. It is not just refilling the federal trough, it is building new ones. It would not restore the economy to health, because it does not push any of the buttons that would trigger an economic recovery. It would not boost private sector investment and employment. It would over-spend on programs of dubious value, and would saddle future budgets with a greatly increased interest burden. It would preclude the sort of tax reductions necessary to generate real economic benefits. There are far better tax cuts that should be adopted instead. Stimulus Mirage. We hear that all economists agree that stimulus is needed, even conservative economists who worked for President Reagan. The correct distinction is not liberal versus conservative, but Keynesian versus non-Keynesian. Richard Nixon said, We are all Keynesians now. But monetarist and supply-side neoclassical economists do not agree, because we do not think that fiscal policy works the way the Keynesians assume. The idea behind the stimulus plan is to jump- start demand. Demand stimulus is a Keynesian view that peaked in the Nixon, Ford, and Carter years - not the economy's finest hours. In fact, as Milton Friedman taught us, government spending and tax hand-outs do not stimulate demand because every dollar doled out by government must be first taken in by other taxes, borrowing, or other spending cuts. The net effect on demand is zero, and there are no subsequent multiplier effects. The stimulus evaporates before it gets started. What if we sell the added federal bonds to the Federal Reserve, instead of borrowing the money from the public? Wouldn't that boost demand? Only if the Federal Reserve allowed the bond purchases to increase bank reserves and the money supply, with no offsets. But that would be due to the change in monetary policy, not the deficit per se. The Federal Reserve does not have to wait for a deficit to create new money, and it does not have to create new money when there is a deficit. What if we sell the bonds to foreigners? If this merely displaces lending they were going to extend to other U.S. borrowers, there would be no effect. If the foreign lending is an additional capital inflow, its demand effect would be offset by a rise in imports and a drop in exports (a rise in the current account deficit) because it would bid up the dollar against other currencies. Again, no help. Not All Tax Cuts Are Created Equal. Republicans are pleased that $275 billion, or a third of the package, is tax cuts, mostly temporary, some permanent. Beware. Temporary rebates do nothing (witness the 2008 rebates and the Ford rebates), but even a permanent trashy tax cut is as ineffective at boosting demand and output as a temporary one. To boost output and income, a tax cut must be the right type, one that cuts taxes at the margin on the additional income associated with additional output (supply), and it should be e~*m S I gg~ g ~gg

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