Why the Spending Stimulus Failed

In the US the intellectual and political left argues that the failed $814 billion stimulus in 2009 wasn't big enough, and that spending control any time soon will derail the economy. But economic theory, history and statistical studies reveal that more taxes and spending are more likely to harm than help the economy, says Michael J. Boskin, a professor of economics at Stanford University and a senior fellow at the Hoover Institution.

Boskin's colleagues John Cogan and John Taylor, with Volker Wieland and Tobias Cwik, demonstrate that government purchases have a gross domestic product (GDP) impact far smaller in New Keynesian than Old Keynesian models and quickly crowd out the private sector.

They estimate the effect of the February 2009 stimulus at a puny 0.2 per cent of GDP by now.

By contrast, the last two major tax cuts – President Reagan's in 1981-1983 and President George W. Bush's in 2003 – boosted growth.

They lowered marginal tax rates and were longer lasting, both keys to success.

In a survey of fiscal policy changes among countries in the Organization for Economic Cooperation and Development (OECD) over the past four decades, Harvard's Albert Alesina and Silvia Ardagna conclude that tax cuts have been far more likely to increase growth than has more spending.

Former Obama adviser Christina Romer and David Romer of the University of California, Berkeley, estimate a tax-cut multiplier of 3.0, meaning $1 of lower taxes raises short-run output by $3.

Andrew Mountford of the University of London and Harald Uhlig of the University of Chicago show that substantial tax cuts have a far larger impact on output and employment than spending increases, with a multiplier up to 5.0.

Conversely, a tax increase is very damaging. The best stimulus now is to stop the impending tax hikes, says Boskin.

Source: Michael J. Boskin, Why the Spending Stimulus Failed, Wall Street Journal, December 1, 2010.

For text: http://online.wsj.com/article/SB10001424052748704679204575646994256446822.html

For more on Taxes: http://www.ncpa.org/sub/dpd/index.php?Article_Category=20

First published by the National Center for Policy Analysis, United States

FMF Policy Bulletin/ 07 December 2010