Wednesday, December 1, 2010

Welcome to "eventually"

Stanford economist Michael Boskin summarizes the latest economic research at
[E]conomic theory, history and statistical studies reveal that more taxes and spending are more likely to harm than help the economy. Those who demand spending control and oppose tax hikes hold the intellectual high ground. . . .

Andrew Mountford of the University of London and Harald Uhlig of the University of Chicago conclude that the small initial spending multiplier turns negative by the start of the second year. In a new cross-national time series study, Ethan Ilzetzki of the London School of Economics and Enrique Mendoza and Carlos Vegh of the University of Maryland conclude that in open economies with flexible exchange rates, "a fiscal expansion leads to no significant output gains."

My colleagues John Cogan and John Taylor, with Volker Wieland and Tobias Cwik, demonstrate that government purchases have a 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% of GDP by now.

In other words, what we've been trying for the past two years doesn't work. "Stimulus" spending doesn't stimulate and very quickly starts to burden the economy even more.

So what does work?

By contrast, the last two major tax cuts—President Reagan's in 1981-83 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 in the 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. . . .

As Thomas Sowell recently pointed out, prior tax cuts, under presidents Coolidge and Kennedy, also boosted growth. There is a track record, if we're willing to look at it.
Conversely, a tax increase is very damaging. . . The best stimulus now is to stop the impending tax hikes. . . [S]pending cuts are more likely to reduce deficits. . . and less likely to cause recessions, than are tax increases. . . [B]ased on the best economic evidence, we should reject increased spending and increased taxes.

So after two years of making things worse, what's the Obama plan moving forward? To increase taxes and increase spending, exactly the opposite of what the best economic evidence suggests will work.
If anything, we should lower marginal effective corporate and personal tax rates further. . . We should quickly enact an enforceable gradual phase-down of the spending explosion of recent years. That's what the president and congressional leaders should initiate. Then let the equally vital task of long-run tax and entitlement reform proceed.

In his inaugural address, Obama promised that he would be guided by evidence rather than by ideology. The evidence says we should cut spending, yet Obama is arguing for more spending. The evidence says we should cut taxes, but not even the Republicans are calling for that, as all their efforts are required just to keep Obama from increasing taxes.

This recession has been a wake up call. History has shown that "progressive" policies do not work. Margaret Thatcher was right when she warned that eventually you run out of other people's money.

"Eventually" has arrived, and it's done taking IOUs.

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