Martin Feldstein tries to sketch out how fiscal policy can be used to boost demand--by boosting incentives to invest--without producing the long-run drag on the economy and the slower long-run growth generated by large, persistent deficits. I approve: this is an interesting and, I think, probably a correct line of thought to pursue:
FT.com Home US: Economic conditions in the US and Europe require a rethinking of the roles of monetary and fiscal policy... fiscal policy can stimulate demand by changing incentives as well as by increasing disposable income. Monetary actions will remain the primary instrument of countercyclical policy in the years ahead. Central banks act faster and more flexibly than parliaments. High real interest rates and slower money growth have lost none of their power to reduce economic activity and damp inflation.... But the current relatively low rates of inflation and correspondingly low nominal interest rates restrict the ability of central banks to stimulate the economy.... In the US, the Bush administration has used fiscal policy to stimulate demand in three ways. First, reductions in income taxes... lower tax rates on future dividends and capital gains... stimulating business investment by lowering the cost of equity capital... new tax depreciation rules allowed companies to reduce their taxable incomes immediately by 50 per cent of the investment in new equipment carried.... An important feature of the recent fiscal package was the use of policies that stimulated demand with little or no increase in budget deficits. The temporary rise in the tax depreciation rate and the resulting tax cut are automatically offset by lower depreciation and therefore high tax liabilities in later years.... The ability to use fiscal incentives to stimulate the economy without increasing the national debt is particularly relevant to Europe, where traditional monetary and fiscal policies are of limited use... a temporary cut in value added tax, balanced by a rise in personal taxes, could stimulate household spending. Both techniques would help to accelerate economic activity and neither would raise the budget deficit.
Persistent budget deficits crowd out investment and thus reduce long-term growth. Fortunately, some of the projected deficits... will shrink as the economies grow. In the US the budget deficit is projected to fall to about 2 per cent of gross domestic product over the next five years...
But one must take note of the fact that the only forecasts showing a fall in the U.S. budget deficit to 2% of GDP over the next five years are the rosy scenarios of the Bush Administration. It would be nice if the focus of Bush Administration fiscal policy had been on policies that were stimulative in the short run without "crowd[ing] out investment and thus reduc[ing]... growth" in the long run. But that's not the world we happen to live in.
Posted by DeLong at August 25, 2003 09:21 PM | TrackBack
Ok so the tax cuts as enacted phase out. But don't tax cuts like the estate tax disappearance not only don't stimulate the economy in the short run (they are backloaded) but they reduce revenue once the economy recovers? What size blinders does one have to wear to write an article that focuses on the 2% of the Bush tax cut that makes sense and ignore the other 98%?
Posted by: bakho on August 25, 2003 10:00 PModd. I didn't read the article (FT wants to charge me for it), but I did read the distillation that fiscal policy can be used to boost demand--by boosting incentives to invest -- which sounds a whole lot like 1980s supply-siders.
what's quoted of the article, on the other hand, seems to ignore the W. Bush model in favor of a somewhat different approach: a temporary cut in value added tax, balanced by a rise in personal taxes -- which is a demand-side stimulus, cutting taxes on consumption while increasing them on income.
where accelerated depreciation, which as far as I can see is a naked tax cut for capital investment, fits into this pushme-pullyou scheme I can't see. can anyone else?
Posted by: wcw on August 26, 2003 01:43 AMSo the solution to sluggish demand and unused capacity is to create more incentives to *invest*?
That's a new one.
Posted by: Lorenzo on August 26, 2003 06:18 AM"Ok so the tax cuts as enacted phase out."
Rubbish. There is no chance at all given this Administration and Republican Congress that tax cuts will be phased out. The Republican Party would be crippled if the Administration were to even think of phasing out the tax cuts.
Posted by: lise on August 26, 2003 08:33 AMWhy am I not impressed by an economist who wishes Social Security and Medicare were gone? Fortunately, there are other economists. When I listen to Marty Feldstein and Glen Hubbard and Gregory Mankiw, I hear only right wing Republican hackery.
This Administration has given us the worst fiscal policy since 1945. How many jobs have been lost since the 2001 tax cut? Three million? Really? Let's cut dividend taxes. Fine with those who happen to collect huge amounts of dividends. Who are they? Blah, blah.
Posted by: dahl on August 26, 2003 08:45 AMSorry, I meant they sunset. If a future budget analysis considers that the tax cuts sunset (end) as is current law, then the long term budget picture is much more rosy than if the tax cuts are extended permanently.
Those who want the tax cuts to end will give budget projections based on what will happen if they are extended. Those who want to extend the tax cuts give projections based on them ending.
Marty is writing about what should happen and it is getting confused with what is truly happening.
Posted by: bakho on August 26, 2003 08:49 AMAgreed completely!
August 26, 2003
"The federal government is heading toward a record $480 billion deficit in 2004 and will rack up red ink of almost $1.4 trillion over the next decade, according to the latest analysis by the Congressional Budget Office."
AP
Posted by: lise on August 26, 2003 09:33 AMDahl
It is true that some conservative economists (including Robert Barro) would rather have us put our retirement funds into a private account rather than this public retirement account. But the one thing I like about Barro is that he is honest enough to admit that changing the name on the account will not add to the amount of money we earn from these accounts and nor would privatization reduce the general fund deficit by even a single penny. Now if we could only get the conservative politicians to be as honest and stop this lie about free lunches.
Posted by: Hal McClure on August 26, 2003 10:55 AMHal McClure
Robert Barro is someone I enjoy arguing with. There are no free lunches. We are going through a period of high productivity growth which is promising to last, however GDP growth is too low to take advantage of our productivity growth. Also, we save too little and will either have to add to saving or find ourselves much constrained as the baby boomers retire. Again, we are in sore need of investment in infrastructure. The electric grid must be renewed and take a look at gasoline prices and ask why a pipeline break in the southwest causes gas to go above $2 in Chicago. We have infrastructure problems, and that will take spending.
Posted by: dahl on August 26, 2003 11:11 AMAugust 26, 2003
DEFICIT PICTURE EVEN GRIMMER THAN NEW CBO PROJECTIONS SUGGEST
By Richard Kogan
On August 26, the Congressional Budget Office
issued new budget estimates and projections. Four aspects of CBO’s new figures should be understood.
The new CBO ten-year projections, like those
CBO has issued over the last 24 months,
significantly understate the likely size of
future deficits because they do not fully reflect
the future costs of policies currently in effect; for example, CBO assumes existing tax cuts enacted since 2001 all will be allowed to expire. In addition, CBO does not include the costs of new policies that are very likely to be enacted, such as a Medicare prescription drug benefit.
CBO’s new report, which is considerably more pessimistic than the projections CBO issued just five months ago, projects deficits totaling $1.4 trillion over the ten-year period from 2004 through 2013. A more realistic assessment of the
budget that uses the CBO estimates but incorporates likely or inevitable costs produces a ten-year deficit projection of $5.1 trillion, with deficits exceeding $400 billion in every year and reaching $650 billion by 2013. Moreover, under this more realistic assessment, the national debt is projected to rise from $4.0
trillion today to $9.1 trillion by 2013. (CBO itself projects in its new report that if
expiring tax cuts are extended, a Medicare prescription drug benefit costing $400 billion over ten years is enacted, and relief that lessens the explosive growth of the Alternative
Minimum Tax is provided, deficits will total $4.4
trillion over ten years.
If the tax cuts are extended and other likely costs occur, deficits will total $5.1 trillion over the next ten years, will never fall below $400 billion in any year, and will reach $650 billion by 2013.
Posted by: anne on August 26, 2003 12:08 PMFurther to Lise's post, the CBO also notes that the projected cumulative deficit through 2013 widens to $3.7 trillion if tax cuts are not allowed to expire. That $2.3 trillion difference is exactly what Republican leaders have in mind, apparently.
(I'm a bit confused, since I had the vague notion that the sunset provisions kicked in in 2012, which would mean all the $2.3 trillion difference would occur in 2012 and 2013. Better look that up.)
Posted by: K Harris on August 26, 2003 12:21 PMK Harris
The tax cut sunsets kick in from 2004 on. cbpp.org has a list of the sunsets and estimates costs for each extension.
Posted by: lise on August 26, 2003 12:33 PM