Temporary, targeted tax reductions and increases in government spending are not good economics

See Stimulus Has Been a Washington Job Killer: The political graveyards are full of politicians who thought that temporary, targeted economic policies would get them re-elected by JOHN F. COGAN AND JOHN B. TAYLOR, WSJ, 10-3-11.

"Consider the evidence. When President Gerald Ford entered office, the economy was in the midst of the serious 1974-75 recession. Responding to the popular clamor to "do something," he proposed a short-term stimulus plan in early 1975. The centerpiece was a temporary income-tax rebate. Congress added a one-time, $50 increase in Social Security benefits and, to bolster the sagging housing market, a one-time tax credit for new home buyers.

The rebate caused only a temporary blip in consumer spending. Economic growth rose to 9% in the first quarter of 1976 but then dropped to only 2% in the third quarter, and unemployment started rising.

Congress enacted a second stimulus plan in July 1976 over Ford's veto. It authorized grants to state and local governments designed to prevent layoffs of public employees or tax increases. This plan also failed to produce the promised stimulus. The economic pause of 1976 was enough to swing the election to Jimmy Carter and cause more incumbent senators to lose their seats than in any election in nearly 20 years.

President Carter took office and by the end of his first month proposed another stimulus plan, which he said would "restore consumer confidence and consumer purchasing power." His plan called for another round of one-time tax rebates and Social Security bonus payments, federal public infrastructure grants and countercyclical aid to state and local governments.

He also added a tax credit for small and medium-size employers hiring new workers. The fine-tuned plan, according to the chairman of Mr. Carter's Council of Economic Advisers, Charles Shultze, was "designed to tread prudently between the twin risks of over and under-stimulation."

In May 1977, Congress enacted the president's proposals in modified form. Although the pace of economic activity quickened for a while, subsequent studies by senior Carter administration Treasury official Emil Sunley and noted economist Ned Gramlich showed that the government-provided stimulus had little effect. The recovery was not sustained and the economy fell into recession in January 1980. The failing economy combined with rapidly rising inflation doomed Mr. Carter's re-election chances, along with the Democratic Party's control of the Senate and 33 Democratic seats in the House.

President Reagan rejected temporary stimulus measures and instead proposed permanent income-tax rate reductions. His tax program, in conjunction with steady monetary policy begun by Paul Volcker, produced the promised results.

By late 1982 the recession was over and in early 1983 employment and investment began to rise rapidly. Nearly two decades of strong, steady, noninflationary economic growth ensued."

"In May of that year (2003), at the urging of Mr. Bush, Congress sharply reduced tax rates on capital gains and dividends and put the 2001 income-tax rate reductions in place immediately.

Within four months, employment began to rise and the unemployment rate began to fall. By 2004, the economic recovery was in full swing."

Hoover Increased Spending During The Depression, Both In Real Terms And In Size Relative To The Economy

Repeating the Hoover Mistake: Paul Krugman and The New Republic by Nick Schulz of AEI.

"Paul Krugman once wrote a column called “Fifty Herbert Hoovers,” in which he blasted state governors for cutting spending during a recession. “No modern American president would repeat the fiscal mistake of 1932, in which the federal government tried to balance its budget in the face of a severe recession,” Krugman wrote. John Judis, in his cover story for The New Republic, recounts what he believes is a gotcha moment on the campaign trail with Mitt Romney in which he said to the candidate:

I want to ask you something about history. You know, when Herbert Hoover had to face a financial crisis and then unemployment, his strategy was to balance the budget and cut spending, and that made things worse. When Roosevelt came in, unemployment was twenty-five and went to fourteen percent by 1937. With deficits. Aren’t you repeating the Hoover mistake?

But as Tim Taylor points out, the only “Hoover mistake” being repeated is by folks like Krugman and Judis who apparently aren’t aware of what Hoover did while in office:

Hoover’s budget strategy over his term of office was not to balance the budget. The budget ran a small deficit of 0.6 percent of GDP in 1931, followed by a much larger deficits of 4.0 percent of GDP in 1932 and 4.5 percent of GDP in fiscal year 1933 (which, as Judis points out at a different point in his discussion, started in June 1932 and was thus mostly completed before Roosevelt took office in 1933).

Taylor puts the matter plainly:

Hoover did not cut spending. In nominal terms, federal spending went from $3.3 billion (!) in 1930 to $4.6 billion in 1933. Given price deflation during that time, the real increase in government spending would have been larger. With the economy declining in size, federal outlays more than doubled from 3.4 percent of GDP in 1930 to 8.0 percent of GDP in fiscal year 1933…

Because of this pattern, it would be hard to find an economic historian to argue that fiscal tightness was a significant factor in worsening the Great Depression from 1929 to 1932.

Washington’s Enron-style Accounting

Great post by James Pethokoukis of AEI.

"The key to accounting legerdemain, whether you’re running a business or a government, is keeping the bad stuff off the books. AEI’s Andrew Biggs notes the following:

On paper, the Congressional Budget Office reports that in 2010, the federal government spent $3.456 trillion, an amount that is equal to 23.8 percent of gross domestic product. That’s one-quarter higher than the historical norm of around 19 percent of GDP.

But direct spending isn’t the only spending Washington does. As Lori Montgomery reports in the Washington Post, last year the federal government spent an additional $1.08 trillion on tax expenditures, which are tax breaks that for all intents and purposes are spending. … That $1.08 trillion in tax expenditures is 24 percent of all federal spending, and is all off the books, allowing a much bigger government than official statistics tell—and much bigger than people might be willing to tolerate if they knew.

Moreover, according to the Congressional Research Service, tax expenditures have grown by about 24 percent relative to the size of the economy since 1974, from 5.8 percent of GDP to 7.2 percent. So not only do tax expenditures add to overall government spending, they’re adding more today than they did 37 years ago.

People, this is why you can’t simply put a hard cap on spending without also cutting tax expenditures. If you only do the former, Congress will start hiding spending in the tax code."

How to Create More Jobs in South Asia: Less Government

Great post by Julissa Milligan of AEI

"A recent World Bank report on South Asia finds that the most significant constraints to business growth in South Asia are poor government policies. Of the top 15 “severe” constraints surveyed firms listed, eight involved dealing with the government. Political instability topped the list, followed by corruption, tax administration, customs laws, government policy uncertainty, macro instability, the courts system, and labor regulations. The World Bank estimates that labor regulations alone cost India 2.8 million new jobs between 1997 and 2007.

Policy-related constraints were more severe for firms operating in the formal sector and for those in urban areas. This comes as no surprise; the informal sector operates outside of government regulation, and institutional capacity to enforce laws in the rural areas is much lower. However, policies not conducive to business growth are particularly harmful in formal, urban employment because these sectors provide the best jobs. The Bank found that jobs in the formal sector lead to the greatest increase in productivity and the biggest gains in poverty reduction. Moreover, jobs in urban areas are growing more quickly than jobs in rural areas and employment growth in urban areas is more likely to involve the switch from farm to more productive non-farm labor.

Over the past ten years, South Asia created an average of 800,000 new jobs per month and absorbed a growing labor force at increasing productivity levels. However, with the working-age population burgeoning, the region must accommodate 1 million to 1.2 million new entrants per month over the next two decades at rising productivity levels to maintain high levels of growth and a strong poverty reduction rate, according to the World Bank—a 25 to 50 percent increase over current job creation levels. Addressing the damaging constraints the region’s governments place on businesses is a necessary first step."

Taxes are more progressive than in 1990

See Friedman vs D. Brin by David Friedman.

"...the top quintile of the income distribution was paying a slightly higher average federal tax rate in 2007, the last year for which I could find CBO data, than in 1990, while the bottom quintile was paying about half the rate in 2007 it was paying in 1990, and asked him if what he was proposing was doubling the taxes on low income taxpayers."

"...the CBO figures for 2007 show the top 1% paying an effective federal tax rate of 29.5%. The figure for 1990 is 28.8%.

The bottom quintile, on the other hand, paid an effective rate of 8.9% in 1990. In 2007, it was 4.0%."

How much have unions hurt Michigan?

See Unions: The Cause of Michigan's Malaise: The Great Lakes state's burgeoning right-to-work movement is a backlash against aggressive union demands by Shikha Dalmia of Reason.

"Grand Valley State University economist Hari Singh found that if Michigan had been a right-to-work state, the auto industry would have seen a 25 percent gain in jobs since 1965. Instead, it lost 56.6 percent just between 2002 and 2009, shrinking its work force by 165,777. In a functioning market, high unemployment would lead to lower wages. But in Michigan’s auto industry, Singh found, wages actually rose 18.1 percent during that time.

Unions congratulate themselves for protecting workers’ wages, but they have imposed a heavy price on everyone else. Not a single foreign automaker has ever taken advantage of Michigan’s legions of out-of-work but highly trained employees, preferring to train novices in right-to-work states.

The upshot is that the economies of these states grew on average 18.1 percent between 2001 and 2006, according to Paul Kersey of the Mackinac Center for Public Policy. Michigan’s? It grew too—a grand total of 3.4 percent over the same five years.

Since jobs can’t come to Michigan, Michigan residents have followed the jobs. Michigan lost 11.7 percent of its 25-34 age group between 1993 and 2003—while right-to-work states gained 3.8 percent. Indeed, the 2009 Census revealed that Michigan had experienced the third-highest emigration in the country. Otherwise, Michigan’s unemployment situation would be even grimmer."

Do prefer some degree of capital flight from the US because it would lower the value of the dollar and promote exports?

See Fred Bergsten on Net Exports by Greg Makniw.

"In today's NY Times, Fred says government policy should focus more on increasing net exports. He says a lot of wise things, especially regarding the need for better intellectual property protection abroad. One part of the article, however, puzzles me. He writes:

The artificially low value of the renminbi — it is 20 to 30 percent less than what it should be — amounts to a subsidy on Chinese exports and a tariff on imports from the United States and other countries.

Think about this for a moment. As I discussed in this old Times column, the way China affects the exchange rate is by buying dollars in foreign exchange markets and using them to buy dollar-denominated assets (such as Treasury bonds). Yet the exact same mechanism is at work whenever any foreigner invests in the United States. All capital flows into the US raise the value of the dollar in foreign exchange markets and make our exports less competitive. Does Fred object to all capital flows into the US? Would he prefer some degree of capital flight from the US because it would lower the value of the dollar and promote exports? That seems to be the logical implication of what he is saying, but I doubt that's what he intends to suggest. So I am puzzled."