Thursday, December 2, 2010

Tax cuts have the lowest fiscal multiplier

The latest CBO assessment of the impact of ARRA once again (here is the earlier evidence) highlights that tax cuts are among the least effective of fiscal stimulus measures. This assumes significance in view of the decision pending before the US Congress on whether to extend the Bush tax cuts beyond its expiration period at the end of the year.

In fact, even the higher estimates on tax cuts on higher income people and corporates, revealed fiscal multipliers less than unity. In contrast, direct government spending, transfers to states, local governments, and individuals ((such as increased food stamp benefits and additional weeks of unemployment benefits), yielded higher multipliers.

In an excellent recent post, Mark Thoma examined the evidence on the impact of the Bush-era tax cuts of 2001 and 2003. The Bush tax cuts were done in two phases - in 2001 the top statutory income tax rate was reduced from 39.6% to 33%, while in 2003 the tax rate on both capital gains and dividends was lowered to 15%.

I have blogged earlier that far from having any positive impact, the marginal income tax rate increases of 2001 adversely affected household incomes, unemployment rates, and deficits. There is a large body of evidence to show that capital gains and dividend tax cuts had little or no impact on stock prices and corporate payouts. Further, the tax cuts on capital gains and dividends has also been held responsible for the massive widening of income inequality in the US in recent years.


KP said...

Dear Gulzar,

The widening disparity in the US and the multiplier effect largely in the circular trading of cash in the financial sector / and into inflated asset valuations is well documented.

However, what is baffling is the ability of politicians to convince the electorate to go with the tax cuts for the wealthy.

That it is heavily contested (letting the tax cuts expire), is in itself not quite convincingly explained by any theory of voter choice.

Or is it that americans are exceptionally tolerant to disparity and wildly optimistic about their own chances of success.

A Pew poll last year found that 77%of Americans say that "there is too much power concentrated in the hands of a few big companies." A clear majority 62% - says businesses make too much profit, while fewer than four-in-ten (37%) say businesses "generally strike a fair balance between profits and the public interest." (source article by Peter Dreier in Huffpo)

Unemployment and the shrinking options of the middle class in the US...explained by this report from The Hindu.... "Twenty deals worth 10 billion dollars that create over 50,000 jobs.' .... These were jobs to be created in the U.S., with Indian money. But we were generously excited nonetheless. Here was a chief executive to be admired. Going out and getting the job — and jobs — done. A little perspective might help. Fifty thousand jobs are about what the United States has lost every week, on average, since December 2007. That is, for a straight 140 weeks".

I hope our own imitation of this cautious..with Indian characteristics.


gulzar said...

thanks KP.

the explanation for the enduring appeal (at least in election results) of supply-side economics (Samuelson called it snake-oil remedy) may be manifold - ranging from its ideological hold (on Republicans) and America's bi-polar political system to its inherent attraction to the individual voter/tax-payer.

inequality is fast emerging as a major drag on growth itself. the breaking point (with supply-side, inequality etc) will happen when its impact on the collective reaches a point that it starts impinging on the individual.

the widespread opposition to the banking bailout even as millions were suffering the fall-out of the Great Recession and the dominant perception that greedy bankers were responsible for that is a positive trend. the democrats could have channelled this anger more effectively, especially wrt the 15% tax on capital gains and dividends and a millennium tax etc. i am inclined to the view that President Obama, like in many other areas, failed to provide the leadership on this.

i completely agree that India should be cautious in embracing elements of US model, and any adoption of it should be distilled with the lessons of the America experience.