In “Look Closer: Tax Increases, Not Spending Cuts, Are the Harmful Austerity,” economist Salim Furth notes two kinds of fiscal austerity: tax increases and budget cuts. He finds that the negative short-run impact of tax increases on GDP is much more than the short-run negative impact of spending cuts.
A key paragraph:
A dollar increase in tax revenue lowers gross domestic product (GDP) by $2.10 over the same time period, while a dollar of spending cuts only lowers it 80 cents. (Those are short-run effects, and in the long run, economists expect that the private sector picks up any slack left by the government.) Greece has a lot of influence on these estimates, and without Greece the revenue effect falls to $1.30 and the spending effect to 40 cents.
This distinction between the two ways of reducing the deficit is important but it’s one that many critics of austerity–Paul Krugman is the main one who comes to mind–seem to have trouble making. Krugman tends to lump the two together. I’m guessing it’s because his Keynesian view of the world tells him that whether you do one or the other shouldn’t matter. But, unfortunately for Krugman’s view and fortunately for those of us who want a smaller government, Furth finds that it does matter.
Incidentally, you might have heard of Furth, as I first did, when Paul Krugman highlighted Senator Sheldon Whitehouse’s attack on him for making data up. It turns out that it was Whitehouse, not Furth, who reported predicted data as if it was actual. As far as I know, neither Krugman nor Whitehouse has ever retracted or apologized for their scurrilous attacks.
By the way, in the video above, I thought that Furth responded at the end with a lot of dignity.
HT to Steven Landsburg.
READER COMMENTS
David C
Oct 29 2013 at 3:07pm
The graph is from 2009-2012 which is a short and unusual time frame from which to draw long-term conclusions. I would say it provides evidence that tax cuts increase growth during a recession more than spending increases, but isn’t very helpful for determining effects during normal economic conditions.
Andrew
Oct 29 2013 at 3:20pm
One more thing. As Scott Sumner has been yelling for the last few years. It also matters how the Central Bank reacts to fiscal “austerity”.
Daniel Kuehn
Oct 29 2013 at 4:51pm
This is interesting – it’s counter-intuitive. Usually the finding is the opposite (positive multipliers in both cases, lower for taxes) and the reason is tied somehow to permanent income. Kinda hard to know what to think of this since it’s just a scatter plot – no attempt at identification or anything (I’ve had the same critique of Krugman).
One reason might be related to the structure of Europe’s welfare state. My understanding (and I’m no expert) is that they have highly progressive benefits and much less progressive taxes. So if we think about the endogeneity bias in that case you’d expect it to be much higher for spending (in the U.S. we think of taxes as being the big automatic stabilizer).
It would also be interesting to see this without the PIIGS. Even if spending wasn’t the direct cause of their problems, nobody doubts it was related. Cutting their spending might be different from others.
Daniel Kuehn
Oct 29 2013 at 5:01pm
Oooh – big working paper. I was just looking at the Heritage blog post initially.
I wouldn’t frame this as a Krugman issue. The somewhat smaller multipliers for tax cuts is a common finding in the literature, and there’s long-standing theoretical reason to think it’s the case. Heck, Heritage was making the same point about the Bush tax cuts not long ago – that PIH muted the impact of tax cuts.
I don’t know what the tax cuts in Europe were like (permanent, not permanent, or no change in rates at all just a change in revenue), and that matters for how to interpret this.
It’s an empirical question, not a political one.
David R. Henderson
Oct 29 2013 at 6:00pm
@Daniel Kuehn,
I’m not sure why you’re making the point that it’s an empirical issue and not a political issue, but I agree with you.
Daniel Kuehn
Oct 30 2013 at 5:50am
David –
Because the Heritage post presented it as Heritage debunking Krugman. Less to do with your post (although you mention Krugman too).
Heritage has published research with the same arguments that Krugman has, and generally research has found lower tax multipliers for these sorts of reasons.
So this Heritage line that Krugman is being misleading is… I think… misleading. And it implicitly injects politics into it that I don’t think are the principle puzzle here.
Julien Couvreur
Oct 31 2013 at 3:29am
“I thought that Furth responded at the end with a lot of dignity.”
Indeed. That is admirable given the vitriol and bullying from that senator.
You also have to consider the physical setting (which the video doesn’t quite capture) of having the senators in a position of authority.
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