Bold Fiscal Testimony

Back in January, Daniel J. Mitchell, a senior fellow at the Cato Institute (the last bastion of hope for libertarian policies) testified before the Senate Budget Committee regarding stimulus policies. His remarks are excellent, clear and concise. I received a link to the testimony in regards to the new Washington whispers of a second round of stimulus checks.

I loved one of his points against Keynesian “pump-priming.”

There are several reasons to be skeptical about Keynesian stimulus. The key shortcoming is that it only looks at one-half of the equation. If the government sends a check to Person A, that person may run out and spend the money. And if the government spends money on Program B, that may result in an immediate outlay. But this type of analysis overlooks the fact that the government first has to borrow the money from Person C. In other words, any money in the pocket of Person A or any money spent on Program B is necessarily offset by less money in the pocket of Person C. There is no increase in the amount of income in the economy — unless the government monetizes the debt, and even that doesn’t work since inflation simply reduces the value of existing money.

The redistribution of wealth is not an increase in national income. And in fact time and time again, merely giving money to consumers has done little to help the economy. A better option is to decrease revenue, rather than to increase expenditure. By lower marginal tax rates, people keep a greater portion of their income and are encouraged to participate in productive and entrepreneurial ventures:

The 2001 episode is particularly instructive. The bulk of the 2001 tax cut — at least the part that took effect right away — was Keynesian-style rebates and child credits. These provisions put money in people’s pockets, but, as explained above, redistributing national income is not the same as increasing national income. As such, the economy’s growth was relatively anemic after the 2001 tax cut was adopted.

The 2003 tax cut, by contrast, was focused on “supply-side” provisions, including lower marginal tax rates on dividends, lower marginal tax rates on capital gains, and — by accelerating the income tax rate reductions scheduled for 2004 and 2006 — lower marginal tax rates on work and entrepreneurship. It is no coincidence that the economy performed much better after the 2003 tax cut than it did after the 2001 tax cut. That’s because the 2003 tax rate reductions improved incentives to earn additional income by lowering tax rates on productive behavior.

Of course the testimony ended with that lawmakers in an election year do not want to hear: that in the short-term there is little effective policy that the government can initiate to have a significant effect and that longer-term policies will lead to ultimately greater prosperity.

The lesson of the story is that policy makers should concentrate on reforms that will improve the economy’s long-run performance. With regards to fiscal policy, that means less government spending, not more government spending. That means permanently lower tax rates, not gimmicky temporary tax rebates.In other words, what matters is the size of government and the structure of the tax system. If government is too big, diverting too many resources from the productive sector, growth will suffer. If the tax system is too punitive, discouraging work, saving, and investment with high marginal tax rates, growth will suffer. Whether or not total spending is more than total revenue, or vice-versa, is a secondary issue.

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