Path to Recovery: A Libertarian Perspective on Economic Crisis

Harvard International Review, Winter 2009 | Go to article overview

Path to Recovery: A Libertarian Perspective on Economic Crisis


In your statements, you have advocated tax cuts over government spending as a policy instrument for economic stimulus. Could you explain why tax cuts would be more efficient?

I would not use the words "more efficient," but I will come back to that. My view is that spending increases would certainly make sense if there were projects available to the government that clearly had benefits in excess of costs. Standard examples would be bridges that are falling down and that need to be repaired. I completely accept that there must be some projects out there that the government needs to do, and there are clearly some parts of the interstate highway system that are in need of repair. However, I am skeptical that there is anything remotely near to US$500 billion of projects that make sense on standard cost-benefit terms, which the government would want to fund independent of the recession.

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Now, if you use the standard Keynesian justification that government expenditure improves the economy, government spending is valid even it is totally wasteful--even it is digging ditches and filling it back up. Nothing in the model assumes that those expenditures are, or requires those expenditures to be, somehow productive. Instead, any kind of expenditure "works."

Yet, it seems very, very unlikely that wasteful government spending could make sense in the long run. Now in the very short run, it might make some sense under some assumptions, but I think those assumptions are not so trivial. In the long run, we do not want to have devoted much government effort to digging ditches and filling them back up. That is crowding out, taking resources away from other, more productive uses of the economy and the government budget. If one argues that we could easily create government projects, even projects of questionable cost-benefit value that would be purely temporary and would get the economy going again--either in jumpstarting the economy away from recession or moving it toward full employment--and if one states that we could eliminate these once they were no longer needed for stimulus purposes, there would need to be a rational argument for that.

My assessment is that many allegedly short-term stimulus measures are still with us decades or even centuries later. Therefore, at a minimum, one should think both about the long-run efficiency effects of government purchases and not just about their short-run stimulus impacts. So, is there a way to try to stimulate the economy without taking the risk that we embark on some ill-conceived government expenditure projects? The answer is yes, we can cut taxes. In the standard Keynesian model, tax cuts are effective at stimulating private demand, creating either more consumer demand or more investment demand. We could certainly use more tax cuts.

Now, the conclusion in the standard model is that one gets a bigger "bang for the buck" with government expenditures--for a given size increase in the deficit, there is a larger effect on output from expenditure increases than from tax cuts. This effect is the government purchase multiplier, which is larger than the tax cut multiplier. The Keynesian model is relatively narrow, and there are other factors that play a role in determining what is more effective. In particular, if you think about the efficiency effects of lower taxes, then that might cause taxes to be more beneficial than government spending over a medium or longer-term horizon, even if not in the short run. Existing evidence suggests that tax cuts also have a large multiplier effect in stimulating output, and government purchases are somewhat more modest. Indeed, the evidence from the tax cut multiplier does not come from some right-wing hyena. It comes from Christie Romer, who is the Chairman of the Council of Economic Advisors under Obama, and should not be ignored.

Now there may be some other factors too, but at a minimum, the tax cut view seems completely logical and consistent.

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