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Thursday, December 11, 2008

Keynesianism versus tax cuts: Tax cuts win!

"At the very least, these puzzles should give us reason to pause when using the Keynesian framework for policy analysis. There is still a lot about macroeconomics that remains deeply puzzling."

So writes Greg Mankiw, professor of economics at Harvard. The puzzles he mentions are two results from econometric analysis that appear to fly in the face of standard expectations using Keynesian models.

The first paper, entitled "What are the effects of fiscal policy shocks" (PDF), appears to show that, contrary to Keynesian expectations, tax cuts are more likely to stimulate an economy than spending shocks. The findings:

Our main results are that

a surprise deficit-financed tax cut is the best fiscal policy to stimulate the economy

a deficit[-financed government] spending shock weakly stimulates the economy.

government spending shocks crowd out both residential and non-residential investment without causing interest rates to rise.

Similar "anomalous" results were found in an earlier paper entitled "An empirical characterization of the dynamic effects of changes in government spending and taxes on output." The results:

we find that both increases in taxes and increases in government spending have a strong negative effect on private investment spending. This effect is consistent with a neoclassical model with distortionary taxes, but more difficult to reconcile with Keynesian theory: while agnostic about the sign, Keynesian theory predicts opposite effects of tax and spending increases on private investment. This does not appear to be the case.

Maybe it's time to rethink bailing out a pile of different industries and sectors and, instead, consider a massive tax cut. For example, a two-month long income tax holiday might do the trick. Or, why not just abolish the income tax entirely and permanently? The whole thing. Just abolish it. Can you imagine the immediate, and positive, impact on the economy of a repeal of the income tax?

We can dream...

But Rep. Louie Gohmert, from the 1st district in Texas, is really trying to get a two-month long income tax holiday passed. From a press release on his Congressional website:

With $350 billion of the $700 billion bailout still available to Paulson pending Congressional approval, a conservative Texas lawmaker is proposing to put that money towards a tax holiday from both personal income tax and FICA tax for Americans during January and February of 2009.

He stated, "By instating a temporary tax holiday, we could electrify the American economy and provide overwhelming relief to taxpayers, all for less than the cost of the current failed Paulson-Pelosi bailout system."

"We need to give this money to the people who earned it. I am sick of Washington millionaires trying to decide which of their cronies should get the next wad of taxpayer money," Rep. Louie Gohmert continued. "Think about how much you would have if you didn't have any social security or income tax withheld from your pay check, or if you didn't have to pay those taxes for January and February! Americans could take and invest their own money where they believe it should go - to paying down mortgages, buying a new car, making credit card payments. The economy would get relief where it is needed the most. Why try to decide how to prevent foreclosures? Just give taxpayers their own money to catch up on their payments. Those in lower income brackets who are hit the hardest by the FICA tax would see huge money back, and then THEY could choose who should benefit from their hard earned money.  Even the self-employed and small business owners would receive a fantastic amount of their own much-needed money, and they will be able to invest that back into their businesses and even create the ability to hire more people.”

That's just the ticket. We'll be watching and rooting for you, Gohmert.

h/t Instapundit

Posted by P.M. Jaworski on December 11, 2008 in Economic freedom | Permalink

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Comments

I am not 100% sure how it works stateside but I'll bet its pretty much the same as Canada.
We are taxed with the idea that we will be taken care of in our old age through Social Security / Canada Pension Plan. We are also told that we must work hard and save for our retirement.
That just doesn't work any more does it?
The money we earn today (under the Keynsian system) won't be worth a plug nickel when we retire in 20 or 30 years. So saving money is a wasted effort. The old age plans of N. America won't support you to rent a basement suite and buy food at the same time, so basically we're being left to quietly starve to death.

Bottom line! We're being fleeced like sheep all the way through life under false pretences and then being thrown away like garbage when we can no longer be fleeced.

We don't have Government's we have "owner's".
It was this realization that brought me to Libertarianism.

Posted by: JC | 2008-12-12 6:53:00 AM


Where the Keynsean model has fallen apart is during the time the economy starts humming again.

Prime example is during the Mulroney era, when the Chin could not cut down the size of bureaucracy built up during tough times.

Keynes theory is simple ... ramp up gov't spending in bad times, save money (budget surpluses) in good times.

If the people hired into the bureaucracies understood their jobs were only temporary, it would be a start in getting out of the mess we've created for ourselves.

Right now is a ‘tough time,' so the solution would be to ... increase our bureaucracy ever bigger?

Posted by: set you free | 2008-12-12 11:25:14 AM


Tax cuts wins the day easily.

The fear of some politicians is that people will put the money from the tax cuts in the bank and not spend it. That is true.
But the advantage is that this money put in the bank allows them to improve the banks balance sheets and to lend that money out to the entrepreneurs who will take the money and create more wealth with it in the long run.

In fact, when you consider the multiplier effect of the $100 savings becoming $1200 or more in new loans, this is the best way to go. That is if the banks will lend it back out.

But of course it is extremely hard for politicians to give up the fallacy that they know better than Mr Market and his attendent chaos.
That's what real capitalism is all about - chaos - where the money goes to the people who handle prudently and carefully and maximize its use, regardless of their station in life.
And most of those people are not politicians.

Posted by: Rocky Thompson | 2008-12-12 12:55:52 PM


You could join the fleecing class and start living off the hard work of honest Canadians. Simply start a company (idealy a corporation in Quebec with a name like "Canadian National Standard Norme nationale du Canada" and bid on bloated contracts for everything regardless of industry. You grossly under bid and then outsource everything to the people who bid the highest and then simply bill the government more for cost over runs. Once you do this a few times you make the point in your bids that you're a trusted and reliable provider with proved results. Once you do this for about 5 years you start buying nice things for non-elected officials, small things at first, you send them from puppet companies with the names like "Bob Smith" and "Jane Doe" then you inform them in private that they've been taking bribes and you have "proof" which you'll feed the media if they don't scratch your back. You then continue this for a few years until you can get a senate appointment. You can now sit back and let other people work their asses off to deliver on your faulty bids while you collect a fat inflation indexed senate pension.

The only draw back is you'll have to live in Ottawa and learn to speak French. It wouldn't hurt to change your name to something like John Macdonald, John MacKenzie with some suitably French middle name like Jean or Pier.

Posted by: Pete | 2008-12-12 10:49:34 PM



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