Budget Surplus? Tax Cut! Budget Deficit? Tax Cut! High Energy Prices? Tax Cut! Deep Recession? More Tax Cuts!

I see a pattern. For some people, the answer to every question is…a tax cut! From WSJ on 29 January:

There’s a serious debate in this country as to how best to end the recession. The average recession will last five to 11 months; the average recovery will last six years. Recessions will end on their own if they’re left alone. What can make the recession worse is the wrong kind of government intervention.

Keynesian economists believe government spending on “shovel-ready” infrastructure projects — schools, roads, bridges — is the best way to stimulate our staggering economy. Supply-side economists make an equally persuasive case that tax cuts are the surest and quickest way to create permanent jobs and cause an economy to rebound. That happened under JFK, Ronald Reagan and George W. Bush. We know that when tax rates are cut in a recession, it brings an economy back.

The article is by Mr. Rush Limbaugh. Typically, I don’t pay heed to this sort of writing, but I make an exception here since apparently a lot of the opponents of the stimulus plan as currently proposed are taking their lead from Mr. Limbaugh (FoxNews WaPo).

I’ll pose a few of questions here.

  • How persuasive is it that tax cuts are the surest and quickest way to … cause the economy to rebound?
  • Is the average recession five to 11 months?
  • Is the average expansion 6 years?

I know that proof by repeated assertion without data is a time honored tradition by some individuals, but Mr. Limbaugh’s first assertion is truly an amazing. In terms of aggregate demand, while tax cuts might get to the individual households quickly, actual spending will be spread out over time. This is illustrated in the dynamic multipliers from the OECD’s macro model.

potgdp3.gif

Figure 1: Multipliers at horizons of N = {1,2,3,4,5} years after implementation, expressed as the ratio of change in GDP relative to baseline to one percentage point of GDP change in X, where X= {government consumption spending, wage/salary taxes}. Source: Dalsgard, Andre and Richardson (2001).In addition, the magnitude of fiscal multipliers, as readers of Econbrowser know, differs substantially in favor of spending increases rather than tax cuts (see [1], [2]).

What about the assertion that the average recession lasts 5 to 11 months? Well, I guess this could be right, depending upon what your definition of average is. Inspection of NBER’s database on business cycles tells me the that the arithmetic average of recessions is 17.4 months and the median is 13.5. The interquartile range (if this is what Mr. Limbaugh means by the average is between “five to 11 months”) is 10 to 18 months. Perhaps, Mr. Limbaugh meant “post-War” recessions; nonetheless, I cannot match his numbers. The arithmetic average length of a post-War recession is 10.4 months, the median is 10, and the interquartile range (IQR) is 8 to 11 months. Note that in all these calculations, I have omitted the ongoing recession, which we know (at least I’m pretty sure) has lasted at least a year…so these measures of central tendency are biased downward.

nbercyc2.gif

Figure 2: Histogram of all contractions, 1854-2007; and histogram of post-War contractions. Source: NBER cycles webpage.What about the characterization of expansion lengths? The NBER database indicates a mean of 38.7 months, the median of 30 months, a lot less than six years. For the post-War period, the mean is 58.4 months and median 45 months — closer, but still not quite the six years (72 months) cited by Mr. Limbaugh.

The most amazing assertion of the oped is here:

I say, cut the U.S. corporate tax rate — at 35%, among the highest of all industrialized nations — in half. Suspend the capital gains tax for a year to incentivize new investment, after which it would be reimposed at 10%. Then get out of the way! Once Wall Street starts ticking up 500 points a day, the rest of the private sector will follow. …

I’ll admit to being irritated by the use of the term “incentivize”, but that is hardly the worst offense. As pointed out in other venues, the citation of the statutory corporate tax rate — instead of the effective — is incredibly misleading (see [1] which cites a CBO report on the subject). Finally, I do wonder about the capital gains tax cut proposal. Will the stock market rise 500 points per day on multiple contiguous days (that seems to be implied by the language), and whether output and the capital stock will rise strongly in response. If one recalls the Bush Treasury’s report, one would be a little skeptical, especially given the temporary nature of the tax cut. For some detail, see this post from 2006.

One last point. I do agree that the “wrong” kind of government intervention can make the recession worse (Limbaugh channeling Cole and Ohanian; see a critique here). But I think the “wrong” kind of interventions include a slavish devotion to tax cuts — especially when the MPC [3] could be argued to be low in the aggregate (although I still believe it would be relative high for liquidity constrained households). This last figure shows how the relationship between the growth rate of consumption and the growth rate of personal income (both in real terms) has changed in the last year, as compared to the entire 1967-08 period.

nbercyc3.gif

Figure 3: Quarter on quarter growth rate of consumption versus quarter on quarter growth rate of personal income, in Ch.2000$. Green line is regression line for 1967-08. Red dots are for 2008. Source: BEA, GDP advance release, 30 January 2009, and author’s calculations.So it bears repeating: The multiplier on spending on goods and services, such as construction, or teachers, or for policemen, etc. will, under these conditions, be larger than that for tax cuts directed at nonliquidity constrained households.


Originally published at Econbrowser and reproduced here with the author’s permission.

5 Responses to "Budget Surplus? Tax Cut! Budget Deficit? Tax Cut! High Energy Prices? Tax Cut! Deep Recession? More Tax Cuts!"

  1. Mohan   February 6, 2009 at 8:55 am

    you are an idiot !!!

  2. Andrej Starkis   February 6, 2009 at 9:45 am

    The comment by Mohan suggests that Rush’s Me!-Me!s do have access to a wider range of reading material than I would have thought. The addition of reading skills (i.e., comprehension) might yet yield a return to some semblance of rational discussion with the drivers of the Republican bus before it heads over the cliff once again.

  3. Guest   February 6, 2009 at 11:07 am

    The Gov can create jobs to some extent by just spending money. However, as soon as the Gov ceases spending money the jobs evaporate. I suppose the politicos could pass an “annual” bailout bill…….Cutting taxes gives a slower response but will create permanent jobs through authentic business expansion.References to Rush on either side are infantile in a forum such as this. Be serious!

  4. Guest   February 6, 2009 at 3:11 pm

    Thanks for the facts, Menzie Chinn.

  5. LetUsHavePeace   February 7, 2009 at 3:23 pm

    Mr. Limbaugh is being cautious. A consolidation of all present tax rates into a single schedule that treated all entities equally would be produce far greater increases in incomes and wealth than any randomly allotted transfer payments aka “government stimulus” (are civil servants really that hard up for a date?). The debate over multipliers is one that those of us who support individual liberty will always lose because the numbers are permanently skewed in favor of the government spenders. Since Master Chinn, the NBER and almost all government economists count the government salaries and stipends as part of the GDP, government spending always produces superior numbers in nominal dollars. What government spending does not produce are increases in individual and collective wealth measured by skills and usable assets. The academic economists and civil servants at CBO, Commerce and Labor, who live in a world of ever-rising pay and zero risk, are the last people to be trusted to measure the benefits produced by the issuance of more circulating credit. They remain its principal beneficiaries. As always, the answer can be found in the simple question: Qui bono?