The American Recovery and Reinvestment Act Cut Taxes Substantially

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Fist of Money 1

In response to the Obama administration advocacy of fiscal stimulus to combat the economic downturn, the American conservative movement had largely abandoned Keynesian views they espoused in 2001 in favor of a real business cycle view of economic downturns. This is not a move, however, that right-of-center professional economists with previous professional commitments to New Keynesian ideas have available to them. This Greg Mankiw takes what I really think should be the mainstream conservative view of the issue, namely that fiscal stimulus is fine by liberals are way too eager to boost government spending when tax cuts are better:

A few days before President Obama’s inauguration, his economic advisors released a document titled “The Job Impact of the American Recovery and Reinvestment Plan,” in which they detailed some of their economic assumptions. They determined that the “government-purchases multiplier” — that is, the multiplier for direct spending — would be 1.57, while the tax-cut multiplier would be 0.99. In other words, every dollar spent by the government would yield $1.57 in aggregate demand, while every dollar in reduced taxes would yield only 99 cents in increased demand. And because 1.57 is larger than 0.99, the Obama team concluded it was better to increase spending than to cut taxes.

Mankiw goes on to argue that this was a mistake.

And perhaps so. But what he doesn’t mention is that the American Recovery and Reinvestment Act did, in fact, contain a very large tax cut component—approximately one third of the total size. And as Brad DeLong points out, when you plug the tax and spending multipliers Mankiw prefers into the actual bill—rather than the made-up all-spending bill—ARRA looks even more effective than the Obama administration claimed it might be. The difference being mainly that Mankiw believes, citing Romer & Romer, that tax cuts are such an effective stimulus that the greater punch from ARRA’s tax cuts far outweighs the lesser level of efficacy he attributes to ARRA’s spending.

Meanwhile, I think that endlessly relitigating ARRA tends to detract from the main problem facing right-of-center and left-of-center proponents of fiscal stabilization alike, namely that the political mechanism of enacting discretionary stimulus through congress is extremely clumsy and leads to bad policy outcomes. The most helpful thing to do before the next downturn would be to establish in advance a reasonably streamlined way of preventing state and local government from hiking taxes and cutting services in the middle of a recession.