Tax Lawyer's Blog

For decades fiscal conservatives have been saying that high tax rates cause the economy to contract. When they haven’t been laughed at by the left they’ve been called greedy and heartless. Now it looks like even the left is beginning to think that across-the-board tax cuts are good for the economy and government stimulus spending, not so good.

Yesterday N. Gregory Mankiw in a column for the New York Times titled Economic View wrote:

When devising its fiscal package, the Obama administration relied on conventional economic models based in part on ideas of John Maynard Keynes. Keynesian theory says that government spending is more potent than tax policy for jump-starting a stalled economy. It says that an extra dollar of government spending raises G.D.P. by $1.57, while a dollar of tax cuts raises G.D.P. by only 99 cents. The implication is that if we are going to increase the budget deficit to promote growth and jobs, it is better to spend more than tax less.

But Manikiw says some economic experts say the Keynesian conventional wisdom is dead wrong (emphasis added):

One piece of evidence comes from Christina D. Romer, the chairwoman of the president’s Council of Economic Advisers. In work with her husband, David H. Romer, written at the University of California, Berkeley, just months before she took her current job, Ms. Romer found that tax policy has a powerful influence on economic activity.

According to the Romers, each dollar of tax cuts has historically raised G.D.P. by about $3 — three times the figure used in the administration report. That is also far greater than most estimates of the effects of government spending.

My Harvard colleagues Alberto Alesina and Silvia Ardagna have recently conducted a comprehensive analysis of the issue. In an October study, they looked at large changes in fiscal policy in 21 nations in the Organization for Economic Cooperation and Development. They identified 91 episodes since 1970 in which policy moved to stimulate the economy. They then compared the policy interventions that succeeded — that is, those that were actually followed by robust growth — with those that failed. The results are striking. Successful stimulus relies almost entirely on cuts in business and income taxes. Failed stimulus relies mostly on increases in government spending. 

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