Thursday, December 11, 2008

Why is it surprising that tax cuts have a bigger effect than spending increases in the real world?

Tax cuts put money into the hands of people who will spend or invest it on things that are economically valuable. The money goes into the market system directly or indirectly.

Spending increases divert money out of the market system and into the sausage factory. In this world, swimming pools and tennis centers are "infrastructure", companies that have been failing for 20+ years are given billions of dollars and a mandate to undertake even less profitable business plans, bridges are built "to nowhere". We're lucky if the "multiplier" on this crap is as big as 1.0.

People, our government produces mass quantities of a particular product: pork. And every time it increases output, the arteries of our economy get a little bit more fatty and clogged.

On average tax cuts free up more money to go toward more highly valued uses (at least if they reduce spending or are given to non-Ricardian agents).

If you are wondering what I am ranting about check out this, this, and this.

I guess I'd rather give my money to people who are going to use it to try to make more money (i.e. save/spend it in the market system) than give it to people who are going to use it to try and get re-elected.

Hat tip to Tyler for getting me wound up on this subject.


Dirty Davey said...

"Spending increases divert money out of the market system and into the sausage factory."

Do not forget: In government decisions to tax and spend, Money Is Neither Created Nor Destroyed.

The money the government "spends" is not "consumed"--it ends up "in the hands of people who will spend or invest it", even if those are not the same people who pay the taxes.

The people who build a swimming pool or a tennis center, or who are paid by a failing company instead of being laid off, or the engineers who build bridges (even those to "nowhere")--all of those individuals will spend or invest that money in the market system.

To treat government spending as if it involves feeding money into a paper shredder is to ignore that principle: Money Is Neither Created Nor Destroyed. The tax collected and then spent, in being spent, goes to actual PEOPLE, who then use it in "the market system".

kebko said...

Dirty Davey - Are you saying that the government can spend that money on absolutely anything, and the result will be positive, because the money then re-enters the economy? Can you imagine any scenario where you would consider the spending to be a bad idea?
If I have a business selling custom-made gilded wicker statues dedicated to my favorite, deceased pet hamster, and the government gives me a $5 billion subsidy to keep my 500 artists hard a work on our statues, are you saying that you would support this as an economic stimulus?
Isn't the point that if the people receiving the distributions aren't compelled to do something reasonably useful for the money, then damage is done to the economy on many levels?

Angus said...

DD that's the dumbest thing I've ever read from you and that is really saying something.

Dirty Davey said...

Kebko-- I am not saying that all expenses are equal. I am saying that money spent by the government is not "taken out of the economy".

Angus-- So can you explain why if my taxes were $100 lower, that $100 is "in the economy", and if the $100 is paid to a doctor to treat a GM retiree, that $100 is somehow "out of the market system"?

Government spending neither creates nor destroys money.

br said...

Here's a simplified example of how gov't spending can destroy money:
Spend $1M on a bridge no one is going to use. Say $.1M of it goes to salaries which stay in the system. Then say $.9M is spent on materials (call it asphalt). Total waste of $.9M in asphalt + interest b/c we borrowed the money (2 years at 6% and we've already lost the benefit of the $.1M in salaries) + increased cost of asphalt to everybody else (ie. legit projects) b/c govt artificially drove up the demand for asphalt.

Did I miss anything?

Dirty Davey said...


First, that money "spent on materials" goes to the vendors of the materials--who use it to pay salaries, pay dividends to investors, or to obtain their own raw materials (which just extends the chain one step further). Every dollar ends up in the pocket of a PERSON, who spends it "in the economy".

Interest goes to bondholders, who use the money as they see fit.

And if spending money on X drives up the demand (and thus the price) of X, the fact that the money is not spent on Y drives DOWN the demand (and thus the price) of Y. So the societal net result can be zero--increased cost of X to everyone else being offset by decreased cost of Y to everyone else.

Angus said...

DD you keep saying over and over that you think I am so stupid that I do not realize that government spending is part of GDP; that I somehow don't know or understand that the bridge to nowhere was built by workers who got a paycheck and bought items with it.

to that I can only respond as I did: "WTF????"

If you would read the links and see what is being debated maybe, just maybe, you might start to get the point.

your catchphrase has nothing to do with the point of my post and I am pretty sure you know that.

Dirty Davey said...

With respect to the original claim about the multiplier, Krugman has it right... looking only at the war years, the government was doing everything in its power to tamp down consumer spending via rationing and such. Postwar economic growth is in part owed to the effects of the wartime spending, particularly in the years right after the war, as artificially suppressed demand rebounded.

(Further, no one would argue that all forms of government spending have the same multiplier--and given that military spending logically has a much lower multiplier than other forms of spending, using the military-spending case to derive the general multiplier will understate the effect. Building a road that improves transportation and commerce in the US will obviously have a higher rate of return to the domestic economy than blowing up a German munitions plant.)

wdomburg said...


Take the example Br proposed of a useless bridge. Sure the original capital is kept in circulation, but what of the thousands of man-hours expended without gain? What of the raw materials that might have otherwise been used fruitfully? What of the energy resources consumed?

In other words, say that bridge had been built somewhere it was actually needed. Not only would you the original capital continue circulating, but you would have created new value (perhaps decreasing supply lines for businesses, thereby boosting their output).

So you're right, government spending doesn't destroy wealth; it prevents it from being created in the first place.

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