The Agenda

David Blanchflower and John Makin on Fiscal Stimulus

Dartmouth economist David Blanchflower is calling for an aggressive program of tax cuts to revive the U.S. economy. He is also very skeptical about deep spending cuts in the U.K. On taxes, he endorses John Makin’s call for a payroll tax holiday:

If the payroll tax (of which households pay half directly) were suspended–say, for a year or eighteen months–households would experience an immediate 3.5 percent increase in disposable income that they could employ to sustain consumption and pay down debts. Since the payroll tax is regressive, falling more heavily on lower income households, its repeal would be progressive, while transferring a substantial increase in disposable income to the low-income households who are likely to need it most and therefore likely to spend most of it.

So far, many tax-cutting conservatives will find much to like in Makin’s analysis. But Makin, like Blanchflower, is quite comfortable with running large deficits for an extended period of time, as he sees it as the only way to avoid a Japan-style slump. 

One thing I found odd about Blanchflower’s column was the following section:

 

U.S. unemployment remains worryingly high at 9.5 percent and initial jobless claims are up again. Banks are still not lending, especially to small businesses and even though mortgage rates are at historic lows, house prices show no signs of recovering. Consumer confidence is down and spending is slowing.

The recently announced trade figures were ghastly. U.S. exports in June were $150.5 billion compared with $200.3 billion of imports, which resulted in a goods-and-services deficit of $49.9 billion, up from $42 billion in May.

It’s not clear that tax cuts will address the widening trade gap. In a rather dark post written over the weekend, Tim Duy offered the following thoughts on the subject:

 

I think the latest trade release clearly show that stronger domestic demand is likely to get translated straight into imports.  The same goes for consumer spending –the recession has ravaged credit ratings, leaving the pool of potential borrowers shriveled.  And even if we can induce households to buy more flat screen TV’s, such stimulus is more of a economic boost for the Port of Long Beach than anything else. 

So, increasingly I worry the most effective policy paths are less than palatable for policymakers. And I can’t say that I am particularly comfortable with said paths as well.  But, at the risk of oversimplifying channels of monetary transmission, if future quantitative easing is to work, I suspect it needs to flow through one of two channels.  The first is the via an explosion of net worth.  In other words, a fresh asset bubble.   I don’t think this will happen spontaneously.  Via financial reform, policymakers are in the process of injecting enough glue into the financial markets to keep asset bubbles at bay, at least for the time being.  The other channel is via a sharp decline in the value of the Dollar.  Undoubtedly, this would stimulate export and import-competing sectors (I tend to think the latter is actually the most important).  The rest of the world, however, would be likely to lean against such a decline. [Emphasis added.]

I tend to think Duy’s take on the offshoring of manufacturing is too bleak. But he does raise a good point: a great deal of U.S. fiscal stimulus is fueling the German labor market recovery rather than our own. 

Blanchflower recommends extending the Bush tax cuts. I’m more sympathetic to Howard Gleckman’s suggestion that we allow them to sunset:

 

Now, keep in mind that Obama’s plan to extend the 2001 and 2003 tax cuts fornearly all–as opposed to all—would still add trillions to the deficit over the next decade. When Adam says the Obama plan would make a “small down payment toward fiscal responsibility” he means it would make the deficit less bad—relative to current law—than extending the tax cuts for everyone, including the highest earners. Still, in today’s political environment, adding $3 trillion to the deficit over the next decade is better than adding $3.7 trillion.

My view (which Adam does not necessarily share) is that given budget realities, Obama is wrong to propose extending the Bush tax cuts indefinitely for as many people as he does. I’d lower the threshold even further–perhaps to $150,000–and continue the tax cuts for only a year or two. But in any event, do we really want to extend them for a handful of the very highest earners as well?     

I actually have no problem with tax cuts for the very highest earners. I’d much rather we had flatter taxes. Before we get there, however, we need to put in place reforms that will, over the long term, dramatically reduce the spending burden. That is, we have to eat our broccoli first.

Reihan Salam — Reihan Salam is executive editor of National Review and a National Review Institute policy fellow.

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