Thursday, November 5, 2009

Evidence for economic growth: government stimulus vs. tax cuts

This is a detailed empirical analysis that carries weight in its conclusions. Read the entire report at your cognitive peril.

Design and effectiveness of fiscal-stimulus programmes by Robert Barro Charles Redlick

Abstract: The recent global recession has made the efficacy of fiscal-stimulus packages one of the most prominent policy debates in economics today. This column finds that the multiplier of defence spending falls in a range of 0.6 to 0.8 and argues that non-defence multipliers are unlikely to be larger. It says we should be sceptical when policymakers claim government-spending multipliers in excess of one and suggests tax cuts may be preferable to spending increases.

Our bottom line from this research is that a healthy scepticism is warranted when policymakers claim government-spending multipliers in excess of one. Our estimates suggest that the multiplier effect of defence spending falls more in the range of 0.6 to 0.8, and we find it unlikely that non-defence multipliers would be larger. Therefore, our conclusion is that total economic output increases less than one-for-one with increased government purchases. However, we do find evidence to support the view that tax cuts stimulate total output, with a one percentage point decrease in the average marginal tax rate leading to an increase of about 0.6% in the growth rate of real per capita GDP. As such, our preference in the design of fiscal stimulus packages would be for more tax cuts and less reliance on increased government spending.

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