Friday, December 4, 2009

Keynes, vindicated?

This is exciting to me. But if it's validated by later analysis, will it mean anything?

In a recent report, the Congressional Budget Office took into account the impact of the entire stimulus package. According to its calculations, GDP was 1.2% to 3.2% higher in the third quarter than it would have been in the absence of stimulus. (According to the latest Commerce Department data, real GDP grew 2.8% in the third quarter vs. a decrease of 0.7% in the second and a decrease of 6.4% in the first.) The CBO estimates that between 600,000 and 1.6 million additional people were employed as a consequence.

The CBO also looked at the stimulative effect of various parts of the stimulus package. It found that purchases of goods and services by the federal government--such as for public works--had the largest bang for the buck, raising GDP by $2.50 for each $1 spent. Transfer payments had a lesser impact, but were still significantly more stimulative than tax cuts. Moreover, tax cuts of the sort favored by Republicans have the least impact. According to the CBO, tax cuts for low-income individuals raise GDP by as much as $1.70 for every $1 of revenue loss, while those for the rich and for corporations raised GDP by at most 50 cents for every $1 of revenue loss.

Lest one suspect the CBO of bias, private economists have also found that tax cuts are far less stimulative than spending under current economic conditions. Mark Zandi of Moody's ( MCO - news - people ), an advisor to John McCain last year, recently testified before the Joint Economic Committee of Congress that the Republicans' favorite tax proposals--making all the Bush tax cuts permanent and cutting the corporate tax rate--would raise GDP by at most 37 cents for each $1 of revenue loss. By contrast, increased outlays for infrastructure, aid to state and local governments and extended unemployment benefits increase GDP by between $1.41 and $1.57 for every $1 spent.

Indeed, one can argue that the failure of the stimulus to create or save more jobs occurred largely because Obama included too many non-stimulative tax cuts in the stimulus package. These tax cuts, such as the Making Work Pay Credit, accounted for more than 40% of the cost of the $787 billion stimulus package. Based on the CBO analysis, I don't think there is any question that the economy would be much worse off today if Republicans had gotten their wish and 100% of the stimulus had been in the form of tax cuts.

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