Paul Krugman explains why some temporary spending hikes (such as unemployment insurance) can boost demand in a way that some tax cuts (e.g., for "the rich") cannot.
It's Christmas in August for me, since I had been railing about this very point recently. My theme was that a payroll tax cut ought to be roughly as stimulative as an increase in unemployment insurance. And today, Krugman clarifies his opposition to tax cuts a bit:
That’s why unemployment benefits are an effective demand stimulus: the unemployed are highly likely to be suffering a temporary income loss but be unable to borrow cheaply. It’s also why tax cuts for working-class families may have some traction: a fair proportion of those families will be people having a bad year, but without assets or borrowing capacity to draw on.
But temporary tax cuts for people with high incomes are likely to be highly ineffective: there are people with incomes over $250,000 who are having a temporary bad time and have neither assets to sell nor the ability to borrow, but they’re very much the exceptions to the rule.
We seem to agree that both unemployment insurance and payroll tax cuts will mostly be spent rather than saved, which is progress. I have no problem imagining that tax cuts for "the rich" are mostly saved, but I am less sure about why I care - the decreased public saving is offset by increased private saving, so the savings/interest rate feedback loop is not activated.
Now, if there was some other constraint on the size of the stimulus package (rather than on the size of the net increase in public and private borrowing), tax cuts for "the rich" would not provide as much apparent bang for the buck. And in the current political environment, I think the political/optical constraint is real, sensible or not.
As to Krugman's position on payroll tax cuts, he has had different but not irreconciliable positions. This is from a Jan 6, 2009 blog post:
How much do tax cuts and spending raise GDP? The widely cited estimates of Mark Zandi of Economy.com indicate a multiplier of around 1.5 for spending, with widely varying estimates for tax cuts. Payroll tax cuts, which make up about half the Obama proposal, are pretty good, with a multiplier of 1.29; business tax cuts, which make up the rest, are much less effective.
But a few days later, payroll tax cuts didn't make the cut in his Jan 11 2009 column:
First, Mr. Obama should scrap his proposal for $150 billion in business tax cuts, which would do little to help the economy. Ideally he’d scrap the proposed $150 billion payroll tax cut as well, though I’m aware that it was a campaign promise.
Money not squandered on ineffective tax cuts could be used to provide further relief to Americans in distress — enhanced unemployment benefits, expanded Medicaid and more. And why not get an early start on the insurance subsidies — probably running at $100 billion or more per year — that will be essential if we’re going to achieve universal health care?
Within five days payroll tax cuts went from "pretty good, with a multiplier of 1.29", to "ineffective". Hmm.
If I believed that (a) all public spending had a multiplier of 1.5 (despite a possible dearth of shovel ready projects); (b) that the payroll tax cut multiplier was "only" 1.29; and (c) that my total stimulus package was subject to some numerical bound regardless of the mix of tax cuts and spending, then I might drop the tax cuts as less effective. But ineffective?
But don't let me start whining! Since payroll tax cuts have now made it back to being possibly effective, I will settle for the progress made so far.