The better option


The blogger, Harvard economist, and former chair of President Bush's Council of Economic Advisers, Greg Mankiw had an interesting piece on his blog yesterday regarding the relative merits of spending increases and tax cuts as ways of boosting the economy. In a nutshell, tax cuts are better:

Bob Hall and Susan Woodward look at spending increases from World War II and the Korean War and conclude that the government spending multiplier is about one: A dollar of government spending raises GDP by about a dollar. Similarly, the results in Valerie Ramey's research suggest a government spending multiplier of about 1.4…

...By contrast, recent research by Christina Romer and David Romer looks at tax changes and concludes that the tax multiplier is about three: A dollar of tax cuts raises GDP by about three dollars.

Of course, I would argue that public spending doesn't really boost the economy at all, since it necessarily involves taking capital away from the (more productive) private sector in the form of taxes or borrowing. Public spending also crowds out private spending which, again, would probably have been more effective in boosting the economy. Still – even if you do accept that public spending is an economic stimulus, the research suggests tax cuts remain the better option.

Hat-tip to James Forsyth on Spectator CoffeeHouse