In Search of Effective Stimulus

Dylan Matthews at the Washington Post has asked what we might be able to do for the economy if we repealed the Bush tax cuts for the wealthy and spent the money on something else.  The result is a nice post full of graphs, but the answer seems to be "not much"--the very best estimate is that we get about $75 billion in added economic activity, or about $25 $250* for every person in the country.

That, mind you, requires some pretty big assumptions. 

For starters, it assumes that the rather optimistic estimates of Mark Zandi about the size of the stimulus multiplier are correct.  Estimating stimulus multipliers is incredibly difficult when you try to do it at the macro level (how much spending equals how much extra GDP), and even more difficult when you try to figure out whether food stamps are better than a jobs program--the examples are fewer, and the amounts are smaller, making it hard to pick up direct effects.

It also assumes that any measured increase in GDP measures some improvement in human welfare.  It is trivially true that if you increase one component of a measured variable, that variable will get bigger.  It's much harder to know that any particular increase in GDP represents a real change in human welfare, or merely moving chess pieces around the board.

Too, this basically assumes that there are no dynamic supply-side effects from the tax increase.  And it assumes that the multiplier from a tax cut is the same as the lost GDP from a tax increase, which is not necessarily the case--where you start matters.  In this case, we're starting in the middle of a recession, when people may find a tax increase more worrying, because they're already feeling more financially insecure.  To be sure, that worry might push them to work harder, or to hunker down and do as little as possible.  But there's no reason to think that it's somehow steady state through good times and bad.

Finally, it seems to assume that we could repeal the Bush tax cuts this year.  We can't.  As far as I know, you can't tax peoples' income retroactively, a legal nicety that considerably frustrated Congress in dealing with the AIG bonuses.  By the time Congress actually got around to repealing the Bush tax cuts for the wealthy, they'd be getting ready to repeal themselves.  It would be a pointless waste of legislative energy this late in the game.

Especially when you think that the cheery estimate is a gain of $75 billion, which sounds like a lot in terms of my income, but is, in terms of our national income, it's very little.  I wouldn't sneeze at $250, but it's much less than the average person spends on fast food in a year.

* Huge mistake; the calculator on my computer won't go into the billions, and I truncated incorrectly.  The main point stands; even a very optimistic set of assumptions doesn't yield huge net benefit.

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Megan McArdle is a columnist at Bloomberg View and a former senior editor at The Atlantic. Her new book is The Up Side of Down.

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