Barro on Taxes and Multipliers
Harvard economist Robert Barro is out with a new paper that undoubtedly will get a lot of attention from conservatives. First, he finds that the multiplier effect from government purchases is well less than one; meaning that each dollar of government spending adds less than a dollar to GDP and is, therefore, contractionary rather than expansionary. Second, he finds very powerful effects from cuts in marginal tax rates; a one percent cut raises the growth rate of GDP per capita by 0.6%. Barro also provides a very useful time series of average marginal tax rates, including Social Security and state taxes, from 1912 to 2006.
Macroeconomic Effects from Government Purchases and Taxes
Robert J. Barro and Charles J. Redlick
NBER Working Paper No. 15369 (September 2009)
Abstract: For U.S. annual data that include WWII, the estimated multiplier for defense spending is 0.6-0.7 at the median unemployment rate. There is some evidence that this multiplier rises with the extent of economic slack and reaches 1.0 when the unemployment rate is around 12%. Multipliers for non-defense purchases cannot be reliably estimated because of the lack of good instruments. For samples that begin in 1950, increases in average marginal income-tax rates (measured by a newly constructed time series) have a significantly negative effect on real GDP. Increases in taxes seem to reduce real GDP with mainly a one-year lag due to income effects and mostly a two-year lag due to substitution (tax-rate) effects. Since the defense-spending multiplier is typically less than one, greater spending tends to crowd out other components of GDP. The largest effects are on private investment, but non-defense purchases and net exports tend also to fall. The response of private consumer expenditure differs insignificantly from zero.
http://papers.nber.org/papers/w15369
Bruce, Re: he finds that the
Bruce,
Re: he finds that the multiplier effect from government purchases is well less than one; meaning that each dollar of government spending adds less than a dollar to GDP and is, therefore, contractionary rather than expansionary.
Is Barro assuming the incremental spending is financed by incremental taxation or by incremental borrowing? Wouldn't the multiplier be different under each scenario since each has a different immediate effect (the former having the immediate effect of reducing after-tax income and the latter increasing interest rates and thus "crowding out")?
And does Barro's finding apply in a deep recession, when both crowding out and spending as a percent of after-tax income would (I think) be lower.
I also would think, just intuitively (I'm not an economist), that incremental spending, particularly if deficit-financed but even if tax-financed, would generally be net stimulative over a short enough time period, since incremental spending is, by definition, 100% spending, whereas only a portion of after-tax income is spent, and incremental investment from lower interest rates takes time to impact GDP. I don't know what time period relates to Barro's multiplier.
Maybe I should spend some after-tax income to invest $5 in his paper to find out all of the above, but I'd appreciate any quick answers you may have.
thanks.
Bruce, Also, Re: he finds
Bruce,
Also, Re: he finds that the multiplier effect from government purchases is well less than one; meaning that each dollar of government spending adds less than a dollar to GDP and is, therefore, contractionary rather than expansionary.
If it's "adding" at all to GDP (i.e., multiplier greater than zero), why would it be "contractionary" (at least, in the short-term)?
Is he ever going to drop
Is he ever going to drop WWII? Contractionary just means war spending replaced some private spending which is what wars have a way of doing, they are expensive.
Defense Spending, per the abstract
If I'm reading the abstract correctly--at the CGI, so no access to NBER right now--he's claiming that every dollar spent on defense has a deadweight 30-40 cents in it, at least until next year.*
He doesn't appear to be talking about overall Government Spending at all—just the part that "liberals" tend to argue has a high degree of deadweight in it from the start.
Finger exercise: anyone want to use the more conservative estimate (0.7) and figure out how much would be saved if we brought all non-combat/medical troops back to the U.S.?
*Or sooner, if he's using the way 12% unemployment was defined in 1959 instead of in 2009.