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Back to More expense or less income?

Fernando Pérez de Gracia, Professor of the School of CC. Economics and Business Administration, University of Navarra

More expense or less income?

Mon, 02 Nov 2009 09:35:35 +0000 Published in Expansion (Madrid)

The current economic crisis has brought to the table the importance of design, execution and effectiveness of economic, monetary and fiscal policy. With respect to stimulus plans on the fiscal side, leaving aside monetary aspects, we have witnessed numerous international experiences from North to South and East to West. In our country, we all have in mind the I Spanish Plan to Stimulate Economics and employment, known as Plan E. Given the continued weakness of some economic indicators, the government is considering extending the life of Plan E with a revised version for next year 2010, Plan E II. The renewed Plan E will be a different plan in terms of objectives and budget, but it will undoubtedly be another fiscal stimulus plan for Economics. The question we are all asking ourselves is whether this plan should really be considered by increasing state purchases or whether taxes on families and companies could really be reduced.

At this stage, it is perhaps too early to answer this question in the Spanish case, although topic raises many doubts. However, international historical experience provides us with some interesting results on the true economic impact of fiscal stimulus plans.

Lessons from the past

Recently, a paper from work of the prestigious National Bureau of Economic Research analyzes the impact of fiscal stimulus plans in the U.S. (see issue 15369 of September 2009 graduate "Macroeconomic Effects from Government Purchases and Taxes"). This paper from work, conducted by economist Robert Barro -Professor of Economics at Harvard University- together with Charles Redlick -Bain Capital, LLC-, quantifies the impact of fiscal stimulus on GDP for both increases in government purchases and reductions in taxes. The main findings of report are threefold.

First, the multiplier effect of expense estimated for the US is less than unity. That is, for a given increase in expense, GDP is expected to increase by a smaller amount.
A second result equally interesting from an economic policy point of view is the following: fiscal stimulus plans that opt for tax reductions reactivate Economics as a whole by favoring consumer demand (improving household income available ) and encouraging business investment. Specifically, Barro and Redlick's estimates confirm that a one percentage point reduction in the average tax subject increases next year's GDP growth by 0.6%.

Finally, the third result of report leaves no room for doubt: the estimates made for the U.S. argue that if we are interested in improving GDP in an environment of economic crisis such as the current one, a tax reduction is preferable to an increase in the public expense as a dynamizing element.

The effects of the fiscal stimulus plans, whether via government purchases or tax reductions, are already on the table. At summary, fiscal stimulus plans via tax cuts rely on the private sector - both households and companies - as the engine of economic recovery (see the recent advertisement by the German authorities on tax cuts) as opposed to increases in government purchases, which rely on the public sector as the driving force. The true effects of the various fiscal stimulus plans will be known over time, but now is a good time to reflect on topic.