Stimulus without deficits

Prominent critics of deficit-financed stimulus measures have nothing to offer but deficit-financed stimulus measures, writes Gavin R. Putland.

The Australian proclaimed on August 19:

Three leading economists contacted by The Australian said the government should reconsider its stimulus spending in light of the improved outlook.

Two other economists mentioned in the story were not of that view; but I shall concentrate on the three that were. The first was reported as follows:

Access Economics director Chris Richardson said, in hindsight, the federal budget could have carried less of the burden of boosting demand, and the Reserve Bank more.

“The less scary this downturn looks, the more that we could have gotten away with relying on interest rates,” he said.

In other words, the more we could have gotten away with encouraging private borrowing — as if we hadn't encouraged too much of that already, and as if monetary policy by itself still worked.

But the Australian found support for Richardson from Australia's leading right-wing think-tank:

Stephen Kirchner, research fellow with the Centre for Independent Studies, said the RBA would have probably cut interest rates faster and harder in the absence of the government's spending spree.

Canberra's spending had been comparatively unproductive, supporting demand-driven imports, and quick and easy projects over more worthwhile ones, he said.

“Government can shift activity from one sector to another and, to some extent, they can bring it forward, but they can't deliver a sustained increase in economic growth, especially when the quality of the spending has been so poor,” Dr Kirchner said.

So it's better to encourage more borrowing by the private sector, presumably because the private sector is so much better than the public sector at picking investments — especially when the tax system encourages speculative investments over productive ones (by taxing “capital gains” at a lower rate than income from capital), and when the taxpayers stand ready to bail out lenders that back losing investments. In a free market, the role of government is to use public money to bail out private lenders when private investments go bad — not to indulge in any investment of its own. How can any Right-thinking person not agree?

Further support came from Sinclair Davidson, whose connection with that other right-wing think-tank, the Institute of Public Affairs, was not acknowledged in the online version of the story:

Sinclair Davidson, a RMIT professor of institutional economics, also backed the use of interest rates over budget spending to support the economy.

“I think the spending by the government was too much, too fast, on things with low economic returns and (that were) fiscally irresponsible,” he said.

Whereas the private sector, as the present global economic situation shows, is the very archetype of financial and fiduciary responsibility!

Why is this nonsense taken seriously? One reason is financial support from vested interests. Another is that whereas the Right has nothing to offer but more private debt, the Left has nothing to offer but more public debt.

Consider, for example, Max Corden's robust defence of fiscal stimuli (favourably reviewed by Mark Davis in the Fairfax press). Against the “conservative allegation” that the benefit of initial public spending would be wiped out by the subsequent increase in interest on public debt, Corden makes two points:

• Public debts are private savings, so that, in the aggregate, the additional assets of private citizens as savers exactly offset their additional liabilities as taxpayers;

• At least some of the public borrowings will be invested in projects that yield recurrent dividends.

One might suggest that the same two points could be made in favour of private borrowing. But in a depression, attempts to stimulate private borrowing through monetary easing tend to fail as both debtors and creditors try to rebuild their balance sheets.

A more serious criticism of Corden's argument is that it fails to allow for the deadweight cost of taxation. The benefit of public expenditure on infrastructure is manifested as uplifts in land values. In principle, the government could amortize the capital cost of the infrastructure by clawing back some of the uplift. While the clawback might be branded a “tax”, it would not be a true tax, because it would not confiscate any fruits of private effort, but would merely retain part of the fruits of public effort in public hands. For the same reason, the clawback would not deter any private effort. In practice, however, governments allow almost all of the uplifts in land values to be privately appropriated, and amortize the capital costs through taxes which punish and deter productive efforts and therefore reduce economic output — the “deadweight” effect. The disappearance of public expenditure on infrastructure into private asset values is the real reason why such expenditure, as currently funded, is “fiscally irresponsible”.

But notice that all the economists mentioned so far seem to agree on one thing: that the necessary stimulus to demand must be funded from debt, which may be private, as the Right wants, or public, as the Left wants. Critics of public deficits have nothing to offer but private deficits. Critics of private debt have nothing to offer but public debt. All seem to accept the assumption that governments can stimulate demand only by increasing expenditure and/or reducing revenue. That assumption is false, as the following examples show:

• Limiting the First Home Owners' Grant to new homes would stimulate construction, because some buyers who would otherwise buy established homes would instead buy new homes. But it would also reduce public outlays, because some buyers who would otherwise get the grant for established homes would instead forgo the grant.

• If the “negative gearing” deduction were disallowed on future purchases of established properties and shares in established companies, but still allowed for new construction and new floats, there would be more construction and more corporate start-ups, because some people who would otherwise invest in established buildings or established companies would instead invest in new buildings or new companies. But the same measure would increase public revenue, because other investors would forgo the deduction.

• Discounting of “capital gains” could be reformed in the same way as negative gearing, with similar results.

• A partial clawback of uplifts in land values (suggested above in connection with infrastructure) would increase the attractiveness of current income relative to “capital gains”, and thereby stimulate efforts to generate income from land. The stimulus would be especially strong if the clawback took the form of a holding charge proportional to the value or the uplift in value, because one would need to generate income in order to cover the charge. But the same measure would increase public revenue (or rather recover some public expenditure from the beneficiaries thereof).

• If every employer received a company-tax credit proportional to the increase in its workforce since a certain reference date, employment would increase, and the direct loss of company-tax revenue would be outweighed by the expansion of tax bases including personal income, consumption, payrolls, and profits. And by some combination of the above measures, one could prevent the benefits of job creation from being dissipated in another round of land speculation leading to another crash.

Why don't these proposals rate a mention in mainstream debate? Because they're incentives, and the vested interests that determine economic policy don't want incentives; they want free gifts.