David R. Henderson  

Murphy on Fiscal Austerity and Higher Tax Rates

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UPDATE: Market monetarist Lars Christensen responds.

As these quotations from [Paul] Krugman and [Christina] Romer illustrate, many of today's proponents of Keynesian policy do not simply disagree with their critics, but go further by leading the general public to believe that only the Keynesians have scientific research on their side. This is simply not the case, as I now demonstrate.

This is from this month's Econlib Featured Article, "What Economic Research Says About Fiscal Austerity and Higher Tax Rates," by Robert P. Murphy.

Murphy, for those of who you might not have noticed, has become one of Econlib's heavy hitters. In fact, I've commissioned more articles from him in my time lining up feature articles, than from anyone else. The count is now 15. I think this is one of his most important. Besides being a nice review of the literature on the effect of tax rates on economic growth, it's an important exploration in the history of recent economic thought, specifically on the thought of Paul Krugman and Christina Romer.

On top of all that, Murphy makes a strong case for "expansionary austerity." He writes:

One implication of this line of research is that a country with a growing public debt burden could benefit from a sharp reduction in government spending, even in the short run. This phenomenon has been called "expansionary austerity."

He cites evidence from Canada and from the European Union countries.

Murphy concludes:

Contrary to the claims of some of today's proponents of both deficit spending and increases in the highest income tax rates, there is a large literature on the historical success of supply-side economics and fiscal austerity based on cuts in government spending. Although the findings of the relevant research are not unanimous, the case for Keynesian pump-priming is not as solid as some of the Keynesians claim. Indeed, in the cases of Paul Krugman and Christina Romer, their own past academic work shows why.


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CATEGORIES: Fiscal Policy , Taxation



COMMENTS (4 to date)
Ron Ronsom writes:

I found this a very interesting article.

From an intuitive perspective then it makes sense that lower marginal tax rates will motivate business and workers in a way that will increase economic activity.

I'm not sure however how relevant this is to the ongoing discussion about austerity.

I think that the reason that Keynesians object to austerity is because they think in a time of depressed aggregate demand that a combination of increased taxes and lower government spending will further depress demand.

In a world of sticky prices it is hard not to believe that such a view is correct. There seems little evidence the RBC theory holds in the real world.

I think one needs to bring monetary policy into the picture before one can get an understanding of how to drive "Expansionary Austerity". A reduction in govt spending combined with tax CUTS is possible so long as appropriate expansionary monetary policy is introduced to offset the decline in demand caused by "fiscal austerity".

Jeremy H. writes:

At the end of the article, it may have been useful to cite Romer as well on the Depression:

http://www.jstor.org/stable/2123226

David R. Henderson writes:

@Jeremy H.,
Good catch. Thanks.

Shayne Cook writes:

It strikes me that there is a very, very great fallacy embedded both in the discussion here as well as with the essay by Robert P. Murphy, not that I disagree with his thesis.

The fallacy I'm referring to being that the U.S. fiscal policy (deficit spending) that has been taking place in the U.S. for the past 6 years should be labeled or discussed as Keynesian. It is not and has not been Keynesian spending at all. It has been nearly exclusively expansive, deficit-funded transfer payments spending. True Keynesian spending would have been on expanded Government purchases of new goods and services produced by the U.S. economy, not expanded transfer payments.

And the distinction is critically important, both to discussions/study of the validity of Keynesianism in general and to the works of the researchers Murphy and Christiansen cite in their articles.

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