Questions of Fact
David Leonhard and Bruce Bartlett on Fiscal Policy

Why Is Marty Feldstein Worrying About Whether Tax Increases Kill The Recovery?

Conor Clarke worries about Martin Feldstein's fears. I would say that it is an argument from the permanent income hypothesis rather than Ricardian equivalence--RE is that tax-law changes have no effect, while the PIH says that taxes matter not because current taxes affect current income but rather because the the long expected stream of future taxes affects the long expected stream of future income:

Will Tax Increases Kill The Recovery? : Martin Feldstein's Wall Street Journal op-ed... the argument he makes ("Tax Increases Could Kill the Recovery") is one that comes up a lot and I want to say one brief -- if slightly wonkish and tedious -- thing about it. When I read Feldstein's headline I thought, "But none of the tax increases take effect until 2011!" And while Feldstein anticipates that argument, I'm not sure his response makes a lot of sense:

Even if the proposed tax increases are not scheduled to take effect until 2011, households will recognize the permanent reduction in their future incomes and will reduce current spending accordingly.

[But] Feldstein supported a deficit-financed fiscal stimulus... when I went back and checked Feldstein's op-ed on the subject of fiscal stimulus I found that he has this to say....

Under normal circumstances, I would oppose this rise in the budget deficit and the higher level of government spending. When an economy is closer to full employment, government borrowing to finance budget deficits can crowd out private investment that would raise productivity and the standard of living. Budget deficits automatically increase government debt, requiring higher future taxes to pay the interest on that debt. The resulting higher tax rates distort economic incentives and thus weaken future economic performance.... Nevertheless, I support the use of fiscal stimulus in the US, because the current recession is much deeper than and different from previous downturns. Even with successful countercyclical policy, this recession is likely to last longer and be more damaging than any since the depression of the 1930's...

I prefer the Marty Feldstein of three months ago. Which one does Feldstein prefer?

My reading is that Marty has two things in mind:

  • Trying to make sure that the current recovery is not derailed by the possibility that lots of press about coming tax increases causes consumers to cut back even more.
  • Setting up the pins for three years from now, when we turn back to worrying about the long-run deficit, with the aim of starting from as low a level of taxes as possible when we start raising taxes and cutting spending to cut the deficit.