INCREASED SPENDING VERSUS TAX CUTS
If there is unemployment and the government wants to raise g.n.p. through active fiscal policy, should it increase expenditures, or cut tax rates? The answer will depend partly on the rela tive flexibility of the two approaches, and partly on your socio-economic preferences for “private enterprise” as against “public spending.” Consider some of the issues.
Public Investment Expenditures
“Regular” government expenditures in normal times include extensive investment in highways, education, parks, and so on. These public projects are presumably undertaken because they fill a greater social need than do alternative private uses of the resources. Citizens’ dollars are diverted through taxation from private to government spending.
Public-investment projects in depression should be considered in the light of these “regular” needs. Such “net-social-gain” public-investment projects should be the ones undertaken first in depression periods unless there are strong counter-arguments. Next, public projects that were marginal in periods of full employment may be worthwhile when expansionary public spending is needed. For example, a new highway that could not quite be justified on its own merits may become clearly desirable when it can double in brass as a recovery stimulant. But how effective is such spending against unemployment and underspending in the private sector?
1. Outlays on public works directly stimulate the durable-goods and construction industries, where unemployment is often centered. Public expenditures “bunched” on public works can provide a big stimulus to demand in such industries (e.g., construction and steel).
2. Public works, unlike unemployment or relief payments, give us “something to show for our money.” Modern schools, parks, and highways are valuable in their own right, beyond the help they provide in raising aggregate demand.
3. By providing jobs for otherwise unemployed workers, public-works projects help maintain the morale, self-respect, and skill of workers. Even with a dole or unemployment compensation to avoid starvation, worker morale may suffer severely from unemployment; self-respect is lost; idleness becomes habitual; skills become rusty or vanish. Such social losses are a major cost of unemployment.
On the other hand, public-investment projects have serious limitations:
1. Most important, flexibility in timing is hard to attain. Public-works projects are generally slow to get started and hard to stop once the need for them is past, because of both their physical nature and their political setting. Every locality and political group demands its share. It takes a long time to draw plans and let contracts for major construction projects. Moreover, it is not practical to cut them off short of completion, once they are begun. A bridge halfway across a river or a partly built schoolhouse must be completed to avoid flagrant waste even if depression has turned to inflation.
2. Public-works projects may perpetuate undesirable relative price-cost maladjustments in the industries where public-works spending is centered. Especially in the construction industry, wages and prices rise rapidly in boom times and stay up when demand slackens. Large government construction projects help keep these costs high.
3. Some types of public works may compete with private investment. This objection is advanced most strongly against government construction of low-cost housing and such combined power, reclamation, and flood-control projects as the Tennessee Valley Authority. \Vhatever the answer is on these public-works projects, a wide range of available outlets, such as education, highways, parks, and resource conservation, is clearly noncompetitive.
Some observers argue that in our now-affluent society we tend to starve the public sector of the economy. We desperately need better education, cleaner streets, slum clearance, and the like. Instead, we “waste” billions annually creating obsolescence through inessential style changes on cars and refrigerators, on vast attempts to create demand for “unneeded” products. These observers argue that there is a presumption in favor of higher government expenditures on increased “public services” at all times, and that at a minimum we can obtain a balanced-budget multiplier effect by raising both expenditures and tax receipts. When we need to stimulate g.n.p., raising government expenditures is the better way. But others strongly oppose more government activities, and favor leaving to individuals the choice of how they spend the dollars they earn. They say cut taxes rather than increasing government spending. Your preference will obviously depend heavily on your basic attitude about how far the government should go in allocating resources in our economy.
Unemployment Payments
The government may also spend through transfer payments, especially direct relief or “unemployment insurance” payments to the unemployed. This is the cheapest and most direct way to get funds to the needy and to assure that they will be promptly spent. Few unemployed recipients will hold idle the funds they receive. And such payments, if authorized in advance, can begin automatically when unemployment occurs. Indeed, we have built up a nationwide compulsory unemployment insurance plan, financed largely by payroll taxes collected while men are employed, that provides just such an automatic spending program. Transfer payments don’t directly raise g.n.p. (give jobs), but their multiplier effects do. And their superior flexibility is a telling plus.
Tax Cuts
Tax cuts are the alternative to increased spending when the government wants to expand aggregate demand. The multiplier effect of any tax cut, as was indicated above, is less than that of the same dollar increase in expenditures. This is because the expenditure counts directly as part of g.n.p., while the tax cut merely increases disposable income. Moreover, cuts in different taxes may have different respending effects. For example, a cut in personal income tax rates is guaranteed to increase disposable personal income accordingly, and the result is highly predictable. Household consumption expenditures will rise roughly in accordance with the long-prevailing propensity to consume, though there may be a lag as people take time to adjust their consumption spending to higher disposable incomes.4 The effect of a cut in corporation income taxes is more difficult to predict; but there is widespread agreement that a cut in corporate income taxes is likely to stimulate investment spending.
Many economists favor tax cuts over increases in government spending, on grounds of greater flexibility. Taxes usually can be cut faster than expenditures can be increased, and they can be more readily reversed, at least in principle. A tax cut immediately increases disposable income, and stimulates aggregate demand promptly. Moreover, tax cuts leave households and businesses free to spend their disposable income as they wish, in contrast to the government control over resourceallocation involved in increased government spending on goods and services.
Which is the better way to increase g.n.p., increased expenditures or tax cuts? To summarize, the first big issue is your basic preference for private spending against governmental provision of “public services.” The second is the relative flexibility of the two plans. Suppose that some time soon you were faced with the need to spur total spending to fight unemployment because a recovery was topping off too soon, leaving 6 or 7 per cent of the total labor force unemployed. The economy needs a $20 billion increase in aggregate demand. Would you ask Congress to cut taxes or to increase government spending? Try justifying your recommendation to an opposition senator who thinks you are wrong.
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