Not So Simple

Why we shouldn’t have a tax cut right now. 

Listener: 13 December, 2008 

Keywords: Macroeconomics & Money;  

With the world in financial turmoil and entering an economic downswing, many of those who once abused Keynesian economics are now clamouring for what they think are Keynesian policies. Unfortunately, their view of Keynesian economics was overly simplistic when they criticised it, and so are the policies they are now proposing. 

In the past, governments deliberately kept public debt low, for the day – expected by Keynesians – when it would be necessary to borrow to sustain the economy during a long, deep recession. That day seems near. We must expect that public debt will rise (even in proportion to GDP). But what will the deficit spending be on? Will the debt liability be matched by assets on the other side of the balance sheet? 

That is why Keynesians do not lightly advocate a cut in taxes. A higher public deficit means increased government debt, which represents an increased burden of debt servicing and repayments. Their preferred strategy for boosting spending has been additional investment, with the idea that the extra productive capacity will generate the future tax revenue to service the debt. 

Immediately after World War II, Keynesian governments built hydro-power stations in New Zealand and steel mills in Britain to sustain the economy, reduce unemployment and add to productive capacity. This strategy is more difficult these day, since a lot of state-owned enterprises have been privatised, and those that are still publicly owned cannot have their investment plans readily directed by the Government. 

Instead, the Government has talked about increasing spending on infrastructure. Although some will be commercial – broadband and energy – much of it will not contribute to additional tax revenue. It should contribute to economic growth, but that does not automatically mean more tax payments. 

For instance, a bypass that reduces traffic jams may mean less revenue, because the vehicles will run more efficiently and use less fuel, and their owners will pay less tax. Motorists may be better off with quicker rides and business improved with cheaper trucking, but this will not directly generate extra tax payments, and those indirectly generated may not cover the cost of the debt servicing. Future generations may have to pay higher taxes, but any grumbling will not be justified if travelling is easier and business costs are lower. 

The situation is further complicated by the time taken to get the investment on infrastructure in place. The previous Government ramped up infrastructural spending (which is why it could not cut taxes as generously as some insisted). More new projects may take years to come on line, although some are already under way. 

There may not be the skilled workforce to implement them. There is a myth that during the Depression, professors helped build the roads. One might allow today’s academics to use a shovel and wheelbarrow, but I am not sure they are fit to drive a bulldozer. 

There is probably some infrastructural spending that can be used to tide us over the gap. Making housing energy-efficient and dry would be a good start, especially if there are courses to give the unemployed the skills to retrofit houses under a master craftsperson’s supervision. Indeed, should we not be absorbing the unemployed in programmes that upskill them for the future? Some environmental spending may be also beneficial using the skills available, but we need to avoid the low priority, make-work jobs that were fashionable in the late 1970s. 

Except for improved state housing, such programmes will not add to government assets. But they will add to the nation’s assets, including its human capital, and will increase our welfare in the long run. Better to spend on them than encourage consumption without matching increases in production – even as the baubles of electoral bribery. 

<>Of course, there are times when taxes should be cut. But not when the additional consumption is offset by climbing public debt. The critics of Keynesianism were right to caution against such simplistic thinking. There are better ways to handle this downswing than to implement such simplifications.