Friday, December 21, 2007

Opportunistic tax cutting 

During the disinflation of the 1980s and 1990s there were references to opportunistic disinflation (this 1996 speech by former Fed governor Laurence Meyer is a good start) as a stabilization strategy. It made monetary policy in essence asymmetric in its response to inflation. If it accelerated the Fed would aggressively tighten monetary policy. But if a recession occurred due to some negative demand shock, the Fed would use that opportunity to move inflationary expectations lower. Likewise, if a favorable supply shock happened that pushed inflation lower the Fed would not try to keep inflation at the current rate.

Suppose one held the view that government is too large. Gridlock in Washington (be it partisan gridlock or an executive branch more small-government conservative than the legislative branch held by the same party -- no, we're not describing the Bush Administration 2001-06 here) makes it difficult to build consensus to right-size government spending. But during recessions, one might be able to argue for tax cuts that temporarily raised the deficit and then as growth returned one could argue for reducing deficits by reducing the size of government spending. I would call this "opportunistic tax cutting" or "opportunistic fiscal policy."

Contra Mark Thoma, I would argue that fiscal policy isn't just stabilization policy. There is an argument for allocative policy (for those of us who grew our public finance roots on the Musgraves), assigning to public funding and provision those goods and services for which there's both a market failure and not a government failure. If one were to believe government was too large then proposing a 0.5-1.0% of GDP tax cut, as former Clinton Treasury Secretary Larry Summers did Wednesday, may be seen as an attempt to chip away at overgrown government. (I sincerely doubt that is Summers' major intent, but it might be a minor one.) When the next boom hits, government may not expand as much since, Felix Salmon puts it, "taxes are a hell of a lot easier to cut than they are to raise." Indeed they are; that's the point of the exercise.

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