Monday, December 03, 2007

The StarTribune with a classic Keynesian wheeze 

It is of course unsurprising that a StarTribue editorial would promote higher taxes as a cure for the state budget shortfall, even while admitting the reserves would be sufficient to cover the deficit. But its last paragraph belies some oversimplified economic thinking.
Pawlenty rejected any state tax increase yesterday, saying he considers the best economic stimulus "more money in Minnesotans' pockets." While money in private pockets can produce economic good, if it stays there, it won't buy the roads, transit, schools and other public assets that a robust economy requires. Strategic use of resources for economic betterment must be state government's guiding principle now.
The state cannot spend money it does not first withdraw from the economy through taxes, so there is a question of whether the government can spend the money more "strategically" than private citizens do. And if people save, says the STrib, that's bad.

This is of course the old Keynesian wheeze of the "paradox of thrift". It hypothesizes that any dollar received by a Minnesotan that is not spent on other goods and services produced by Minnesotans (or at least sold by them) is a leakage from the economic system. To offset that leakage, government spending should be injected into the economy. But of course the dollar the state injects is just a dollar leaked out in higher taxes. The usual story is that state government spending is subject to a "balanced budget multiplier". (Here's AmosWeb with a review of multiplier analysis for those of you who remember it vaguely from a principles class in the past. See also the one for tax multipliers.)

With states there's the additional complication of spending on goods from other states and countries. The simple balanced budget multiplier is equal to 1 if there is no leakage to purchases of goods and services from other jurisdictions, otherwise it is quite likely less than one. For example, the St. Cloud area employs about 14% of its workforce in retail sales, but retail produces only 8% of its area GDP because much of the goods sold come from outside St. Cloud.

How is it that the STrib knows that dollars spent by the state government will be more sticky in the state economy than dollars spent by private individuals? Even if we assume the tax dollars taken in come from those "idle balances" in people's savings accounts, it may very well be that the dollars expended must use resources from outside the state. Furthermore, expectations of higher taxes later to pay for bonding requests may lead individuals to save more now (a story economists call Ricardian equivalence.) In fact, there is no reason to believe a priori that state governments can be at all stimulative to their economies -- though particular programs might be found to do so after the fact.

Add to this the efficiency arguments, that private citizens will better know what to buy to improve their welfare than governments will, and a solid case can be made for not increasing taxes to stimulate a soft state economy.

There may be a case made that Pawlenty's plan -- offer individual property tax relief across the board, paid for by closing the foreign operating corporation tax loophole -- could be more stimulative. I don't know that this is true, but it is something to be determined by an efficiency argument that I can see one making. There is a commission working on these very issues right now with representatives from the Governor's office and the Legislature. I'd wait to see what they find before making any recommendations.

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