Government persistence does not necessarily mean assistance

Published: January 6 2009 02:00
LEX column
Financial Times

The received economic wisdom is that tax cuts should be timely, temporary and targeted. But the US government's record in this regard is poor. Analysis by Christina and David Romer of 50 significant tax cuts since 1945 highlight five changes that were specifically designed to spur short-term growth. On four occasions the cuts occurred within one quarter of the economy starting to slow, and, on average, there was an implementation lag of just 3 months.

But while the government has been commendably quick to get its skates on in the past, it has been slower to take them off again - nearly 40 per cent of these cyclically motivated tax changes ended up being permanent. Their efficacy was questionable. Referring to a bang-for-buck rating scheme used by the Congressional Budget Office, the IMF notes that only half the cuts were cost-effective. The best packages were weighted towards lump-sum payments, while the least effective were the tax cuts of 1970 and 2002, which favoured corporate rebates and broad tax-rate reductions.

That should be food for thought for an Obama administration which is said to favour income tax cuts. The unpalatable truth is that the evidence is mixed at best whether fiscal packages stimulate output during a downturn at all, as the IMF's latest World Economic Outlook report concedes. Governments everywhere are proposing bold fiscal plans but should not be given blank cheques.