fiscal policy for recessions

Fiscal response to recession is weak in the United States, for two reasons. First, central government is small. Second, lower levels of government have to balance their budgets, so cut spending and increase taxes during recessions. Barack Obama’s stimulus package in 2009 seemed large, but was actually weak because much of it was offset by austerity at the state level. FT columnist Clive Crook proposes three fiscal reforms that would strengthen federal response to future recessions.

First, introduce a national sales tax. This could raise new revenue, which the US will need, but that is not the point. Consumption fluctuates more than income during the cycle, so shifting some of the tax base from income to spending would increase revenues in booms and reduce it in downturns. If Congress had the wit to alter the rate counter-cyclically, so much the better, but let us not make wild assumptions.

Second, lean hard against tax preferences for borrowing. In a credit-fuelled boom, tax reliefs for bigger mortgages and other kinds of debt reduce revenues. In a recession, as people pay down debt, their taxes rise. This is pro-bubble, then pro-slump. What could be more stupid?

Third, expand help for the unemployed by enlarging the Trade Adjustment Assistance programme. …. The scheme is too narrow and too complicated. It should be simplified, merged with unemployment insurance and widened to cover everybody who loses a job.

I see the flaw in the logic, of course. Why should a Congress incapable of raising the debt ceiling without an operatic ideological battle be capable of changes such as this? Fair question. All I can say is that this approach requires responsible action on a one-time rather than an ongoing basis. Perhaps, if it only needs to do it once, Congress could get it right by accident.

Clive Crook, “A fiscal policy fit for the next crisis“, Financial Times, 27 June 2011.

A key feature of Mr Crook’s proposed measures is that they are automatic stabilisers, producing budget surpluses (or reduced deficits) in booms, and deficits as the economy shrinks. Discretionary policies – such as changes in tax rates – in theory might work as well, but political obstacles make it difficult to get the timing right.

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