Monday, March 9, 2009

The Economic Definition of "Government Expenditures"

The debate over the various government "bailouts" and "stimulus packages" really glosses over the difference between a "subsidy" (negative tax) versus true "direct expenditures" by the government. The definition is important because the impact of these components of the current legislation have different "multiplier effects." Some of them behave similar to "tax cuts" (even if they are negative taxes) and some of them behave like "government expenditures" in the Keynesian framework. Here is a brief taxonomy:
Tax cuts/Negative taxes:
1. reductions in the tax rates;
2. subsidies to struggling private firms ("bailouts");
3. transfer payments (welfare).
Government expenditures:
1. direct government production (e.g. building/repairing roads);
2. government purchases of final goods and services;
So, in terms of the economic impact (multiplier effects) TARP, the auto bailout, unemployment insurance, subsidies to private clean-energy firms, and explicit reductions in tax rates are in the "TAX CUT" category, and tend to have less impact in the short run, because firms (perhaps rationally, and to the long-run benefit of the economy) might hold back some of that form of "stimulus." The other category only includes things that directly inject expenditures into the economy, such as building a tank, repairing a road, or a direct public investment into the building of new infrastructure, such as a new energy grid. These direct expenditures MIGHT have a larger short-run impact IF AND ONLY IF they occur when the economy has substantial unemployment, and if they are enacted before the recovery. If they are enacted after the recovery begins, they will tend to be inflationary.

The Editors of the Economist should be Flogged

Printing anything that uses the terms "Calculus" or "Second derivative" should be punishable with public beatings, as exemplified by this article in the Economist.