Abe Increases Both Stimulus Spending and Taxes!? What’s Up with That?

October 2nd, 2013 at 4:05 pm

Turning to the actions of more functional governments for a moment—which very much extends one’s palette these days–a number of people have asked me about this move by the Abe government to both increase taxes and stimulus spending.  Does the tax increase imply that the Japanese Prime Minister is departing from his aggressive push to revive the economy through the stimulus measures known collectively as Abenomics?

No, and in fact, this is a pretty good example of tapping what economists call a balanced budget multiplier (which does not, as it sounds, imply actually balancing the budget).  It’s based a simple theory that maintains if, in a weak economy, you raise taxes and spending by the same amount, on average, people are no worse off in terms of their incomes, but the economy’s doing a little better and the debt as a share of GDP should actually fall a bit.

Again, on average, before-tax incomes are up by the amount of spending and after-tax incomes are down by the amount that’s taxed, so you’re even in that regard.  But since the economy has an output gap, you’re contributing to higher GDP yet not increasing the deficit or debt, so debt/GDP falls.

Lots of ways this can go wrong or run into political trouble, of course.  It doesn’t work if the spending multiplier is <1, and while all the results above are average ones, it’s likely that the people benefitting from the spending are different from those benefitting from the spending, invoking distributional concerns, which in the US case quickly morphs into “makers” supporting “takers.”

However, in the Japanese case, the higher tax is on broad consumer spending, making it more likely that the incidence of both sides of the deal—spending and tax—could fall on the same people.

So why haven’t I advocated this from the beginning?  Why have I even worried that our budget deficits are falling too quickly?  Because in a deep and protracted recession, you want to avoid any fiscal drag from higher taxes, and you expect your deficit to grow as needed.  But when the worst of the contraction is behind you and the deficit hawks begin to preen their feathers, or in Japan’s case, when you want to signal that you haven’t forgotten about your relatively high debt burden, matching spending increases with tax increases is not such a bad idea.

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One comment in reply to "Abe Increases Both Stimulus Spending and Taxes!? What’s Up with That?"

  1. urban legend says:

    It would seem as a matter of logic that only making the tax more progressive — higher taxes on the people who won’t spend much of it anyway (and are more likely to spend what they do outside the U.S.), i.e., with the lowest multipliers — while using the revenues to create more jobs directly and drive incomes for those who will spend the increased amounts up? Where is the net benefit in taxing takers to use the revenues to hire takers?
    If someone wants to make the “makers” and “takers” line of argument, why not welcome them? It didn’t do wonders for Romney.