Tuesday, 19 November 2013

Fiscal policy is not distortionary.

Those who want stimulus effected primarily via monetary rather than fiscal policy often disparage fiscal policy by referring to the alleged distortionary effects of fiscal policy. E.g. see Scott Sumner. And this NBER paper simply prefixes the word “taxation” with the word “distortionary” about thirty times with no explanation as to why taxes are necessarily distortionary. And if you Google “fiscal” and “distortionary” you’ll find plenty more in the same vein.
The flaws in the “distortion” idea are as follows.
Obviously any type of tax (or its opposite, a form of government spending) CAN BE distortionary. It doesn’t take a genius to think a distortionary form of taxation: e.g. a tax on people with red hair, to take a silly example.
Conversely, it doesn’t take a genius to think up types of taxation which are pretty much distortion free: e.g. a sales tax on ALL GOODS AND SERVICES.
Next, the fact that most taxes do in fact contain an element of distortion is not a characteristic of fiscal policy AS SUCH: it results from, or is a characteristic of some sort of political or social objective. E.g. whisky is taxed far more heavily than soft drinks, and for obvious social reasons.
Put that another way, it would be perfectly feasible to have ZERO fiscal stimulus, and indeed zero government spending on real goods and services, while retaining a whiskey tax: we’d just collect money from the whiskey tax and distribute the money to the population at large.
In contrast to taxes (fiscal “anti-stimulus” so to speak) there is government spending (i.e. stimulus). And here again, fiscal stimulus does not need to be distortionary. For example the same percentage increase on ALL FORMS OF government spending, plus some sort of boost to household incomes that induced households to increase their spending by the same percentage would not be distortionary: or at least would not involve any more distortion than already existed.

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