Fiscal policy in the U.S.: Lessons from 2001

Page 27 

Government in the United States is being embraced again, thanks in part to the terrorist attacks of last year, but also the recession. What America needs now, argues Thomas Palley, a leading U.S. labour representative, are sound fiscal policies to promote economic activity, rather than the regressive tax cuts of spring 2001. 

Who would have thought it? After two decades during which government economic activity has been under attack, even on the retreat, there is a renewed and vigorous interest in fiscal policy in the United States. This is partly because of the serious events of 2001 that reminded us of the value of government, but it is also due to the recession, which has highlighted government’s role in stabilising market economies.

Aided by the smooth workings of automatic stabiliser mechanisms such as the progressive income tax, the huge on-budget surplus disappeared. This has helped dampen the recession’s impact and highlighted the virtues of tried and trusted Keynesian principles of mobilising government money to steady the economy. When interest rates were higher, recessions could be fought by lowering them, which immediately reduced debt service burdens. In particular, families could refinance their mortgages with lower, more affordable rates, thereby freeing up disposable income. Now that inflation and interest rates are both down, monetary policy has less room for manoeuvre, increasing the need for alternative mechanisms to combat demand slumps.

Automatic stabilisers are one channel through which fiscal policy can help combat recessions; discretionary fiscal policy is another. Here, the record of 2001 is less sanguine. Though presented as immediate fiscal stimulus, the individual tax cut of spring 2001 was in fact little more than a back-loaded tax redistribution to the wealthy. Thus, 47.1% of the benefits go to the top 5% of income earners, and because many of the provisions are phased in over the next 10 years, it significantly worsens the long-term fiscal outlook. Good discretionary fiscal policy should provide immediate stimulus by getting money to those who will spend it, and it should “sunset” when recovery begins.

The spring 2001 tax cut largely failed both of these tests. Another area where policy failed was unemployment insurance (UI), which was held hostage to demands for corporate tax relief. UI is perhaps the single most effective instrument of fiscal stimulus, in that it reaches those who need income most and who will spend it all. Moreover, as the unemployed are often geographically concentrated, unemployment insurance helps whole communities. Finally, the importance of UI diminishes – as counter-cyclical policy should – when the unemployed find new jobs.

Yet, despite these clear benefits, action on UI was blocked by political demands for corporate tax relief. In some instances, this relief contained little stimulus value, either because it rewarded old investments already in place or because it cost a lot. For instance, the proposed investment tax credit made no attempt to target marginal investment spending and instead rewarded all investment spending, including that which would have taken place with or without the tax credit.

Public infrastructure investment is another area where policy can be strengthened. The 28 September terrorist attacks prompted some increased spending in the form of re-building assistance, and defence and security expenditures. But more is needed. Infrastructure spending can be effective as a generator of jobs, and it can also help address long-unfilled needs and enhance future productivity. Another useful fiscal policy for speeding recovery is federal aid for states. Since many states are subject to balanced budget rules, downturns lead to pro-cyclical cutbacks in state spending, making matters worse. Federal aid for states can mitigate this consequence of state budget rules. If the recession continues in 2002, such aid should be a focal point of federal fiscal policy action.

Thankfully, the era of fiscal repair to resolve unsustainable deficits is over. Looking ahead, government should renew its commitment to the principles of a good tax system –sufficiency, fairness, efficiency and economic stability. Unfortunately, many of the discretionary changes in US tax policy in 2001 betray these principles. The tax cut was unfair because it was skewed towards the richest segments of the population, and its phased-in design promises to reduce future revenue streams in such a way that there will be insufficient resources to meet America’s public service and infrastructure needs. This suggests that policymakers should repeal the 2001 tax cut. However, this will be a difficult message to craft. On the one hand, fiscal stimulus may still be needed if the recession continues. Yet on the other hand – and superficially in contradiction – the 2001 tax cut should be repealed because it undermines the long-run fiscal outlook and provides minimal fiscal stimulus.

Reference

• Godley, W., “Kick-start strategy fails to fire spluttering US economic motor”, in The Guardian, United Kingdom, 21 January, 2001; see http://www.guardian.co.uk/Archive/

©OECD Observer No 230, January 2001 




Economic data

GDP growth: +0.6% Q4 2017 year-on-year
Consumer price inflation: 2.6% May 2018 annual
Trade: +2.7% exp, +3.0% imp, Q4 2017
Unemployment: 5.4% Mar 2018
Last update: 06 Jul 2018

E-Newsletter

Stay up-to-date with the latest news from the OECD by signing up for our e-newsletter :

Twitter feed

Suscribe now

<b>Subscribe now!</b>

To receive your exclusive paper editions delivered to you directly


Online edition
Previous editions

Don't miss

  • Watch the webcast of the final press conference of the OECD annual ministerial meeting 2018.
  • International co-operation, inclusive growth and digitalisation lead the themes of the 2018 OECD Forum in Paris on 29-30 May, under the banner of What brings us together www.oecd.org/forum. It is held alongside the annual OECD Ministerial Council Meeting on 30-31 May, chaired this year by France with a focus on multilateralism www.oecd.org/mcm.
  • Listen to the "Robots are coming for our jobs" episode of The Guardian's "Chips with Everything podcast", in which The Guardian’s economics editor, Larry Elliott, and Jeremy Wyatt, a professor of robotics and artificial intelligence at the University of Birmingham, and Jordan Erica Webber, freelance journalist, discuss the findings of the new OECD report "Automation, skills use and training". Listen here.
  • Do we really know the difference between right and wrong? Alison Taylor of BSR and Susan Hawley of Corruption Watch tell us why it matters to play by the rules. Watch the recording of our Facebook live interview here.
  • Has public decision-making been hijacked by a privileged few? Watch the recording of our Facebook live interview with Stav Shaffir, MK (Zionist Union) Chair of the Knesset Committee on Transparency here.
  • Can a nudge help us make more ethical decisions? Watch the recording of our Facebook live interview with Saugatto Datta, managing director at ideas42 here.
  • Ambassador Aleksander Surdej, Permanent Representative of Poland to the OECD, was a guest on France 24’s English-language show “The Debate”, where he discussed French President Emmanuel Macron’s speech at the World Economic Forum in Davos.
  • The fight against tax evasion is gaining further momentum as Barbados, Côte d’Ivoire, Jamaica, Malaysia, Panama and Tunisia signed the BEPS Multilateral Convention on 24 January, bringing the total number of signatories to 78. The Convention strengthens existing tax treaties and reduces opportunities for tax avoidance by multinational enterprises.
  • Rousseau
  • Do you trust your government? The OECD’s How's life 2017 report finds that only 38% of people in OECD countries trust their government. How can we improve our old "Social contract?" Read more.
  • Papers show “past coming back to haunt us”: OECD Secretary-General Angel Gurria tells Sky News that the so-called "Paradise Papers" show a past coming back to haunt us, but one which is now being dismantled. Please watch the video.
  • When someone asks me to describe an ideal girl, in my head, she is a person who is physically and mentally independent, brave to speak her mind, treated with respect just like she treats others, and inspiring to herself and others. But I know that the reality is still so much different. By Alda, 18, on International Day of the Girl. Read more.
  • Globalisation’s many benefits have been unequally shared, and public policy has struggled to keep up with a rapidly-shifting world. The OECD is working alongside governments and international organisations to help improve and harness the gains while tackling the root causes of inequality, and ensuring a level playing field globally. Please watch.
  • Read some of the insightful remarks made at OECD Forum 2017, held on 6-7 June. OECD Forum kick-started events with a focus on inclusive growth, digitalisation, and trust, under the overall theme of Bridging Divides.
  • Checking out the job situation with the OECD scoreboard of labour market performances: do you want to know how your country compares with neighbours and competitors on income levels or employment?
  • Trade is an important point of focus in today’s international economy. This video presents facts and statistics from OECD’s most recent publications on this topic.
  • The OECD Gender Initiative examines existing barriers to gender equality in education, employment, and entrepreneurship. The gender portal monitors the progress made by governments to promote gender equality in both OECD and non-OECD countries and provides good practices based on analytical tools and reliable data.
  • Interested in a career in Paris at the OECD? The OECD is a major international organisation, with a mission to build better policies for better lives. With our hub based in one of the world's global cities and offices across continents, find out more at www.oecd.org/careers .
  • Visit the OECD Gender Data Portal. Selected indicators shedding light on gender inequalities in education, employment and entrepreneurship.

Most Popular Articles

OECD Insights Blog

NOTE: All signed articles in the OECD Observer express the opinions of the authors
and do not necessarily represent the official views of OECD member countries.

All rights reserved. OECD 2018