Back in March, Chris House wrote a blog post explaining why he thinks that tax rebates make better stimulus than government spending. He concludes that tax rebates are the best form of stimulus, and that government spending projects should only be undertaken if the projects would pass a cost-benefit test in the absence of any stimulus effect. House:
If a project doesn’t meet the basic cost / benefit test, then it shouldn’t be funded, regardless of the need for stimulus...If the social value of a government project exceeds its social cost then we should continue to fund the project whether we are in a recession or not. If the social value falls short of the social cost then, even if the economy is in “dire need” of stimulus we should not fund it. If we really need stimulus but there are no socially viable projects in the queue then the government should use tax cuts...
If the direct social benefit of a bridge is $100, then all the government needs to consider is whether the cost of building the bridge is greater or less than $100. If you then tell me that, because we are in a recession, there are additional stimulus benefits from the project (e.g., the workers who build the bridge take their new wage income and buy goods and services from other businesses further stimulating demand, increasing employment, and so on.), the government should exclude these additional benefits from its calculation.I don't understand this assertion at all. It makes no sense to me.
Let's consider a simple numerical example. Suppose that the economy is in a recession. And suppose that, because of the Zero Lower Bound or whatever, the pure fiscal "multiplier" is substantial. Specifically, suppose that $100 of tax rebates will increase GDP by $110. In this case, stimulus spending is a "free lunch."
Now suppose that instead of doing tax rebates, the government can build a bridge. The social benefit of the bridge is $90, and the bridge would cost $100. In the absence of stimulus effects, therefore, the bridge would not pass a cost-benefit analysis. For simplicity's sake, suppose that spending money on the bridge would create exactly the same stimulus effect as doing a tax rebate - spend $100 on the bridge, and GDP goes up by $110 from the stimulus effect.
In this case, the net social benefit of spending $100 building the bridge is $90 + $110 - $100 = $100.
And the net social benefit of spending $100 on a tax rebate is $110 - $100 = $10.
In fact, it turns out that the bridge wins even with a pure multiplier of less than 1! As long as the multiplier is greater than 0.2, in fact, it's worth it for the government to build the bridge. This will mean that the apparent multiplier of bridge-building will far exceed the "pure" multiplier. In this case, the apparent multiplier from bridge-building will be 2.
This fits the results of Auerbach and Gorodnichenko (2012). It also fits with the simple Keynesian theories you'd read in an Econ 102 textbook. It also fits the results of Bachmann and Sims (2011). And if true, it means Chris House is completely wrong.
Now let's relax the assumption that the pure stimulus effect is equal for the two cases. Suppose that government spending creates waste, for example. Or suppose that due to the particular nature of the mechanism that makes stimulus effective in the first place, the people who build the bridge will tend to stick most of their fee in a bank instead, rather than spending it as people would do if they got a tax rebate. Concretely, suppose that due to government waste or reduced stimulus effect, the pure stimulus benefit of building the bridge is only $30 instead of $110 (a pure multiplier of only 0.3 for government spending vs. 1.1 for tax rebates).
In that case, the net social benefit of building the bridge is $90 + $30 - $100 = $20. Bridge still wins! House is still wrong!
The difference between bridge-building and tax rebates can be stated in simple terms. If you give people a tax rebate, they may stick the whole thing in the bank, completely negating the stimulus. If you pay unemployed people to build a bridge, they may stick 100% of their earnings in the bank - but now you have a new bridge.
So basically, I don't see how House is doing his cost-benefit analysis. His conclusion is diametrically opposed to Econ 102 textbook Keynesianism, which is fine, but I feel like there should be some justification. Almost everyone - even John Taylor! - thinks that infrastructure spending makes better stimulus than tax rebates, not worse. Chris House asserts that the exact opposite is true, and that's fishy.