The Dim-Post

April 6, 2011

Economics and earthquake

Filed under: economics — danylmc @ 9:09 am

DPF criticises the Herald editorial for the blasphemous suggestion that the rebuilding of Christchurch be funded via a tax levy on middle and high income earners, instead of the government’s preferred option of cutting government spending:

But now let’s dissect the Herald’s economic argument. They say a tax increase will strengthen the faltering economy. It will not. In fact it will do the opposite by sucking money out of taxpayers, meaning it can’t be spent . . . it would be economic stupidity to increase taxes as we recover from the earthquake.

I think the logic here is that when individuals spend their money they spend it productively, stimulating the economy, and when governments take the money off them in tax they then burn it so it gets sucked out of the economy forever. But the reality is that government spending flows into the economy, so if you cut it you’re going to have basically the same impact as raising taxes. Actually the taxes would have a greater stimulus effect, since a non-zero percentage of the money would have been spent by individuals on things like overseas holidays or importing luxury goods, while the levy would be directed solely at rebuilding Christchurch’s economic productivity.

But the other reality is that a city is a piece of infrastructure – it has a high return on investment, it has a lifespan measured in centuries – and the sensible way to fund infrastructure is to borrow. The real issue here is that the last round of ‘fiscally neutral’ tax-cuts have left a huge hole in the government’s books and the earthquake has aggravated the fiscal situation. The government wants to cut spending to make up the shortfall. The opposition parties want to cancel the tax cuts for high income earners. Everyone’s using the earthquake as an excuse to argue for economic policy that they supported before it happened.

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33 Comments »

  1. Yeah, I prefer DPF’s approach. Lets cut that Government spending.

    We’ll see at election time which of the two approaches wins in the marketplace of ideas.

    Comment by OECD rank 22 kiwi — April 6, 2011 @ 9:56 am

  2. Great analysis as always OECD. You obviously thought about that for some time (when you weren’t plotting to get Russell Brown fired).

    Comment by Guy Smiley — April 6, 2011 @ 10:04 am

  3. What I don’t get is why cutting spending and cutting taxes is advocated by anyone who even has a remote understanding of the history of the twentieth century.

    But, then I guess you don’t need to learn the lessons of the past when you have magic pixie dust and dragons to do your bidding. Just one more sprinkle and the economy should come right…

    Comment by Philoff — April 6, 2011 @ 10:36 am

  4. Philoff, didn’t you get the memo? Keynes has been discredited and we are living in an age of economic enlightenment. Or something like that. Now drop those tariffs and stop excising that tax, we’ve got televisions to import.

    Comment by Simon Poole — April 6, 2011 @ 10:43 am

  5. “Actually the taxes would have a greater stimulus effect, since a non-zero percentage of the money would have been spent by individuals on things like overseas holidays or importing luxury goods, while the levy would be directed solely at rebuilding Christchurch’s economic productivity.

    The related Economics 102 argument is that tax changes in either direction inevitably have more of an effect on the rich than the poor, marginal income changes for the rich proportionately affect savings more than spending, and in a recession you really want to spend, not save.

    It’s probably more important that the earthquake levy won’t be perceived as a typical tax; i.e. most taxpayers won’t complain about paying it (prominent bloggers excepted).

    Comment by bradluen — April 6, 2011 @ 10:46 am

  6. More taxes?! We can’t possibly leave people with less money through a recession. Instead we should cut WFF or benefit payments, which… well, leaves people with less money. Or we could stop Govt funding of services so people have to pay for them themselves, which… ummmm… leaves them with less money. But still, taxes?!

    Comment by garethw — April 6, 2011 @ 11:00 am

  7. We’ve heard many times that this is an act of God; tax churches.

    Comment by taranaki — April 6, 2011 @ 11:03 am

  8. Two points – one is that people forget the deadweight loss impact of taxation http://en.wikipedia.org/wiki/Deadweight_loss and second whilst some infrastructure can be productivity enhancing, not all infrastructure is (e.g., a railway or road to nowhere is an expensive way to burn money). If you have a sound business case that your infrastructure project will be cost/benefit positive then there is a good case. the next question is how to fund? Taxation or debt? Debt has an advantage of addressing issues of intergenerational equity, particularly if its is a long lived infrastructure project. Tax has advantages if you want to achieve short term equity redistribution. The impact of further tax or debt on the economy needs to be considered also where both tax and debt effecting decisions at the margin (this is the deadweight loss issue) where some higher value projects may not proceed which would have been better for the economy e.g., science funding.

    Ultimately this debate breaks down into different value perspectives of individuals, often normally filtered through a political tribe lens.

    Comment by WH — April 6, 2011 @ 11:20 am

  9. We’ve heard many times that this is an act of God; tax churches.

    The Churches have denied God’s involvement in this one.
    The Bishop who led the Wellington memorial service said something like “[The earthquake] was not an act of God, but the Earth doing what it has always done.”

    Comment by Phil — April 6, 2011 @ 11:25 am

  10. I’m with taranaki on this one.

    Comment by Purple-Shirted Eye Stabber — April 6, 2011 @ 11:26 am

  11. WH: We already have National-led infrastructure projects with CBR of less than 1. Unfortunately, they refuse to cancel or defer them – Puhoi-Wellsford being the most obvious.

    Why should we put up with an argument that CBR needs to be taken into account on infrastructure spending in Christchurch when it clearly doesn’t matter north of Auckland?

    Comment by Simon Poole — April 6, 2011 @ 11:27 am

  12. @WG

    “(e.g., a railway or road to nowhere is an expensive way to burn money)”

    But it adds to GDP right? Isn’t that the oft stated goal?

    Comment by TBWood — April 6, 2011 @ 11:28 am

  13. “[The earthquake] was not an act of God, but the Earth doing what it has always done.”

    The earth “doing what it’s always done” is therefore God’s leaky homes debacle.

    Comment by Purple-Shirted Eye Stabber — April 6, 2011 @ 11:31 am

  14. Hey econ people: Is there an economically sound* reason why English shouldn’t temporarily add an extra point to the Reserve Bank’s inflation target, to give Bollard a bit more room to move? The 2.5% cash rate didn’t seem to do enough in 2009-10, and that was before the earthquake. Meanwhile, at the moment inflation is the least of our problems. Increasing spending is anathema to National; this would seem to be an easier way out.

    *”We’ll become Iceland” is not an economically sound reason, as we’re nothing like Iceland.

    Comment by bradluen — April 6, 2011 @ 11:33 am

  15. Re Simon Poole – no argument with you that low value projects should not proceed regardless of where they are located in favour of higher value productivity enhancing ones. Consistency is what i’d prefer.

    TBWood – no it doesn’t add to GDP. Money in and money out (on bad projects) for a net sum of zero (or less than zero) is the fast way to reduce GDP and the part that matters, the ability of New Zealanders to make choices for higher health, education or other good or service valued by people.

    Comment by WH — April 6, 2011 @ 11:35 am

  16. The massive hole in DPF’s argument is that cutting spending WILL take money out of the economy and people will be less likely to spend. Like the effect that GST had.

    Comment by max — April 6, 2011 @ 11:38 am

  17. bradluen – possibly, but remember higher inflation is simply devaluing the future value of your dollar. This might be worthwhile where you are addressing a demand shock today, and therefore you stimulate demand by spending today rather than save for your house deposit at the end of the year. however if you have a supply problem then increased spending today, may not address the underlying supply problem and in fact exacerbate it generating more demand than supply can handle (and therefore generate more inflation). You may want to have a look at The IS/LM model http://en.wikipedia.org/wiki/IS/LM_model which is a macroeconomic tool that demonstrates the relationship between interest rates and real output in the goods and services market and the money market. The intersection of the IS and LM curves is the “General Equilibrium” where there is simultaneous equilibrium in both markets.[1] IS/LM stands for Investment Saving / Liquidity preference Money supply.

    What really matters is the underlying problem – and from there using the different tools available noting that there are trade-offs, e.g., maybe more inflation but maybe more employment short term and keep in mind the long run effect. A policy might be justifiable short term but could in teh long run leave you better off. Where and how you place those trade-offs is normally an individual value decision.

    Comment by WH — April 6, 2011 @ 11:48 am

  18. I should note that as a lefty I would be pretty happy with a big bunch of spending on infrastructure over the next few years, with cost offset in the long-run by high-income tax hikes. I’m just trying to come up a strategy for a return to growth that the Nats would be happy with.

    At the moment the plan seems to be 1. tax cuts 2. ??? 3. profit!!! And yeah, this actually would be a stimulus if it weren’t (at best) canceled out by spending cuts.

    Comment by bradluen — April 6, 2011 @ 11:51 am

  19. WH: I would argue that it would be more efficient to cut such infrastructure projects and re-allocate the funding to Christchurch than it would be to decrease transfer payments during a time of increased unemployment.

    Unfortunately, it seems that some ministers (Joyce) are much better at justifying their spending than others (Bennett). I can’t find any other rational explanation for the how National chooses which things to cut and which to keep.

    Comment by Simon Poole — April 6, 2011 @ 11:51 am

  20. Hi Guy Smiley.

    Talking of Government spending cuts:

    Public service television all but gone

    Mission Accomplished.

    Comment by OECD rank 22 kiwi — April 6, 2011 @ 1:11 pm

  21. I think another point (not sure if it has already been made)is that the tax would be credibly for a finite length of time. Thus arguments about taxes discouraging business investment would not be so valid in this case.

    Comment by swan — April 6, 2011 @ 1:36 pm

  22. Simon P: not in disagreement on allocative efficiency, just need to be consistent regardless of government. Both teams have/had ministers who were better at protecting their own patch rather than consider allocative efficiency across government – we are now in the world of public choice theory and on that I direct you to Tyler Cowen http://www.marginalrevolution.com/ and Eric Crampton http://offsettingbehaviour.blogspot.com/

    Comment by WH — April 6, 2011 @ 1:39 pm

  23. “Everyone’s using the earthquake as an excuse to argue for economic policy that they supported before it happened.”

    That’s politics, I hate politics.

    I still think putting the levy on now is bad economics – but when did policy ever pay attention the the intergenerational equity considerations associated with it …

    Comment by Matt Nolan — April 6, 2011 @ 4:58 pm

  24. Additional to comment 22. Both Matt Nolan and Eric Crampton have excellent pieces on economics of a levy see http://offsettingbehaviour.blogspot.com/2011/04/levies-borrowing-and-spending-cuts.html and http://www.tvhe.co.nz/2011/04/06/tax-levy-and-timing/

    Comment by WH — April 6, 2011 @ 5:58 pm

  25. A levy is what those who can least afford it have to pay.
    A levy is what is never applied to the wealthiest. They might see it as as a “tax”.

    John Key and Bill English would rather prefer the wealthy not to pay any tax.

    Slash and burn the most vulnerable. Defend the well protected.

    I just love this government ,and its sycophants.

    Comment by peterlepaysan — April 6, 2011 @ 10:06 pm

  26. ohKay Peter. *backing away slowly*

    Comment by will — April 6, 2011 @ 10:20 pm

  27. “Unfortunately, it seems that some ministers (Joyce) are much better at justifying their spending than others (Bennett). I can’t find any other rational explanation for the how National chooses which things to cut and which to keep.”

    Really? NOOOO. The government’s transport and social welfare policies are based on rational economics and long-term thinking…that’s what I believe.

    Honestly, Puhoi to Wellsford and Transmission Gully are just massive ego trips. We would be better off building giant statues of John Key made out of butter as a way to stimulate jobs.

    Comment by LucyJH — April 6, 2011 @ 11:59 pm

  28. @WH

    “”Strange,” mused the Director, as they turned away, “strange to think that even in Our Ford’s day most games were played without more apparatus than a ball or two and a few sticks and perhaps a bit of netting. imagine the folly of allowing people to play elaborate games which do nothing whatever to increase consumption. It’s madness. Nowadays the Controllers won’t approve of any new game unless it can be shown that it requires at least as much apparatus as the most complicated of existing games.””

    Comment by TBWood — April 7, 2011 @ 2:03 pm

  29. LucyJH: Yeah, I swing between calm debate and something that resembles a gibbering maniac whenever I have to talk about the current government. Honestly, I don’t see how Blinglish can justify half the things they do even within their framework of neoclassical economics. AUTOMATIC STABILISERS, ANYONE?

    Ugh.

    Comment by Simon Poole — April 7, 2011 @ 2:23 pm

  30. @TBWood

    You’ll be prising my game of centrifugal bumblepuppy from my cold, dead hands….

    Comment by Rich — April 7, 2011 @ 2:34 pm

  31. As I’ve always said, lower income taxes (especially those below the poverty line), cut GST, make fresh fruits and veges exempt from GST, give people the right to smoke without having to pay for the nose for it, but introduce Capital Gains Taxation and Death Duties. Make the law as such that it is impossible for the rich to bypass these taxes. Some make take their companies abroad but they will only be the big ones. All the middle and small businesses will be left, and business will be booming for them because of the dramatic decreases in income tax and GST.

    Comment by Betty — April 7, 2011 @ 3:17 pm

  32. @rich

    I’m sure there’s an expensive, complicated machine for doing just that.

    Comment by TBWood — April 7, 2011 @ 3:38 pm

  33. Betty: I don’t understand the reasoning behind dropping excise tax on cigarettes. The revenue doesn’t even cover the additional cost to the health system. It’s about as close as ‘user-pays’ as we’re going to get in that respect.

    Comment by Simon Poole — April 7, 2011 @ 3:43 pm


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