Conversation abounds as to the chances that we are moving out of the recession and on our way to a robust recovery. But the downer in these discussions is the continuing increase in unemployment rates and absence of any evidence of growth in job creation. No surprises here. As Robert Barro and Charles Redick remind us in their recent research, which tracks the GDP and job growth effects of stimulus inputs over the past century, there is no evidence of a so-called Keynesian “multiplier effect” from government spending stimuli, but plenty of evidence for the enhancement of growth from tax rate reductions. In fact, the available empirical evidence shows that government spending stimuli will likely increase GDP by less than the increase in the spending itself.
What else is new? Jean Baptiste Say illustrated the validity of this theory centuries ago, and the late Jude Wanniski elaborated on his supply-side laws thirty years ago in his writings which helped inspire the Reagan tax cuts. But the problem is not limited to high tax rates; it also involves other types of what Wanniski called “wedges”, which can include such things as increased regulation, property taxes, health care mandates, and other penalties on capital that constitute impediments to innovation and risk-taking. These wedges have a particular dampening impact on small business, which is primarily responsible for the innovation and entrepreneurship that produce the large majority of our job creation. And with the probability of a rollback of the Bush income tax rate cuts next year, this wedge phenomenon could get worse.
It is for this reason that we run the risk of a long, slow recovery with the probability of increased inflation and without robust growth. We have taken Federal Reserve monetary policy as far as it can go in stimulation; we had better wake up to the need for fiscal restraint and tax reduction to spur meaningful incentives to growth.