Nobel Laureate Says No To More US Tax Cuts

by Mike Godfrey, Tax-News.com, New York

12 October 2001

August economist Milton Friedman, writing in the Canadian Financial Post, says that the US economy does not need further stimulus. Professor Friedman, famous for his monetary theories, points out that as a result of the Fed's reductions in interest rates monetary growth (M2) in the US during the past year already exceeds 10%, a level which would normally be enough to ensure a rapid upturn in inflation.

'By historical standards, the Fed's behaviour was pre-emptive and aggressive,' says Professor Friedman, giving a number of reasons why it would now be better to await events than rush to inject yet more demand (of the wrong type) into the economy with further tax cuts:

' The economic slowdown to date has been relatively mild. Unemployment is still at levels that more often accompany prosperity than recession, let alone depression. Sept. 11 was a major shock psychologically, but its direct economic effect -- perhaps US$25-billion to US$100-billion -- is a pinprick in a US$10-trillion economy.'

'Given the lag between monetary change and economic change, the monetary stimulus is only now beginning to take effect. But note that the stimulus is permanent: Once the money supply is increased, it is there to pass from hand to hand as it is spent again and again. Under this stimulus, the economy is likely to turn around in the next quarter or two.'

' Fiscal stimulus also takes time to have any effect. Anything passed now is not likely to affect actual spending or tax receipts until after the economy has already started to recover, and to come full flood only when the economy is expanding. Talk about locking the stable door after the horse is stolen.'

Professor Friedman argues that historically, fiscal stimulus through increased government spending - the only type of stimulus which can be applied quickly - is ineffective, pointing to japan's experience over the last 10 years.

'The reason is not far to seek,' he says, 'Extra government spending means less repayment of government debt, or the incurring of more debt. In either case, private individuals have less to spend. Government projects replace private projects. Which are likely to be more productive?'

' Cutting taxes now would promote private spending rather than government spending and provide a supply-side incentive. That is highly relevant for the long run, but not for cyclical stimulus. Here, too, time delay is crucial. The effect of the tax reductions is likely to come into effect when the economy is already on the mend.'

Will anyone listen to Professor Friedman, though, when around the world governments are in the grip of an severe epidemic of Keynesian Frenzy?

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