Wednesday, February 11, 2009

Fair: Fiscal Stimulus Package May Lead to Large Tax Increases

Yale economist Fair used his famous macro model to evaluate the government spending stimulus package (HT Mankiw). Predictions range from worrisome to scary. The stimulus plan has only a short term positive effect on the economy, and we may end up with huge tax increases as the only permanent consequence. A very high price to be paid for such a small achievement indeed.

Here's how Fair summarizes the results:

The stimulus has a big effect in 2010, but by 2012 the economy is roughly back to baseline (except for variables like the federal government debt). In the baseline case the federal debt rises from $5.78 trillion at the end of 2008 to $8.74 trillion at the end of 2012. In the stimulus case the debt at the end of 2012 is $9.34 trillion, about $600 billion more than in the baseline case. This does not take account of possible increases in the federal debt from the bailout activity.

So there is short run gain from the stimulus bill, mostly in 2010, but the potential long run costs do not seem trivial. If the stimulus bill is passed and the bailout continues, it may be that large tax increases will be needed starting in late 2011 or 2012.

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