Framing: Taxpayers money and Fiscal Space at the IMF

Taxpayers Money

In writing this recent post, when I discussed the potential cost of a government scheme, I initial wrote ‘a cost that taxpayers will bear’. That is what everyone does when pointing out that the government’s finances are really our finances. But I changed what I wrote, because I realised this description is actually incorrect.

One possible reading of the similar phrase ‘taxpayers money’ is that this money in some sense belongs to the taxpayer. That is clearly wrong. This money belongs to the state, and the state is meant to reflect the people’s wishes. So if we want to remind ourselves that we live in a democracy, we could talk about the people’s money, or society’s money, or our money.

Now perhaps you are thinking that the phrase ‘taxpayers money’ is simply designed to remind ourselves where the government’s money comes from. I guess some people need to be reminded that most of the government’s money once belonged to taxpayers. But of course everyone in society is a taxpayer, because we all buy things which the government levies indirect taxes on. Yet I suspect most people read taxpayer as someone who pays income tax, so I would argue that the phase is misleading compared to something like ‘society’s money’ or ‘citizens’ money’.

The actual phrase that I was going to use, and which is so often used, is that some item of government spending represents ‘a cost to the taxpayer’. Additional government spending could be financed by raising income taxes. But it might not be. It could be financed by cutting some type of government transfer. [1] In fact, in the UK at the moment, if you had to guess what was the most likely source of finance for the marginal item of government spending, it would be cuts in welfare benefits. So the probability is that the phrase ‘this is a cost that welfare recipients will bear’ will be more accurate than ‘this is a cost that taxpayers will bear’. Yet I have never seen the first phrase used.

Is this me being pedantic? I would argue this is an example of framing. A related phrase is ‘tax relief’. There is nothing incorrect about using the phrase, but it equates the idea of paying taxes with some kind of affliction. An alternative phrase might be ‘tax dodge’, which has completely the opposite connotation, invoking taxes as a duty which someone is unfairly not fulfilling. I think another example is ‘free market’. Those who favour market solutions often use ‘free market’ instead of just saying ‘market’. We all want to be free. But an alternative description might be ‘unregulated market’, which sounds (to most) less good. One final example might be intellectual property, but I am sure there are many more. [2]

Fiscal Space at the IMF

Unlike the phrases discussed above, ‘fiscal space’ is less widely used, but I want to argue that it too frames a debate in a biased way. There are many good things in the just issued ‘Rethinking Macro Policy II: Getting Granular’ by Blanchard, Dell'Ariccia and Mauro at the IMF. Their discussion of ‘Should Central Banks Explicitly Target Activity’ reflected many of the points I tried to make recently here, although of course they were not rude about the ECB. But the section on fiscal policy was strange, and it made me think about why I have always been reluctant to use the phrase ‘fiscal space’.

The section of the paper on fiscal policy goes as follows. (The letters in brackets refer to the subsections in the paper, and I will use them as references below.) Government debt is too high and needs to come down (A). For some countries where a default premium on government debt has emerged, then debt reduction has to be rapid. The idea that monetary policy could help in these circumstances raises the problem of fiscal dominance (B). In other countries there is ‘fiscal space’, so debt consolidation does not have to be so quick (C). Maybe these countries might think about redesigning their automatic stabilisers (D).

Fiscal space is like a breathing space. The debate is all about the speed of fiscal consolidation, and some countries can afford to take a small breather before getting back on the consolidation path. Taking a breather might be a good idea, because going too fast may have some unintended consequences when we are stuck at a zero lower bound. The idea of active fiscal stimulus becomes reduced to a slower speed of fiscal consolidation and tinkering with automatic stabilisers.

Take this sentence from the paper. “Underlying the debate about multipliers has been the question of the optimal speed of fiscal consolidation (with some in the United States actually arguing for further fiscal stimulus).” Well one or two people outside the US have been arguing for fiscal stimulus too, but the key message here is that there is just one primary role for fiscal policy (fiscal consolidation), and anything to do with multipliers and recovering from recessions just influences its speed.

This framing is wrong. Fiscal policy has two roles. In normal times outside of a monetary union the primary role should be debt stabilisation/reduction. At the zero lower bound the primary role should be fiscal stimulus. In a monetary union both roles are equally important all the time. Framing fiscal policy discussion around the idea of fiscal space negates the countercyclical role. This negation was a key factor behind the Eurozone crisis, and more generally it has intensified and prolonged the current recession.

One of the features of framing is that it is not literally wrong (it is not like the doublespeak of Orwell’s Ministry of Peace ). In the statements above, I agree with (A). But once you concede it is all about (A), then the discussion of (B) and (C) becomes distorted, and the policy endpoint (D) becomes quite inadequate. In fact, you suspect that part of the idea is to deliberately avoid the thought that governments could use fiscal policy in a discretionary manner to stimulate the economy. (The word countercyclical appears only once in the paper.) In that sense, I’m afraid to say, the IMF inhabit the same fiscal space as the European Commission!

[1] Reaction functions relating policy to debt, for example, find no systematic tendency for taxes to respond by more than spending: some evidence is briefly reviewed here. Current austerity programs vary from spending based to tax based: see the IMF analysis reported here.

[2] An earlier version of this post, before I read the IMF paper, ended with a different link. Just as the phrase ‘taxpayers money’ presumed incorrectly that (income) taxes were the residual source of finance, too much macroeconomic analysis of temporary government spending changes uses income taxes as the residual source of finance. This allows opponents of fiscal stimulus too much scope: see for example John Taylor’s latest analysis of the impact of austerity, as discussed by Noah Smith here. The few theoretical cases of expansionary austerity that have been produced nearly all depend on these supply side effects of higher future income taxes outweighing the current impact of higher government spending: see also Campbell Leith here. It would be much better, as I have suggested before, if we instead focused in the first instance on what I have called ‘pure’ countercyclical policy: in this case higher government spending eventually paid for by lower government spending. This way we separate issues to do with intertemporal demand management (the business cycle) from issues to do with tax incentives. I couldn’t decide whether this link inspired or contrived.