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Brooks Wilson's Economics Blog: Mankiw on the ITC as a Fiscal Stimulus

Friday, December 18, 2009

Mankiw on the ITC as a Fiscal Stimulus

Greg Mankiw describes "Nine Observations about Investment," on Greg Mankiw's Blog. In the fourth observation, he explains why he believes that an investment tax credit would be an effective fiscal stimulus. I quote the first four.
1. Above is a chart of the growth rate, from four quarters earlier, of real investment in equipment and software. Notice the left scale. Investment spending is very volatile. This is one of the standard stylized facts about the business cycle.

2. Investment has been particularly weak during this economic downturn. Weak residential investment is not a surprise, as the downturn was started by events in the housing market. But as this graph shows, business investment has also been very weak. Indeed, by the metric used in this graph, it is far weaker than in previous deep recessions, such as 1982.
3. Why is business investment so weak? Part of the reason is that the downturn is severe and investment responds to the overall economy. Part of the reason is that the credit crunch makes financing more difficult. Part of the reason is that the policy environment seems adverse to business. I am referring here to a group of policies that include higher minimum wages, the seeming retreat from free trade, proposed mandates to provide employees health insurance, higher prospective energy costs from climate change regulation, and the likelihood of higher future tax rates resulting from the huge fiscal imbalance we are now experiencing. All of these factors have worked in concert to depress business investment.

4. The recent weakness of business investment was one of unstated reasons why, in my recent NY Times column, I suggested that an investment tax credit (ITC) might have been a better form of fiscal stimulus than what we in fact were given. Given the amount of money being spent on stimulus, the ITC could have been sizable. The measure of investment used in the chart above is about $1 trillion per year. So, to give a very rough example, if Congress had passed a 20 percent ITC in 2009, 10 percent in 2010, it would have cost the Treasury about $300 billion. Essentially, the Treasury would have picked up 20 percent of the cost of all of these investments if done this past year, and half that amount next year.

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