Sunday, November 14, 2021

"It's not inflationary because it's paid for."

In the discussion of President Biden's so-called Build Back Better plan, a common refrain among its proponents is that the bill will not increase inflation because it is paid for with tax increases on corporations and wealthy individuals. There are four problems with this logic:

1. The bill is likely to include permanent tax increases along with spending provisions that will sunset. The proponents want the spending to be extended later. So, in a true sense, it is not paid for.

2. The key issue is not what the plan does to the economy over a 10-year budget window but what it does over the next few years. So look at the path of fiscal policy, not just the 10-year totals. While I wait for CBO's budget projections, I will guess the bill will expand the budget deficit in the near term.*

3. Even paid-for increases in spending can expand aggregate demand and thus be inflationary. Recall the balanced budget multiplier.  

4. If the wealthy have especially low marginal propensities to consume, as some research suggests, and they are the people on whom the new taxes are to be levied, then the increase in aggregate demand could be large. That is, the reduced spending by the wealthy taxpayers would not offset the increased spending that the new taxes are financing.

A final thought: The BBB plan should not be judged by its impact on inflation. Whatever its inflationary effect is, monetary policy can offset it. The plan should be judged by whether we want a substantial increase in the size and scope of government social spending.

*Update (11/18): As predicted, the CBO says the bill will increase the budget deficit by about $750 billion over the first five years. The additional revenue will cover less than a quarter of the additional spending.