How do you Stimulate an Economy? Part 2 - Why Aaron prefers Tax Cuts

In part 1 I discussed how difficult it is to even know what is the correct course of action to take to help improve an economy.  The is both a remarkably complex system and one in which seemingly small events can have massive impact.  Mathematically speaking it is a chaotic system, which makes it very hard to predict much less guide and control.

That is the primary reason that I prefer using tax cuts to stimulate the economy. While I don't think businesses are inherently any more competent or less corrupt than politicians, the bottom line is that there are many more of them and their methods produce success or failure much more directly for them and much more quickly.  This leads to a system in which many different plans are attempted and ones which lead to success are emulated and refined while ones that lead to failure are discarded.

Now of course, on major drawback is that these plans are not designed for the benefit of the economy, but rather for the benefit of the company, or the company owner/shareholder.  Such actions, however, almost always also increase the overall economy.  Making businesses successful is the key driver in making the economy healthy.

The plan of using the government spending, provides more direct control of things into the hands of fewer decision makers.  That can be a good thing, especially when there is a clear case of something that needs to be done.  A good example of this, and something good that is in the current US stimulus is funding research into non-hydrocarbon energy generation.  While I have some disagreements with the details of how it is being done, overall it is a good program to use government funding to promote this research.  However, that is because even if it isn't something that will directly help the economy overall in the near term (it in help in many ways and hurt in many others) it is something that, if successful, will help the economy greatly in the long term by reducing the costs (either political or economic) of energy.  Because it is clearly beneficial to the economy and may be too long term to be correctly promoted by business it is a good candidate for government funding.  However, those cases are, I believe, limited in number. 

It is far more often that we don't know what the best path to promoting the economy is and when that is the case I prefer, to steal the term from Glenn Reynolds, an Army of Davids to the management of a Goliath.  As we decrease tax burdens it increases profitability and therefore incentive for new players to enter with new ideas.  Yes, we also get old players with old ideas, but failing ideas lead to either abandonment or failing business, successful ideas lead to emulation.  

So while I think that both spending and tax reduction can and to stimulate the economy in some ways and depress it in others, overall I prefer tax reduction because it empowers larger numbers of solutions to a problem that we don't understand well enough to have all the answers for.