Krugman: Disaster Relief Economics

[LongTomH]

In his latest op-ed in the NY times, Paul Krugman attempts to school Eric Kantor in real economics:

In a way, I may be wasting my time doing any kind of rational analysis of Eric Cantor’s demand that any disaster aid in the wake of Irene be offset by spending cuts elsewhere. Cantor is, of course, being totally hypocritical; where were the demands for offsets to the cost of invading Iraq?

Still, it may be worth talking about just how bad an idea this is in terms of basic economics — and in this case, regular economics, not fancy-schmancy macro.

Think of the government budget as involving tradeoffs similar to those an individual household makes. On one side, there are all kinds of things the government could be doing, from dropping freedom bombs to providing children with dental care; think of each of these things as involving a certain marginal benefit per additional dollar spent, with the marginal benefit declining in the total amount spent on each concern. On the other side, raising revenue has a cost, both the direct cost of the money taken from taxpayers and the possible reduction in incentives from higher tax rates.

Prof. Krugman goes on to discuss the concept of 'marginals,' explaining that government "needs to set all the marginals equal." He extends the concept of marginals to future as well as current expenditures and income.

But wait: even more important, the government can borrow (or, in principle, lend, if it pays off all its debt). So it should balance its budget in present discounted value terms, not year by year. This means that the tradeoffs should include future spending and taxes as well as this year’s spending and taxes. And a natural disaster, like a war, is a temporary event; it should be met largely through higher taxes and lower spending in the future rather than right away, which is another way of saying that it should be paid for in large part by a temporary increase in the deficit.

This isn’t some novel idea, by the way — it’s the standard theory of public finance during war, going all the way back to Ricardo. And the logic of wartime finance applies equally to natural disasters.

Following the link to Prof. Krugman's post on Irregular Economics is worth the time; he explains the limitations of 'regular economics.'

[dkf]

1. Isn't this what we always say though? Tomorrow we do the hard stuff. Lol.

" it should be met largely through higher taxes and lower spending in the future rather than right away, which is another way of saying that it should be paid for in large part by a temporary increase in the deficit."