Tax increases (actually, preventing scheduled phase-out of tax cuts, but no matter) are contractionary. People have less money to spend, less employment results. Government spending cuts are expansionary. People have less money to spend, and more employment results. I have to say that at my age, contractioning can be hard to avoid.
It does seem that the folks at the Heritage Foundation are arguing that tax cuts create more aggregate demand, so Max – who does understand what Keynes wrote – is simply pointing out that reducing government spending would tend to lower aggregate demand. But the source of the confusion from the Heritage Foundation is even deeper than their failure to read the General Theory:
Nationally, however, the fundamental reduction of aggregate supply, mixed with government-back increase in aggregate demand means that generally higher inflation over the next year is a sure thing … The enduring lesson of the Great Depression is that economic policy should not be contractionary in the face of a contraction. That fundamental rule is adhered to by neoclassical economists and is also one of the sacred commandments of Keynesians—a rare point of agreement between the two groups…Making the Bush tax cuts permanent would create 430,000 additional jobs nationally in 2006 alone and an average of 624,000 per year over the next decade, according to our macroeconomic modeling … Congress now has a very tough political decision: whether to make the 2003 tax cuts permanent, to let them to phase out as scheduled, or to repeal them promptly in order to help “pay for” Katrina. There is an alternative to taxing more, and that is spending less. It may be tough politically, but re-prioritizing spending and limiting its future growth is the only way to change fiscal policy without harming the economy. Spending discipline is the path to making tax cuts permanent and creating more jobs.
On the one hand, they seem to be arguing that aggregate demand may fall below full employment, while on the other hand, they seem to agree with the David Altig view that we are near full employment. Now Max does not agree with Dr. Altig – and neither do I. But most Keynesian economists tend to agree with the classical view that economies do gravitate towards full employment. As such, reductions in the national savings rate from permanent tax cuts would lead to less investment – not more.