For U.S. annual data that include WWII, the estimated multiplier for defense spending is 0.6-0.7 at the median unemployment rate (while holding fixed average marginal income-tax rates). There is some evidence that the spending multiplier rises with the extent of economic slack and reaches 1.0 when the unemployment rate is around 12%. We cannot estimate reliable multipliers for non-defense purchases because we lack good instruments. Since the defense-spending multiplier is typically less than one, greater spending tends to crowd out other components of GDP. The largest effects are on private investment, but non-defense purchases and net exports tend also to fall. The response of private consumer expenditure differs insignificantly from zero. For a sample that begins in 1950, increases in average marginal income-tax rates (measured by a newly constructed time series) have a significantly negative effect on GDP. When interpreted as a tax multiplier, the magnitude is around 1.1. We lack reliable statistical evidence on how the responses to tax changes divide up between substitution effects from changes in tax rates versus income effects from changes in tax revenue. The combination of the estimated spending and tax multipliers implies that, as the median unemployment rate, the estimated balanced-budget multiplier for defense spending is negative.
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This paper was revised on December 7, 2009
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