Here's an interesting albeit still pioneering finding by Andrew Mountford and Harald Uhlig (a prominent econometrician now at the University of Chicago) in an empirical study called "What are the Effects of Fiscal Policy Shocks?":
Our main results are that:
- a surprise deficit-financed tax cut is the best fiscal policy to stimulate the economy.
- a deficit[-financed government] spending shock weakly stimulates the economy.
- government spending shocks crowd out both residential and non-residential investment without causing interest rates to rise.
Greg Mankiw's observation is that these finding are not consistent with standard Keynesian theory, according to which government spending multipliers are larger than tax multipliers and crowding out occurs through increases in interest rates.
In these trying times, a gradual income tax reduction from the current 29% top rate to an 18% top rate might just be the good stimulus that the Malaysian government should seriously consider.
The lower income tax rates will be offset by increased economic activity and, therefore, greater income tax collections.
It will do the Malaysian government well to remember that necessity is the mother of invention and the mother that gave birth to the ultra-radical capital controls and de-pegging of the Ringgit in 1997 (I'm certain that he has the sense of humour to forgive the maternalistic metaphor) was the redoubtable and unsinkable Dr M of Malaysia.