With the publication of Jon Chait's new book, The Big Con: The True Story of How Washington Got Hoodwinked and Hijacked by Crackpot Economics, I think we can expect to see a repeat of the bomb-throwing that took place between liberal and conservative economists, and their often sketchily informed supporters, surrounding the Bush tax cuts in 2003. So I thought it might be wise to arm my readers against the more extravagent claims:
1) Cutting marginal tax rates can make tax revenues rise. This is trivially true: at some tax rate, people will stop working, and you can therefore increase the amount of revenue you raise. But the United States is not anywhere near this point. Except for one group--high income women--the labour supply is surprisingly inelastic with respect to tax. that elasticity does mean that you get some extra money back by cutting taxes, though no one knows exactly how much; Greg Mankiw's estimate of roughly 25% of the total tax cut sounds about right to me. But that still leaves a 75% hole in the revenue stream.2) Cutting the budget deficit magically makes the economy grow. I dealt with this at great length on my old blog.
3) Increasing the size of the budget deficit restrains government spending growth. The evidence for this intuitively attractive premise is, at best, extremely shaky.
4) Highly respected economists Greg Mankiw and Glenn Hubbard shilled for the crackpot supply side theories of the Bush administration. This accusation is, to put the most charitable light on it, horribly overblown by people who don't really understand the debate very well. The Bush administration was not cutting taxes out of crackpot supply-sidism; it was cutting taxes because it wanted to cut taxes, and making extravagently exaggerated claims about the benefits of its policies. This is not exactly surprising or novel behavior for a presidential administration; in his book, Bob Rubin claims that real interest rates fell by an utterly implausibly large amount due to deficit cuttery.
The accusation against Bush's two economic advisors comes in two flavors. The first, concerning Mankiw, is that he couldn't possibly have really believed in tax cuts without spending cuts . . . because it would be, like, totally unimaginable for a Keynsian to believe that the government should borrow money to spend during a recession.
For the record, I don't think the tax cuts did much to help the economy--or to hurt it, either. But then, I am not a Keynesian. Greg Mankiw is, so I have absolutely no difficulty believing that he believed that the tax cuts were a good idea.
The second is that Glenn Hubbard said that budget deficits weren't hurting the economy, when his very own textbook affirmed the standard economic model in which raising the budget deficit caused interest rates to rise (and thus savings and investment, and ultimately economic growth, to contract).
This is a bit of cheap fun by those who don't understand the model they are talking about, or are too interested in scoring rhetorical points to care. People who understand the model, which is pretty much bog-standard macro, know you have to look at how all the variables move, not just the one that makes the prettiest argument. As I wrote in that piece on the budget deficit:
. . . as Glen Hubbard has repeatedly pointed out, it is very, very hard to build a credible model in which budget deficits matter to investors, but taxes do not. The basic idea behind the "Deficit reduction causes growth thesis", known to journalists as "Rubinomics", is that by reducing the government's demand for capital, you lower interest rates. Ceteris paribus, I agree with that.However, the Clinton deficit reduction was not ceteris paribus; he got as far as he got mostly by raising taxes. If you lower interest rates, but increase taxes, you increase the demand for investment capital, but you decrease the supply of it, because savers now make less of a return on each dollar they invest. Higher demand for capital, combined with a lower supply of it, raises interest rates right back up again. How far is a matter for debate, but I see no reason to believe that the positive effect of deficit reduction could be anything close to what the Clinton team claims.
Indeed, Robert Rubin's claims in his memoir border on the ludicrous. (Border? Hell, the hedges are growing well over the property line, and the neighbours are threatening to sue.)
Reasonable macroeconomists may (do) disagree about the relative impacts of taxes and deficits; the weight you put on the two variables will determine how much you like the Bush tax cuts, or the Clinton tax increases. But it was not, as Hubbard's critics have implied, unreasonable or dishonest for him to support the tax cuts after printing that model in his book; depending on those relative values, the model could either have indicated or contraindicated cutting taxes as he did.
More as I actually read the book.
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What I love is how liberals sometimes (and only sometimes) admit that inflation and interest rates affect how people make decisions but never admit or accept that tax rates affect how people make decisions. They also forget that people will do as much as possible to minimize their tax bill, seriously reducing the revenue of any tax increase but doing almost as much damage to the economy in deadweight losses with much of the money goes to accountants and tax lawyers, as grateful people want to save at least some money on their taxes.
One benefit of tax cuts is that it reduces the deadweight loss to the economy of accountancy and tax services. Revenue doesn't drop as much as predicted because people stop using tax shelters and just use the regular tax system. You get increases in GDP as money gets targeted on useful activity instead of to the rentiers of the tax system, smaller than epected revenue losses, and none of this is predicated on marginal investment.
Unfortunately the lawyers and accountants are a huge lobby for complexity in tax and bureaucracy. The lawyers, especially, have captured the legislature and thus little is done to threaten the business of lawyers and grow the economy. Tax simplification, tax cuts, and red tape reduction imperil the gulfstreams of lawyers (John Edwards is one of thousands of gulfstream liberal lawyers screwing the poor while spouting class warfare).
Posted by Hey | September 5, 2007 12:55 PM