Politicians who advertise themselves as “fiscal conservatives” sometimes campaign on crowd-pleasing pledges to cut taxes and simultaneously reduce budget deficits. These are difficult promises to deliver on in practice, since the budget deficit equals government spending minus tax revenue.
Aspiring fiscal conservatives may be interested in learning four innovative tricks that are commonly used by American politicians who like to promise what seems impossible. Each of these feats has been perfected over three decades or more. Indeed they first acquired their colorful names in the early years of the Ronald Reagan presidency:
President Obama proposes allowing the Bush tax cuts to expire next year — as they are scheduled to do if nothing is changed — for those earning more than $250,000, but changing the law so as to extend the tax cuts for those earning less than that amount. Republican politicians are opposing the proposal. I don’t understand what they are thinking. Their position doesn’t make sense to me, regardless whether they are thinking about short-term stimulus, long-term fiscal conservatism, good economics, or even pure politics.
Martin Feldstein and others predicted that the tax-cut component of the 2009 fiscal stimulus package would have substantially less expansionary bang-for-the-buck than the spending component of the package, because much of the tax cut would be saved, as had been the case with the 2008 tax cut. (“Bang for the buck” in this case could be defined as demand stimulus divided by budget cost.) We knew this from Milton Friedman’s permanent income hypothesis, or even from good old Keynesian multiplier theory.
Over the past month, I , citing Feldstein, have said that if one looks at available information on monthly GDP, available from estimates of MacroAdvisers, that output declined within the first quarter of the year, even though as standardly reported GDP was higher in QI overall than it had been in the last quarter of 2007. But, as it turns out, there is some ambiguity to the question.
The estimates do show GDP falling in February, by a hefty 10.1% anualized. But the numbers for January and March are up. To net out the three months, one must split hairs. The positive numbers for January plus March are just slightly greater in absolute value than February’s negative 0.9 (monthly). So the net is up? Not necessarily.
Following up on my preceding post, I will here document who has said what.
High officials in the Reagan Administration apparently did subscribe to the Laffer Hypothesis:
• Reagan himself: “…our kind of tax cut will so stimulate the economy that we will actually increase government revenues…” July 7, 1981 speech 1/
• His Secretary of the Treasury, Don Regan, even after events had falsified the proposition to the satisfaction of most observers, wrote of his “very strong opinion that a tax cut would produce more revenue than a tax increase.”2/
Also: “The increase in revenues should be financed not by new and higher taxes, but by lower tax rates that would produce more money for the government by stimulating higher earnings by corporations and workers…” (p.173).
So Arthur Laffer — still arguing the improbable “supply side” proposition that cutting income tax rates generally raises total tax revenue — is apparently now a special adviser to John McCain. And McCain has taken on a big consignment of the snake oil, to Greg Mankiw’s dismay. The political temptation for a Republican candidate to promise both lower tax rates and higher revenues is irresistible. The policy-makers who cut taxes when Ronald Reagan and George W. Bush, respectively, came to power subscribed to this claim. Remarkably, at the same time, the economists who were the chief economic advisers to Reagan and Bush during these tax cuts disavow the proposition that they increase revenue (Murray Weidenbaum, Martin Feldstein, Glenn Hubbard, Mankiw…) . Almost all serious economists – let us say Ph.D. economists – disagree with this proposition, with only a microscopic handful of exceptions like Laffer. Indeed some of the advisers who defend the Reagan and Bush economic policies claim that this formulation of supply side economics is a caricature, and was not the true rationale of the tax cuts. This wishful thinking is directly at odds with quotes from the presidents themselves and their Treasury secretaries and other economic officials, to the effect that tax cuts stimulate income so much as to produce more tax revenue. Laffer is not a straw man. (See my next post.)