My preceding post bemoaned the tendency for many US politicians to exhibit a procyclicalist pattern: supporting tax cuts and spending increases when the economy is booming, which should be the time to save money for a rainy day, and then re-discovering the evils of budget deficits only in times of recession, thus supporting fiscal contraction at precisely the wrong time. Procyclicalists exacerbate the magnitude of the swings in the business cycle.
This is not just an American problem. A similar unfortunate cycle — large fiscal deficits when the economy is already expanding anyway, followed by fiscal contraction in response to a recession — has also been visible in the United Kingdom and euroland in recent years. Greece and Portugal are the two most infamous examples. But the larger European countries, as well, failed to take advantage of the expansionary period 2003-07 to strengthen their public finances, and instead ran budget deficits in excess of the limits (3% of GDP) that they were supposed to obey under the Stability and Growth Pact. Then, over the last few years, politicians in both the UK and the continent have made their recessions worse by imposing aggressive fiscal austerity at precisely the wrong time.
Why do so many countries so often wander far off the path of fiscal responsibility? Concern about budget deficits has become a burning political issue in the United States, has helped persuade the United Kingdom to enact stringent cuts despite a weak economy, and is the proximate cause of the Greek sovereign-debt crisis, which has grown to engulf the entire eurozone. Indeed, among industrialized countries, hardly a one is immune from fiscal woes.
Clearly, part of the blame lies with voters who don’t want to hear that budget discipline means cutting programs that matter to them, and with politicians who tell voters only what they want to hear. But another factor has attracted insufficient notice: systematically over-optimistic official forecasts.
The famous Paradox of Thrift holds now more than ever: what is good for the individual, and for the economy in the long run — high saving — is bad for the economy in the short run. During the current worst-post-30s recession we need a boost to demand. In the longer run we need more saving.
Americans could not have gotten the timing worse. During the three expansions of 1983-2007 the economy grew well, and by the end of the period the first baby boomers had reached their peak earning years. Yet households’ saving rates declined, falling almost to zero in 2005-07. Meanwhile, the government ran record deficits, reducing national saving even more (in the 1980s and 2000s; the late 1990s saw surpluses). It is ironic that the pro-capital orientation to the Reagan tax cuts of 1981-83 and the Bush tax cuts of 2001-03 was largely sold as an incentive to increase saving and investment, and yet household saving fell sharply subsequent to both policy changes — to say nothing of national saving. The increase in the after-tax return to saving did not lead to a “return to saving.”
In my earlier post, I catalogued some quotes from high Bush Administration officials asserting the Laffer claim that a cut in US tax rates stimulates income so much that the Treasury ends up taking in more revenue than before. I didn’t then quote in detail the extensive statements made by the Director of Office of Management and Budget, Joshua Bolten, in July 2005.
Director Bolton’s statements are of particular interest for several reasons. First, by 2005 it had become obvious to any objective observer that (1) the record budget surplus inherited by the Bush Administration had been quickly converted into a record budget deficit, and that (2) the aggressive Bush tax cuts were a major cause of that swing (as was the sharp acceleration in federal spending, both domestic and international, relative to the 1990s). Second, while the utterings of President Bush himself can in general perhaps be dismissed as not to be taken seriously, Bolten was the professional whose job is to be responsible for the integrity of the budget process. (Indeed, he is a higher-quality civil servant than some in the Bush Administration who have been quick to “bolt on” crazy ideological propositions to what should be serious positions.)
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).