X or not X

Which of the following is closer to truth?

(1) The 2003 tax cut stimulated spending and thereby helped strengthen the current recovery.

(2) The 2003 tax cut did not stimulate spending and therefore is not contributing to the low national savings rate.

I tend to go with (1), but I’m willing to look at evidence for (2). What troubles me, though, is that most Democrats – including people like Paul Krugman and Brad DeLong, who should know better – seem to think the answer is “none of the above.” I happen to be a Democrat myself, but I also support the Party of Logic and Arithmetic, which somehow seems to be opposed by both major parties (not to mention most occasional third parties) most of the time. Either people spent the tax cut or they saved it, or perhaps they spent half of it and saved the other half, but you can’t say, “For purposes of calculating the short-run macroeconomic impact, they saved the tax cut, but for purposes of calculating the growth and balance of payments implications, they spent it.”

I’d like to suggest that, if you want to make the case for the Democrats, you’re better off with (1). Yes, you do have to acknowledge that the Bush administration did something that was not 100% stupid or 100% evil. But in return, you get to make a logically coherent case that they did something maybe 50% stupid or 50% evil, depending on how you look at it. After all, most economists consider the low national savings rate to be a big problem.

On the other hand, if you want to make the case for the Republicans, you’re better off with (2). Yes, you have to give up the argument that the tax cut saved the country from ruin. But in return you get – well, a free lunch. If the tax cut didn’t affect the overall savings rate, then young people will inherit the same savings, so there is no intergenerational transfer. Taxpayers overall are a little better off. If you’re a risk-averse taxpayer, you’re right where you started: just buy a Treasury bond and make your future tax payments with the proceeds. If you’re a less risk-averse taxpayer, you get to take advantage of the government’s credit rating and invest the money in something more profitable. So all these macro effects add up to a slight benefit, and the micro effect – less distortionary taxation, leading to a more efficient economy – is just gravy.

Of course, the Democrats could counter that this tax cut went to the rich, while the compensating future tax receipts (or benefit cuts) might come from the middle class (or the poor). But that argument only works if you expect the Republicans to stay in power. And frankly, personally, Democrat though I am, I would not be terribly unhappy to see the revenue made up with, say, a value added tax. I do like progressive taxes, but my feeling is, since people with nothing at all pay no taxes at all, any tax is progressive in the most critical income range.