Monday, May 29, 2006

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.

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18 Comments:

Anonymous mvpy said...

knzn, it gives me no pleasure to report that this piece convinces me you are smoking some illegal substance. And living in a room with no windows.

Let me begin.

"including people like Paul Krugman and Brad DeLong, who should know better – seem to think the answer is “none of the above.”"

Do you not know that these are political hacks? Also, they do concede grudgingly your point 1). Look at Krugmans textbook; the chapter on fiscal policy and he attributes the economic recovery to Bush. (Its available at "Bobbys" website; the krugman fan page).

Also, knzn, people like me supported the Bush tax cuts not for silly Keynesian reasons. These were a supply side package (incentives to work and invest), and, mind you, have worked miraculously. These cuts have triggered a phenomenal boom just as supply side economists like me predicted. I just hope theyre made fully permanent.

"After all, most economists consider the low national savings rate to be a big problem."

Well, I dont. Ever heard of consumption smoothing. Budget deficits are not a prob if theyre the result of tax cuts. They help restrain gov expenditure and, whats more, ensure nothing is LEFT for the LEFT.

"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."

This is insane. Wake up. The tax cuts were to stimulate investment and work effort. We now have high investment and unemployment at levels below normal estimates of the NAIRU. And astonishing productivity levels. And all as a result of these tax cuts. Given potential output has risen, so has the tax base; we do not have an equal tax hike in the offing, as you say. See ManQs paper.

This was not -I repeat not - a spending package. Keynesian fine tuning is in the long run - dead.

"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 this is Democratic rubbish; baloney. So what if they went to the rich. The rich invest, you know, raising the capital stock and real wages for all. Has a poor man ever given you a job knzn. Has one? Sit back and consider that, my friend.
That the Dems say the the rich get the tax cut and then that the poor pay for it is a complete double standard. Just plain lies. The tax system is at all times progressive, regardless of whos in power. Get real.

"But that argument only works if you expect the Republicans to stay in power."

Oh, they will. The DEMS are gone, dead. Theyre not an anti-Bush party; theyve taken the bait and destroyed themselves. Theres no money left anyway; theyve lost their raison d'etre. Theyve no message, nothing. Someone like Rudi or McCain will walk it next time round.

"And frankly, personally, Democrat though I am"

Come over to the right, knzn. Its just great over here. We're right.

.........
Oh, knzn, you know, I spend hours wondering who you might be. Im figuring you're working for some ultra leftist think tank (funded by Soros?) in Boston?

Wed May 31, 12:34:00 AM EDT  
Blogger knzn said...

mvpy: “These were a supply side package (incentives to work and invest), and, mind you, have worked miraculously. These cuts have triggered a phenomenal boom just as supply side economists like me predicted.” Sometimes you say very reasonable things, but this (and most of the rest of your comment here) is total nonsense. Talk to your sensible economist personality and ask him about the lags involved in the effects of supply-side policies (the lags which allow you to attribute the Clinton-era boom to Reagan’s policies). Savings is down; labor force participation is down; corporate investment is unimpressive given the high level of profits. I’m still willing to believe there will be a worthwhile supply-side effect in the long run, but so far we haven’t seen any evidence of it. And even if we did, it couldn’t explain the current “phenomenal boom.”

Wed May 31, 10:35:00 AM EDT  
Anonymous mvpy said...

knzn,
Employment figures improved dramatically after the 2003 tax cuts. So did investment. Did I say there were strong supply side effects?

You mentioned saving and labor force paricipation. Frankly, these werent especially relevant to what I said; I didnt expect big changes in lfp - thats related to more sociological issues, but the tax cuts helped. LFP by women started increasing in the seventies, totally unrelated to taxation issues. In any case, consider the counterfactual; what would lfp been without the tax cuts. Less, Id say. (Unemployment is what matters. You are conveniently now emphasizing LFP; thats playing dirty, knzn. After all, surely, LFP could go down if people felt better off. Right?).

Also, Id argue that the fall in the savings rate is possibly attributable to wealth effects and consumption smoothing and, as such, I dont think it adverse.

Also, you misrepresented what I said; I didnt say there were necessarily lags. I emphasized the effects last in the long run, I didnt say they occur in the long run.

By the way, your piece was a very good illumination onto the disengenous tricks of your leftist heros.

Wed May 31, 01:39:00 PM EDT  
Anonymous mvpy said...

To fill you in on more details, knzn,heres an article I found by Don Luskin at poorandstupid.com. So take this in your little pipe and smoke it:

"So what's the secret of this amazing economy? I'll be happy to tell you, because it's a secret that's laying out there in plain sight. But there is none so blind as he who cannot see. And politics can blind the best of us. The secret is the 2003 tax cuts on dividends and capital gains.

Let me walk you again through some of the statistics about this current economic expansion -- but instead of looking at what's happened from the official recession bottom in November 2001 to now, let's also look at what happened from April 2003, which is the last month-end before the tax cuts were enacted into law.

Let's start with the stock market. From the recession bottom to April 2003, the S&P 500 actually lost 18%. Since April 2003, the S&P 500 has gained 51%. Now that's a bull market -- but you just have to start at the right place.

From the recession bottom to April 2003, 1.03 million payroll jobs were lost, and the unemployment rate actually went up from 5.5% to 6.0%. Talk about a jobless recovery! But since April 2003, payroll jobs have increased by 5.11 million, and the unemployment rate has fallen to 4.7%.

From the recession bottom to April 2003, real GDP grew 3.2%. Since April 2003, it has grown 11.3%.

From the recession bottom to April 2003, S&P 500 earnings increased only 7%. Since April 2003, earnings have grown 59%.

From the recession bottom to April 2003, manufacturers' new orders fell 5%. Since April 2003, they have increased by 38%.

From the recession bottom to April 2003, non-residential fixed investment fell 1%. Since April 2003, it has increased by 35%.

And here's the most remarkable of all. From the recession bottom to April 2003, federal income tax receipts fell by 11%. Since April 2003, they have increased by 26%, and now stand at all time record highs. Think about that one for a second. We cut taxes on personal incomes, capital gains, and dividends -- and tax receipts went up.

Let's hear it for voodoo economics. It works.

Why does it work? It's really so simple. Tell people they will get to keep more of the fruits of their labors and the fruits of their investments, and they will labor more and invest more. The economy will grow -- and so will tax receipts.

But there's something else at work when you cut the taxes on dividends and capital gains in particular. By doing that, you've directly removed a disincentive to risk-taking and capital formation. There has never in history been any kind of economic growth that came from anything else. Risk-taking and capital formation are what it's all about -- and when you lower the taxes on them, you get more of them. So you get more growth.

Lower taxes on capital are a windfall for the rich, I suppose. That's the demagogic message we always hear opposing this policy that has wrought such miracles. It's true that the rich get to keep more of their dividends and capital gains after taxes. But ordinary Americans benefit, too.

Even if you are not rich, but only a member of the huge "investor class" that invests through IRAs and 401ks -- which means you already weren't paying taxes at all on dividends and capital gains -- you still benefit. Why? Because lower taxes on capital make stock prices go up.

Do the math. If a taxable investor pays a lower tax on his dividends or capital gains, effectively his expected return is going to be higher. And when expected returns are higher, you're willing to pay more for a share of stock today -- because you'll get more from it over time. So stock prices go up.

For rich investors, then, lower taxes on dividends and capital gains are actually offset by the higher stock prices that must be paid to get that income in the first place. But with stock prices higher, that means the cost of capital is lower across the entire economy. That means more money can be raised to fund the innovation that leads to productivity growth, which, in the end, is the wellspring of wage growth."

Thu Jun 01, 01:47:00 PM EDT  
Anonymous Chris (a different different one) said...

As a conservative Republican, I also go with (1)--this is not necessarily a good thing since I believe, like Barro, that tax rate smoothing should be a major priority for fiscal policy. This is what I would consider to be the respectable supply side argument.

mvpy: Budget deficits ARE a problem if they're permanent and we have some kind of nominal rigidities. The fiscal theory of the price level (basically, debt deflation) begins to kick in, and the Fed no longer has the ability to smooth out inflation. Looking at the gov't debt to GDP ratio, which has barely budged in the past five years, seems to bear this out.

Basically, my critiques of the current political parties are that the Democrats underestimate the power of incentives and the Republicans don't understand accounting for present value relationships and transversality conditions.

There's also a post-hoc ergo propter hoc fallacy in the background here. I can attribute the boom since '03 to the exact date that I left the labor force and went to grad school. Conversely, things began to go sour when I entered the labor force in July 2000. That doesn't mean, necessarily, that my presence is bad for productivity. Some might still argue otherwise.

I'll leave a discussion about labor force participation for another day. There's something going on there that we don't quite understand, and I think that it's at a lower frequency than we all think.

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