Taxes, Housing, Growth, and War

The following seem to be a standard set of tenets for anti-Bush crowd:

• The Bush tax cuts were irresponsible.


• The housing boom was unhealthy.


• Employment growth over the past five years has been inadequate.

I’m no fan of W myself, but I’m puzzled by this triplethink. What macroeconomic policies were people hoping for? What policies would have increased employment without exacerbating either the budget deficit or the housing boom?

Let’s look at an alternative path in which the tax cuts hadn’t taken place. The tech bubble would have burst anyhow. (It started to burst long before the first tax cut.) Without the 2001 tax cut, the recession would have been deeper and lasted longer. Without the 2001 and 2003 tax cuts, the painfully slow recovery would have been even slower. Quite possibly the Fed would have cut rates all the way down to zero. (That’s only one percentage point away from what actually happened.) The housing boom – as the only major source of demand facilitating a recovery – would have been pushed to an extreme that would make last year’s experience look mild. (Exercise for the reader: calculate the present value of a perpetual stream of housing services discounted at 0%.)

If anything, the tax cuts were not irresponsible enough. Instead of tax cuts on capital income, designed to encourage virtuous activities like saving and investment, what we needed were sleazy, Keynesian tax cuts to encourage Joe Sixpack to switch to high-quality microbrews. (Fortunately, the tax cuts were entirely ineffective at encouraging saving.) Or perhaps, instead of tax cuts, we should have built a lot more bridges to nowhere back when we were facing an excess of unbroken windows.

The only alternative economic stimulus would have been a weaker dollar. You may recall, though, that Europe and Japan were facing inadequate growth at the same time, and the other Asian countries had plenty of unexploited potential. A deliberate weak dollar policy, back in 2001-2004, would have fallen into the classic “beggar thy neighbor” category. And with the rest of the world playing the same game, it’s implausible that ordinary fiscal, monetary, and “talking down” policies could have made the dollar so weak as to substitute for the stimulus of the tax cuts. That would have required dramatic intervention against the dollar, on a scale never even imagined, and with the explicitly aggressive intent of forcing the Asians (under threat of bankruptcy) to give up their own intervention policies. I don’t recall anyone advocating such actions at the time.

If you want to blame Bush for the economic problems of this decade, don’t blame his economic policies; blame his foreign policy. Whatever its ex ante merits may have been, the Iraq war, along with the atmosphere of tension it induces in the region, has clearly been partly responsible for the rising price of oil, which is exactly what has placed such a tight limit on the current recovery. (Try this thought experiment: assume the actual path for the cost of non-energy value added in the US, and suppose that the price of oil had risen much less. What would the inflation rate be? Would the Fed have kept tightening so long?)