Tax cuts and the budget deficit

[sam h]

Brad Delong has a good article in Salon about this topic, and since it comes up so often here and so is often misunderstood, I thought I would summarize the key points. They rest on mainstream economic perspectives. If you don't believe in neo-classical economics, then that is another cup of tea, but not really the point here.

(1) Almost all economists believe that tax cuts (construed broadly) stimulate growth. Therefore, you need to think about the effects of tax cuts as dynamic, rather than simply taking a static picture of the decreased revenues.

(2) However, almost all economists also agree that tax cuts do not pay for themselves. Their dynamic effects on growth increase revenue, but not to the level of the decreased revenue from the cuts themselves. Gregory Mankiw, who Bush tapped to chair the Council of Economic Advisors, has estimated that dynamic effects of labor taxes end up paying for about 17% of the cuts, while dynamic effects of capital taxes end up paying for about 50%.

(3) Therefore, tax cuts will increase budget deficits unless accompanied by spending cuts.

(4) Increasing budget deficits cuts into the dynamic effects of tax cuts down the road, because deficits themselves tend to depress the economy by exerting upward pressure on interest rates. As Delong points out, this is something that Ben Bernanke, who Bush recently chose to chair the Fed, has stressed in his academic writings.

(5) In sum, tax cuts are thought (a) not to pay for themselves and (b) to be beneficial for economic growth only to the extent that they are accompanied by spending cuts that will decrease the deficit or keep it steady. These positions are supported by Bush's own appointments.

(6) The take home message is this: All of the sound and fury about the tax cuts paying for themselves is just political posturing and BS. It is a convenient way for the real issue to be lost, which is the Bush administration's (and our politicians' in general, on both sides of the aisle) inability or unwillingness to do anything about spending.

[bdk3clash]

See also this article that discusses a study by the ultra-liberal Cato Institute that found that cutting taxes actually increases government spending. I was meaning to make a separate thread about this Cato study.

[tread]

Very well stated, and definitely one of the most mis-understood concepts in the economy today. Probably because the president and vice-president so frequently lie about it and tell the public that the ARE paying for themselves.

I would also question as to what extent tax cuts actually stimulate the economy. In order for there to be a statistical correlation, you have to have stats that show the opposite action produces the opposite result. In the 90s the economy was stimulated during a time of tax increases.

[natedogg]

Surely you're not suggesting we should raise taxes by $300 billion rather than cut spending? They didn't cut spending and in fact the deficit is $300 Billion even though revenues are HIGHER than during clinton's terms.

They suck. But please let's not suggest that the answer to raise taxes to pay for this madness.

natedogg

[sam h]

[ QUOTE ]
Surely you're not suggesting we should raise taxes by $300 billion rather than cut spending? They didn't cut spending and in fact the deficit is $300 Billion even though revenues are HIGHER than during clinton's terms.

They suck. But please let's not suggest that the answer to raise taxes to pay for this madness.

natedogg

[/ QUOTE ]

Nate,

I'm suggesting exactly the opposite - that the tax cuts are pretty meaningless unless we cut spending. I am all for cutting spending.

Sam

[sam h]

[ QUOTE ]
See also this article that discusses a study by the ultra-liberal Cato Institute that found that cutting taxes actually increases government spending. I was meaning to make a separate thread about this Cato study.

[/ QUOTE ]

Hi Bdk,

I'm kind of skeptical about the argument that tax cuts increase spending, but certainly there is little evidence for the opposite argument ("starve the beast") that is often trotted out to justify tax cuts. I will take a closer look at the Cato study though.

Sam

[Borodog]

Tax cutting based on the economic stimulus argument is indeed fallacious if you believe that increasing revenue to the government is the goal.

However, that isn't the goal. The goal is to improve the bottom line of market participants, not the government. In short, if the government loses money on a tax cut, they can go [censored] themselves.

Furthermore, the waters are considerably muddied by an inflationary monetary policy. Artificial credit expansion of course increases government tax receipts, which can then be attributed to the stimulus from tax cuts. If I recall correctly, during the height of the Clinton boom in 97 or 98, the Fed was increasing the money supply at the amazing clip of 17% per annum. These new funds are preferentially available to those paying the lion's share of taxes, and voila, tax receipts jump, and you get the Clinton "surplusses."

We are seeing the exact same effect now. Greenspan pumped the money supply like mad in the early 2000s for the Bush administration, and now magicly the budget deficit is significantly reduced, even in times of a costly war and ballooning domestic spending.

The fact that tax receipts have indeed gone up despite the fact that tax cuts cannot pay for themselves should tip you off that there is something deeper at work, and that something is manipulation of the money supply.

It's no coincidence that they've stopped tracking M3, either.

[tread]

[ QUOTE ]
Surely you're not suggesting we should raise taxes by $300 billion rather than cut spending? They didn't cut spending and in fact the deficit is $300 Billion even though revenues are HIGHER than during clinton's terms.

They suck. But please let's not suggest that the answer to raise taxes to pay for this madness.

natedogg

[/ QUOTE ]

I guess you didn't read any of the tax thread about revenues. Revenues are NOT as high as they were under Clinton adjusted for inflation or as a % of GDP. No where near close. You love to compare absolute, non-adjusted numbers, I just don't get it. It has taken Bush 5 YEARS just to get revenues back to the aboslute, non-adjusted numbers they were in 2000. This is piss poor performance.

Again I ask you, itemize your 300 billion in spending cuts for me. Spending as a % of GDP is very much in line with what it has been in the past 50 years. Starve the beast does not work, we have 17 years for Reagans and Bushes to prove it.

I'm not suggesting that we "raise taxes". Im suggesting that talk of extending current tax cuts for dividends/capgains and talk of estate tax repeal, both which heavily benefit the rich, is extremely irresponsible given that a current deficit exists and that fact tax cuts do not return enough revenue to pay for themselves, either in the short or long term.

Either that or itemize the spending cuts for me so they can be debated. But since Congress appears incapable of that, they have to defer tax cut talk until they can. I am all for tax cuts when there is a budget surplus, but if they can't produce a surplus, then tax cuts should not be allowed. THIS is what would piss people off enough to get congress to cut spending, if tax cuts could only be grated during budget surpluses.

[Propertarian]

Cato is an ultra-libertarian (or classic, as opposed to modern, liberal) organization. Very far to the right on economic policy.

[Borodog]

Get your sarcasm detector recalibrated.