March 10, 2001

Arnold

you clearly need some tips on titling your pieces. this one, for instance, would have been much better if you'd called it Hootie and the Tax Cut.

--RB

Paul Krugman, whose New York Times column makes him the de facto spokesman for the economics profession, is terribly worked up about President Bush's tax cut. It is as though the tax cut is Moby Dick, and Krugman is Captain Ahab.

The reality is that the Bush tax cut is not a great whale. Viewed in proper perspective, it is more on the order of a blowfish.

Krugman distorts the size of the Bush tax cut in many ways (admittedly, Bush is guilty of some of these same distortions).

1. He compares the tax cut to the budget surplus. This is like dividing by zero.

   But are there not trillions of dollars in projected surpluses? How can I call that zero?

   The surpluses appear to be large, because they are calculated in absolute dollars on a cumulative basis, under dubious assumptions. Realistically, the best guess for the surplus would be 0, plus or minus 2 percent of GDP.

   Krugman would agree that the projected budget surplus is too small relative to GDP to be relied upon. However, this fact implies that to show that the tax cut is too big one must do more than compare it to the projected surplus. Anything divided by zero is too big.

2. He focuses on the cumulative size of the tax cut over ten years. However, if you take the $1.6 trillion tax cut and divide it by ten, then it becomes an average annual tax cut of $160 billion. It seems odd that we talk about Federal spending on a one-year cycle and taxes on a ten-year cycle. Granted, both parties do this.

3. He compares the Bush tax cut with no tax cut at all. In fact, the Democratic alternative is a tax cut about half the size of the Bush tax cut.

4. He looks at the Bush tax cut without looking at the Bush spending cuts.

We can solve the problems of (1) and (2) by comparing the size of the Bush tax cut to GDP, which is the total amount of goods and services produced each year. The tax cut is about one percent of GDP. Using this scale, the Kennedy tax cut was larger, and the Reagan tax cut of 1981 was over twice as large.

If we take into account the Democratic tax cut, then the difference between the two parties on taxes amounts to about 1/2 of one percent of GDP. However, Bush proposes to keep spending as a percent of GDP constant. Without his intended restraint, spending would increase by about 1/2 percent of GDP.

After one has cleared away all of the misconceptions, the issue of George Bush's tax cut concerns the appropriate size of the Federal Government. It boils down to something like the following: Should the target for receipts and expenditures of the Federal Government be 19.5 percent of GDP or 20.0 percent of GDP?

My instinct is to respond, "That is a political question. Economics has almost nothing to do with it. Moreover, those are really small differences in the whole scheme of things. To a first approximation, it does not matter."

My guess is that any responsible economist would have approximately this reaction. There is no economic case to be made, one way or the other.

The Reagan tax cut, alluded to earlier, was a different story. It had a very large impact on the Federal Budget. As a result, from 1982 through 1988, the deficit averaged more than 4 percent of GDP.

However, the Reagan tax cut was different from the Bush tax cut in many respects. As a percent of GDP, it was over twice as large. It was proposed at a time when the government Budget deficit already was 2.5 percent of GDP, compared with a surplus of 1.7 percent today. It was proposed at a time when Federal expenditures increased sharply as a percent of GDP, because Reagan undertook a defense buildup and there was little hope of restraining non-defense spending with a Democratic Congress.

Krugman is correct that Alan Greenspan is blowing smoke by suggesting that once the Treasury's debt is paid down the government will be forced to intrude malevolently into financial markets by buying private assets. I'm sure that the Treasury could add a few mortgage-backed securities to its portfolio without ending capitalism as we know it.

The supply-side arguments that are surfacing for tax cuts (see my last essay) also are bogus, as always. These are the same people who promised us that the Clinton tax increase would kill the economy.

On the other hand, Krugman endorses the Democrats' favorite last refuge of scoundrels, which is that we need high taxes to "save" social security. As I wrote in Farmers and Parasites, mainstream economic analysis views social security's unsoundness as a demographic problem, not a fiscal problem.

As an economist, I see both sides of the tax cut debate as being engaged in partisan demagoguery. For some reason, however, Krugman sees it as his job to clear away only the Republicans' smoke screen while leaving the Democratic counterpart in the air.

The more harpoons that he launches at the Bush tax cut blowfish, the more I wish that Krugman would return to research and teaching full time. I would like to see someone who speaks consistently for the economics profession, even though on occasion this may embarrass the Democratic Party. Krugman is going about it the other way around.