Saturday, April 19, 2008

It's a Laffer, all right...

Supply-side economics is not just alive and well in political thinking, it is being embraced as the only life-preserver floating in our sea of federal red ink. The trouble is, it's an anvil in disguise.

The premise that tax cuts yield more revenue was an instant hit for the rich, as you might expect. And by simply lining some charts up side by side (see comment below), you could almost see the proof. Except it turned out to be a correlation that even supply-siders could not convert into cause and effect.
They’re aided in that extrapolation by the simple fact that the American economy grows over time. As a result, even if you cut taxes the federal government will eventually take in more tax revenue than it once did. And that allows supply-siders to fashion a spurious syllogism: taxes were cut in 2001, government revenues are higher in 2007 than they were in 2001, therefore the tax cuts increased revenue. The comparison that really matters in analyzing the impact of the tax cuts, of course, is not between government revenue in 2001 and government revenue in 2007. It’s the comparison between actual tax revenue in 2007 and what tax revenue would have been in 2007 had there been no tax cuts in 2001. And studies that make these types of comparisons—including one by Bush’s own Treasury Department that looked at the tax cuts’ impact on economic growth—find that government revenues would be greater had taxes not been cut. But that hasn’t stopped President Bush from claiming victory. [More]
One of Bush's leading economic advisers, and noted economist Greg Mankiw rejects the idea the Reagan tax cuts "paid for themselves". And he is far from alone.
I used the phrase "charlatans and cranks" in the first edition of my principles textbook to describe some of the economic advisers to Ronald Reagan, who told him that broad-based income tax cuts would have such large supply-side effects that the tax cuts would raise tax revenue. I did not find such a claim credible, based on the available evidence. I never have, and I still don't. [More]
My earlier post referring to this report from the Congessional Budget Office carries more weight in my thinking because it is an effort to model mathematically - not philosophically - how such results could be achieved. Perhaps it could be argued that the CBO aimed for a particular answer, but certainly no more so than than the Heritage Foundation on this issue.

One reason is I have never found the Heritage Foundation to embrace any taxation or reject any tax cut. The second reason is conservative think tanks such as Heritage rightly point out the REAL problem is uncontrolled government spending, and vigorously rail against it, but then seemingly shrug their shoulders when no fiscal restraint is forthcoming and get back to the main business of lowering taxes, especially on the wealthy.

Since there is NO reason to expect any meaningful, even perhaps measurable change in government spending (I mean, the Republicans are worse than the Democrats!), ranting about taxation strikes me as single-minded self-interest. Supply-side think tanks need to get real about how they are going to raise revenues, since no effort to control spending has a prayer.

In short, I hate "tax and spend", but I really hate "borrow and spend". Take a look at our deficit growth, fer cryin' out loud! Promising to cut taxes is a political winner, I grant you, but who's gonna pay your farm subsidy? The preponderance of economic thought seems to me to side with Mankiw, especially with our economy mired in slow or even negative growth. We can watch tax revenues and prove this point or not pretty quickly.

Supply-siders happened to be in the right place at the right time with a faulty idea that got carried by good fortune. Expecting a second lottery ticket to win is not my idea of a prudent economic plan. Like energy, the obvious budget solution virtually all want to ignore is using less.

We are not over-taxed, we are under-restrained. Until even growth in public spending is brought under control, don't talk to me about tax cuts. Even my own.

4 comments:

Anonymous said...

Don't you think that the private sector could out preform the Government, and grow the economy creating a larger tax base to feed the Government?

From Virginia said...

While I have no formal training in economics, I can't help but observe that taxing something more will generally reduce its production. Since our tax code basically taxes productivity, I can't see how higher taxes will not, to some extent, lower the GDP of this country, result in fewer jobs, and basically a less robust economy.

You also will get no argument from me that the real problem is on the spending side, and I hate borrowing for deficit spending as well. As Mike Huckabee said about the stimulus package, we are doing to borrow a couple hundred billion from the Chinese to send checks out to all Americans, so they can all go out and buy merchandise made in China!

Likewise, Congress dawdles, fusses and fumes over finding away to increase farm bill spending by $12 billion dollars over the baseline at the same time that we have record farm income and average farm household incomes that exceed average American household incomes by more than 30%.

For instance, the Senate version of the Farm Bill calls for spending $400 million per year for incentive payments for the production of "healthy oilseeds". With beans at $12-$14 dollars does ASA think we really need that?

Likewise, the Senate calls for new programs to pay annual rental payments on flooded land in North Dakota, to pay cost share for fungicide treatments of durham wheat, to pay incentive payments for the production of hard white wheat.....I could go on and on. So when I have a choice between higher taxes that would slow or drain energy from the economy while further growing the reach of government OR lower taxes that would strengthen the economy while making it at least marginally more difficult to grow the scope and reach of government, I can only choose the latter.

John Phipps said...

Anon:

I do agree the private sector can utilize money more efficiently, but what is the point in growing the tax base if you are reducing the rates faster?

Are there things you are willing to pay taxes for that only the government could/should do: war, for example? If so how much?

VA:
In the process of "starving the beast" (a strategy of tragic failure) we're building a place in history for ourselves that will mark us as the shortest-sighted and most self-interested generation ever. We have proven we will not control spending, but we will not pay for it either, pretending against evidence that a miracle will happen like in the 90's to pick up the tab.

Until we can no longer borrow we will not fully appreciate the gravity of this relentless approach in the face of contravening fact.

From Virginia said...

I admit you are right, we are short sighted. It is the inherent weakness of a democracy, no delayed gratification, just bring the bacon home now and send the bill to my kids.

Yes, there are some things we need government for and we should fund them well. But when we have the federal government funding local education (where in the Constitution is that?) and with incredible spending increases on the horizon for entitlements for baby boomers, the truly necessary things like defense, transportation for interstate commerce and the like are only a fraction of our federal spending. We reallly are becoming a socialist nation expecting the government to do more for us all the time, and the bills are adding up.

I wish I knew the answer, because I am just as confident that for every new dime of revenue, either from an expanding tax base or from higher tax rates that Congress finds, Congress will spend another dollar. And if the dollar comes to my county/my home, I will say "good job" and re-elect them.

Sigh, now you have me all depressed!