Tuesday, January 6, 2009

A Case Against New Tax Cuts

One major debate among economists and politicians is whether or not tax cuts actually stimulate the economy. Yesterday President-Elect Barack Obama shared details about his new economic stimulus plan where he is calling for around $300 billion in tax cuts. Many people are in support of these cuts, however, there is also an opposition side as well. Jeff Madrick is one such opponent, he believes in higher taxes and bigger government. While you certainly do not have to agree with his views, it is interesting to hear his arguments. Economics professor Mark Thoma takes a closer look at Madrick's article, and adds some thoughts in his blog post below.

Jeff Madrick makes the case for government:

No New Tax Cuts, by Jeff Madrick, Boston Review: ...Even Friedman acknowledged that free markets do not adequately supply some public goods, like primary education and roads. ... And there are other strong theoretical arguments to be made for state intervention in areas of information economics, behavioral economics, agency problems..., and institutional economics and the power of the firm.

However, it is possible to look at the question ... empirically rather than theoretically. ... One argument against government is that public spending is unproductive and crowds out private spending. But, time and again, [Peter H. Lindert, a leading economic historian,] found that studies claiming that high taxes reduce economic growth simply did not hold up. ... No matter how he juggled the data, he found no relationship between the growth of GDP per capita and productivity and the level of taxes or the extent of social spending. There is a dramatic “conflict between intuition and evidence,” he writes. ...

Other economists have ... shown that one of the other anti-tax arguments—that it significantly reduces incentives to invest and work—is highly exaggerated. ... Then there is the argument that government is always inefficient. Sometimes it surely is. But Medicare’s administrative expenses consume only 2 or 3 percent of outlays compared to 15 to 20 percent for private medical insurance. The administrative expenses of Social Security, a marvel of efficiency, are miniscule.

Indeed, the economic history of the United States is one of consistent and vigorous government action... Even when government expenditures were low, government established regulations that seriously affected the nation. Thomas Jefferson was one of the early regulators of land-distribution policies, which were radical by any standard we know today... As a consequence, land was widely distributed at a fair price in the nation early on, and speculators (to the degree possible) kept at bay.

State and local government spent on public improvements aggressively in the early 1800s, building canals and roads. By 1850 the United States had one of the the world’s great free primary education systems. Through land donations—a form of spending—the federal government supported the new agricultural and technical colleges, such as MIT and the University of California, Berkeley, and invested heavily in railroads. In the late 1800s and early 1900s, government built the sanitation, water, and sewer systems that made urban life possible. In the 1900s, government built the new high schools necessary for an advancing economy, along with new roads, dams, bridges, and all manner of public works. Look at your own city. After World War II, the federal government built the national highway system, subsidized college for GIs, supplied the polio vaccine, developed the Internet—and on.

That is where tax dollars go. The reason higher-tax nations do well economically is that government spending can and often does succor economic growth. All rich nations today have robust government. ...

America’s to-do list is now very long..., and many, with an unnecessary fear of budget deficits, believe it cannot do what it must. The first step will be to jettison ideology and return to America’s pragmatic roots. That has not happened yet, but push-back has already started...

[Read other pieces in this special economics feature by Dean Baker and Robert Pollin.]

I have argued that targeted tax cuts need to be a part of the stimulus package for a variety of reasons, e.g. the speed with which tax cuts can be implemented, and as part of a portfolio of policies that recognize we aren't sure whether tax cuts or changes in government expenditures work the best to name just two. So I don't agree with the title's call to not cut taxes, in the short-run we may need to lower taxes as part of a recovery package. To the extent that tax cuts support the goal of economic recovery, and do so better than any other option, they are needed. But if the goal of the tax cuts is simply to use the crisis as leverage to exploit a ratchet effect, or at least an asymmetry where taxes can be lowered much easier than they can be raised and hence squeeze government in the future, then that's another matter entirely. Republicans have a history of using crises to try and ram through their favorite policy, e.g.:

Just two days after 9/11, I learned from Congressional staffers that Republicans on Capitol Hill were already exploiting the atrocity, trying to use it to push through tax cuts for corporations and the wealthy.

That's not the only example from the past, and in the present we've already heard calls to repeal the capital gains tax as a stimulus measure. I'm sure if the GOP could come up with an estate tax repeal argument that sounded even remotely plausible as a stimulus measure, we'd hear that too. So while I can support targeted tax cuts to some degree, I am worried that we'll avoid the tough political battle in the name of expediency, go too far, and compromise the best economic options in order to satisfy ideological demands. (And that is true not only of the magnitude of the tax cuts versus spending other polices such as infrastructure and aid to state and local governments, but also of the type of tax cuts -- I am not thinking of the trickle down variety when I use the word "targeted".)

This blog post can also be viewed at economistsview.typepad.com.

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