How (and a touch of Why) You're Being Lied to About the Effect of Tax Cuts

The declarations coming out of the White House of increased revenue success caused by the Bush tax cuts, even though the deficit is still well over $200B, flies in the face of statements made by two of Bush's former chiefs of his Council of Economic Advisors.

from Brad DeLong (I emboldened some parts):

Suppose you cut taxes. By how much do you have to cut spending in order to keep the budget deficit from growing? Gregory Mankiw--chosen by George W. Bush to chair his Council of Economic Advisers and be his chief economic adviser in 2003-2004--and his coauthor Matthew Weinzierl provide us with their answers to this question in "Dynamic Scoring: A Back-of-the-Envelope Guide". Mankiw and Weinzierl say that, initially, you have to cut spending by almost the entire amount of the tax cut. But if you do so, they say, you find that the economy does grow faster with lower taxes: people work more, people hide less income, and more is saved and invested. In that long run that economists love so much, you only have to cut spending by five dollars out of every six in order to finance a cut in taxes on labor, and you only have to cut spending by one dollar out of every two in order to finance a cut in taxes on capital.

This is ex-Bush CEA Chair Gregory Mankiw's view. It is in accord with the consensus of professional economists: tax cuts that do not unbalance the budget do increase economic growth, but not to the extent that you don't need to cut spending at all.

What if you cut taxes but don't cut spending? There the consensus of economists is equally clear. A tax cut without accompanying spending cuts does not raise but lowers economic growth. In the end taxes must be raised, and raised to a higher level than they were initially. As Ben Bernanke--whom George W. Bush chose to succeed Greg Mankiw as chair of the Council of Economic Advisers, and then chose again to chair the Federal Reserve--puts it:

"The tendency of government budget deficits to reduce investment spending is called crowding out. Reduced investment spending implies slower capital formation, and thus lower economic growth.... This adverse effect of budget deficits on economic growth is probably the most important cost of deficits, and a major reason why economists advise governments to minimize their deficits..."

Hold on tight to both of these views. They are Republican--spotlessly Republican. They are, however, the views of reality-based Republicans, a remnant that are much scarcer on the ground these days than even wild quail.

So why, then, is the Bush administration holding a big press event this afternoon (Tuesday) in order to claim that because of its supply-side policies the 2006 budget deficit will be about $300 billion, much lower than the $423 billion the Bush administration forecast last February? That its 2003 tax cuts have more than paid for themselves? That the tax cuts have accelerated economic growth enough so that they produced a net gain in revenue?

Do they think that reporters won't ask the first obvious question--that back in February your forecasts already included the effects of the 2003 tax cuts on revenue, and do you really think your audience is too stupid to realize that revisions in the forecast since February come from things that have happened since February and not from things that happened three years ago? Do they think that reporters won't ask the second obvious question--that Republicans like Dick Cheney claimed that the 2001 taxcut wouldn't create a deficit, that the 1993 tax increase wouldn't reduce the deficit, and that the 1981 tax cut wouldn't increase the deficit; shouldn't people who are 0 for 3 be less sure of themselves?

Well, actually, yes.

They do think reporters won't ask the obvious questions--or that even if they do the stories that will get written about the press event will be "he said, she said" stories about how "experts" differ, and who knows who is right. Paul Krugman has the best line about the elite Washington press corps's coverage of the Bush administration: if it were to announce this afternoon that the Earth was flat, tomorrow's headlines would read "Bush, Democrats Views on Shape of Earth Differ."

If you read page A1 of last Saturday's New York Times you saw evidence that the Bush administration's expectations of the press corps are not completely wong, as they snookered the generally-reliable Edmund Andrews, who wrote:

"White House officials are expected to announce that... the deficit will be about $100 billion less than what they projected six months ago. The rising tide in tax payments has been building for months, but the increased scale is surprising even seasoned budget analysts.... Tax revenues are climbing twice as fast as the administration predicted in February, so fast that the budget deficit could actually decline this year..."

Andrews makes no mention of the fact that the Bush forecast of six months ago was deliberately highballed by $60 billion or so--precisely so that the administration could claim now that recent news on the deficit has been very good. As non-partisan budge analyst Stan Collender wrote half a year ago, "The Bush administration held a conference call... to say that the 2006 deficit would be $400 billion or more.... [T]his president has a well-established history of overstating the deficit early in the year and then taking credit when it turns out to be lower than projected, even if it has done nothing to make that happen..."

In July 2003 the fiscal 2003 deficit was estimated at $459 billion; the actual outcome was $378 billion. In February 2004 the fiscal 2004 deficit was estimated at $521 billion--more than $100 billion higher than the Congressional Budget Office's contemporaneous estimate, and $108 billion higher than the actual fiscal 2004 deficit of $413 billion. In January 2005 the adminnistration's forecast for the fiscal 2005 deficit was $427 billion--the deficit came in at $318 billion. And in each case the Bush administration trumpeted the "progress" on the deficit made relative to the benchmark set by its own highballed previous forecasts.

How did the Repulican Party ever get into the business of claiming that tax cuts in America today don't just expand the economy enough to make back some of the revenue lost, but expand it enough to make back all? It's not because any group of reality-based Republican economists believed it--they muttered about "charlatans and cranks... fad economics... voodoo economics... snake-oil salesm[e]n... trying to sell a miracle cure..." It's because a Republican journal of ideas called The Public Interest thought it would be a politically convenient claim to make. As its editor [Irving Kristol later explained (here)], his "own rather cavalier attitude toward the budget deficit and other monetary or fiscal problems" arose because "the task, as I saw it, was to create a new majority, which evidently would mean a conservative majority, which came to mean, in turn, a Republican majority--so political effectiveness was the priority, not the accounting deficiencies of government."

Call it a game of Dingbat Kabuki. There has been good news about economic growth and tax revenue this year, but not $120 billion worth. By highballing early estimates of the deficit, and claiming that lower deficits than their own previous forecasts show that tax cuts pay for themselves, they can keep the big-spending and the low-taxes and the balanced-budget Republicans all inside the tent for just a little longer. That is what is going on here.

But if you are actually interested in what is good for the country, and what the effects of tax cuts on the economy are? You will learn nothing from the administration's press event. Remember: "political effectiveness was the priority, not the accounting deficiencies of government."

How can you not love that Krugman quote?