Asymmetrical Information

The article doesn't necessarily support your conclusion. It does, however, reveal that Democratic rhetoric about "huge tax cuts" is bogus. The CBO correctly notes that the cuts are too small.

With Democrats actively rooting for the economy to stay stagnant until the 2000 election, is it any wonder that they would oppose tax cuts?

Stan,

Most of my friends are dems. I'm a dem. and I can hoenstly tell you, NO ONE I know is "...actively rooting for the economy to stay stagnant until the 2000 election..." (by which you obviously mean 2004 election). To imply otherwise is insulting.

Many of my friends (reps and dems) have been laid-off and are having difficulty finding employment outside of a McDonalds or Kinkos, can't even find a job, or have been laid-off and had to take lower paying jobs to pay their mostgages. None of those people want to see the economy tank until 2004, they'll loose their houses. They want it to recover tomorrow.

Sweeping generalizations like that effectively quash any chance for meritorious debate on the issue at hand (which I know very little about and would find educational). It's as if I were saying some broad general statement like "republicans hate civil rights." I could probably find a great deal of anicdotal evidence to support this statement, but obviously it's much too broad and inherently wrong.

We're all better than that.

Fine, change Stan's statement to "the Democratic leadership actively rooting...", and his statement stands.

No, it doesn't.

Yes, it does.

Sure it does. We've heard nothing from the Democratic leadership since Bush was elected but "the economy is in the crapper and it is all Bush's fault", even though the downturn started when Clinton was in office. How would their case look if the economy recovered right before the election?

Yes, it does.

Okay, so you're saying that in 1979 the Republicans were rooting for the economy to stay crappy so that they could get Reagen elected? If you claim one side actively root for a bad economy, then surely you must honestly admit that the other side does it as well.

Clinton left a mess. Bush has turned that into a bigger mess.

Boy, now that we know whose fault it is, maybe we can try to think of a solution?

GT, even you have to have noticed that, given that the war hasn't been a total catastrophe, and given that unless they nominate Edwards or Lieberman, their nominee is going to have less credibility on foreign policy than my Aunt Fanny, and given that their major domestic policy initiative, other than complaining about Republicans, seems to still be some form of nationalized health care, an economy in the tank for the next eighteen months is pretty much the Democrats' only hope of getting elected in 2004. And let's not forget that your front runner looks like a decrepit spider. If you think that Terry McCauliffe is not down on his knees every night praying for the economy to stay down, you don't know anything about politics or politicians.

Yes Kate, the Republicans probably WERE praying for the economy to stay in the crapper in 1979. Geez, politics isn't the angels vs the saints. It's the scum vs the slightly less scummy. But denying your team has scummy elements is asinine.

Oops, that should be "angels vs devils".

Things to keep in mind about the CBO analysis:
http://www.cbo.gov/showdoc.cfm?index=4129&sequence=0

1. It is not a general analysis but a specific analysis of the President's totla budget (both spending and revenue).

2. It does not say that tax cuts do not have Supply-side effects. It said that the mix of tax cuts proposed by the President did not have sufficient growth effects to overcome the deficit spending envisioned by the President.

3. The proposed tax cuts are small relative to the economy and are not uniformly pro-investment, some of the cuts are pro-consumption.

It doesn't get as much press as the President's budget but the House-passed budget proposed actual spending cuts from both mandatory and discretionary spending programs. The budget is in conference now. If you support spending cuts -- call you Congressman/Senators.

Still, Megan is in general correct. Unless a tax policy has significant disincentive effects -- tax cuts will raise less revenue than current law. However, at the level of tax cuts the Congress is talking about -- the effect of GDP on revenues swamps the effect of the tax cuts.

Okay, I wasn't old enough to really understand issues back in 1979, but I think there were enough other issues going on that Republicans didn't have to pray for the economy to stay bad to get Reagan elected.
And, actually, it WAS bad for a few years after he was elected, until he turned things around with a huge tax cut as a significant component of the plan. Just like JFK did. When will people learn from history?

Poor supply-side tax cuts!

I agree with some of the others here who note that the CBO study does not address the supply-side idea of tax cuts in general so much as one specific proposal.

It seems conceivable that the right kind of tax cut could indeed pay for itself. If the starting tax conditions are so punitive that they discourage productive effort, or encourage that effort to go underground in black and grey markets, then a tax easing could indeed result in an eventual increase in tax revenues.

The question is whether here in the U.S. such conditions apply. The black and grey market one doesn't, but measuring discouraged productive effort is harder. It's conceivable that lowering the right taxes by the right amount would lead to more economic activity that, even taxed at the lower rates, could raise tax revenue.

I mean, heck, maybe it won't, but the CBO study addressed only one proposal, not the general theory.

I wonder if this analysis really considers the *kind* of tax cut being proposed? For example, the dividend tax cut--if money is returned to shareholders rather than being retained, then there is some evidence that corporations will be less likely to engage in poor investments (especially acquisitions). I don't know how you model something like this, but that doesn't mean it can't be a real phenomenon...

I should have been more specific. At current levels of US taxation, the supply side effects of cuts in gneral personal income or dividend tax rates are not sufficient to replace the tax revenues lost, both because demand for work versus leisure is too inelastic, and because the income effect of increased disposable income counterweights the marginal incentives to work provided by cutting taxes. That is not to say that lowering taxes never raises revenue: the Russian tax cut, for example, manifestly did so, by simplifying the code and dropping the benefits of evasion to the point where it was less costly than the penalties.

The corporate income tax is a different thing entirely, and I would expect to see a supply-side benefit from eliminating it sufficient to recoup the lost revenue.

this website is cool

http://www.meki.tk/

this website is cool

http://www.meki.tk/

Jane,

I have written here that I think that economics is the single best predictor of the outcome of a presidential election.

So if the statement is that the opposition tends to gain from an economic downturn (just like the incumbent gains from an economic expansion) and leave it at that then we can all agree. But if anybody pretends that there is any difference in how the GOP and the Dems act and think while in the opposition then that's another story.

As for the topic at hand, I think you are wrong about Russia. It was not lowering the income tax rate that raised reveneus. As I understand it they imposed national VAT tax that has proved quite efficient.

Finally I suggest to all interested to read this.

"Triumphantly vindicated" is a bit of an overstatement, Megan. (Though that doesn't mean you don't have the best blog in the entire history of the universe!)

Really, the CBO cranked estimates through some economic models, and some show some minor revenue increases (vs the static model) and some show minor revenue decreases.

I think it's pretty clear that (almost) no tax cut would pay for itself in the first year. At the same time, any tax cut with positive economic effects will eventually pay for itself (unless the rate is cut to zero, and sometimes even then).

So, what we're really saying is that the CBO's models suggest the Bush tax cut will not lead to increased government revenues in the next 5 years. Probably.

Kate, note that the CBO says Bush's tax cuts will lead to increased labor supply; so the odds for your unemployed friends would improve under Bush's tax cut.

...their nominee is going to have less credibility on foreign policy than my Aunt Fanny...
I've never forgiven Megan's Aunt Fanny for the mess in the Balkans. On the other had, she did good work for us in Eastern Europe...

They also lowered the corporate tax rate, and my understanding is that corporate tax revenues rose. One can argue about where the inflection point is on the laffer curve is, but I don't think that anyone, on the one hand, seriously argues that there is not some level of taxation which is counterproductive, and on the other hand, that the US has reached the counterproductive (in terms of tax revenues) level of personal income taxation. There are supply side arguments that I buy about deductions, credits, and structural changes, but I think the overwhelming weight of theoretical and empirical evidence is against the idea that current marginal tax rates would produce more revenue if we lowered them. On the other hand, I doubt any serious economist would argue that the benefits of the corporate tax outweigh the economic costs -- including the folks who signed the petition against Bush's tax cut, which included a paen to the removal of the corporate income tax.

an economy in the tank for the next eighteen months is pretty much the Democrats' only hope of getting elected in 2004.

Worked on Bush I. Politicians with nothing to lose but an election are doubtless doing rain dances every single night hoping for that outcome.

Jane,

a) you can't say you're an econoblog and then provide no additional value other than "lookie here I'm right whoo hoo."

b) can you explain why supply-side tax cuts do not pay for themselves?

I'm sure you can, I'd just like to see your explaination. I read Arnold Kling's blog daily so how about you do less copy-pasting and more writing.

The Democrats great hope and next President (or at least the next Al Gore):

http://www.house.gov/apps/list/press/oh10_kucinich/030401floorwar.html

I'm sorry Matt. I thought this was Jane's blog and she could do anything she damn well wanted.

angels vs the saints

That would be the most interesting cross-sport game ever. Where would they square off - Anaheim or New Orleans? Which field? Time limits or innings? Which ball? Who would do play-by-play?

Regardless, the Saints would likely win, what with their advantage in bulk and padding as protection against bean-balls and flung bats.

Megan, I'd venture to guess that the inflection point on the Laffer Curve is a hell of a lot farther down the rate pole than it is now - for anybody who pays taxes. Especially with today's higher-rate progressivity. It's almost dehumanizing to assume that removing restrictions on available capital wouldn't result in productivity and gradually increased revenue to - at least in the government's eyes - "justify" the tax relief. One aspect of economists by which I always find myself amazed is their ability to semantically whittle away at painfully simply concepts.

Fred: ah, Denny. Old Default Denny. My congressmen, bless the poor masochists of Cleveland. I saw the fellow as our respective groups lined up for a nearby city's Labor Day parade. He gave me a long look; I returned it, perhaps a slight scowl as well. I wanted to punch him. On second glance he looked like a hapless child. I thought better of it and simply voted against him in November.

Jane,

You may be right - but you shouldn't count the CBO as vindicating the position that supply side tax cuts do not pay for themselves. The CBO methodology is a political compromise - there is no reason to consider it authoritative. For years the CBO refused to accept any dynamic scoring. Now the CBO does accept dynamic scoring (an implied but major admission of years of error), but a version which is arguably too conservative. Glenn Hubbard pointed this out in his Wall Street Journal item on the topic - written, by the way, after he left the government. I have posted on this topic and Professor Hubbard's item here.

It increases revenue off the static line reduction in revenues, but it simply doesn't increase revenues to make up the shortfall from the lower marginal rates. No tax cut in recent history has "paid for itself" in terms of tax revenues, although I'd be among those arguing that it certainly paid for itself from the perspective of the taxpayer.

I don't disagree with your approach. But the CBO numbers shouldn't be cited as authoritative - in my opinion.

I gave a try at an explanation at my blog. There will be more investment, but I think reduced wage income (people using the tax cut to retire early or to be a stay-at-home mom) will offset extra investment income in the short term.

From the little I understand about this subject the crux of "tax cuts paying for themselves" is that the return of capital into the private sector increases investments which allows business to finance growth which leads to higher profits, higher investor returns and/or higher salaries - at least one of which must be taxed in order for the government to recover the revenue from the tax cut.

In other words, the government is shifting spending from government services back towards private industry.

OK, but if the government is incurring debt to do this then the interest payments must be counted against the investment (just like a business loan - it is one thing to invest profits but you have to have a higher rate of return on your investment to cover a business loan).

Plus there has to be a need for business to increase their current rate of investment.

Plus the amount of the tax cut that is reinvested into business needs to have a significant impact on the current cost of capital.

And hundreds of other effects of different magnitudes.

The CBO measured 9 different models with various assumptions. To say that you could play long and hard enough with the assumptions in the model in order to find one in which this tax cut proposal pays for itself is a lot like all those dot coms with the overly optimistic revenue projections.

jjj,

I'ts even worse.

As the WSJ noted: For the handful of people who read the report in its entirety, there is another surprise. Of the nine different economic models used to analyze the president's plan, only two showed a large improvement in the deficit over the next decade as a result of "supply side" effects. Both those models got their results by assuming that after 2013, taxes would be raised to eliminate the remaining deficit. The theory is that people will work harder between 2004 and 2013 because they know that their taxes will be going up, and will want to earn more money before those tax increases take effect.

Using those same models, if the assumption is changed so that government spending falls after 2013 to close the deficit -- the outcome preferred by most supply-siders -- the economic benefits disappear. The president's plan would cause the deficit to become slightly wider over the next 10 years than it would have been otherwise.

But of course the usual economic cranks will now say that the CBO needs to change its models to show the benefits that they know, they simply KNOW, to be true.

As Krugman wrote supply side economics offers self esteem to the intellectually insecure. In his words:

Because economics touches so much of life, everyone wants to have an opinion. Yet the kind of economics covered in the textbooks is a technical subject that many people find hard to follow. How reassuring, then, to be told that it is all irrelevant--that all you really need to know are a few simple ideas! Quite a few supply-siders have created for themselves a wonderful alternative intellectual history in which John Maynard Keynes was a fraud, Paul Samuelson and even Milton Friedman are fools, and the true line of deep economic thought runs from Adam Smith through obscure turn-of-the-century Austrians straight to them.

Because economics touches so much of life, everyone wants to have an opinion. Yet the kind of economics covered in the textbooks is a technical subject that many people find hard to follow. How reassuring, then, to be told that it is all irrelevant--that all you really need to know are a few simple ideas!

Eugenics, as I understand it, was postulated by technically highly intelligent people - but that doesn't make it any less preposterous.

Scholastics are hardly the exclusory factor in terms of judgment; Eric Hoffer demonstrates that rightly. Krugman's sneer is almost as bad as European "nuance," dispatching ideas of good and evil as infantile, fantasy opiate. ;-) GT, most things in life are fairly simple, though all of them can be complicated for the benefit of obfuscation.

But this is all academic (or rather only titularly so), because Paul Krugman thinks our ideas are stupid (The Lemon is just great).

One of the difficulties of the various models CBO is using is that if you extrapolate the baseline in to the outyears(beyond ten years) -- you have neverending deficits. (Forget the tax cuts this is Medicare and SSI exploding on us). All of the models assume various things about people's ability forsee the fiscal future. In those models that assumed people had rather good (in some models perfect) foresight - the models brokedown because the people were assumed to expect infinite deficits.

To make the models work, CBO arbitrarily assumed either drastic spending cuts or tax increases in year 11 because CBO only cares about years 1-10. this wasn't intended as a realistic policy prescription -- it was just a kludge to make the models work.

It has nothing to do with people working harder now because they see tax increases coming in the future. That was just creative Democrat spin that I heard at yesterday's House/Senate conference meeting on the budget. Why or how that ended up in the WSJ I don't have the patience to figure out.

OK, I just got back from a quick lunch (tacos and the WSJ for the curious) and the WSJ editorial page had a take on the CBO analysis.

They blamed Congress.

I'm not kidding (OK, they didn't blame Congress directly but anytime the WSJ editorial page mentions government spending they have historically blamed Congress). The CBO assumes the current rate of increase in government spending will carry forward. A reasonable assumption IMHO since the president's budget did nothing to counteract this assumption and b/c the president has not mentioned any significant and specific areas to cut.

Spending cuts has nothing to do with dynamic scoring or the president's plan (as proposed).

I was only saved from my head exploding by turning to the front page and reading the actual worthwhile part of the journal, the part where analysis and logic are used, i.e. the rest of the paper.

Megan,

You give more creedence to supply-side economics, if you can call a school of thought based on a single curve any type of economics, than I do. As a long-run phenomenon moving money from an unproductive sector to a productive sector will probably generate more tax revenue per capita than leaving it with the government.

As for myself, I would rather look at the tax system for what it should be: a way for the government to raise revenue to meet its needs and the simpler, the better.

Just my $.02 and worth every penny!

Supply-side economics is not "based on a single curve." For example, the structure of a tax cut is also very important - a conclusion which is no more controversial than the obvious fact (and basic principle of taxation) that the structure of a tax is very important.

Here, the elimination of the dividends tax is more than just a reduction in tax - it is the elimination of a tax located at just about the most perverse point one could imagine. Better, of course, would be the direct and complete elimination of the entire corporate income tax. Elimination of the corporate income tax actually might "pay for itself" in even the strictest sense - especially once one includes all the costs savings from elimination of the distorted investments and huge efforts on the part of corporations to avoid the corporate income tax and on the government part to collect it. Too bad liberal and Democratic carping prevents direct elimination of the corporate income tax.

Elimination of the inheritance tax might also pay for itself in the long run. That tax forces expensive, weird structures on personal assets as "estate planning" devices - and, where those devices don't succeed, the tax forces dispositions of real assets for no other reason than taxation. That is in direct conflict with any notion of efficient taxation. The CBO methodology is particularly deficient with respect to this tax - whose elimination the CBO counts as essentially a dead weight loss in revenue (pardon the pun).

The phenomena of actively hoping for negative events, out of a desire to see one's political party gain advantage, is a fairly common phenomena across the political spectrum, and yet one more reason why I have never identified with a political party. What a hideous attitude to approach life with! Having said that, I understand that political parties are necessary, and that all who choose to associate with one are not such stunted souls. It ain't the crowd I want to spend my finite time with, though.

"their nominee is going to have less credibility on foreign policy than my Aunt Fanny"

How much does Bush have, and how did he compare with your Aunt Fanny in 2000?

Nice to see you happy that the silly Bush-Cheney-Fleischer rhetoric about the tax cuts paying for themselves has been shown to be wrong.

no tax cut has ever paid for itself??

right

jfk's didn't?

for this, i have a question: did the savings take into account reduced corp compliance costs?

wouldn't eliminating payrolll taxes pay for themselves?

and i've seen numbers that the estate tax (and possibly amt) lose money

I think it's possible that the estate tax loses money, but I very much doubt the dividend tax does, because its supply side effect is, in my opinion, muted much more than equivalent tax relief on the corporate side would be.

I wouldn't call JFK's tax cut recent history. taxwise. He was lowering the top marginal rate from 70%, which probably did pay for itself, but my guess is that the lower brackets didn't. I don't know the history on that one, so I can't comment.

Why would the estate tax lose money? Are you saying that a lower estate tax would reduce the value of planning enough that revenues would be higher?

For example, you could argue that it would be worthwhile to spend $100,000 to lower my estate tax from $500,000 to $350,000 (assuming I care about the size of my estate) but not to lower it from $400,000 to $350,000. So lowering the rate increases revenue by $50,000.

That's true as a matter of arithmetic, but the question is what the numbers really look like.

But it's hard to see by what logic eliminating the estate tax altogether will increase revenue.

The estate tax is highly distortionary. For example, it diverts assets from large estates into foundations and trusts that are permanently tax free. You'd have to do a study to show which way the net long term revenue effects would lie. (Some effects would be extremely long term.)

Puh-lease. Who died and gave the career bureaucrats at the CBO the final word?

if you grant the article its claim, i am puzzled by the arguments raised in defence of the efficiency of supply side tax cuts. what is going to be passed is NOT the ideal tax cut many of you are calling for, but the one, or a version of it, that appears to increase deficits, and which will not do the job you want it to do.

IF that is so, you won't get the chance to cut taxes--again, because there won't be any political will to enact the tax cuts you want, facing an increasing sea of red ink, 3 years from now--that's from sea to shining sea.

My problem with the debate you are having is its fixation on the government's take. That is, "do tax cuts pay for themselves" means "does the government end up collecting more $". Both sides are guilty of ignoring the $ that the government does not take. For my money that is rather more important.

"At the same time, any tax cut with positive economic effects will eventually pay for itself (unless the rate is cut to zero, and sometimes even then)."

In terms of raw revenue replacement, maybe. If you include the cost of deficit financing the shortfall during the intervening time, though?

Alan Reynolds really goes to town on this one!

Sample:

The Congressional Budget Office's "Analysis of the President's Budgetary Proposals" is the agency's amateur audition for something it calls "dynamic scoring."

Until now, that phrase mainly meant taking into account how people are likely to respond to different tax incentives. But genuine dynamic scoring would be an admission the CBO has been doing its job badly, so CBO bureaucrats had a strong incentive to botch this unwanted job as meticulously as possible. Asking the CBO to go through these unfamiliar motions was like asking employees of the Social Security Administration to report on the benefits of privatizing their Ponzi scheme.

Under the circumstances, the wording of the CBO report generally reflects surprisingly good economics. The numbers are a different matter. Alleged estimates of supply-side effects are somehow squeezed out of two private models, which, a footnote reveals, "are designed primarily to capture short-run business-cycle developments." Such models are famously useless for forecasting the next quarter, much less then next 10 years. And tinkering with an antique Keynesian computer program could no more convert a demand-side model into a supply-side model than it could turn a rotting pumpkin into a gilded carriage.

The writers of the report were thus forced to fabricate seemingly dynamic excuses for budget estimates spewed from rehashed Keynesian models.

And that's just the warm up!

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