StanCollender'sCapitalGainsandGames Washington, Wall Street and Everything in Between



Will Higher Taxes Tank the Economy?

26 Jun 2011
Posted by Bruce Bartlett
The main sticking point in negotiations between Republicans and Democrats on deficit reduction measures to accompany a rise in the debt limit is whether higher revenues should make any contribution. A key Republican concern is that any tax increase would depress the economy.
 
Given the slow patch that the economy is going through, any realistic threat to growth is one that has to be taken seriously. But the Republican position that spending cuts are expansionary while tax increases are depressing is not logically consistent. Both spending cuts and tax increases affect the economy in roughly the same way in the short run – by reducing aggregate demand. Fiscal contraction, whether on the tax side or the spending side, will have a negative effect under current economic conditions.
 
Of course, it goes without saying that there will be different economic effects depending on how spending is cut or taxes are raised. But the first-order effect in either case will be to reduce national income and depress growth. In the longer run, some spending cuts could well be expansionary if they altered economic behavior in a positive direction. In general, subsidies are a bad idea because they distort economic decisionmaking and reduce growth below what would occur in a free market environment.
 
But the same is true for tax subsidies. If someone pays lower taxes because they produce ethanol it is really no different than just getting a government check for doing the same thing. Yet many Republicans oppose abolishing tax-based subsidies because it would be an impermissible and economically depressing “tax increase,” while eliminating budget-based subsidies would be a beneficial “spending cut” that would be economically stimulating.
 
Economists have known for many years that many tax cuts are nothing more than spending by another name. They call such things “tax expenditures” and there are about $1 trillion worth in the tax code. Getting rid of many of them would have exactly the same economic benefits as reducing on-budget subsidies. Nevertheless, Republicans oppose eliminating tax expenditures unless other taxes are cut because any net tax increase would depress growth. The historical evidence, however, does not necessarily support this view.
 
Back in 1982, Ronald Reagan was persuaded that the deficit was such a severe impediment to growth that a tax increase to reduce it would be economically beneficial. Many in his party strenuously objected, citing research by Republican economists. For example, on August 12, 1982, U.S. Chamber of Commerce president Richard Lesher sent to Congress an analysis of the proposed tax increase. Said Lesher:
 
If H.R. 4961 is passed in these troublesome economic times, we have no doubt that it will curb the economic recovery everyone wants. It will mean a lower cash flow as more businesses pay more taxes, with a depressing effect on stock prices. It will reduce incentives for the increased savings and investment so badly needed to improve productivity and create more jobs. It will mean higher prices for many products and services. It will increase government costs in caring for those who, because the economy is held down, cannot find employment.
 
It would be hard to find an economic forecast that was more wrong in every respect. Looking at real gross domestic product, it grew 4.5 percent in 1983 and 7.2 percent in 1984 – an exceptionally strong performance. The stock market had one of its best years ever in 1983 – both the Dow Jones Industrial Average and the S&P 500 Index rose 35 percent. There was no increase in the rate of inflation, which was exactly the same in 1983 and 1984 as it was in 1982. The unemployment rate fell from 10.6 percent in December 1982 to 8.1 percent by December 1983 and 7.1 percent in December 1984.
 
The Chamber was not an outlier. Virtually every Republican economist made similar dire predictions. Economist Arthur Laffer told his clients on July 26, 1982, that the Tax Equity and Fiscal Responsibility Act, which raised taxes by about one percent of GDP, “will stifle economic recovery,” “retard economic growth,” and undercut “the economy’s ability to enter into a period of expansion.” On August 20, 1982, he told his clients that TEFRA “will tend to lengthen and deepen the recession.” Writing in the New York Times on September 12, 1982, economist Norman Ture said the administration’s claim that TEFRA would promote economic growth was “bizarre.” He said it would “weaken the impetus for economic growth” and make the economic recovery “less certain and less vigorous.”
 
Despite these erroneous predictions, Republican economists said pretty much the same thing when Bill Clinton proposed a tax increase in 1993. On April 12, 1993, the Republican members of the Joint Economic Committee predicted that the unemployment rate would be 0.3 percent higher in 1994 and 1995, 0.5 percent higher in 1996, and 0.6 percent higher in 1997. Real GDP growth would be 0.4 percent slower in 1994, 0.5 percent slower in 1995, 0.8 percent slower in 1996, and a full percentage point lower in 1997.
 
On August 20, 1993, Laffer told his clients, “Clinton’s tax bill will do about as much damage to the U.S. economy as could feasibly be done in the current political environment.” He said that interest rates would rise and the stock market would fall.
 
Once again, it would be hard to find a forecast that was more completely wrong. The unemployment rate fell from 7.1 percent in January 1993 to 5.4 percent by December 1994. Real GDP growth rose from 2.9 percent in 1993 to 4.1 percent in 1994. Stock prices rose and interest rates fell. More importantly, the 1993 tax increase and accompanying spending controls, which were opposed by every Republican in Congress, laid the foundation for the phenomenal growth of the late 1990s that actually produced budget surpluses before Republican tax cuts in the 2000s dissipated them.
 
Despite these facts, it is Republican dogma that tax increases are so offensive that they are willing to walk away from trillions of dollars of spending cuts that the Obama administration has agreed to and risk defaulting on the national debt just to prevent so much as $1 of tax increase from being enacted. While obviously any tax increase needs to be carefully considered, there is no doubt that closing loopholes and eliminating many tax subsidies would have the same effect as cutting spending. If Republicans believe that cutting spending is stimulative, they can’t logically oppose cuts in spending through the tax code.
 
Reprinted from the Fiscal Times
 

>>If Republicans believe that

>>If Republicans believe that cutting spending is stimulative, they can’t logically oppose cuts in spending through the tax code.>>

The difference in positions is likely due to distributional issues. Raising taxes takes money from high income earners. Cutting spending tax money from the middle class and poor. That's why the Republicans are desperate to cut spending rather than raise taxes.

The major problem with the economy is that people aren't buying stuff. Businesses won't hire and grow unless people are buying what they produce. We do not need lower interest rates, as rates are very very low.

I decreasing the deficit is important at the moment, the obvious answer is to tax those who save a substantial portion of their income (i.e., high income earners) and have government spend the money. This unquestionably boosts demand. It moves money from something we don't need (more savings) to something we do need (more consumption). Raising taxes on the cash constrained middle class would cut spending rather than saving, so that's not the right thing to do today. In more normal conditions, these moves would not be helpful, but in an environment of low interest rates, massive unemployment, etc., and where taxes are at a very low point compared to GDP, it would help.


Cutting spending that is

Cutting spending that is value detracting will increase resources and growth

Tough to argue that all public spending adds value.


"any"

Bruce wrote essentially the same post when Republicans opposed "any" cuts to Medicare. When politicians oppose "any" they really are opposed to "the stuff currently on the table". Republicans are opposed to Democrat proposed tax increases, not necessarily Bartlett proposed tax expenditure reductions. The negotiations are not specific, but given everything Obama has pledged not to increase, the Republicans are probably correct in their opposition.


"It would be hard to find an

"It would be hard to find an economic forecast that was more wrong in every respect. Looking at real gross domestic product, it grew 4.5 percent in 1983 and 7.2 percent in 1984 – an exceptionally strong performance."

And here is the chart to show it:

http://research.stlouisfed.org/fred2/graph/fredgraph.pdf?&chart_type=lin...

Now what else was going on in 1983:

http://research.stlouisfed.org/fred2/graph/fredgraph.pdf?&chart_type=lin...

Real interest rates were positive. Hmmm... Positive real interest rates leads to positive real domestic product. It was true during Reagan, Bush I, and Clinton, and yet somehow Ben Bernanke believes otherwise.

What else happened circa 1982-1983? Housing prices in the consumer price index were replaced with owner's equivalent rent. This is what effectively ended the wage price spiral that was going on through out the 1970's and early 1980's.

That is the good part. The bad part was this:

http://research.stlouisfed.org/fred2/graph/fredgraph.pdf?&chart_type=lin...

Trade balance was adversely affected because of the combination of the government spending policies of the 1970's that continued through most of the 1980's AND the Reagan tax cuts.

http://research.stlouisfed.org/fred2/graph/fredgraph.pdf?&chart_type=lin...


You've forgotten about the deadweight loss of taxes.

Thus your thesis claim is simply not true:

"Both spending cuts and tax increases affect the economy in roughly the same way in the short run – by reducing aggregate demand."

A government spending cut of a certain magnitude *will* result in a larger economy than a tax increase of the same magnitude due to the added deadweight loss of increasing taxes.

This is economics 101.


On government and economic efficiency...

From the wikipedia website on economic efficiency and deadweight loss:

"In economics, the term economic efficiency refers to the use of resources so as to maximize the production of goods and services."

"In economics, a deadweight loss (also known as excess burden or allocative inefficiency) is a loss of economic efficiency that can occur when equilibrium for a good or service is not Pareto optimal."

Basic supply side economics. Because taxes are a cost in the production of any good or service, lowering the tax burden in the private sector lowers a cost in the production of a good or service.

The other cost that the federal government has influence is the cost of debt service via interest rates. And so lowering the cost of debt service also lowers the cost of the production of a good or service.

And so why does the federal reserve raise the cost of debt service to combat a rise in the price level?

The reason is productivity - productivity = real gross domestic product / total debt outstanding. The federal reserve controls the cost of debt service for the federal government. Because the federal government produces nothing, increases in the federal debt (to fund, for instance, wars in Iraq, Afghanistan, and Libya) tend to be inflationary without countervening action by the federal reserve (ala Paul Volcker).

"A government spending cut of a certain magnitude *will* result in a larger economy than a tax increase of the same magnitude due to the added deadweight loss of increasing taxes."

This statement needs some clarification because not all tax increases and spending cuts are created equal. There is marginal propensity to consume AS WELL AS marginal propensity to produce. This comes about from monopolistic enterprises. Cutting taxes for a company that has a 95% market share is not going to encourage that company to produce more goods. The whole point of supply side economics is to affect the marginal cost of production. That does not apply to companies that do not have to compete on cost.


Capital Gains

When is serious action concerning a capital gains tax going to enter the mix?


What about deadweight losses on tax expenditures

"A government spending cut of a certain magnitude *will* result in a larger economy than a tax increase of the same magnitude due to the added deadweight loss of increasing taxes.

This is economics 101."

It's also economics 101 that tax expenditures also cause deadweight loss. Take a look at corn ethanol subsidies for example.


When Bruce began by taking a

When Bruce began by taking a naive view, accepting a political argument at face value, I suppose it's no surprise that the discussion has continued in a naive way.

First, there is no reason to believe that Republicans believe their own arguments about economic growth and fiscal policy. As Dean Baker repeatedly notes as regards press coverage of political statements, we can know only what politicians say and do, not what they believe. Thus this statement:

"A key Republican concern is that any tax increase would depress the economy."

should actually read:

"A key Republican talking point is that any tax increase would depress the economy."

Even Republicans can check the record and discover that their so-called "concern" is not backed up by the facts of recent decades.

We get similarly naive comments about the dead-weight loss of taxes and lectures that not all government spending is equal, so not all adds equally to output. Firms are saving like mad and hiring very little, so giving them more money through tax cuts is unlikely to add much to hiring. Those who are well-paid spend less of their income than those who are poorly paid, and so giving the well-paid more money to spend is a poor way to address a demand shortage. These issues have been discussed at length over the entire course of the recession and the recovery. To ignore them while citing textbook stuff that has surprisingly little to do with the current case is just silly.


Why is Laughter still allowed

Why is Laughter still allowed to shower us with his concoctions and his junk economics ?


Question

Hi Bruce, I saw your interview with Lawrence O'Donnell, and you said that nobody in the Reagan Administration ever said that tax cuts pay for themselves. But in your book "The New American Economy," on page 111, you said that Reagan in an October 1981 news conference claimed that the Kennedy tax cut paid for itself. I'm not accusing you of anything, but is this an inconsistency, or did I take you out of context?


I said

that no one in the Reagan administration ever said that the Reagan tax cuts would pay for themselves. 


If Republicans believe that

If Republicans believe that cutting spending is stimulative, they can’t logically oppose cuts in spending through the tax code.

Where on earth did you get the cockamamie idea that republicans care on iota about "logic"? They care about one thing alone, and it sure as hell ain't the well-being of the citizens of the US.


The GOP are a bunch of

The GOP are a bunch of terrorists, and you should not negotitate with terrorists. Just declare the debt ceiling unconstitutional (the 14th ammendment gives lots of support to the argument) and ignore it.


Negotiating with terrorists

Yes, negotiating with Republicans has become a joke. They've no regard (sure I except people like Bartlett, he's not at the table) for facts, no concern for the public welfare, and no check on absolute ruthlessness.

I believe in negotiation when it makes sense -- but acting like you can negotiate with these folk is the act of quislings and fools.

President Obama had a veto pen and did not have to go along with continuation of the disastrous Bush tax cuts last fall -- but he did, and he did because he's pretty much in league with the Republicans on EVERY big issue.

I made the mistake of voting for him, but won't repeat that; however, there is no one responsible to vote for.

Two such bad Presidents and meekness on the part of sensible people have put our country in a ditch. I applaud the sane people like those on this blog, but they are not running the asylum, alas.


past debt limit increases

I read, possibly in Krugman's column, that Congress raised the debt limit 7 times during the 8 years of the Bush Administration. I do not recall that there were any "negotiations" which accompanied those raises. More than half of the debt was created by Republican tax cuts and the two wars, so it is no surprise that Republicans would not want to oppose their own policies. The only logical explanation for Republican outcries about the horrors of the debt ceiling today is that they are opposing a Democratic president for political gain. It would be nice if they actually cared and took action about creating jobs as they trumpeted so loudly prior to the recent elections. Mr. Bartlett has shown that jobs grew following tax increases during both Reagan and Clinton administrations, further evidence that today's Republicans are willing to ignore facts, and further evidence of their desire to prolong the economic malaise and portray the Obama administration as an economic failure.




Recent comments


Advertising


Order from Amazon


Copyright

Creative Commons LicenseThe content of CapitalGainsandGames.com is licensed under a Creative Commons Attribution-Noncommercial-Share Alike 3.0 United States License. Need permissions beyond the scope of this license? Please submit a request here.