Arnold Kling  

Did the Bush Tax Cut Fail?

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Did the New Deal Fail?... Comment of the Week, 2003-08-2...

This group of economists with strong Democratic Party ties says that we needed fiscal policy that provided more stimulus in the short run and a lower deficit in the long run. Robert Solow says,


There are three characteristics you want a stimulus package to have. One – that it stimulates. Two – that it be temporary. And three – that it not pursue a partisan political agenda. Everything that the Bush administration has done has failed all three of those tests.

For Discussion. In December of 2000, I proposed $280 billion in temporary revenue sharing for state and local governments. Would this have met Solow's tests?


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COMMENTS (51 to date)
Eric Krieg writes:

Jesus, I hate Democrats.

The only reason that the 2001 tax cuts were phased in over 10 years, rather than made immediate, was because of their criticisms!

But now hacks like Solow complain that the cuts weren't immediate enough?

Give me a frigging break.

And considering that this was the shallowest recession EVER, how can you even say that the tax cuts failed?

As for a Federal bailout of the states, regardless of it meeting Solow's test, it is a horrible idea. For all intents and purposes, well run states like Colorado would be bailing out profligate states like California.

Mcwop writes:

Solow said it has failed to stimulate but offers little to no proof. The bulk of the cuts are just kicking in, and the dividend tax cut has had a stimulating effect. Companies have been hiking dividend payments substantially, which has a positive effect on corporate fiscal responsibility. The prices of the stocks that pay dividends have gone up as a result, which bolsters the stock market. A stronger market allows copanies to raise capital.

What is Solow's proposal?

Tim Swanson writes:

Ceteris paribus, if State spending continues (deficit spending) as it has over the past decade neither the existing tax breaks or proposed will matter.

In order to fund it's programs, the State will have to print more money thereby devaluing the currency once more (via inflation), thus nullifying any positive effects "tax breaks" give.

US Debt Clock

Tim Swanson writes:

HTML tags apparently don't work, here is the url for the Debt Clock:

http://www.brillig.com/debt_clock/

Marc writes:

A stimulus package which does 'not pursue a partisan political agenda.'

Wait a second, I have one here, right between the snark and the perpetual motion machine.

Marc writes:

A stimulus package which does 'not pursue a partisan political agenda.'

Wait a second, I have one here, right between the snark and the perpetual motion machine.

Mcwop writes:

Tim wrote:
"Ceteris paribus, if State spending continues (deficit spending) as it has over the past decade neither the existing tax breaks or proposed will matter."

Alea iacta est! It appears that deficit spending will continue now that a very expensive addition to Medicare is coming, and other spending (Social Security, Medicare) continues to snowball.

Eric Krieg writes:

>>In order to fund it's programs, the State will have to print more money thereby devaluing the currency once more (via inflation), thus nullifying any positive effects "tax breaks" give.

Eric Krieg writes:

As we have discussed before, more than 50% of the defecit is due to the poor economy. The tax cuts are a direct cause of a VERY small amount of the defecit.

But the supply siders tell us that it is the incentives built into the tax cuts that are important. If the incentives revive the economy, the (small) portion of the defecit caused by the tax cuts is swamped by new tax revenue due to economic growth.

Eric Krieg writes:

Yeah, and Hoover's tax increases both revived the economy AND eliminated the deficit, right?

Dubya's no Hoover. Thank God for that.

Mcwop writes:

Eric wrote:
"Yeah, and Hoover's tax increases both revived the economy AND eliminated the deficit, right?

Dubya's no Hoover. Thank God for that."

I might expand on that to add Bush I. He raised taxes, which did not reduce deficts or quickly revive the economy either.

Further, many people miss what caused the boom during the mid to late 90's. It was massive capital spending on technology, made possible by innovation. Think of all the software, web servers, and money spend on people to put it all together. You can thank faster processor speeds, and the creation of modern web browers for that.

Eric Krieg writes:

Mcwop, your timing is impecable.

http://www.businessweek.com/bwdaily/dnflash/aug2003/nf20030827_6640_db016.htm

The next round of the tech revolution is about to begin.

Got Wi-Fi?

Boonton writes:

"Further, many people miss what caused the boom during the mid to late 90's. It was massive capital spending on technology, made possible by innovation. Think of all the software, web servers, and money spend on people to put it all together. You can thank faster processor speeds, and the creation of modern web browers for that."

And also Clinton's tax increases. I think it was Joseph Stiglitz who had a very good piece in the Atlantic that explored how those tax increases fueled the boom (but also why one cannot be so certain that they would able to be reproduced again).

Eric Krieg writes:

>>And also Clinton's tax increases.

Mcwop writes:

Boonton, I don't see it. The tax increase had nothing to do with the tech boom. I fail to see how the increase caused every company without a web site (about every company at one point in the 90's) to build one. This happened because: a) you could build one; b) people had computers to look at one; c) once one company built one other companies needed one to compete.

Second, I point to the negative effects of taxes. One example is the luxury tax on boats. That hike cost the government more in revenues than it took in:

http://www.nysscpa.org/cpajournal/old/11583345.htm

http://www.pbs.org/newshour/bb/budget/budget_1-1.html

Boonton writes:

"Bull. Can you summarize in 20 words or less how the tax increases led to the boom? There is no valid economic explanation."

I can give you a more detailed explanation but let's just start with a simple thought experiment. Given a certain level of gov't spending, is a tax cut always a good thing? If it is always good then logic says you should cut taxes to zero.

Even more simply, if the tax rate is 30% and tax cuts are always good then cutting it to 29% is a good idea. But such logic says that going to 28% is also good and so on until you hit 0%.

Obviously there must be some point where given a certain level of gov't spend, additional tax cuts are bad. If that is the case then its reasonable that tax increases would be sensible if you're below that point.

Boonton writes:

"Boonton, I don't see it. The tax increase had nothing to do with the tech boom. I fail to see how the increase caused every company without a web site (about every company at one point in the 90's) to build one."

Here's Stiglitz's view, in the early 90's the banking system was in hot water. They lost a lot of money when a bubble in a property market burst and they put a lot of reserves in Treasury bonds. They also got bank regulators to let them list this as a riskless asset. Unfortunately bonds are only riskless for default, you can lose a lot of money on them if interest rates rise. With projections of increasing deficits forever there was a serious danger that long term rates would do just that making the S&L debacle look like chump change.

This never happened because Clinton's tax increases signaled that the gov't was serious about controlling the deficit. Bonds rose in price and now banks had windfall profits. Since long term rates had fallen the banks had little incentive to invest these profits in more bonds so they started lending again kicking off a boom.

So yes tax increases can sometimes cause a recovery. Now what caused the bubble that made the boom huge is another subject.

"Second, I point to the negative effects of taxes. One example is the luxury tax on boats. That hike cost the government more in revenues than it took in:"

Yes, a tax on a highly elastic good like luxury yachts will have that effect. When we talk about taxes we are talking about a big topic...just like when we talk about gov't spending we are talking about a broad topic that covers everything from the space shuttle to welfare to sidewalks.

Mcwop writes:

Boonton, you are correct and you basically speak of the Laffer Curve. I would argue though that much of the Bush tax cuts are harmless, and some such as the dividend cut very good. Moreover I believe the Clinton tax hikes were not harmful, but did not cause the economic boom.

Eric Krieg writes:

>>Even more simply, if the tax rate is 30% and tax cuts are always good then cutting it to 29% is a good idea.

Mcwop writes:

Boonton, didn't lower interest rates play a big factor in Banks being able to shore up there balance sheets?

Tim Swanson writes:

Several of the comments here have been in the logical fallacy form of: Post Hoc Ergo Propter Hoc...

Eric Krieg writes:

With Google, I am all powerful and all knowing, like the Wizard of Oz or something.

In Latin it means "after this therefore because of this". This describes the fallacy. Boonton commited the fallacy when he assumed that because the boom followed the tax increases, the boom was caused by the tax increases.

Or, better yet, causality is not causation.

Latin is for lawyer pinheads who use it to obscure easy concepts, so you are not tempted to represent yourself and put them collectively out of business.

Tim Swanson writes:

Haha, I'll have to remember that when I bump into my attorney amigos... and I really wasn't trying to be a smart ass, that's what the fallacy is technically called.

Boonton writes:

"Obviously, neither 100% or 0% are very effective tax rates. The question is, what did raising the top rate from 28% to 39% in two steps and 4 years do to the economy. I say that it was negative. Ask anyone who tried to get a job in '94 how the economy was back then."

"Also, don't forget the capital gains tax cut instituted in 1996. And, of course, the Republican Revolution of 1995."

Let's take a peek at GDP growth & unemployment rates:

1990 5.7
1991 3.2
1992 5.6
1993 5.1 3.6
1994 6.2 4.3
1995 4.9 3.3
1996 5.6 4.9
1997 6.5 3.7
1998 5.6 3.0
1999 5.6 2.8
2000 5.9 2.9


GDP growth pre-Gingrich looks a lot like post-Gingrich. Unemployment rates aren't the best figure because they are a combination of two variables (people looking for work & jobs). If the economy does good the rate may actually increase as formerly discouraged workers enter the market.

"Say what you want about Newt Gingrich, he put the brakes on spending. He is as responsible for the boom as much as anyone else, especially Slick Willey."

Kind of hard to make this case IMO. Gingrich's power was never that great (Democratic Senate). The last two years of Republican rule of all branches of gov't kind of puts an end to the idea that the route to lower gov't spending is thru the GOP.

Boonton writes:

"In Latin it means "after this therefore because of this". This describes the fallacy. Boonton commited the fallacy when he assumed that because the boom followed the tax increases, the boom was caused by the tax increases."

"Or, better yet, causality is not causation."

Nice try but you can only wish this was my argument. I presented a mechanism by which the tax increase could have caused an economic boom and noted how this fit the circumstances. Doesn't prove my case by any means but it's a lot more of an argument than...say...'Good things happened after Gingrich became Speaker, Gingrich must have made good things happen'..

Mcwop writes:

My argument is that the politicians had almost 0% to do with the economic boom of the nineties. The few good things that happened are:
- Capital gains tax cut
- Government spending held relatively in check
- They did not add a sales tax to goods sold on the net

Politicians take far too much credit (or place blame on others) for the state of the economy. The best they can do is try to stay out of the way, and exhibit good fiduciary responsibility with the budget.

Boonton writes:

Going in reverse order:

1. Goods sold over the net were never a significant share of consumption in the 90's. Even today they have yet to achieve that status.

2. Gov't spending being held in check would have been a political decision. But there are also other elements that determine the variable. Lower interest rates automatically reduce gov'ts debt service. A strong economy reduces spending on unemployment, Medicaid & other income based programs. Even SSI payments may be cut by a strong economy since some people will delay retirement if they are having a good run.

3. Capital gains tax cuts, IMO, are probably the most overrated gov't policy. First of all, lower capital gains tax rates actually encourage selling stock in the short term. Second income from capital gains is already taxed at a lower rate than income from labor. Third, only a small portion of shares sold in any period goes towards direct investment. When a company goes public or issues shares, only then will purchasing shares provide the company with funds to invest. After that nearly all the trading of shares has only a detached, indirect relationship to the real economy.

Bob writes:

Lower interest rates automatically reduce gov'ts debt service.

Not on existing debt.

Boonton writes:

Existing debt is rolled over on a continuous basis. Also the Treasury can sometimes 'call' older debt and refinance it if the rates go down enough to make such an operation rational.

Bernard Yomtov writes:

"hacks like Solow"

Right Eric. You know more about economics than Robert Solow.

Get over yourself.

Eric Krieg writes:

>>Gingrich's power was never that great (Democratic Senate).

Eric Krieg writes:

>>"hacks like Solow"

Right Eric. You know more about economics than Robert Solow.

Eric Krieg writes:

>>Get over yourself.

Eric Krieg writes:

>>Haha, I'll have to remember that when I bump into my attorney amigos...

Eric Krieg writes:

1990 5.7
1991 3.2
1992 5.6
>>1993 5.1 3.6
1994 6.2 4.3
1995 4.9 3.3
1996 5.6 4.9
1997 6.5 3.7
1998 5.6 3.0
1999 5.6 2.8
2000 5.9 2.9

Boonton writes:

You know I had the URL's on my work computer but erased them. The GDP growth figures I computed myself from an Excel table of GDP from a US gov't source. The unemployment rate (which I found surprisingly difficult to locate) came from a pdf file which I copied by hand.

I'm willing to entertain any source which does show a significant change between the 'Gingrich years' versus the 'Clinton years'.

Eric Krieg writes:

B, there is no way that unemployment was 3.6% in '93. Sorry, it just wasn't so. The 3.9% unemployment rate in 2000 was the lowest rate since the 1960's.

Bernard Yomtov writes:

"Why is it that you don't have word one to say to me (in fact don't even post) until I say something political?"

Actually, I've said a lot, both agreeing and disagreeing with you on a number of occasions.

I was moved to respond to this comment because it is so blatantly absurd.

Boonton writes:

After a bit of digging I found a better source:
http://w3.access.gpo.gov/usbudget/fy2004/sheets/b42.xls

1990 5.6 0.3 106%
1991 6.8 1.2 121%
1992 7.5 0.7 110%
1993 6.9 -0.6 92%
1994 6.1 -0.8 88%
1995 5.6 -0.5 92%
1996 5.4 -0.2 96%
1997 4.9 -0.5 91%
1998 4.5 -0.4 92%
1999 4.2 -0.3 93%
2000 4.0 -0.2 -5%

The first two columns come from the source. The second is the change from the previous period and the last is the % of the current period compared to the previous. So while '94 had people looking for jobs the situation was clearly improving. I don't see an argument here that the economy was in shambles until Dole and Gingrich took power in the Congress.

Eric Krieg writes:

So all we are talking about is unemployment? That's the statistics you reference.

Remember when people thought that unemployment couldn't go below 6% without sparking inflation? And the year that unemployment dropped below 6% was...

1995!

And it dropped further from there, with no real increase in the rate of inflation.

You can argue that the trend in unemployment was down long before 1995. But the trend was down in the 1980s too. In 1986, when unemployment went below 6%, inflation went up. That didn't happen in the late 1990s.

Something changed. That change was Republican fiscal discipline, which for the first time in a long time allowed the economy to grow faster than the federal budget, depite all that extra revenure thrown off by capital gains.

What will be interesting to see now is, now that both Newt and fiscal restraint are gone from Washington, if inflation will return once the economy heats up again.

Eric Krieg writes:

I really dislike Solow. He writes a column for Businessweek, so I am familar with his writting. I like him SLIGHTLY better than fellow columnist Laura Tyson, who isn't even worth reading because you know what she is going to say before she even says it.

Boonton writes:

We are talking about more than unemployment, you alleged that the boom had nothing to do with Clinton's tax increase but was due to the magic of a Republican Congress in 95. Looking at just unemployment does not bear this out as it was dropping since '92.

Let's look at Real GDP Growth:
1990 6,707.9 1.76%
1991 6,676.4 -0.47%
1992 6,880.0 3.05%
1993 7,062.6 2.65%
1994 7,347.7 4.04%
1995 7,543.8 2.67%
1996 7,813.2 3.57%
1997 8,159.5 4.43%
1998 8,508.9 4.28%
1999 8,859.0 4.11%
2000 9,191.4 3.75%
2001 9,214.5 0.25%

Again the recovery was real and was strong in the pre-95 era which looked a lot like the post 95 era. Let's looks at government spending:

1990 1,181.4 7.4%
1991 1,235.5 4.6%
1992 1,270.5 2.8%
1993 1,293.0 1.8%
1994 1,327.9 2.7%
1995 1,372.0 3.3%
1996 1,421.9 3.6%
1997 1,487.9 4.6%
1998 1,538.5 3.4%
1999 1,641.0 6.7%
2000 1,751.0 6.7%

This excludes transfer payments (SSI) but also includes state gov't spending. Since entitlement programs are the most difficult to change, 'fiscal restraint' should be seen as a decrease (or holding firm on) gov't expenditures in both the Federal and State budgets (remember, Congress has sometimes 'cut' spending by simply forcing the states to increase their spending).

Again, the pre-Republican Congress era looks more restrained than the post one. This isn't surprising since that time enjoyed:

1. Lower interest rates which cut debt service.
2. A recovering economy which cuts some automatic expenditures.

The boom of the Clinton years started before there was a Republican Congress. The evidence just does not point otherwise.

Eric Krieg writes:

>>Since entitlement programs are the most difficult to change, 'fiscal restraint' should be seen as a decrease (or holding firm on) gov't expenditures in both the Federal and State budgets

Boonton writes:

Does the word 'unfunded mandate' sound familiar? 'Restraint' of Federal spending may be real restraint or it may simply be pushing spending onto a different accounting ledger.

Here are the same numbers but restricted to Federal consumption expenditure with real GDP growth in the 3rd column, the 4th column is Gov't spending growth minus GDP growth:

1990 508.4 5.35% 1.76% 5.33
1991 527.4 3.74% -0.47% 3.74
1992 534.5 1.35% 3.05 1.32
1993 527.3 -1.35% 2.65 -1.38
1994 521.1 -1.18% 4.04 -1.22
1995 521.5 0.08% 2.67 0.05
1996 531.6 1.94% 3.57 1.90
1997 538.2 1.24% 4.43 1.20
1998 539.2 0.19% 4.28 0.15
1999 565.0 4.78% 4.11 4.74
2000 589.2 4.28% 3.75 4.24
2001 628.1 6.60% 0.25 6.60

The most dramatic cuts in gov't releative to the economy appear a bit before the Gingrich era, 93 & 94. In fact, the pattern seems to be that as the gov't became more Republican gov't spending climbed relative to the economy. You can't even blame 9/11 for this since that happened near the end of the fiscal year most of the spending on the Afghan war & cleanup probably hit the 2002 budget.

This isn't surprising since the GOP wanted increased military spending but had little desire to make serious cuts in spending. I'm basing these numbers off of the 2003 Economic Report of the President (a really useful source of data) & I'm excluding entitlement programs since no major change was made to them during the 90's except for welfare which represents a small portion of the entitlement system.

Boonton writes:

Bahhh, I hate cutting and pasting into Excel, ignore that 4th column, I clearly botched the %'s.

Eric Krieg writes:

'93 and '94 represent years that military spending dropped the most. Over the entire Clinton period, military spending dropped precipitously (and I would say, dangerously, as we saw on September 11th).

I agree with your analysis of the post-Gingrich Republican years. All that capital gains tax revenue was hard to resist, and spending increased. And more recently, President Bush has had little appetite for resisting the spenders in Congress, all a part of his "New Tone". And then we had Sepetember 11th, the war on terror, Afghanistan, and Iraq.

But the '95 to '98 period WAS a period of historically low spending relative to GDP. Your statistics bear that out.

Also, don't forget about the Fed. Rates were rising in '95 and '96, not dropping. Greenspan ALMOST caused another recession, pre-emptively fighting an inflation that simply was not there. He so much as admitted it later.

Boonton writes:

Here is a corrected chart. Hopefully I can get this one to look better & be accurate:

1990 508.4 5.35 .... 1.76 ... 3.59
1991 527.4 3.74 .... -0.47 ... 4.21
1992 534.5 1.35 .... 3.05 ... -1.70
1993 527.3 -1.35 .... 2.65 ... -4.00
1994 521.1 -1.18 .... 4.04 ... -5.22
1995 521.5 0.08 .... 2.67 ... -2.59
1996 531.6 1.94 .... 3.57 ... -1.63
1997 538.2 1.24 .... 4.43 ... -3.19
1998 539.2 0.19 .... 4.28 ... -4.09
1999 565 4.78 ...... 4.11 ... 0.67
2000 589.2 4.28 .... 3.75 ... 0.53
2001 628.1 6.60 .... 0.25 ... 6.35

It would still seem that the most dramatic cases of fiscal restraint happend from 93-95 which then reversed. To be fair there was a peak again in 98 but this followed immediately by rapid spending increases which are covered up by a growing economy until 2001 when the growth came to a screaching halt.

Boonton writes:

"But the '95 to '98 period WAS a period of historically low spending relative to GDP. Your statistics bear that out."

But my case for giving Clinton credit only requires me to show that your 'magic ingredients' existed before and they did. I suppose you could argue that the combination of Clinton in the W.H. and the GOP in Congress enabled fiscal restraint to stay steady because they both neutralized each other's sterotyped tendancies (Democratic spending would be chocked as would GOP tax cuts). Then again the sterotypes don't hold. Pre-95 also appears to be a time of fiscal restraint even though the sterotype tells us the Democratic Pres. Democratic Congress combo should have been a spendong bonanza.

Rather it looks like a GOP W.H. GOP Congress combo is the recipe for a spending orgy.

BTW here is the data for national defense spending in real '96 dollars:

1990 443.2 ... -0.02%
1991 438.4 ... -1.08%
1992 417.1 ... -4.86%
1993 394.7 ... -5.37%
1994 375.9 ... -4.76%
1995 361.9 ... -3.72%
1996 357.0 ... -1.35%
1997 347.7 ... -2.61%
1998 341.6 ... -1.75%
1999 348.8 ... 2.11%
2000 348.7 ... -0.03%
2001 366.0 ... 4.96%


Assuming N.D. *should have* been $366 all along it looks like the deepest cut Clinton ever made was in 98 when N.D. was $25 below ideal. I'm not going to argue that N.D. was too low or not but I would observe that most of national defense spending from the pre-Clinton days was totally irrelevant to 9/11. In other words the 'right type' of defense spending has probably been increasing during the 90's while the spending taking place at the beginning of the 90's was probably irrelevant to terrorism.

As in education we should all be aware that just because you're spending a lot of $ doesn't mean you're getting more.

Eric Krieg writes:

>>Pre-95 also appears to be a time of fiscal restraint even though the sterotype tells us the Democratic Pres. >As in education we should all be aware that just because you're spending a lot of $ doesn't mean you're getting more.

Eric Krieg writes:

>>1993 394.7 ... -5.37%
1994 375.9 ... -4.76%

Boonton writes:

1. The military has been transitioning from a Cold War stance to a 22nd Century stance throughout the 90's. We've seen a dramatic increase in precision guided weapons, air power over raw infantry (remember Kosovo was fought almost by nothing other than NATO air power), intelligence gathering (remember right wingers attacked Clinton throughout the 90's for supposedly trying to infringe on civil liberties...some like Phil Gramm & George Bush even accused Clinton of racial profiling of Arabs & Chinese).

2. I serously doubt you have a plausible story of how keeping troops out of Hati, Kosovo, Somalia etc. in the 90's would have prevented 9/11. That is one of those statements that sounds very sensible until you actually think about it for a few minutes. If troops weren't stationed in Kosovo on 9/11 would they have been guarding airports in the US? Flying on planes fully armed?

"The two biggest defense cutting years were 1993 and 1994 (and 1992 was #3, interestingly)."

True but remember that is coming off the first Gulf War. Also let's note that defense spending settled around $366B in 2001. Assuming that was the proper amount for the pre-9/11 error then defense in 93 and 94 were higher than that level.

"That's the big difference right there. The rate of decrease for defense spending moderated in the Gingrich years. Spending restraint came in other, non-defense (and admitadely, non-entitlement) spending."

Except your dates are a bit off, Gingrich won the House in 94 but he didn't actually take office as Speaker until 95. It was only in 95 that he had that infamous budget showdown with Clinton. Gingrich's influence on the budget probably wouldn't have even been felt until 96 but even if we grant you 95 it still leaves the most dramatic fiscal restraint (relative to economic growth) in the pre-Gingrich era.

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