Can Tax Cuts Pay for Themselves?

By SIMON JOHNSON

Simon Johnson, the former chief economist at the International Monetary Fund, is the co-author of “13 Bankers.”
Can tax cuts “pay for themselves,” inducing so much additional economic growth that government revenue actually increases, rather than decreases? The evidence clearly says no.

Today’s Economist

Perspectives from expert contributors.

Nevertheless, a version of this idea, under the guise of “dynamic scoring,” has apparently surfaced in the supercommittee charged with deficit reduction — the joint Congressional committee with 12 members. Dynamic scoring sounds technical or perhaps even scientific, but here the argument means simply that any pro-growth effect of tax cuts should be stressed when assessing potential policy changes (e.g., reforming the tax code). For anyone seriously concerned with fiscal responsibility, this is a dangerous notion.
Economists disagree about almost everything, of course, and the effect of tax cuts is no exception. One reasonable way to assess the evidence is to begin with the highest plausible effects, then see what happens if some of the more extreme assumptions are relaxed (this is a nice way of saying that we don’t believe everything the authors are trying to tell us).
I would start with a study by Gregory Mankiw, former chairman of George W. Bush’s Council of Economic Advisers – and therefore presumably on the tax-cutting side of American politics – and Matthew Weinzierl (published in The Journal of Public Economics in 2006 and, unfortunately, available only to subscribers) that shows the economic growth caused by a tax cut can offset, at best, a portion of the revenues lost by that tax cut.

Specifically, Professors. Mankiw and Weinzierl calculated that 32.4 percent of the “static” or direct revenue loss of a capital-gains tax cut and 14.7 percent of the static revenue loss of a labor tax cut could be offset in present-value terms by additional growth, ignoring short-term Keynesian effects (i.e., any immediate stimulus provided to the economy).
Now 32.4 percent is a lot, but it is far less than 100 percent. And a critical assumption for Professors Mankiw and Weinzierl is that government spending falls to keep the budget in balance. In their framework that’s a good thing — as they are effectively assuming away the consequences of any productive effects of government spending (e.g., what if less spending on schools means less education and this hurts “human capital” and therefore productivity down the road?).
Sticking for a moment with just with their view of the world, if instead the tax cuts are financed by additional debt, as was our collective experience during the 2000s, the ultimate effect of those cuts can be to lower economic growth in the long term, depending on whether the larger debt eventually leads to lower government transfers, lower government consumption, higher taxes on capital or higher taxes on labor. (Eric M. Leeper and Shu-Chun Susan Yang discuss this in “Dynamic Scoring: Alternative Financing Schemes,” also in The Journal of Public Economics, in 2008.)
More broadly, in 2005, the Congressional Budget Office, then headed by a Republican appointee, Douglas Holtz-Eakin, estimated that the economic effects of a 10 percent cut in income taxes would offset from 1 to 22 percent of the revenue loss in the first five years; in the following five years, the economic effects might offset up to 32 percent of the revenue loss, but might also add 5 percent to the revenue loss.
This is an entirely reasonable assessment — the budget office exists to provide balanced analysis for the budget process. The bottom line is that betting that tax cuts will pay for themselves is a high-risk strategy and not a good idea at our current levels of government debt relative to gross domestic product. We do not have a large margin for error. (Disclosure: I’m on the Panel of Economic Advisers for the the budget office, but I didn’t have anything to do with that study.)
Of course, economic studies do not necessarily have a direct effect on political discourse. For example, President George W. Bush asserted in 2007, “It is also a fact that our tax cuts have fueled robust economic growth and record revenues.” But this is nothing more than an assertion. Growth during the 2001-7 expansion was only 2.7 percent compared, for example, with 3.7 percent during the 1990s expansion (when tax rates were higher).
And much of the growth during the Bush period turned out to be illusory; it was based on our corporate and national accounting system, which measures profits (an important part of G.D.P.) but not on a risk-adjusted basis. When the risks materialized in the financial crisis of 2008-9, we lost so much output that G.D.P. per capita in real terms today is only at about the level of 2005.
To assess growth properly, you should look “over the cycle,” meaning roughly 10 years for the modern American economy. It is hard to argue that the last decade was any kind of growth success. Of course, other things happened during the 2000s, including further financial sector deregulation not directly related to the tax cuts.
That’s why we have the economic analysis, particularly by the budget office, to disentangle what tax cuts can really do. If the supercommittee buys into dynamic scoring for tax cuts, at best this would be wishful thinking. At worst, it would represent yet another round of fiscal irresponsibility at the top of American politics.
And if people are seriously considering altering the rules under which the the budget office operates, they should stop and think again. Changing the score-keeping guidelines at this stage would amount to undermining the credibility of the office, one of the few remaining impartial and well-informed observers of the nation’s economy.
Perhaps this strategy might yield some short-term political gains, but the damage to our creditworthiness would be immense, and the consequences would be felt sooner rather than later.
The nightmare downward spiral and fiscal implosion in the euro zone began with a few countries cheating on their numbers — first to get into the currency union and then to avoid various forms of official criticism. We do not want to start down the same path.

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Congressional Budget Office, Daily Economist, deficit reduction, politics, Simon Johnson, tax, Taxation

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Rent vs. Buy

For years my colleague David Leonhardt has been helping people calculate whether it makes more sense to rent or buy a home, based on the relative costs of each decision. This week, the economists at Capital Economics noticed an interesting phenomenon related to this tradeoff. For the first time in three decades, the median monthly mortgage payment is about the same as the median rental payment:

Source: Capital Economics, Thomson Reuters

Of course, this chart is a little bit misleading because it excludes many of the upfront expenses of buying a home, like a down payment and closing costs. Perhaps more important, not everyone has the option to buy.
Credit conditions are still significantly tighter than they were a few years ago, despite the Federal Reserve’s efforts to loosen credit markets. Many lenders now require a credit score of 700 as opposed to 650, the previous standard. Capital Economics estimates that that requirement alone has shut 13 million households out of the mortgage market.

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Capital Economics, credit, Mortgages, rent ratio, rent vs. buy

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• Seattle’s Foreseeable Housing Bust

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Debating a Labor Contract on Facebook By NICK BUNKLEY

By NICK BUNKLEY

A screen shot of a U.A.W. Facebook page.

DETROIT — As Ford’s 41,000 hourly workers weigh the merits of their proposed four-year contract in plants and union halls across the United States this week, their debates have spilled onto Facebook, providing a glimpse into which issues are influencing their votes most.

For the first time, the United Automobile Workers union has been using social media to communicate with its members during the contract talks in Detroit, and the most intense back-and-forth has occurred in the last few days, as ratification voting got under way at Ford.

Some bemoaned the lack of a wage increase while Ford’s two top executives got bonuses totaling about $100 million. Others criticized the continuation of a two-tier wage scale.

Even those who said they supported the deal acknowledged being unhappy with many portions of it. Some suggested the deal would be much better received if it covered just two years instead of four, so the terms could be revisited sooner.

One of the union staff members who administer the “U.A.W. Ford Department” page and worked closely with the bargaining team during talks, conceded that the agreement was less than ideal but argued that circumstances did not allow for anything better.

“In 2015 we will do better,” the post said. “This is not the last agreement we will ever settle and hopefully our economy, our image, and our ability to bargain with a bigger stick will be better in the future. But this is not the time to wage this war.”

As it became apparent that more workers were voting “no,” talk turned to the possibility of a strike as soon as next week.

A man who identified himself as working in the body shop of Ford’s Kentucky Truck Plant in Louisville, said the mood had become “somber and quiet” there.

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HR Strategies Inc

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ING DIRECT

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Norrep Inc.

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Picton Mahoney

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Primevest Capital Corp.

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Redwood Asset Management Inc

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Resolute Funds Ltd.

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Sentry Select Capital Corp Includes: Sentry Select Cap F Cl, Sentry Select Cap I Class, Sentry Select Capital , Sentry Select Capital Crp.

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Standard Life Includes: SL Ideal – Platinum 100, SL Ideal – Platinum 75, SL Ideal Income – PLTN, SL Ideal Income (GLWB), Standard Life A-Series, Standard Life Corp Cl A, Standard Life E-Series, Standard Life F-Series , Standard Life Ideal RST, Standard Life Ideal Seg, Standard Life Legend, Standard Life P – Series, Standard Life SI Ideal 75, Standard Life SI Ideal100, Standard Life T-Series.

Stanton Asset Management Inc. Includes: O’Leary Funds Mgmt , O’Leary Funds Mgmt F, O’Leary Funds Mgmt H, O’Leary Funds Mgmt I, O’Leary Funds Mgmt M, O’Leary Funds Mgmt T, O’Leary Funds Mgmt X.

Sterling Group of Funds

Stone & Co. Limited Includes: Stone & Co. Limited Cl F, Stone & Co. Limited Ser A, Stone & Co. Limited Ser B, Stone & Co. Limited Ser C, Stone & Co. Limited Ser L, Stone & Co. Ltd Ser T8A, Stone Funds Series T8B, Stone Funds Series T8C.

TD Asset Management Inc. Includes: TD Advant Invest Ptf – F, TD Advant Invest Ptf – H, TD Advant Invest Ptf – S, TD Advant Invest Ptf – T, TD Advant Invest Ptf -Adv, TD Advant Invest Ptf -Inv, TD Comfort Port – Inv Ser, TD e-Series Funds, TD Funds-Invest Series U$, TD GIF I, TD GIF II (TA), TD GIF II (TA) Class A, TD GIF II (TA) Class B, TD Index Funds – Inv Ser, TD Institutional Series, TD Managed Portfolios – H, TD Managed Portfolios – K, TD Managed Portfolios – T, TD MAP FundSmart Ptfl – H, TD MAP FundSmart Ptfl – K, TD MAP FundSmart Ptfl – T, TD MAP FundSmart Ptfl-Adv, TD MAP FundSmart Ptfl-Inv, TD MAP FundSmart Ptfl-Pre, TD MAP Idx ePortfolios, TD MAP Index Ptfls-InvSer, TD MAP Mgd Ptfls-Adv. Ser, TD MAP Mgd Ptfls-Inv. Ser, TD MAP Mgd Ptfls-Pre. Ser, TD Mutual Funds Adv U$, TD Mutual Funds Adv. Ser, TD Mutual Funds Inv. Ser, TD Mutual Funds Premium , TD Mutual Funds Series F, TD Mutual Funds Series H, TD Mutual Funds Series S, TD Mutual Funds Series T.

Terra Fund Management Ltd.

The Goodwood Fund

Tradex Management Inc.

Transamerica Life Canada Includes: Transamerica 5FL Seg, Transamerica GIF, Transamerica Growsafe, Transamerica GS3 100/100, Transamerica GS3 75/100, Transamerica GS3 75/75, Transamerica Life Canada, Transam-imaxxGIF 100/100, Transam-imaxxGIF 75/100, Transam-imaxxGIF 75/75.

Value Partners Investments

Van Arbor Asset Mgmt Ltd

Venator Capital Mgmt. Ltd.

Vertex One

VMD-McLean Budden LifePlan

W.A. Robinson & Associates

Webb Asset Management

West Face Capital Inc.