Reverse Rubinomics

Kash asks in Why Bush’s Tax Cuts Failed:

Shouldn’t the largest tax cuts in history have had more effect? How could such massive tax cuts have such little impact on the economy? The answer is that it matters a great deal exactly how you cut taxes.

This short-run Keynesian issue might seem to be a different criticism from the long-run growth issues raised by William G. Gale and Samara R. Potter in An Economic Evaluation of the Economic Growth and Tax Relief Reconciliation Act of 2001 (ultimately published in National Tax Journal, March 2002). The sum of consumption and government purchases relative to GDP has increased from 86.2% in 2000 to 89.2% in 2003, which means the sum of investment and net exports as a share of GDP fell from 13.8% to 10.8%.

Income Tax Cuts, the Business Cycle, and Economic Growth by Marc Labonte and Gail Makinen (Congressional Research Service, March 28, 2001) strived to examine both the long-run and short-run implications of the 2001 tax cut noting:

Unless households saved all of their increase in disposable income, the net effect of the tax cut is that a reduced budget surplus would reduce the national savings rate and encourage additional consumption spending. As a result, interest sensitive spending, which is largely spending by businesses on capital goods, would be reduced or crowded out….Dollar appreciation would, in turn, increase the price of American goods in foreign countries and decrease the price of foreign goods in the United States…The difference in the open economy is that the increase in aggregate demand is instead dissipated through the exchange rate and the current account of the balance of payments, reallocating output away from exports and import substitutes, rather than through investment spending…The tax cuts would embody a shift in the American fiscal regime from one that emphasizes private capital formation to one that emphasizes consumption…From that perspective, it may have an adverse effect in the short run on business expectations and private investment spending.

This last sentence was reminscient of a critique of the 1981 tax cut made by James Tobin who worried that the crowding-out effects from a tax cuts announced to be permanent but phased-in might overwhelm the pro-consumption effects in the short-run. Indeed, from 1980 to 1982, investment and exports both fell by more than 6% where as consumption and government purchases rose by less than 3%, which led to almost non-existent real GDP growth as well as a decline in the sum of the share of GDP going to gross national savings (sum of gross investment and net exports) from 13% to 11%. This reduction in national savings as a share of GDP was maintained throughout the Reagan term even as the economy returned later to full employment.

Re-reading Chapter 13 of An Uncertain World (They Call It Rubinomics), I noticed that Robert Rubin was very concerned that the long-term but phased-in aspects of the 2001 tax cut would also lead to more crowding-out of investment than it lead to an increase in consumption. If one compares the second quarter of 2003 to the second quarter of 2000, it’s startling to notice that real GDP grew by a mere 4.5% over this three-year period, which is less than the one-year growth over the past year (4.7%). Consumption may have risen by 9.1% with government purchases rising by 10.7%. However, investment fell by 11.8% with exports falling by 7.8% (notice that the decline in the current account relative to GDP is not attributable to a flood of imports). Even as investment and exports have recovered a bit in the past year, their shares of GDP are still below where they were four years ago.

Robert Rubin returned to policymaking discussions in late 2001 during a period where there was a bipartisan consensus among moderate Senators in both parties for an emphasis on short-term stimulus with clear and credible signals to Wall Street that fiscal policy would turn to restraint over the long-term. After all, it was this type of fiscal policy that Rubin and others convinced President Clinton to pursue in 1993. Alas, George Bush and Bill Thomas conspired against these sensible efforts.

If we wish to both return to full employment and provide for more savings and long-term growth, a return to Rubinomics is in order, which means the Clinton economic team should return to the White House. John Kerry has selected as his economic advisors key members of the old Clinton team. If we could only now get Kerry to occupy the White House and to listen to his economic advisors the way Clinton did…