Four Years After the 2001 Tax Cut
During the spring of 2001, Marc Labonte and Gail Makinen of the Congressional Research Service wrote:
In general, many economists would support the concept that lower taxes made possible through lower government spending would increase the long run sustainable rate of economic growth. There is an important distinction between this concept and a tax reduction that is almost entirely offset by lower budget surpluses rather than by lower government spending, as all recent proposals plan to do. This distinction has important consequences for national saving and private investment.
Their discussion described how the reduction in national savings could crowd out both private investment and net exports. A similar discussion was later offered by William Gale and Samara Potter. Some recent cheerleading from Lawrence Kudlow encouraged me to go back and look at shares of GDP captured by consumption, Investment (I), government purchases (G), exports (X), and imports (M).
The tax cuts did increase consumption so that its share of GDP rose from 68.65% in 2000 to 70.13% in 2004. In addition, government purchases rose from 17.6% of GDP to 18.6%. Despite all the NRO cheerleading about how investment demand has roared under the Bush fiscal regime, about half of the crowding-out came from a reduction in investment relative to GDP.
So when Kudlow says the “core economy” – defined as the sum of consumption and investment – has soared, what he really means is that not all of the crowding-out comes from a decline in the investment share. Kudlow also writes:
Headline writers and media pundits notwithstanding, the culprit for the lower-than-consensus GDP was once again higher imports (net of exports), which are really a sign of economic strength.
Imports as a share of GDP were only slightly higher in 2004 than they were in 2000. The rise in the trade balance deficit is mainly from a fall in exports as a share of GDP, which were 11.2% in 2000 but only 10% in 2004. I’m wondering if Kudlow might offer an explanation to the companies that export American products why they are not part of the “core economy”. But it looks like the predictions of the Congressional Research Service economists, William Gale, and Samara Potter were right on the money.