Nouriel Roubini v. the Free-Lunch Supply-Siders
Nouriel Roubini did yeoman’s work in his Déjà Vu Voodoo Economics (June 20), which was his summary of a debate with Art Laffer. Roubini noted that CNBC had him debate Laffer in light of this news, which included April tax revenues coming in $1 billion more than estimated. And yet, Victor Canto writes:
It also is somewhat disappointing that the administration is not touting all of today’s good economic news. For instance, tax-revenue collections are coming in at much-higher-than-forecast levels, meaning lower tax rates have sparked people to work harder and have encouraged corporations to unlock capital.
An extra $1 billion is not exactly “much higher” and I’m not sure what Canto means by “working harder” given the fact that the average workweek and the employment to population ratio are still below 2000 levels. My real beef, however, is with Michael Darda:
Pro-growth tax-rate reductions on labor and capital in the 1920s, 1960s, 1980s, and then again in 1997 and 2003 all exhibited revenue-reflow effects, although some were stronger than others … The 2001 tax cuts combined small, glacially phased-in reductions in income-tax rates with credits and rebates designed to “put money in peoples’ pockets.” This traditional Keynesian stimulus technique has an incredibly poor track record. Tax credits and rebates simply shift money from one place to another, which can’t “create demand” and doesn’t stimulate behavior at the margin.
I could remind Mr. Darda that the 1964 tax cut – like the tax cuts in the 1920’s – were part of aggregate demand stimulus packages. But let’s have Nouriel take the microphone:
So today Laffer argued that the latest fiscal figures of increased revenues had vindicated his Voodoo Magic while the reality is that, of course, return to trend GDP growth was bound to eventually lead to some temporary recovery of revenues relative to their totally dismal lows of recent years.
This sounds like Keynesian stimulus to me. Nouriel was describing the current (partial) recovery, but these comments equally apply to the 1964-65 recovery. And the free-lunch crowd tends to leave off the 1966 credit crunch even though the Keynesian CEA was warning President Johnson in December 1965 that fiscal stimulus was becoming excessive. As far as the 1981 tax cut, the free-lunch crowd tends to forget that it was followed by the 1982 recession as the Volcker anti-inflation jihad overwhelmed the fiscal stimulus. They also leave off the fact that the Reagan recovery occurred when monetary policy reversed course. But Nouriel’s discussion and links details these issues from 1981 to the present very well.
So let me turn to something I asked (via an email on 6/27) Mr. Darda to explain:
A dynamic analysis of the Bush tax cuts shows that long-run growth could be lifted by 0.85 percentage points as long as the lower-tax schedules on capital and labor remain in place.
Since he neither provided the source for this alleged claim nor responded to my email, I tried a small experiment with a simple Solow growth model. Let’s assume an economy initially in a steady state where the growth rate of effective labor is 3%, the capital-to-output ratio is 3, and the savings rate is 9% – which implies a growth rate of 3.0%. If we doubled the savings rate, we might get the result Darda suggests. While most economists concede that lower tax rates financed by spending cuts might increase the savings rate a little, I know of no model that suggests a doubling of the savings rate from a fiscally neutral small government lowering of tax rates. Additionally, the Bush43 type “give you your money back” tax cuts have not come with a smaller government, which means his fiscal policies have lowered the savings rate. While one might try to go beyond my simple growth model, Mr. Darda has provided us with no model – just a spurious assertion.