Is the Current Recovery Due to Tax Cuts and Less Government Spending?
President Bush says yes:
Bush said November’s strong job growth was due to what he said was a policy of cutting taxes and restraining spending and pledged to continue with that strategy.
Restraining spending? I thought the rightwing talking points were supposed to blame the deficit on an explosion in government spending as tax cuts allegedly lead to Laffer curve effects? As in the National Review’s Phil Kerpen & Peter Roff who claim:
The 2003 tax-rate cuts supercharged business investment, which climbed by 4.4 percent in 2003 and an outsized 13.2 percent in 2004. The 2003 tax bill was a huge supply-side success story. The bill’s provisions, especially the capital-gains rate cut, the dividend rate cut, and the small business expensing provisions, boosted the after-tax returns on capital and encouraged a sharp turnaround in business investment. With the budget deficit standing at a paltry 2.6 percent of GDP and the economy humming along, it should be unthinkable that policymakers would enact a series of massive tax hikes that could derail the good times.
Does this remind you of Greenspan’s remarks, which were also covered by Mark Thoma?:
His view is that tax increases alone cannot solve the budget problem because the size of the tax increases required would severely curtail economic growth. Thus, cuts in spending will be necessary.
If large tax increases severely curtail growth via Keynesian aggregate demand effects, then won’t reduction in government spending do the same? OK, this is an excuse to note another Mark Thoma post:
For example, consider an increase in government spending. This is, in part, self-financing, just like tax cuts are claimed to be. When government spending increases, output increases by some multiple of the increase in government spending through the expenditure multiplier, and this causes taxes to increase. Therefore, an increase in government spending raises taxes and helps to pay for itself.
OK – if the concern is short-term variations in output and transitory effects on the deficit, I could understand all of this Keynesian talk. But if the issue is long-term growth and long-run fiscal solvency, Greenspan’s and Bush’s remarks likely have Keynes rolling in the grave (I’m assuming Mark is just having fun with Bush and Greenspan).
But let me give Kerpen & Roff the benefit of the doubt and assume that they are talking about long-term growth. What is the evidence that Bush’s fiscal policies have spurred investment via some supply-side effect? First of all, the fact that the sum of consumption and government purchases as shares of output have risen means less national savings – not more. Secondly, let’s check out the following graph of investment relative to GDP (OK, this was all one gigantic excuse to draw a graph) from the first quarter of 2000 to the third quarter of 2005. Investment as a share of GDP is still lower than it was five years ago when tax rates were higher. So the Kerpen & Roff case for tax rate reductions leading to more investment does not quite cut it.
Tyler Cowen provides a more serious case for reducing tax rates on capital income by increasing other tax rates. More on Tyler’s argument later.
Follow-up: The Commerce Department’s NIPA table 1.1.3 is entitled “Real Gross Domestic Product, Quantity Indexes” and have as its index, 2000 = 100. The numbers provide an easy way to see the increase in real GDP and real government purchases since 2000. Real GDP has increased by 14.15%, which is not all that terrific for a 5-year period.
Bush’s claim that government spending has been restrained seems to be a bit of a lie. Total government purchases (Federal, state, and local) have risen by 16.15%, while Federal government purchases have increased by 29.68%.