What Tax Cut?

Tyler Cowen cuts through a quarter of a century of free lunch Republican spin in just two sentences:

Taxes already were raised when the government spending occurred. In that sense the “tax cuts” never were permanent.

This is what I love about conservative economists – they get right to the point. Twenty-five years ago, I’m afraid we liberals spent too much time screaming about the Reagan tax cuts, while a few conservatives nailed the real problems with the philosophy of “give people their money back so they can spend more”. It’s called classical crowding-out in the sense that more private consumption with no offset in terms of reduced government purchases equates to less savings and investment – not more.

We also saw twenty-five years ago the publication of “Some Unpleasant Monetarist Arithmetic” by Thomas Sargent and Neil Wallace that declared the reduction in current taxes back then would lead to greater taxes in the future. Years later, this idea became known as “generational accounting”, which put forth the simple proposition that the present value of taxes over time must cover the present value of spending plus past accumulated government debt. Of course, Ricardian Equivalence types would say this arithmetic predates even Sargent & Wallace.

Federal debt as a share of GDP had dropped to 57.4% by the end of fiscal year 2001 but is projected to rise to 67.5% by the end of this year. Republicans want to tell us that they can make the tax cut permanent by spending cuts, but let’s just think about the projection of Federal spending today versus what a reasonable forecast would have been back in 2000.

Total Federal spending was only 19% of GDP in 2000 as compared to 20.4% in 2005. Much of this increase is related to Federal defense purchases, which rose from 3.8% of GDP in 2000 to 4.7% of GDP in 2005. A small portion of the increase comes from Federal nondefense purchases, which rose from 2.1% of GDP in 2000 to 2.3% of GDP in 2005. It is true that the Global War on Terror necessitated some of the increases – as did that decision on March 19, 2003 to invade Iraq, which was likely a major blunder from our point of view or a “gift from God” as Osama bin Laden would put it. In other words, the clowns running the show in the Administration have insured that this Global War on Terror will be prolonged and very costly. And read the analysis on “The Future of National Security” provided by Kevin Drum as one reviews Bush’s proposals to further increase defense spending to fight the Cold War (for some odd reason) rather than Al Qaeda.

Tyler says he is hoping for reductions in entitlements. Note, however, the explosive in deficit spending has not been due to an increase in transfer payments – YET. But the pork-filled prescription drug benefit program has just begun. Speaking of pork, the increases in pork during the Bush Administration swamp whatever reductions in transfer payments that Congress had imposed – often on the needy. But suppose we simply eliminate this prescription drug benefit program. Massive General Fund deficits will continue unabated if the tax cut is made permanent. But be of good cheer as Bush wishes to slash our Social Security retirement benefits. Now if he does so and gives us payroll taxes cuts of equivalent amounts, the deficit will continue unabated. So what is the conservative plan to reduce the deficit without repealing these pretend tax cuts? Is it slashing Social Security benefits while maintaining high payroll contributions, which will be transformed by fiat into employment taxation. Is this the plan – to reduce taxes on capital income by increasing taxes on labor income? If so – could we have one Republican with the integrity to simply admit it?