Shanea Watkins (Heritage Foundation) on the Economic Impact of Fiscal Responsibility

Shanea Watkins:

is the Policy Analyst in Empirical Social Studies at The Heritage Foundation’s Center for Data Analysis. At the center, Watkins performs social science research in the areas of education, poverty, immigration and family structure. Her recent Heritage research includes the fiscal costs of low-skill households to the U.S. taxpayer and the impact of federal budget resolutions on individual congressional districts. Before joining Heritage in 2006, Watkins was a research assistant at George Mason University’s School of Public Policy. While there, she worked on a research project that was published in November 2006 as part of a briefing report by the U.S. Commission on Civil Rights. The report analyzed data from the National Assessment of Educational Progress (NAEP) to determine if there is a relationship between the racial composition of schools and minority achievement. Watkins received a doctorate in public policy from George Mason University in 2007. She also has a master’s degree in psychology from East Tennessee State University and a bachelor’s degree in psychology and criminal justice at the University of Virginia’s College at Wise.

Prior to this March 11, 2008 publication that was criticized by Cactus, the only thing I’m aware that she published on macroeconomics was this May 7, 2007 publication:

On March 29, the House passed its fiscal year 2008 budget resolution. The House’s budget, if imple¬mented, could increase taxes significantly over the next five years, in turn decreasing job growth, reduc¬ing personal income, and weakening the economy … The House leadership has proposed to increase spending over the next five years. Given the leader¬ship’s avowed commitment to paying for spending increases, tax revenues will have to rise … The House budget resolution has the potential to cost the average American taxpayer an additional $3,026 in taxes. In addition to the increased tax bur¬den, Americans could also see their personal income decrease by an average of $502 dollars due to a weaker economy. Moreover, the budget resolution could dam¬age employment growth, causing about one million fewer jobs to be created, and has the potential to damage economic output by over $100 billion nationally … The culprit for these negative impacts is higher taxes. Many economists believe that higher taxes, particularly on capital, cause the level of private investment to fall, thereby slowing productivity improvements and weakening the earning capac¬ity of households. Wages and business earnings, which are closely tied to productivity, would fall as well.

Much of what appears in the March 11, 2008 write-up seems to be verbatim from her May 7, 2007. OK, she’s consistent in this regard but I agree with Cactus:

At the very least, if I’m expected to accept the results of these models, I would expect to see the following:
1. A description of the results the model spit out in times past. For example, what happens when you pump in data available through the end of 1992, and the information about the 1993 tax hike? What about when you put in information available through the end of 2000, and information about the 2001 and 2002 and 2003 tax cuts? Does it tell you what happened with any degree of accuracy? If not, why not?
2. A description of the assumptions that went into the model.

Watkins seems to be emphasizing the fact that raising taxes lowers disposable income which in turns reduces consumption demand. Maybe her CDA Microsimulation Tax Model is very much like what many macroeconomic professors teach their freshman students, which is the very simple version of the Keynesian multiplier model, which might go like this:

Income (Y) = Consumption (C) plus Autonomous Spending (A)

T = b + t(Y), where t = the marginal tax rate and b represents other aspects of tax policy.

Now if c = 0.8 and t = 0.25, then the Keynesian multiplier = 2.5. And if b is increased by $200 billion, the direct impact on consumption is negative $160 billion with an overall income decrease equal to $400 billion.

Now you may be thinking that this is too simple and I agree. But before we trash such a simple exercise, let’s also remember that Watkins was not talking about a return to fiscal sanity – she was talking about increasing both government spending and taxes by the same amount. She just forget to tell us that higher government spending would tend to increase aggregate demand just as higher taxes lower aggregate demand. And in this simple Keynesian model, a balanced budget increase in spending and taxes increases income.

But didn’t you say that this model was too simple? Doesn’t it leave out other effects from fiscal policy such as the impact on interest rates and exchange rates? The case for a return to fiscal sanity – that is increasing taxes without increasing government spending – goes more like this. The reduction in consumption, that is the increase in national savings, would lead to more investment demand as interest rates fell and would lead to more net exports as the dollar devalued. But we would have no idea how the CDA Microsimulation Tax Model handles these other effects from fiscal policy unless Dr. Watkins and the Heritage Foundation lets other economists review their model. Which is I believe the point that Cactus was making. Until they do, we have no reason to take their forecasts seriously.