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Are the Trump tax cuts justified?

5 Dec

There are two reasons to cut taxes. Keynesian tax cuts prime economic growth by increasing consumer spending power. This requires that government spending remain at current or increasing levels, thus expanding the budget deficit. Current estimates suggest that the proposed tax cuts will increase this deficit by more than a trillion dollars. GOP leaders are channeling Keynes to say that the economy will grow by enough to reduce the deficit in the unforeseeable future.

However, government borrows to finance deficits. If the promised economic growth happens, continued deficits require the government to compete with private investors for loans. This raises interest rates and therefore reduces investment and economic growth. Thus, cutting taxes when the economy is growing is a bad idea – unless the country as a whole can borrow cheaply from foreigners. But that caveat REQUIRES a capital account surplus and therefore a trade deficit. Thus, a Keynesian tax cut designed to “grow” the economy out of a deficit will have precisely the opposite effect if enacted when the economy is booming. It therefore seems to be a bad time for a Keynesian tax cut given that President Trump and the GOP are taking credit for a booming economy AND have signaled a desire to cut our current capital account surplus by reducing the trade deficit.

Alternatively, the GOP could plausibly justify tax cuts (and has in a more principled past) as a way to reduce government’s ability to transfer wealth from one group to another. This approach requires government spending to be cut as well since the purpose is to let the private sector be the engine of economic growth. This approach therefore reduces the size of the budget deficit. That ain’t happening!

The GOP’s tax cut justifications make no economic sense. The GOP has no economic credibility left.


The impact of Republican intransigence on passing the budget and raising the debt ceiling

4 Oct

It should come as no surprise that our country finds itself in yet another internecine squabble regarding questions about how much to, or maybe even if we should, fund governmental operations.  It is a source of national embarrassment that the United States hasn’t passed a full slate of Appropriation Bills since Fiscal Year (FY) 2008.  Looking back to FY 1977, there have been 17 funding gaps of at least one day or more (Congressional Research Service). The funding gap in Fiscal Year 1997 was, until now, the most highly publicized funding gap.  In FY 1997, the U.S. Government shut down from 15 December 1996 until 6 January 1997.  While our current shutdown commands the attention of the vast majority of the press, the effects of a shutdown are mostly temporary; they do not extend much past the lost productivity of government workers. There may be very real impacts in specific sectors of the economy. Closed national parks may affects tourism related businesses, closed Headstart facilities would affect the working poor, and closed licensing authorities may affect whether businesses get certain permits or not. However, this could be balanced against the economic activity created by people who substitute their vacation dollars away from national parks or by depending on friends and family for daycare. Moreover, the impact of the shutdown will begin to be felt – even in these sorts of affected sectors – only if the shutdown drags on. Thus, it is hard for us to get overly excited about another crisis of artificial proportions.

The bigger issue associated with yet another game of brinksmanship played by two kids who can’t play nicely on the playground, is the issue of a possible link between this fight and the yet-to-be-had fight over raising the debt ceiling.  Even without the current intervention by the Federal Reserve, the United States dollar enjoys reserve currency status, which allows the U.S. to borrow at very low interest rates.  Certainly artificially low interest rates hurts U.S. savers, but it is a boon for the U.S. in terms of lessening the burden of servicing the fast-growing U.S. debt.  Now, though, we are quickly approaching the date when all extraordinary financial measures will be exhausted and the U.S. will default on its legal obligations.  This date is widely believed to be 17 Oct (side note – just approaching the debt-ceiling deadline in 2011 caused the U.S. to suffer a downgrade to its heretofore sterling credit rating; an actual default will potentially have long-lasting implications, as it will most likely raise borrowing costs substantially and it will make asset valuation harder because treasury bonds will not be risk free anymore), but the first large, default-inducing payment comes on the 1st of November when benefit checks are due.  Currently there are no indications that countries are actually worried about a default; in fact, the yield on the 10-year U.S. Treasury bond closed unchanged on the first day of the shutdown, which suggests there isn’t any panic selling as of yet.  But let’s do some back-of-the-envelope calculations to get an idea of what may transpire.  As of 31 August 2013 (latest data available from, there is $16.7 trillion of total U.S. Treasury securities outstanding.  The average interest rate now is 2.4 percent; this equals about $400 billion a year in interest payments.  Assuming that a simultaneous credit rating downgrade and a limited default causes a one percentage point increase in the average interest rate from 2.4 percent to 3.4 percent (a rate last seen in August 2009), interest payments will increase by $170 billion a year.  To put this in perspective, last year’s Fiscal Cliff deal is projected to raise $617 billion in new revenue over 10 years; all of this new revenue will be subsumed by increased interest payments in less than four years.

A less obvious but more pernicious consequence is the uncertainty that results from nearly five continuous years of partisan gridlock.  Businesses and individuals cannot plan if they do not know whether a law will exist or not. This puts a damper on economic activity and job creation. Moreover, to the extent larger businesses have more resources to deal with uncertainty, partisan bickering serves as a tax on small job creating businesses.

— Commentary provided by me and Jeff Smith.

Taxes and…..

28 May

Alan Simpson told Fareed Zakaria that any one who thinks that the current deficit problem can be solved without raising taxes (in some form — either directly or indirectly through inflation and/or high interest rates) has rocks instead of brains. I like the salty rhetoric. But is it true? I suppose it depends on beliefs about the short and long run.

By and large most economists would believe that economies where the government has a light touch — creating and protecting basic institutions that promote economic freedom — are more likely to generate prosperity. Low taxes are part of this mix since taxes are how governments extract rents from creative individuals. Of course there is an optimum amount of taxation necessary to protect the aforesaid institutions. But this is a long term view. As of now we have increasingly an extractive political economy. Rising inequality in the US does not help. Some inequality is of course good since it provides an incentive to work (as a recent book by a Bain Capital colleague of Mitt Romney’s rightly claims). But as inequality increases it enables a class of wealthy individuals to capture the legislative process to their favor. This is a fundamentally anti capitalist process which starts a vicious cycle that reinforces both extractive political and extractive economic institutions (Acemoglu and Robinson make this case in their recent book “Why Nations Fail”). At any rate, the rising deficit also extracts wealth from the economy and the ROI on this deficit spending is at best unclear. But taxation is an extractive process as well. One obvious solution is to get rid of all transfers (social security, medicare, etc.) and gut military spending. But this appears to be politically unfeasible. Another solution is to raise tax REVENUES by simplifying the tax code and cut spending at the same time. This would reduce the power of extractive economic institutions. This is effectively the Bowles Simpson approach and the approach that President Obama claims as his own. Then there is the Mitt Romney approach — cut taxes on his first day in office and do very little for spending. Cutting taxes may appear to be a blow against extractive economic institutions. But runaway spending will continue. Remember that even Paul Ryan’s so called revolutionary plan merely limits the GROWTH of spending! Thus the deficit may be expected to rise. In other words the rise of extractive institutions will in fact be abetted by tax cuts! Current, stated, Republican policy may appear to disfavor extractive political institutions (the tax cuts) but in reality will increase their power (by doing very little for the deficit). Why?

One answer may be that the Republican party has been captured by wealthy interests who wish to capture the legislative process and jumpstart a system of extractive political and economic institutions. In other words, its not a question of rocks instead of brains. This is very intelligent rent seeking at work. I think I disagree with Mr. Simpson. Republicans are not stupid.

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