EMAIL DETAILS

>
> I know you are busy but this piece is important that slices through
> the Republican economic policy. - Michael
>
>
> The political genius of supply-side economics
> July 25, 2010 4:18pm | Share
> The future of fiscal policy was intensely debated in the FT last
> week. In this Exchange, I want to examine what is going on in the US
> and, in particular, what is going on inside the Republican party.
> This matters for the US and, because the US remains the world’s most
> important economy, it also matters greatly for the world.
>
> My reading of contemporary Republican thinking is that there is no
> chance of any attempt to arrest adverse long-term fiscal trends
> should they return to power. Moreover, since the Republicans have no
> interest in doing anything sensible, the Democrats will gain nothing
> from trying to do much either. That is the lesson Democrats have to
> draw from the Clinton era’s successful frugality, which merely gave
> George W. Bush the opportunity to make massive (irresponsible and
> unsustainable) tax cuts. In practice, then, nothing will be done.
>
> Indeed, nothing may be done even if a genuine fiscal crisis were to
> emerge. According to my friend, Bruce Bartlett, a highly informed,
> if jaundiced, observer, some “conservatives” (in truth, extreme
> radicals) think a federal default would be an effective way to bring
> public spending they detest under control. It should be noted, in
> passing, that a federal default would surely create the biggest
> financial crisis in world economic history.
>
> To understand modern Republican thinking on fiscal policy, we need
> to go back to perhaps the most politically brilliant (albeit
> economically unconvincing) idea in the history of fiscal policy:
> “supply-side economics”. Supply-side economics liberated
> conservatives from any need to insist on fiscal rectitude and
> balanced budgets. Supply-side economics said that one could cut
> taxes and balance budgets, because incentive effects would generate
> new activity and so higher revenue.
>
> The political genius of this idea is evident. Supply-side economics
> transformed Republicans from a minority party into a majority party.
> It allowed them to promise lower taxes, lower deficits and, in
> effect, unchanged spending. Why should people not like this
> combination? Who does not like a free lunch?
>
> How did supply-side economics bring these benefits? First, it
> allowed conservatives to ignore deficits. They could argue that,
> whatever the impact of the tax cuts in the short run, they would
> bring the budget back into balance, in the longer run. Second, the
> theory gave an economic justification – the argument from incentives
> - for lowering taxes on politically important supporters. Finally,
> if deficits did not, in fact, disappear, conservatives could fall
> back on the “starve the beast” theory: deficits would create a
> fiscal crisis that would force the government to cut spending and
> even destroy the hated welfare state.
>
> In this way, the Republicans were transformed from a balanced-budget
> party to a tax-cutting party. This innovative stance proved highly
> politically effective, consistently putting the Democrats at a
> political disadvantage. It also made the Republicans de facto
> Keynesians in a de facto Keynesian nation. Whatever the rhetoric, I
> have long considered the US the advanced world’s most Keynesian
> nation – the one in which government (including the Federal Reserve)
> is most expected to generate healthy demand at all times, largely
> because jobs are, in the US, the only safety net for those of
> working age.
>
> True, the theory that cuts would pay for themselves has proved
> altogether wrong. That this might well be the case was evident:
> cutting tax rates from, say, 30 per cent to zero would unambiguously
> reduce revenue to zero. This is not to argue there were no incentive
> effects. But they were not large enough to offset the fiscal impact
> of the cuts (see, on this, Wikipedia and a nice chart from Paul
> Krugman).
>
> Indeed, Greg Mankiw, no less, chairman of the Council of Economic
> Advisers under George W. Bush, has responded to the view that broad-
> based tax cuts would pay for themselves, as follows: “I did not find
> such a claim credible, based on the available evidence. I never
> have, and I still don’t.” Indeed, he has referred to those who
> believe this as “charlatans and cranks”. Those are his words, not
> mine, though I agree. They apply, in force, to contemporary
> Republicans, alas,
>
> Since the fiscal theory of supply-side economics did not work, the
> tax-cutting eras of Ronald Reagan and George H. Bush and again of
> George W. Bush saw very substantial rises in ratios of federal debt
> to gross domestic product. Under Reagan and the first Bush, the
> ratio of public debt to GDP went from 33 per cent to 64 per cent. It
> fell to 57 per cent under Bill Clinton. It then rose to 69 per cent
> under the second George Bush. Equally, tax cuts in the era of George
> W. Bush, wars and the economic crisis account for almost all the
> dire fiscal outlook for the next ten years (see the Center on Budget
> and Policy Priorities).
>
> Today’s extremely high deficits are also an inheritance from Bush-
> era tax-and-spending policies and the financial crisis, also, of
> course, inherited by the present administration. Thus, according to
> the International Monetary Fund, the impact of discretionary
> stimulus on the US fiscal deficit amounts to a cumulative total of
> 4.7 per cent of GDP in 2009 and 2010, while the cumulative deficit
> over these years is forecast at 23.5 per cent of GDP. In any case,
> the stimulus was certainly too small, not too large.
>
> The evidence shows, then, that contemporary conservatives (unlike
> those of old) simply do not think deficits matter, as former vice-
> president Richard Cheney isreported to have told former treasury
> secretary Paul O’Neill. But this is not because the supply-side
> theory of self-financing tax cuts, on which Reagan era tax cuts were
> justified, has worked, but despite the fact it has not. The faith
> has outlived its economic (though not its political) rationale.
>
> So, when Republicans assail the deficits under President Obama, are
> they to be taken seriously? Yes and no. Yes, they are politically
> interested in blaming Mr Obama for deficits, since all is viewed
> fair in love and partisan politics. And yes, they are, indeed,
> rhetorically opposed to deficits created by extra spending (although
> that did not prevent them from enacting the unfunded prescription
> drug benefit, under President Bush). But no, it is not deficits
> themselves that worry Republicans, but rather how they are caused:
> deficits caused by tax cuts are fine; but spending increases brought
> in by Democrats are diabolical, unless on the military.
>
> Indeed, this is precisely what John Kyl (Arizona), a senior
> Republican senator, has just said:
>
> “[Y]ou should never raise taxes in order to cut taxes. Surely
> Congress has the authority, and it would be right to — if we decide
> we want to cut taxes to spur the economy, not to have to raise taxes
> in order to offset those costs. You do need to offset the cost of
> increased spending, and that’s what Republicans object to. But you
> should never have to offset the cost of a deliberate decision to
> reduce tax rates on Americans”
>
> What conclusions should outsiders draw about the likely future of US
> fiscal policy?
>
> First, if Republicans win the mid-terms in November, as seems
> likely, they are surely going to come up with huge tax cut proposals
> (probably well beyond extending the already unaffordable Bush-era
> tax cuts).
>
> Second, the White House will probably veto these cuts, making itself
> even more politically unpopular.
>
> Third, some additional fiscal stimulus is, in fact, what the US
> needs, in the short term, even though across-the-board tax cuts are
> an extremely inefficient way of providing it.
>
> Fourth, the Republican proposals would not, alas, be short term, but
> dangerously long term, in their impact.
>
> Finally, with one party indifferent to deficits, provided they are
> brought about by tax cuts, and the other party relatively fiscally
> responsible (well, everything is relative, after all), but opposed
> to spending cuts on core programmes, US fiscal policy is paralysed.
> I may think the policies of the UK government dangerously austere,
> but at least it can act.
>
> This is extraordinarily dangerous. The danger does not arise from
> the fiscal deficits of today, but the attitudes to fiscal policy,
> over the long run, of one of the two main parties. Those radical
> conservatives (a small minority, I hope) who want to destroy the
> credit of the US federal government may succeed. If so, that would
> be the end of the US era of global dominance. The destruction of
> fiscal credibility could be the outcome of the policies of the party
> that considers itself the most patriotic.
>
> In sum, a great deal of trouble lies ahead, for the US and the world.
>
> Where am I wrong, if at all?
>
> Martin Wolf’s first response:
>
> Bruce Bartlett writes “I think my friend Martin is a bit too hard on
> Reagan, who did try to cut spending and signed 11 major tax
> increases into law to bring down the deficit. And Bush 41 initiated
> a budget deal in 1990 that eventually led to budget surpluses. It
> was Bush 43 and his willing accomplices among the Republicans who
> controlled Congress that deserve the vast bulk of the blame.”
>
> Martin Wolf on Americans being entitled to make their own choices:
>
> A number of commentators assume that I am a European socialist (not
> true) and am attacking the Republicans for this reason (also not
> true). I believe Americans are entitled to make their own choices.
> But then make it an honest choice.
>
> Martin Wolf asks whether the US government can default:
>
> The answer, in part, depends on what one means by default.
>
> July 25, 2010 4:18pm in Financial crisis, Supply-side economics | 84
> comments
>