May 07, 2003

Why Oh Why Can't We Have a Competent Executive Branch? Part MCIX

Bruce Bartlett (one of the few sane people in Washington, DC, as evidenced by his decision to live in beautiful Great Falls, Virginia) has switched from believing that Job #1 is to reform and reduce the taxation of income from capital in order to boost long-run economic growth to believing that Job #1 is to boost demand and stimulate the economy over the next two years. Unfortunately, he says, as the economic news making the case for immediate stimulus stronger has dribbled in over the past half year, "the White House [which] recognizes that the political and economic landscape has changed... has simply revised its rhetoric. Now, instead of making the correct argument for its dividend plan -- that it will raise productivity, growth and incomes over time -- the White House talks only about jobs, jobs, jobs. The problem is that the dividend plan probably won't create many new jobs and very few of those will come in the short run."

The Thomas option -- The Washington Times: May 7, 2003

The Thomas option

Bruce Bartlett

     By tomorrow , both the House Ways and Means Committee and the Senate Finance Committee will have completed mark-up of a major tax bill. They will probably bear little resemblance to each other, because the Senate is operating under a $350 billion revenue loss cap while the House has $550 billion to play with.
     Within even the lower number, there is a lot of good that could be done. But it is essential for the White House to push as hard as possible for meaningful growth provisions. Unfortunately, it is not doing so because it is still wedded to its own $726 billion plan that has no chance of passage as is.
     I strongly supported President Bush's proposal to eliminate the double taxation of corporate profits by allowing shareholders to receive dividends tax-free. But since that proposal was made in January, the economy has been much more sluggish than the administration or I expected it to be. This means that there is much greater need for tax cuts that will provide more immediate stimulus than the president's plan does.
     The White House recognizes that the political and economic landscape has changed. But rather than alter its proposal, it has simply revised its rhetoric. Now, instead of making the correct argument for its dividend plan ? that it will raise productivity, growth and incomes over time ? the White House talks only about jobs, jobs, jobs. The problem is that the dividend plan probably won't create many new jobs and very few of those will come in the short run.
     True, the Council of Economic Advisers has forecast that by 2004 there will be 900,000 more jobs than would be the case without additional stimulus. But there are any number of stimulus proposals that would be predicted to do as well or better, given the CEA's methodology for calculating the figures. Basically, it used a standard Keynesian model in which tax cuts stimulate growth mainly by increasing demand via the deficit. There are no supply-side effects in the CEA analysis.
     The problem is that fiscal stimulus can probably be delivered more efficiently in other ways. This means that the same model the CEA used could potentially show more jobs being created in the short-run with the same impact on the deficit. Moreover, the nature of Keynesian demand models is such that the impact of fiscal stimulus wears off once the economy gets back to its potential. In other words, there is no permanent increase in jobs or growth.
     By contrast, in a supply-side model, tax cuts can permanently increase jobs by reducing the after-tax cost of employment. By reducing the wedge between what it costs employers to create jobs and the after-tax wages received by workers, it is possible both to lower the cost of employment and increase the reward to work simultaneously. But this only results if tax rates are cut. Tax rebates and other tax cuts that do not alter effective marginal tax rates will have no impact whatsoever.
     Oddly, the Bush administration has never made this argument, even though its proposal would reduce income tax rates for all taxpayers. Nor has the administration ever released a revenue estimate of its proposal that would take account of the faster growth that would result from its enactment. Reportedly, such an analysis was done several weeks ago by the Treasury Department, but was never released by the White House.
     Those who have seen the Treasury analysis tell me that it strongly supports the president's plan and shows why it would lose much less revenue than the official estimate of $726 billion. Why the administration would bury such an analysis when its plan is under severe attack is a mystery.
     Another mystery is why the administration continues to press for full elimination of taxes on dividends when it has been clear for weeks that this is untenable, given the limited amount of revenue available under the congressional budget resolution. By continuing to press for its plan ? no matter how stupidly it is implemented, perhaps with long phase-ins and a sunset provision ? it reduces the chances of enacting good supply-side tax measures such as those proposed by Ways and Means Committee Chairman Bill Thomas, California Republican.
     Mr. Thomas would cut the tax rate on both capital gains and dividends to 15 percent and increase first-year depreciation allowances on new equipment by 50 percent, along with other measures that President Bush has proposed such as speeding up rate reductions, increasing the child credit and reduction of the marriage penalty. I believe that such a plan is as solidly growth-oriented as the president's plan, but with the added virtue of being more stimulative in the short-run.
     The White House should get behind the Thomas plan and start figuring out how to get as much of it as possible through the Senate.

Posted by DeLong at May 7, 2003 09:52 AM | TrackBack


Wouldn't someone trying to get re-elected want a stronger economy and more jobs? Is there any resepected economist who thinks the Bush plan is optimal, or even sensible?

Posted by: richard on May 7, 2003 10:44 AM

Well, yes. One of the most extraordinary things about the GWB administration is the inability of the economists to establish the point that *they knew stuff* and that if their policy advice was followed in 2001 and 2002 (no steel tariff, anyone?) you would have a better chance of having better economic news in the summer of 2004.

Posted by: Brad DeLong on May 7, 2003 11:14 AM

While I applaud Mr. Bartlett for clearly explaining the difference between Keynesian stimulus to correct a shortage of aggregate demand versus supply-side incentives to increase aggregate supply (something that is rare for him), the question remains whether this Thomas proposal will do much to encourage aggregate demand. Will this change in the tax code really spur that much more new investment?

Posted by: Hal McClure on May 7, 2003 11:39 AM

Giving tax breaks to businesses only stimulates demand if the businesses can productively invest the money. I thought the problem with the present economy was that demand is low and overcapicty is in place so that deflation may appear.

Why would business invest in more capacity if there is already overcapacity? I know that sometimes temporary overcapacity can result when new technology comes into play. Our large dinosaur steel mills cannot compete with the more efficient mini-mills for most types of steel. There is overcapacity of steel because the dinosaurs have not yet all folded. However, no amount of tax break is going to cause the steel industry to increase investment under current overcapacity conditions.

The steel tariffs don't help because higher steel prices cause manufacturers to switch to less expensive alternatives such as concrete and plastics or import finished steel products manufactured abroad from cheaper steel. Plus there was a big to do about steel tariffs that were eroded by a continuous stream of exemptions.

How much stimulus is needed if states like California alone will have to enact tens of billions in tax increases or spending decreases? How does it help reduce the overcapacity in the steel industry to have the states cancelling bridge and building projects left and right to make their budgets balance?

I suspect the economists are having trouble getting traction in this administration because their advice runs counter to the deep ideological beliefs at the top.

Posted by: bakho on May 7, 2003 12:48 PM

>>The steel tariffs don't help because higher steel prices cause manufacturers to switch to less expensive alternatives such as concrete and plastics or import finished steel products manufactured abroad from cheaper steel<<

Don't forget that we consume lots of steel. The tariffs raise costs for the economy (or cut down on free money foreign steel producers want to send us). Not to mention all those good comparative advantage arguments.

Farm subsidies, anyone?

Posted by: richard on May 7, 2003 12:57 PM

Do tariffs and export (farm) subsidies increase aggregate demand? Standard open economy Keynesian multiplier models might tell you that they do and they increase net exports assuming the exchange rate is fixed. But then consider the fact that the U.S. has a freely floating exchange rate. The old Mundell model would tell you these attempts to increase net exports only make the dollar stronger. So steel imports fall and farm exports rise. But other exports fell and imports rise as a result of the stronger dollar. Net aggregate result? None. But it sure does help the politician whoa certain voters.

Posted by: Hal McClure on May 7, 2003 03:35 PM

"Wouldn't someone trying to get re-elected want a stronger economy and more jobs? "

Well, if that's the best way of getting re-elected, yes -- but if it's not, no.

Take the two top politicians in my own state, NYS, George and Hillary (sorry Chuck).

Gov. George arrived and governed for some years as a real budget-hawking Republican fiscal conservative. He always warned about how politically-motivated spending could land the state in a steep crisis again like it did in the '70s. But when *his* re-election year came up, he suddenly become the biggest spendthrift in state history (making Cuomo look like a piker). Now he is the budget hawk again -- but is trapped in *exactly* the crisis situation he always warned about.

Wasn't he serious about fiscal responsibility? Sure he was. But to be responsible and keep some irresponsible Democrats out of his job he had to get re-elected, so that came first, ahead of fiscal responsibility.

Meanwhile Hillary arrived and ran for Senate selling herself to voters as caring compassionately for the welfare of average people, the poor, and *especially* poor children. And the first thing she did to mark herself as a new NYer was prominently sign up in support of the milk cartel that artificially jacks up milk prices to benefit upstate farmers. She did that because she had to show herself to be a NY-*stater* who would look out for upstate interests, rather than just another visitor to NYC.

Who pays the cost of the milk cartel? Average people pay a welfare cost greater than the rich, of course, while the poor with children pay most of all.

Wasn't she serious about the welfare of poor children? Of course she was. But to be able to do anything about it, and keep some heartless Republican out of that senate seat, she had to get elected first -- and that came ahead of the children.

That's just how politics works. It's a fully bipartisan thing. Getting elected is always the first-priority consideration no matter the hypocrisy involved. But how could it be any other way? If you don't get elected your other priorities don't count. (And from a Darwinian point of view, those who don't put priority on being elected won't be.)

"One of the most extraordinary things about the GWB administration is the inability of the economists to establish the point that *they knew stuff*..."

Oh, I think the Bush politicos know full well what the Bush economists know, it's just a second-order consideration to them. They calculate the political payoff from steel protection in the steel states to be much larger than the political payoff they'd get from a *very slightly* better economy resulting from the lack of steel protection.

Just like Hillary knows full well who pays the welfare costs of the milk cartel, but figures the political cost of that little bit of hypocrisy to her is much less than the political benefit she gets from it.

I think it was Virginia Postrel who noted that the steel industry which extracted such huge payoffs to prevent its collapse from the Bushies (as it has from prior Administrations for decades) is located in politically marginal, swing states, while Enron, which was supposed to own the Bushies but got no comparable help from them as it collapsed, is located in a non-marginal state solidly locked up by Republicans. She observed that no economist should be surprised by all that.

The first-order consideration of all politics is to get elected, for all parties, left and right. It can hardly be any other way so I'm always surprised by people who are shocked by all the political dissembling and underhandedness that follows -- by finding politics in politics! Of course, many people are only shocked to find this in the *other* side's party -- that's the easy way out. Others see it in both parties and become cynical about all politics. But that's wrong too.

The differences in second-order considerations between politicians and parties count. George and Hillary have the very same first-order priority -- but their second order priorities are miles apart, and they matter.

In 1940 FDR made the famous campaign pledge "over and over" that he wasn't going to send any American boys into any foreign wars, even as he was working to get into WWII as fast as possible. That made him a damned willful liar politician dishonestly looking after his first priority while dissembling to an electorate that was still soundly anti-war isolationist. But it didn't mean the nation would have been better off electing the other guy.

Skill at being a lying hypocrite and being able to get away with it isn't a fault in a politician, it's a feature, a job essential. What matters are the purposes to which the skill is applied, the second-order considerations.

Posted by: Jim Glass on May 7, 2003 04:47 PM

Ahhhhh, I believe the cool breeze blowing through my brain after reading Jim's post is called sanity.

Posted by: David Mercer on May 8, 2003 02:17 AM

Jim, I agree with you on the steel tariff rhetoric from the Bush administration, but I do not agree on the reasons for fiscal policy. People do vote based on jobs and unemployment, especially the swing voters. The first president Bush was angry at Alan Greenspan because he kept interest rates high and that translated to high unemployment during the 1992 election period. Politicians know that full employment is very desireable to maintaining their job. These other issues can swing some close states, but low unemployment translates into bigger margins of victory all around.

There are numerous conservative institutes that preach that government can do very little positive to help the economy other than to cut taxes and get out of the way. The evidence for this view is not strong, but at Cato and other think tanks, it is accepted as fact. The politicos in the Bush administration BELIEVE in the ideology. So no matter what the economists tell them about fiscal policy, the politicos are going to stick with their core beliefs that tax cuts are good and revenue sharing or other government investments in the workforce are bad.

To use the creationist analogy from another thread, an evolutionist could propose a research project to develop a better dating system for determining the age of fossils. However, she would not get the grant if the person making the decision was a creationist that believed that the world was no older than 6000 years. To the creationist, it is preposterous to try to date objects to millions of years ago if he KNOWS that the earth is 6000 years old. Thus, the politicos in the Bush administration cannot accept the advice of the econonists without abandoning deeply held BELIEFS about the relationship between the government and the economy. Of course this is not rational and is frustrating for those that prefer to operate on the basis of reasoned arguments, but not everyone does. Many operate from a system of first principles and core beliefs that are not open to argument. Thus, this administration will continue to push tax cuts because they BELIEVE that tax cuts are the best policy, whether or not there is good evidence.

Posted by: bakho on May 8, 2003 06:53 AM

Jim's post is excellent, insofar as he has a good descriptive theory as to how politics does often work. What's not so clear to me is how to compare the damage caused by the politics he outlines, which surely afflicts all politicians (as he noted), to the differences that he calls second order.

I myself don't think that cutting taxes on the rich, as the Republicans are wont to do, is a second order effect; I think it's a first order effect (in what I believe to be its negative impact on the economy). Of course, I would agree that you could put *that* under the aegis of public choice theory: wealthy people, who comprise a very small part of the population, give Bush a lot of money (but a relatively small %age of their wealth) to cut their taxes. Since someone has to pay for the loss of revenue, it falls on everyone *else* ultimately, but most people don't notice (which AFAICT falls within the rubric of PCT).



Posted by: Stephen J Fromm on May 8, 2003 07:36 AM


I agree with two of your statements: (a) the FED's slowness to reduce interest rates did cost Bush41 re-election as it delayed the recovery; and (b) Bush43 is hoping to get us back to full employment. But listen to any of Bush43's recent speeches and this fellow is preaching from the "good book" known as the General Theory of Lord Keynes. So his case for fiscal stimulus is clearly to promote more consumption spending. Two points: (1) if one is going to preach the Keynesian multiplier, then cutting government spending reduces aggregate demand; and (2) Keynes himself would say the his multiplier only works for the short-run and not an excuse for permanent fiscal stiimulus. Which goes to say EITHER Bush43 is terribly confused OR he has another hidden agenda.

Posted by: Harold McClure on May 8, 2003 07:41 AM

Brad's response and much that follows serves to highlight the difference in political importance between good optimizing policies and narrow, interest group serving policies. Yes, a better set of policies, from an economic point of view, is easy to jot down. However, tax cuts for a core constituency, steel cuts and farm subsidies for swing states - these make good electoral sense, maybe even better electoral sense than optimal policies for stimulating growth and employment. Variable lags in response to policy changes make optimal policies risky, anyhow. Add in a healthy dose of CEO disregard for analysis that doesn't fit their agenda (a caricature, I know, but apt here) and there you have it. (Maybe the disregard is of the true-believer stripe. Maybe its a compound of both. Who knows?)

Posted by: K Harris on May 8, 2003 08:20 AM

K Harris- yes, any of those special interest issues can move a swing state in a very close election, but a good economy makes an election not close in the first place. A very very bad economy will negate any of the pandering to special interests. People really do vote the pocketbook.

For those who don't want to spend the time to learn the underlying principles, memorizing a few easy facts can get you by on an exam. However, when the exam is running the US economy, maybe memorizing a few key phrases is not enough. Such people are very susceptible to spurrious arguments by the fringe. People can be very smart in one area but totally deficient in others. Bush is very good at JR Ewing style hardball politics. However, he is arrogant and vindictive. This makes him unable to accept constructive criticism. He hears what he wants to hear. He repeats to us what he hears. What he hears is not the complete picture. This is why Ivins says "With Bush, what you see is not what you get. What you hear is not what you get. What you get is all you get."

Get it?

Posted by: bakho on May 8, 2003 10:05 PM
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