Tuesday, January 8, 2008

The Economy is Great But Let’s Cut Taxes Anyway?

Has Paul Krugman turned to forecasting NRO opeds by Lawrence Kudlow? Paul writes:

But the opponents of change, those who want to keep the Bush legacy intact, are not without resources. In fact, they’ve already made their standard pivot when things turn bad - the pivot from hype to fear. And in case you haven’t noticed, they’re very, very good at the fear thing ... When the economy is doing reasonably well, the debate is dominated by hype - by the claim that America’s prosperity is truly wondrous, and that conservative economic policies deserve all the credit. But when things turn down, there is a seamless transition from “It’s morning in America! Hurray for tax cuts!” to “The economy is slumping! Raising taxes would be a disaster!” Thus, until just the other day Bush administration officials were in denial about the economy’s problems. They were still insisting that the economy was strong, and touting the “Bush boom” - the improvement in the job situation that took place between the summer of 2003 and the end of 2006 - as proof of the efficacy of tax cuts. But now, without ever acknowledging that maybe things weren’t that great after all, President Bush is warning that given the economy’s problems, “the worst thing the Congress could do is raise taxes on the American people and on American businesses.”

If you think this was a bit unfair to the Bush cheerleaders, read Larry’s latest:

the Goldilocks economy remains alive and well. It’s still the greatest story never told ... And the reality is that today’s economic weakness is coming from the business side, not the sub-prime/housing/consumer side. We’re witnessing high energy and raw-material prices cause unit costs for businesses to rise faster than prices. That spells weakening profits … Right now the single best thing President Bush and Congress can do is slash the corporate tax rate for large and small businesses. Bush must reach out to Charlie Rangel and move the corporate tax to 25 percent from 35 percent. Then, instead of taxing successful capitalists as an offset, Congress can entirely abolish corporate-tax subsidy loopholes, special provisions, and other corruption-inducing K-Street earmarks. A middle-class tax cut to help families and small businesses would also work wonders.

Times are good? Give everyone a tax cut. Times are not so good? Give everyone a tax cut. In Larry’s world – there is no long-run government But the suggestion that today’s weakness is coming from the business investment side and not the housing investment side sort of ignores the fact that business investment has increased by more than 5 percent in real terms since last year, while residential investment has declined by more than 16 percent in real terms. Does anyone at NRO fact check Larry’s fluff before publication?


wellbasically said...

Kudlow is right in this sense: the weak economy is due to inflation. In the world of the floating dollar inflation is made worse by weak growth ("stag-flation, slug-flation" etc).

In the world of the floating dollar, cutting taxes will result in higher growth, and that is deflationary.

My friend R.P. has made some progress on this issue, but his austrian solutions are bad. The Republicans will have the right answer for the wrong reasons as long as they just cut taxes. Krugman is unfortunately clueless.

ProGrowthLiberal said...

well? You failed to explain how stimulating consumption via a tax cut would lower inflation. I seem to recall this silly argument being made in 1981 to which James Tobin had loads of fun mocking it.

wellbasically said...

Inflation and deflation represent mismatches between money supply and money demand.

ProGrowthLiberal said...

well? Nice, trite slogan but not exactly an answer to my question.

wellbasically said...

In our floating system, the money supply is determined by whatever the Fed decides to do. Changes in the money demand occur because of business conditions, and one condition is the tax environment.

If there is a fixed amount of dollars in the system, and you make a tax change that promotes investment and production, the existing dollars become more valuable.

The proof is in the pudding. The 1981 tax cuts did cause a deflation, gold went from $800/oz down to $300/oz. Clinton's 1997 tax cuts did the same thing.

Tax cuts now might stop the inflation for now, or they might cause deflation. It depends how big!

Now you could have advised that Clinton raise taxes in 1998 to slow down the economy, just as you could advise the Fed to cut rates now, but wouldn't it be better to have a money system that responds to the economy and keep the growth?

ProGrowthLiberal said...

wb is indeed a true believer. Inflation did fall but that's no surprise given Volcker's draconian tight money and the massive 1981-82 recession. Chairman Paul, however, did his draconian bit in 1981 as he feared Reagan's fiscal folly would lead to excessive aggregate demand. Oh yea - we did have $ appreciation and a massive current account deficit as a result. Worst macroeconomic mix I've ever seen in the US and WB praises it?

wellbasically said...

I don't think there were a lot of good solutions to the inflation of the 1970s which saw a tenfold rise in prices. And as you point out, Volcker and Reagan were not on the same page.

Over the long term it would have been better to fix the dollar again, wouldn't it? And let tax cuts or increases stand on their own, not as crude instruments of monetary policy.

Instead you have to defend the tax system during an oncoming recession.

Unfortunately the economists who advise Democrats still believe that the Fed is better off monkeying with the currency for mercantilist advantage of exports or imports.

rosserjb@jmu.edu said...


You are missing entirely what is going on here. The inflation is tied to stimulus, not the opposite, or at least part of it. It is the declining dollar, which is importing inflation, but also stimulating exports. I have seen charts on several blogs and in the press that pretty much show that the overall balance between recession and not right now for the US economy is whether the rising exports from the declining dollar will be sufficient to hold of the downward drag from declining housing construction. So far, it has been, just barely (although not anymore), but certainly at the cost of higher inflation.

juan said...

In our floating system, the money supply is determined by whatever the Fed decides to do. Changes in the money demand occur because of business conditions, and one condition is the tax environment.

- 'our system' is not national but global.
- Fed, and other central banks', control over 'the money supply' ended with financial deregulation, rise of nonbank lenders and globalization. The whole organizational structure of financial intermediation changed.
- In their infinite wisdom, neo-liberals promoted this, achieved their apparently desired free market end and now begin to recognize "nuclear credit fission" (Lindsey), uncontrollability and overaccumulated debt are not exactly what they had in mind, not quite what their ideology told them would happen.

So, in desperation, back to notions of 'fiscal fine tuning' and 'tax cuts will save the day'. Sheesh.

wellbasically said...

Well thanks for answering, let's get off the history. But Barkley, there is no purpose in exporting more if the dollars you're getting paid in are worth less. This is the condition of most poor countries that are under a devaluation regime.

Politics politics politics politics: I'll try to conclude by saying the time is right for a Democrat to propose fixing the dollar again. In 2000, it was to Gore's advantage to wave Greenspan around as an implicit endorsement of Clinton. But now the Dems don't have to endorse the Fed.

The candidate who connects $3 gas with inflation will be the real populist. How can somebody go to NH and tell them that $3 gas is good for them so they should stop driving trucks? That's not populist.

juan said...

WB, if you want populist, connect $3 gas to trade in energy derivatives, and from this to finance and the 'evil' speculators.