Wednesday, March 4, 2015

Mankiw on Paying for Tax Cuts

Maybe I was too critical of Greg Mankiw:
Dynamic scoring requires the solution of a general equilibrium model. To solve a dynamic GE model, you need to specify how the government is going to satisfy its present-value budget constraint. You might be tempted to ask the model what happens if the government cuts taxes and never does anything else. But you won't get very far.
I’ll only note that the Reagan Administration never exactly got around to addressing the run-up in Federal deficits from its tax cut. And we know the Administration of George W. Bush not only cut taxes twice but also increased Federal spending both through two expensive wars and that Prescription Drug Benefit. As one of his economic advisers, what was Greg Mankiw telling President Bush about satisfying the present-value budget constraint?


Unknown said...

In any case, what is the budget constraint? Uncle Sam has decided that he will match his income from taxes and borrowing to his spending from his left pocket, the Treasury. But Uncle Sam's right pocket, the Fed, has no similar constraint.

Uncle Sam, both pockets, has no such thing as a budget constraint. He does not have to get the money he spends from anyone else. He can always pay any obligation he wishes to pay.

This is entirely different from the situation for states and local governments, or for any actor in the private sector.

Adam Eran said...

I'll add to Unknown's accurate comment that the entire notion that government (with sovereign, fiat currency--in other words, dollar, pound, yen, but *not* euro) is not constrained by taxes or borrowing in any way. That's right, taxes don't fund government. Obviously.

Where would tax payers get the dollars to pay taxes with if government didn't spend them out into the economy first?

Taxes make the money valuable, they do not fund government programs.

"B...but, if you just *print* money, then you'll make [gasp!][hyper-]inflation!"

Let's admit the entirely theoretical premise that government, with its unlimited dollar resources, could bid up prices competing with the private sector for limited goods and services.

But who else is bidding for the unemployed, or for all that slack in the manufacturing sector? (Hint: No one.)

We could legally and literally mint a few trillion-dollar coins and pay the entire federal "debt" tomorrow without causing inflation, too. Those "debt" dollars have already done whatever bidding they are going to do.

So literally nothing prevents the federal government from offering jobs to everyone who wants a job.

The misery of austerity is a bizarre, neurotic legacy of the kind of thinking Mankiw represents.

Don Coffin said...

Of course, for Mankiw, politics matters...The present value budget constraint was not an issue when it was Reagan's budget, or Bush's. Only when it's a politician whose policies he does not like (I suspect he was not a supporter of Clinton's fiscal actions, either).