Monday, February 23, 2015

Kudlow’s Deficit Dance

I was not invited to the private dinner with Scott Walker but Paul Krugman notes who was on the guest list:
Scott Walker, the governor of Wisconsin, is said to be a rising contender for the Republican presidential nomination. So, on Wednesday, he did what, these days, any ambitious Republican must, and pledged allegiance to charlatans and cranks … the three most prominent supply-siders: Art Laffer (he of the curve); Larry Kudlow of CNBC; and Stephen Moore, chief economist of the Heritage Foundation.
Paul notes some of the recent ramblings from this trio including their predictions that the use of expansionary monetary policy to combat the Great Recession would lead to runaway inflation and high interest rates. But let’s turn back the clock to the first term of the Bush43 Administration when Kudlow writing for the National Review was all in defending Bush’s fiscal stimulus and arguing at several points how the labor market was booming even when it was not. Kudlow was infamous for claiming the household survey was a better measure of employment when it showed that employment was rising while the payroll survey said the opposite. Of course there were months when the payroll survey showed better job growth than the household survey showed – to which Kudlow declared the payroll survey was more reliable. And during those months when the unemployment rate fell even though the employment-population ratio fell, Kudlow was all aglow that labor force participation rates were falling. After all, spinning for the Bush-Cheney 2004 campaign was more important than actual improvement in the labor market: My favorite Kudlow spin had to be what he wrote on November 22, 2002:
The federal budget deficit was $158 billion for fiscal year 2002. Democratic politicians blame this shortfall on the Bush tax cut of 2001. But how can they? The bulk of the reduction in personal tax rates designated in that cut do not occur until the 2004 to 2006 period. Thus far, only about 10% of the tax cut has even taken place. The real blame for the deficit can be placed on sub-par economic growth over the past two years .. As a result, actual economic performance has fallen below the long-term 3.5% historical trend line, which reflects the economy’s indisputable potential to grow. If that trend line were extended through 2002, as though no slowdown had occurred, then the potential third-quarter gross domestic product would have been $9.829 trillion. Instead, actual GDP fell $364 billion short of the mark. Cumulatively, over the past two years, the loss of potential GDP comes to $1.95 trillion — a considerable amount. If you apply the 18% economy-wide tax rate of recent years to the nearly $2 trillion loss of potential output, you get a $351 billion shortfall in tax revenues — which we’d be counting now if the economy had been running at full steam.
I used to watch The Capital Gang until I could not take Robert “That’s Class Warfare” Novak lecturing to everybody that only he knew anything about economics, which he tended to get by reading Kudlow. One Saturday night in November of 2002, he claimed that if the economy were only at full employment – we would have a $190 billion surplus. OK, I knew that despite all the Bush cheerleader from the National Review, we did have a considerable GDP gap. But this claim sounded extreme so I found Kudlow’s Deficit Dance which is where Novak got this bizarre claim. Where to begin with this? One could point out that Kudlow is using the unified budget deficit as the starting point which pulls the Social Security Trust Fund into the discussion as an offset to the larger General Fund deficit. Our first graph shows, however, that not only did total debt (TD) grow relative to GDP after both the 1981 tax cut and the 2001 tax cut but debt held by the public (DHP) also grew relative to GDP. One could also point out that potential GDP does not always grow at 3.5% per year especially when fiscal stimulus reduces national savings and investment (a topic for another post). But the real problem is that this implicit assertion that the GDP gap was $2 trillion per year is based on summing 8 observations when one should be taking the average. OK Kudlow said this $2 trillion was a gap over 2 years so we can blame Novak by not dividing these figures by two. But Kudlow was also using annual flow information as if it were quarterly flow information. So to correct even what he wrote – we needed to further divide his figures by four. Our second graph shows the GDP gap on an annual basis using the CBO estimate of potential GDP and they were nowhere near $1 trillion per year. Could Kudlow really be this incredibly stupid or did he know he was trying to deceive stupid readers? I guess he did because Robert Novak certainly fell for this incredibly misleading and incorrect assertion.

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