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The Efficacy of Tax Cuts Is Now Questioned

Tax policy and tax cuts in particular are elements central to the Republican Party's economic philosophy. Republicans have made tax cuts one of their primary tools for fighting the Great Recession and returning America to prosperity. When advocating cuts, many on the Right have waxed nostalgic for the Reagan era tax cuts and their supposed economic benefits. The "record" of those cuts is held up as a justification for extending the Bush tax cuts beyond their expiration date and likewise for cutting taxes generally. All of this as an ideological counterpoint to what the Obama Administration has done in addressing the current downturn. Thus when economists who describe themselves as free market advocates, Libertarians, Republicans and even conservatives call extending the Bush era tax cuts into question one can only take note and inquire further as to why those whom we would expect to endorse tax cuts count themselves among the opposition.
Tax policy and tax cuts in particular are elements central to the Republican Party's economic philosophy. Republicans have made tax cuts one of their primary tools for fighting the Great Recession and returning America to prosperity. When advocating cuts, many on the Right have waxed nostalgic for the Reagan era tax cuts and their supposed economic benefits. The "record" of those cuts is held up as a justification for extending the Bush tax cuts beyond their expiration date and likewise for cutting taxes generally. All of this as an ideological counterpoint to what the Obama Administration has done in addressing the current downturn. Thus when economists who describe themselves as free market advocates, Libertarians, Republicans and even conservatives call extending the Bush era tax cuts into question one can only take note and inquire further as to why those whom we would expect to endorse tax cuts count themselves among the opposition.

Opposition to extending the tax cuts of the Bush Administration falls generally into two different schools of thought. In one camp you have people like Alan Greenspan and David Stockman the former Director of OMB during the Reagan years, both of whom argue that tax cuts are being supplemented by foreign borrowing and are as such unwarranted. In another camp you have people like Bill Gross of PIMCO and former Bush Administration economist Glenn Hubbard who support more federal spending due to the severity of the current downturn. Appearing on Meet the Press on August 1st Greenspan voiced opposition to the idea of tax cuts combined with continued borrowing. He reinforced this point in a New York Times interview the next week that stated: "Mr. Greenspan is calling for the complete repeal of the 2001 and 2003 tax cuts, brushing aside the arguments of Republicans and even a few Democrats that doing so could threaten the already shaky economic recovery." Greenspan went on to point out that tax cuts are appropriate when the government is running a surplus and that his original support of tax cuts was combined with other economic requirements that were ignored by economic policy makers within the Bush Administration. A far more scathing condemnation of the Republican Party, it's economic performance and it's fixation with tax cuts was voiced by David Stockman in two separate pieces: "Bush Tax Cuts Will Make U.S. Bankrupt" and "Four Deformations of the Apocalypse". Quoting Stockman: "Yes, there was a good idea that in certain circumstances, lower tax rates will encourage economic activity and savings. But when you make it a religion, when you make it a catechism and you say you cut taxes no matter what the circumstance, what the season, what the condition, then I think the whole idea has been perverted...I find it unconscionable that the Republican leadership faced with a 1.5 trillion deficit could possibly believe that good public policy is to maintain tax cuts for the top 2 percent of the population who, after all, have benefited enormously from this phony boom we've had over the last 10 years as a result of the casino on Wall Street." Stockman goes on to analyze the four deformations of the American economy that he says resulted from Republican policies that abrogated the Bretton Woods Agreement, the exportation of jobs overseas, the hyper-growth of the financial sector and the explosion of public debt. Yet it is in addressing the growth of public debt that Stockman is especially harsh in analyzing the Republican policies both during the Reagan era and beyond. Again to the author: "This debt explosion has resulted not from big spending by the Democrats, but instead the Republican Party's embrace, about three decades ago, of the insidious doctrine that deficits don't matter if they result from tax cuts."

The alternate point of view is put forth by those who see the economy as being so structurally unsound that no amount of tax cuts will help and that only massive public works projects and spending on retraining will provide the necessary remedial aid the economy requires. Bill Gross the fixed income guru of PIMCO was interviewed for an article in the New York Times by Nelson Schwartz, "Jobless and Staying that Way" with the following takeaway: "Despite his long-held belief in free markets, smaller government and lower taxes, Mr. Gross said politicians must recognize that this time, "government is part of the solution." He added, "In the new-normal world, there are structural problems, which require structural solutions... Mr. Gross believes that it's time for the government to spend tens of billions on new infrastructure projects to put people to work and stimulate demand." Quoting Gross: "We think the coma will last for years unless government policy changes to restimulate the private sector and bring unemployment down," In the same camp is former Bush economic advisor Glenn Hubbard who stresses a new, expanded role for the government in addressing the problem of structural unemployment. He talks about a "new normal," where economic growth is too slow to bring down the unemployment rate which in turn requires the government to be more actively involved in mitigating problems that now emerge as the result of globalization. In Hubbard's words: "If there is a new normal, it's more about the labor market than G.D.P. "We have to help people face a new world."

In contrast, the Republican Party continues to talk about the current downturn as if it were a garden variety economic contraction that could be dealt with through tools and policies related thereto. It continues to advocate tax cuts as if they would somehow create consumer demand where it currently doesn't exist. Conservatives have repeatedly pointed to the Reagan era tax cuts as a prime example of the efficacy of such measures in stimulating demand and at the same time they have ignored the massive Reagan era stimulus provided by military spending. In a recent article titled "Unemployment: What Would Reagan Do? Henry Olsen of the American Enterprise Institute talked extensively of Reagan's tax cuts but mentioned not a word of his spending. To paraphrase the source "Reaganomics" below: "Reagan very significantly increased public expenditure, primarily the Department of Defense, which rose from $267.1 billion in 1980 to $393.1 billion in 1988." That meant that "defense spending went from being 22.7% to 27.3% of total public spending. In order to cover new federal budget deficits, the United States borrowed heavily both domestically and abroad, raising the national debt from $700 billion to $3 trillion, and the United States moved from being the world's largest international creditor to the world's largest debtor nation." Beyond spending for military goods, Reagan expanded the size of the federal government creating a new cabinet level department and presiding over a federal workforce that was larger when he left office than it was when he arrived. Economist Robert Reich points out the fallacy of the Reagan era tax cuts as follows:" Unfortunately for supply-siders, history has proven them wrong again and again. During almost three decades spanning 1951 to 1980, when America's top marginal tax rate was between 70 and 92 percent, the nation's average annual growth was 3.7 percent. But between 1983 and start of the Great Recession, when the top rate was far lower -- ranging between 35 and 39 percent -- the economy grew an average of just 3 percent per year. Supply-siders are fond of claiming that Ronald Reagan's 1981 cuts caused the 1980s economic boom. In fact, that boom followed Reagan's 1982 tax increase." An analysis from the Center on Budget and Policy Priorities argues that "history shows that the large reductions in income tax rates in 1981 were followed by abnormally slow growth in income tax receipts, while the increases in income-tax rates enacted in 1990 and 1993 were followed by sizeable growth in income-tax receipts." Specifically, the analysis calculated that the average annual growth rate of real income-tax receipts per working-age person was 0.2% from 1981 to 1990 and a much higher 3.1% from 1990 to 2001. Thus if you want to find the wellspring of economic growth in the Reagan era you won't find it in tax policy, ironically it can be found in simulative spending for military hardware and the growth in federal employment.

In their constant baying "Where are the jobs?" the Republican leadership on Capitol Hill has ignored the fact that the present downturn is far more severe than their rhetoric would allow. In analyzing the current downturn Sara Murray points out:" GDP was revised down in seven of the 12 quarters of 2007, 2008 and 2009, primarily because consumer spending grew more slowly and home building fell more sharply than previously estimated...The overall depth of the latest recession surpassed that of any other downturn since the late 1940s. GDP fell by 4.1% from the fourth quarter of 2007, when the recession officially began, to the second quarter of 2009, when many economists believe it ended. The previous estimate for the peak-to-trough decline was 3.7%...The new data show that the worst of the recession came in the last quarter of 2008." With economic utilization rates down by 30% across much of the economy and manufacturing output off 28% in the U.S. and 23% worldwide and with services down significantly as well, it was more than evident that tax cuts could not restart the world economy and that is why they were not a major element in the initial policy response in any major economy. The value of government action has been outlined by Jon Hilsenrath as follows: "Most mainstream economists agree on some points: The U.S. economy needed some kind of fiscal help in 2009 as the financial system teetered and the Federal Reserve pushed interest rates near zero. The deficit has to be reined in eventually, in part by restraining the growth of spending on health and other benefits. And developing a long-term plan to do so now would reduce risks of a future financial market calamity and help hold interest rates down... But today, neither side can say with certainty whether the latest stimulus worked, because nobody knows what would have happened in its absence...One big issue: Lessons about fiscal policy in normal times aren't necessarily applicable to today, when the Fed has cut interest rates to zero and unemployment remains high. Skeptics of fiscal stimulus traditionally argue that government borrowing crowds out private investment and pushes up long-term interest rates. True, says Obama adviser Lawrence Summers, but not at times like these...When private-sector lending was drying up and the credit markets froze, "government investment and creation of demand for consumers was a form of alternative financing, not a threat to private investment," Likewise, David Wessel author of "In Fed We Trust" notes: "Government, which did fail to head off the crisis, saved us from an even worse outcome... But we know now that the economy was imploding in late 2008. We know now with detail how paralyzed financial markets were, and how rotten were the foundations of some big banks. We know now that even after all the Fed has done, we still risk devastating deflation... So the short answer has to be: Yes, it would have been far worse had the government failed to act." The factors that affect unemployment predate the Obama Administration as the economic downturn started roughly a year before he took office and you can see unemployment starting to rise in the last quarter of 2008. One could make the argument that the stimulus has been far less effective in getting people back to work than one would hope, but there is little reason or historical evidence at hand to lead to the conclusion that we would have done better by employing tax cuts. Some conservatives would point to Calvin Coolidge's tax policies in fighting the 1920-1921 downturn as evidence that these policies work, but in doing so the avoid the influence of sharp tariffs that were also part and parcel of his response and the negative chain reaction that ensued worldwide as a result. Besides, what was the follow on act to the Roaring 20s, the Great Depression.

In analyzing the effect of the controversy surrounding stimulus verses tax cuts on the recessionary economy, Jon Hilsenrath states:" Tax cuts haven't been a cure-all. President Bush tried $168 billion of tax rebates in 2008, and a recession ensued anyhow. Economists note that households tend to save temporary tax cuts or use them to pay down debt, so they don't provide much short-term stimulus." Hilsenrath goes on to point out that one third of the Obama stimulus was in the form of tax cuts. This fact has also been pointed out by Steve Weisman of the Petersen Institute for International Economics who has stated that the tax cuts included in the stimulus have had zero simulative effect. There is now evidence that business is starting to spend money on capital goods regardless of the specifics of tax policy. Nomura Securities economist David Resler calculates "that businesses didn't spend enough in 2009 on new equipment to offset the wear and tear on their existing equipment...Mr. Resler estimates that even with the recent sharp increases in capital spending, the total capital stock is still $100 billion less than it was two years ago. That suggests that capital spending could continue to grow strongly the rest of the year." Mr. Greenspan himself added that the relationship between taxation and growth was still not well understood. "I don't think anybody can know exactly what the impact of these taxes is on G.D.P.," he said, referring to gross domestic product, the broadest measure of output. "We put them through econometric models that have a very poor record forecasting recession. Conclusions based on such models must be suspect." The fact of the matter is that companies spend money on replacement and expansion when they see an economic reason to do so, not primarily as a result of tax policy. While tax incentives for plant and equipment can be helpful, they alone are not enough to give rise to business spending if there is a perceived lack of demand for a firm's goods or services. After all, companies still have to lay out millions of dollars in expenditure and why would they do so if they have idle capacity to the tune of 30%?

So the question is this; if so many influential people are pointing to the lack of effectiveness of tax cuts in this particular economic environment, why do Republicans cling so desperately to the idea? As I have said in earlier articles, I believe that, in a large part, the G.O.P. is at the point of ideological exhaustion and is sorely lacking when it comes to new and compelling ideas. It is basically, with few exceptions, pushing old wine in old bottles. Their one big exception is Congressman Paul Ryan's " A Roadmap For America's Future", which contains a number of tax reform ideas and advocates for a privatization of Social Security, a tall order to fill in this environment and one that Republicans could not pull off during the Bush Administration when they had control of the presidency and both houses of Congress. Ryan's plan has been picked apart by Economist Paul Krugman for what he claims are its faulty assumptions. One is Ryan's claim that based on OMB estimates; his policies would cut the budget deficit in half by 2020. Krugman's critique is as follows: "But the budget office has done no such thing. At Mr. Ryan's request, it produced an estimate of the budget effects of his proposed spending cuts - period. It didn't address the revenue losses from his tax cuts... The nonpartisan Tax Policy Center has... Its numbers indicate that the Ryan plan would reduce revenue by almost $4 trillion over the next decade. If you add these revenue losses to the numbers... you get a much larger deficit in 2020, roughly $1.3 trillion. And that's about the same as the budget office's estimate of the 2020 deficit under the Obama administration's plans...The Tax Policy Center finds that the Ryan plan would cut taxes on the richest 1 percent of the population in half, giving them 117 percent of the plan's total tax cuts... Even as it slashed taxes at the top, the plan would raise taxes for 95 percent of the population...Finally; let's talk about those spending cuts. In its first decade, most of the alleged savings in the Ryan plan come from assuming zero dollar growth in domestic discretionary spending, which includes everything from energy policy to education to the court system. This would amount to a 25 percent cut once you adjust for inflation and population growth. How would such a severe cut be achieved? What specific programs would be slashed? Mr. Ryan doesn't say."

There is a curious lack of candor and directness among Republican leaders making the rounds on the political talk show circuit when it comes to detailing specifics. Appearing on the Bloomberg network, Senator Mitch McConnell (R-KY) declined to outline what comprised the G.O.P.'s political or economic platform for the 2010 election cycle saying he "did not want to scoop himself". A week later in an August 8th Meet the Press interview, John Boehner (R-OH) would not provide specifics on the same topic choosing to talk around the issue by saying that the G.O.P. was "still listening to the American people." That's a sharp contrast to Mr. Boehner's comments on Meet the Press this past January when he said: "Leadership is about standing on principles and offering alternative policy solutions" The fact of the matter is that if they were in power now, they would most likely have favored simulative spending as well as there is no historical evidence that tax cuts alone, or as a primary strategy, has ever pulled an economy out of a downturn as deep as this one. They certainly can't harken back to the business friendly 19th century America as taxes then were low or nonexistent on economic activity as well as personal incomes. And interestingly enough, Senator McConnell appearing again on Meet the Press, 22nd of August, was unwilling or unable to come up with an answer as to how to pay for extending the Bush era tax cuts as well as answer the question of the viability of Congressman Ryan's Roadmap. As per the moderator, David Gregory's take on the Ryan plan: "it lays out some Draconian steps to balance the budget, to cut spending in both Social Security and Medicare. I'm wondering why it is if Republican leaders are so serious about cutting the deficit and cutting spending, why there aren't more than 13 cosponsors in the United States Congress for this plan?" Somehow the new found fiscal rectitude of the G.O.P. seems to ring hollow when you consider that much of the present Republican leadership on Capitol Hill are the same culprits who took this country from surplus to deficit and endorsed a military misadventure that has by now cost over one trillion dollars that would have been better spent here fighting the downturn.

Perhaps it is this lack of compelling new ideas in the midst of the worst downturn since the 1930s that has led the G.O.P. to basically avoid policy specifics and let the far right media fringe do much of the talking for the Party. Perhaps that is why so little is known about the ideas of a Paul Ryan, he can't be heard over the roar and din of the fanatics on the far Right and the political theater of people like Newt Gingrich, Rush Limbaugh, Glenn Beck and the rest of the entertainers on the right who pawn themseleves off as legitimate news analysts. Perhaps that is why many of its leading figures have been so enmeshed in the Ground Zero Mosque controversy or perhaps why they have let the "Birther Mania" run wild and unabated. After all, if you don't have compelling ideas to offer voters in general, you're left with having to rile up the base and keep them engaged no matter what the method or the reasoning. Columnist David Brooks addresses this as part and parcel of the lack of civil public discourse currently gripping the nation in his latest op-ed "Case of Mental Courage":"Many conservatives declare that Barack Obama is a Muslim because it feels so good to say so. Many liberals would never ask themselves why they were so wrong about the surge in Iraq while George Bush was so right. The question is too uncomfortable...There's a seller's market in ideologies that gives people a chance to feel victimized. There's rigidity to political debate. Issues like tax cuts and the size of government, which should be shaped by circumstances (often it's good to cut taxes; sometimes it's necessary to raise them), are now treated as inflexible tests of tribal purity." While the Republican Party will surely make gains in the 2010 election cycle, it will be a function of the natural progression of electoral cycles rather than the start of a renaissance. We are now in a brave new world of globalized economic competition where military power may very well play a diminished role. No amount of tax cutting will help us in combating the cost of production in China and the Far East. We are in need of bold new ideas and to date, the Republicans have largely offered an agenda of obstruction and out of date economic concepts that proved lacking in the 19th Century as well as in 2008. Generally the voters still blame the Bush Administration for the current economic disaster and the G.O.P. remains at historic lows in favorability ratings. In spite of the fact that some 30% of the voters identify as conservative, the long term demographics are trending against the G.O.P. and its core philosophy and at some point it will either have to redefine its reason for being or it will have to accept a role as the default party of American politics.


Steven J. Gulitti
New Haven CT 8/25/2010



Sources:

Meet the Press 8/1/10;  http://www.msnbc.msn.com/id/38487969/ns/meet_the_press-transcripts/
Greenspan Calls for Repeal of All the Bush Tax Cuts:  http://www.nytimes.com/2010/08/07/business/economy/07greenspan.html?emc=eta1

Stockman: Bush Tax Cuts Will Make U.S. Bankrupt;  http://www.npr.org/templates/story/story.php?storyId=129052425&sc=emaf

Stockman: Four Deformations of the Apocalypse;  http://www.nytimes.com/2010/08/01/opinion/01stockman.html?_r=1&emc=eta1

Jobless and Staying That Way by Nelson Schwartz
 http://www.nytimes.com/2010/08/08/weekinreview/08schwartz.html?emc=eta1

Unemployment: What Would Reagan Do?
 link to online.wsj.com

Course of Economy Hinges on Fight Over Stimulus by Jon Hilsenrath  link to online.wsj.com

Reaganomics:  http://en.wikipedia.org/wiki/Reaganomics

Robert Reich; Why We Really Shouldn't Keep the Bush Tax Cut for the Wealthy  link to www.huffingtonpost.com

SARA MURRAY
Revisions Show Slower Recovery, Deeper Recession online.wsj.com/.../NA_WSJ_PUB:SB10001424052748703578104575397520711904... -

David Wessel
Emerging Lessons From Fighting the Financial Crisis:  link to online.wsj.com

The U.S. Unemployment Rate Since 1990;
 http://www.econedlink.org/lessons/images_lessons/813_em813_figure11.gif

The Politics of Boom and Bust, 1920-1932: The Republican "Old Guard" Returns Chapter 33:  link to www.apstudynotes.org

Firms Spend More-Warily: Equipment Outlays Aim to Make Up for Cutbacks, Not to Boost Production and Jobs
 link to online.wsj.com

A Roadmap for America's Future
 http://www.roadmap.republicans.budget.house.gov/

Paul Krugman: The Flimflam Man;
 http://www.nytimes.com/2010/08/06/opinion/06krugman.html?_r=1&emc=eta1

Meet the Press 8/22/10
 link to thepage.time.com

David Brooks: Case of Mental Courage
New York Times; Tuesday, August 24, 2010

Reuters/Ipsos poll: Obama approval hits new low, but Republicans catch blame too.
 link to blogs.reuters.com


AUGUST 11, 2010.Grim Voter Mood Turns Grimmer: Pessimism Rises on Economy and War; Bad Reviews for Both Democrats and GOP link to online.wsj.com