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Economic voodoo liberals do so well

By W. James Antle III
web posted September 10, 2001

Blanket liberal opposition to lower tax rates has led to some surprising economic conclusions. Gone are the days of using deficit spending as "pump-priming" to jolt a sagging economy back to life. Now liberals regard budget surpluses as vital and tax cuts that aren't really welfare payments (i.e., "refundable tax credits" for those who don't pay taxes) as something to be avoided at all costs.

Case in point is the latest economic advice of Robert Kuttner, co-editor of The American Prospect. In an August 28 syndicated column, he suggests repealing President Bush's recently enacted tax cut to "reclaim the surplus" and then devote the entire surplus to government spending. At least he is honest about what the president's critics plan to do with the surplus in the absence of a tax cut. Now, he may not have noticed that the economy continues to slow despite the fact the past fiscal year saw non-defense discretionary spending rise 14.1 per cent and government spending at all levels has continued to rise up through the last quarter. Presumably, he has some nifty "investments" that he would like the federal government to make in the national economy. Yet the tax cut is already coming into effect and repealing it at this point would essentially raise taxes on 75 million people.

John Maynard Keynes: On his way out?
John Maynard Keynes: On his way out?

Since the economy grew only 0.2 per cent last quarter and the real private-sector economy actually shrank, the following question becomes relevant: What economics text recommends raising taxes during an economic slowdown? It is certainly not recognizable as Keynesian economics, which was until recently mainstream liberal economics. Of course, Kuttner would have the feds inject money into the economy in the form of public spending (money they first extracted from the economy via taxes). Other than possibly making income distribution charts more closely reflect Kuttner's personal value system, what could we hope to accomplish by doing this? To say nothing of what this does to incentives and the stability of the after-tax return on work and investment, the federal government will spend the money less economically than the private sector.

Sure, a new round of government spending might be able to set up a national health insurance system and subsidize below-poverty wages, among other activities. But whatever benefits Kuttner might argue this would have, economic benefits aren't among them. Consider the social democracies of Western Europe. As European Union countries increased their state spending from 34 per cent of GDP in 1961 to 51 per cent in 1995, their unemployment rates tripled while ours remained relatively stable. We compare very nicely to our friends across the pond in terms of annual economic growth rates, per capita GDP, unemployment, long-term unemployment and net job growth. If government spending were the best way to stimulate growth, especially in bust times, the opposite would be the case.

Leaving Kuttner aside, let us examine a more mainstream example of the deviation of neo-liberal economics from Keynesian orthodoxy. The New Republic's Noam Scheiber was recently up in arms about a Wall Street Journal op-ed piece by Glenn Hubbard, chairman of the president's Council of Economic Advisors. Scheiber savages Hubbard for defending the Bush tax cut and not conceding that it is responsible for the decline in the surplus, an event he accuses Hubbard of not considering important enough in the first place. He conveniently downplays the effect slower growth has had on revenues and ignores the role of government spending altogether. In fact, the surplus is $57 billion smaller due to spending increases as opposed to the $40 billion cost of the tax rebates.

Moreover, the tax rebates were primarily a Democratic idea. When the Treasury Department gave credit for them to President Bush in the letter that accompanies the rebate checks, Democratic leaders cried foul. The main component of Bush's proposal was lower marginal rates, the results of which have yet to be measured.

Scheiber doesn't need to get into all those details, as he may confuse us dummies on the right. He contends that authors of "supply-side screeds" are either "shamelessly dishonest or just not particularly bright." After all, "no one capable of stringing together two sentences... could honestly believe" such gems as "...articles attributing the late '90s economic boom to the Reagan tax cuts of the early '80s..." This is a textbook example of constructing a straw man.

No serious conservative maintains that Reagan's tax cut from the 1980s suddenly led to a boom at the end of the '90s. What we do argue, based on ample evidence, is that the lower marginal rates resulting from the Reagan tax cut have helped to create a general trend toward job creation, lower unemployment, higher productivity and economic growth. The economy has experienced longer periods of sustained growth and faster growth rates since their enactment; in fact, the economy has been in recession only 3 per cent of the time since then, compared to one-third of the time historically. Clearly, there were other factors leading to an increase in annual growth rates in the late '90s. But 18 years of prosperity with a brief interruption (in between two record-breaking periods of continuous growth, incidentally) cannot be denied.

Scheiber oddly enough believes that the prosperity of the 1990s was achieved by higher taxes. He argues, "By raising taxes and cutting spending, Clinton signaled his commitment to reduce the deficit, which persuaded bond traders that Alan Greenspan wouldn't ratchet up interest rates in the future, which helped lower long-term interest rates and stimulate economic growth." This is an interesting departure from Keynesian economics, but it is the party line on how Clinton ushered in economic growth.

This does not explain how both short-term and long-term interest rates fell during the large deficits of the 1980s and the early 1990s, nor does it account for the interest rate increases immediately after the Clinton tax increase was passed. The economic recovery began in March 1991 and the economy grew at a 3.7 per cent rate in the final quarter of 1992. During Clinton's first term, the economy grew only 2.4 per cent a year. If the economy had continued along the lines it did following the tax increase, it would have grown 2.6 per cent annually from 1993 to 1999. Clinton's own budget documents indicate such sub-par growth would have added $99 billion a year to the deficit.

Consider also that our current economic problems began in mid-2000, long before there was any indication George W. Bush would be elected and that there would be any significant tax cut. Interest rates rose. Economic growth declined from 5.7 per cent in the second quarter of 2000 to 1.9 per cent in the fourth quarter, before Bush took office. Clinton did not propose some major tax cut to frighten the bond traders, so it strains credulity to believe that robust growth in the late '90s and anemic growth over the past several months were the result of Scheiber's high taxes mean low interest rates, low taxes mean high interest rates paradigm. When confronted with the failure of repeated interest-rate cuts to re-ignite the economy, just as similar policies have failed in Japan, Scheiber insists that this proves long-term interest rates are the problem and illogically blames the Bush tax cut enacted long after this stagnation began.

Many Republicans did foolishly predict that the Clinton tax increase would cause a recession, but this was itself a misapprehension of supply-side economics. The Clinton tax increase was large in terms of gross tax take, but it left marginal rates well below the 70 per cent Reagan found them at. The top rate for earned income was 39.6 per cent compared to 50 per cent and capital gains held steady at 28 per cent - thus the Reagan tax cuts were eroded, but intact. Marginal rates are more important to work incentives than average tax rates, as they affect after-tax returns on additional income. Additionally, continued disinflation lowered the cost of capital and acted as a sort of tax cut for accelerated depreciation, offsetting the Clinton tax hike. This was followed by a series of pro-growth initiatives once the Republicans took Congress, most importantly lowering the capital gains tax rate to 20 per cent in 1997. Healthy growth then resumed - the Clinton experience does not vindicate those who advocate higher taxes.

Scheiber also leaves unexamined Austrian economic theories of the business cycle that may help explain our present slower growth. The policies of easier borrowing and artificially low interest rates that he advocates helped exaggerate growth rates and inflate stock prices in the late '90s. This led to malinvestment that is now being liquidated from the economy, being replaced with sounder investments. Defenders of Clintonomics not only pretend to offer a fiscal policy of "tax-and-don't-spend," but they implicitly endorse credit expansion as the key to growth. It is odd that those who once so vocally chided the Reagan administration for presiding over an expansion in the public debt consider massive private debt harmless.

Even if Scheiber had both the relationship between deficits and long-term interest rates and long-term interest rates and sustained growth correct, the fact is we still have the second-largest surplus on record during a slow economy after issuing $40 billion in tax rebates and increasing government spending. It is far from clear that deficits will again become "the norm" due to the tax cut unless solid growth doesn't resume, a scenario a high-tax policy makes more likely. Past major tax cuts in the 1920s, 1960s, 1980s and 1990s have led to increases in growth and, in the long run, tax receipts.

While the policy preferences for Federal Reserve meddling and higher taxes, along with opposition to free-market policies, remain a liberal staple, their economic recommendations seem to be straying from traditional Keynes. Whatever the theory, they still look like the real practitioners of voodoo economics. ESR

W. James Antle III is a senior writer for Enter Stage Right and can be reached at wjantle@enterstageright.com.

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