On Wednesday, the President writes in a Wall Street Journal op-ed (sub. req.):
“America’s priorities also include keeping our economy strong. The elections have not reversed the laws of economics. It is a fact that economies do best when you reward hard work by allowing people to keep more of what they have earned. And we have seen that businesses can expand and hire more workers when they have more money to invest — and since August 2003, America’s employers have added more than seven million new jobs.
It is also a fact that our tax cuts have fueled robust economic growth and record revenues. Because revenues have grown and we’ve done a better job of holding the line on domestic spending, we met our goal of cutting the deficit in half three years ahead of schedule. By continuing these policies, we can balance the federal budget by 2012 while funding our priorities and making the tax cuts permanent. In early February, I will submit a budget that does exactly that. The bottom line is tax relief and spending restraint are good for the American worker, good for the American taxpayer, and good for the federal budget. Now is not the time to raise taxes on the American people.
By balancing the budget through pro-growth economic policies and spending restraint, we are better positioned to tackle the longer term fiscal challenge facing our country: reforming entitlements — Social Security, Medicare and Medicaid — so future generations can benefit from these vital programs without bankrupting our country.”
I’ll outsource the supply-side-redux argument for Andrew Samwick to address (although see also here). But I do await the President’s plan to eliminate the budget deficit by 2012 with anticipation. It surely must be easier to project budget deficit decreases when so much of defense spending is funded via supplementals (as illuminated by this WSJ article (sub.req.) (PDF here) wherein all sorts of non-emergency spending items are lumped into these emergency supplementals. The Administration is said to be proposing an approximately $100 billion supplemental, in addition to the $70 billion already passed, implying a total of $170 billion for FY2007.
The President’s faith in tax reductions as a means of generating rapid employment and output growth must be sorely tested when (if ever?) he is confronted with real world data demonstrating the previous expansion (under pre-Bush tax relief) was as — or more — robust than the current one. For completeness’ sake, I repeat these graphs below, the first from 11/15 post, the second from 11/4 post.
Figure 1: Log GDP (Ch.2000$), normalized to zero at trough, in current expansion (blue), previous expansion (green). DeutscheBank forecasts (red squares). Source: BEA, NBER, and DeutscheBank 11/10/06.
Figure 2: Official payroll employment-current expansion (blue), Adjusted-for-preliminary-benchmark revision payroll employment-current expansion (red), and official payroll employment (1991-2001 expansion, green), all normalied to value of unity at NBER defined cyclical peak. Gray shading defines NBER defined recession period. Sources: St. Louis Fed FRED II, BLS Preliminary benchmark revisions to establishment survey, author’s calculations, and NBER.
I do wonder what the short term deficit outlook will look like given the President has not settled on what the nature of the troop level surge in Iraq will look like. In Figure 3, I reprise a recent guess as to the monthly burn rates for operations in Iraq alone. The range for FY07 is 9.17 to 11.3 bpdm (billions of dollars per month), excluding reset costs.
Figure 3: Monthly burn rate for Iraq Theater of Operations, in billions of dollars per month (bdpm), by fiscal year. Source: For FY2003-06, Amy Belasco, “The Cost of Iraq, Afghanistan, and Other Global
War on Terror Operations Since 9/11,” Congressional Research Service Report RL33110, September 22, 2006, Table 5. For FY 2007, author’s calculations based upon reported figures (see text).
More details of the President’s intentions can be seen on the White House website. One particular element makes entertaining reading:
“Rising Entitlement Spending Is A Long-Term Challenge That We Must Address Now. A balanced budget better positions us to deal with the unsustainable growth in entitlement spending. While the near-term fiscal outlook is bright, entitlement reform is needed to help address our long-term budgetary challenges and ensure these vital programs are available for future beneficiaries. The President has led the way in focusing attention on this problem and in promoting real solutions, but forging a solution will require bipartisan cooperation.”
If only the President had had such dedication before pushing for Medicare Part D, saddling the Nation with an extra $9 trillion worth of fiscal exposure, greater in magnitude than the entire Social Security fiscal exposure, according to the GAO’s David Walker.
More coverage: See Cactus and PGL at Angry Bear, Mark Thoma (I) and (II) at Economists View.
Technorati Tags: fiscal exposure, budget deficits
fiscal policy, monetary policy, and
tax cuts
There are three parlor tricks in the president’s comments:
1) Doubtless the GDP is being used as the measure of the economy’s growth. But the GDP includes national debt accumulation as “growth”. Deficit to wealth. Presto!
2) If we balance the budget by 2012, that’s little consolation. In 2012 social security start’s running short of revenues. That’s when the real challenge begins. Right now is just the calm before the storm.
3) 7 million jobs says who? Does this count all the homeland security buildup (read: government) jobs, all the marginal “self-employed” jobs, all the undermployed college grads working at starbucks, and construction workers and real estate agents who are a few months short of formally “unemployed”? I bet it does.
The piece is available for free at OpinionJournal.
Menzie,
Have you done any analysis of what the budget deficit might be if we had not had 9-11 and were not spending on the Iraq war? Only twice before – the Revolutionary War and the Civil War – have we faced such destruction in our own country. Yet even with this disaster we are still growing.
The growth of the 1990s was actually supply side growth as Clinton signed Welfare Reform and lowered the capital gains tax to mention two of many.
We must also understand that fiscal changes continue in effect for 20 to 30 years as contracts unwind so much of the Reagan economy contained effects of Nixon and Ford and the Clinton economy contained effects of Reagan and GHW Bush.
But perhaps the most important change since 1980 is that the progressive tax rates that ran greater than 75% during the 1970s at the upper levels were eliminated by the Reagan administration. In 1979 if you counted all of the tax brackets, personal and business, you had over 100 brackets. Progressive tax brackets over the top of hyper-inflation is insanity.
The Democrats do have a chance to also impact the supply side by getting rid of the AMT that is due to strike over 20 million this year.
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Aaron, your point 1 is important when considering such things as growth but please notice that Bush has been talking about tax receipts and the projected deficit.
On point 2 imagine what we will face if the SS shortfall comes before we deal with the budget problems (a point Bush made BTW).
On point 3 if you take such employment out of the employment numbers then you must agree that the costs for the war on terror should be left out of the spending numbers.
I must comment on Welfare Part D. This addresses only a small part of total health care. If you think this is expensive imagine totally nationalized health care.
Ha, ha, that’s funny, Welfare Part D. I will start using that; thanks!
Aaron Krowne: I agree, there have been, and will be, many more “magic asterisks” in the President’s budgets.
DickF: Leaving aside the question of whether the War of 1812 and Pearl Harbor attack during WWII as being of equal destructiveness (in constant dollars), let’s take your premise of 9/11 being a cause of the deficits. According to CRS (Belasco, Sep. 2006) which I have linked to repeatedly, the expenditures for GWOT (including Iraq, which I have argued was a war of choice) as of the date of writing were $437 billion. According to the CBO (August 2006), the actual on-budget budget deficit for FY2005 was $493 billion (unified was $318 billion). In other words, look elsewhere as well for the source of those deficits, including rapid discretionary spending growth and tax cuts.
By the way, I don’t think we have experienced “hyper-inflation” in the U.S. during the post-War era. The maximal year-on-year annualized CPI-urban all inflation rate in 1980 was 15%. This is far below the monthly inflation rate of 50% (non-annualized) rate that is often cited as the relevant threshold.
“the GDP includes national debt accumulation as “growth”.”
I’m not clear on that: could you spell this out?
Dick:
On point 1, yes, but if GDP is being used to measure the debt burden, then that is somewhat dishonest.
On point 2, yes, but what’s the use of “balancing the budget” just in time for it to be structurally imbalanced again? I actually agree with the president here: entitlements need to be fixed.
On point 3: I know too much about how “productive” homeland security complex spending is to concede that employment in this sector is “real” in any significant sense. So these factors don’t cancel out: the spending is in deficit and wasteful, and the employment generated is transient. Those budgets will get cut (and the employment will get lost — I wonder if the president realizes what he’s wishing for here). Beyond this, it will be interesting to see how upbeat employment looks in a year, when realtors and builders have thrown in the towel.
Nick: GDP includes debt borrowings as if they went towards productive output. In other words, all that money loaned back to us from China and OPEC is counted towards the GDP. This strikes me as an objective error when measuring the deficit or debt burden compared to national output.
Wikipedia’s definitions of GDP and GNP should cover it. Here’s an article that introduces a number of national income and output metrics.
Aaron,
Please clarify:
Are you saying that trade deficits and debt are the same?
“let’s take your premise of 9/11 being a cause of the deficits”
This is not at all my premise, but your models cry out for this analysis. There can be no doubt that 9-11 created huge short-term losses for business, especially to the airlines, and a resulting reduction in tax revenue. Your references point to direct costs of the GWOT but do not take into account the associated costs such as limits to business travel, restrictions on shipping, and other. But let’s not quibble.
If you will I believe the deficits were created by the FED attacking the economy during the late 1990s, their over expansion for Y2K, then their over-reaction when attempting to correct their error. This combined with government’s attacks on business (Microsoft, and others) in late 1999 created the 2000 recession. Since that time we have been slowly digging our way out of the FED mess. Thankfully the FED got out of the way for much of the early 2000s, but this past year they returned to their questionable antics and the economy is feeling the pain.
I understand your resistance to the dynamic impact of tax cuts, and I am sure that you can reference devised econometric models that prove they do not increase revenue. I will consider your premise if you can direct me to one time in the history of the world when actual tax revenue did not increase after a national tax cut. It is the nature of politics and politicians to always tax above Point E on the Laffer Curve. Conversely look at all of the instances where tax revenue took a nosedive after tax increases, the most obvious being Hoover’s tax increases that thwarted recovery then deepened and extended the Great Depression.
DickF: Since there is no time frame given for “tax revenues to rise” after a “tax cut”, and since nominal tax revenues are well characterized as an I(1) process with upward drift (brownian motion with drift in continuous time nomenclature) your assertion is not falsifiable.
I will consider your premise if you can direct me to one time in the history of the world when actual tax revenue did not increase after a national tax cut.
Menzie,
The above is easily falsifiable if there is such a time.
Grzesiek:
They are not “the same”, but trade deficits and fiscal deficits both end up in the national debt burden. At least, they tend to. It’s possible that trade deficits could end up in private investment, but that isn’t happening, which is bad (see “Pitchford Thesis”).
I should also say the reason I bring up GDP and debt burden comparisons is because whenever Bush says we’ve “grown the economy”, he’s talking about GDP growth. This is a very subjective metric to use to talk about how the nation’s economy has “grown”.
Aaron,
What metric would you use?
DickF:
According to the US government (see historical tables, 2MB pdf), US tax revenues decreased from 2001 to 2002. Tax revenues also decreased between 1981 and 1982 (a slight increase in personal tax revenue not enough to make up the loss of corporate tax revenue) and between 1982 and 1983 (a decrease in both categories). I didn’t bother looking farther.
See Table 2.1
Pianoguy,
You need to consider when tax cuts are actually in effect rather than when they are passed by congress. The four primary tax cuts in US history, Mellon in the 1920s, Kennedy (enacted by Johnson) in the 1960s, Reagan in the 1980, and Bush in 2000s, all led to increased prosperity and tax revenue.
If you look at the major tax increases you will find just the opposite effect.
Pianoguy,
Another interesting effect is that increasing the taxes on the upper quintiles actually lowers the amount of tax revenue the upper quintiles pay in taxes while tax cuts on the upper quintiles increase the amount they pay. Many do not understand supply side tax cuts believing that any tax cuts is part of supply side but that is not true. The Democrats are proposing a “middle class” tax cuts with their pay-as-you-go proposal offset by increased taxes on the upper quintiles. Even though static analysis shows no net change and most people would see not supply side effect, supply side analysis actually forecasts reduce tax revenue as the upper quintiles pay a lower percentage of overall taxes.
All tax cuts are not created equal. For example the first Bush tax cut was primarily Keynesain in that it was designed to increase consumption. The result is that it had virtually no effect. The second tax cut primarily engineered by Bill Thomas in the house was a strong supply side tax cut and the economy reacted positively almost immediately.
DickF,
Thanks for your clarification, but I’m afraid I still don’t understand what you’re saying. The table I referenced shows that tax revenue, as of 2005 (the last year for which there’s an actual number instead of an estimate), had not yet reached the inflation-adjusted 2000 tax revenue. Obviously you’re not claiming that Bush’s tax cuts haven’t yet taken effect.
Tax cuts may indeed increase prosperity, but I don’t yet see support for your claim that they also increase tax revenue.