The Problem With Tax Cuts

by folkbum

I mean, there are several problems with tax cuts. For one, they provide very little actual stimulus effect. For another, they tend to be political bon-bons rather actual economic strategies.

But here's the problem I mean today: Tax cuts cause insanity. Exhibit A, Jon Kyl:


On a friendly network with a friendly anchor, Kyl can't hit the relative softball of what he would do to offset the cost of keeping Bush tax cuts in place for the one income group that has weathered the recession and can afford to pay a little more--the top few percent of earners. He swings and misses and settles for a dumb "you never have to offset tax cuts" line that grates against reality. Insanity, I say again.

This is a similar effect as that seen with military spending, where any spending on war or war toys is sacrosanct and magically disconnected from the fiscal reality that is the federal budget. (Exhibit A for that this week is Sarah Palin, who can--in the same speech!--demand that the government beast be starved and that the Pentagon's own requests to trim programs be ignored in favor of more blowy-uppy power.) It stems from an irrational belief that cutting taxes is always the right thing to do and that it has no effect on government revenue or deficits.

Not just similar--the two are actually symptomatic of the same problem, which is what you might call faux-hawkery: Pretending to care about the deficit just long enough to convince people to let you cut programs for the poor and cut taxes for your wealthy friends and neighbors, but not long enough to actually eliminate the deficit and start paying down debt. Kyl can't be specific about offsetting the tax cut because saying what he wants out loud--cuts to Medicare, Medicaid, Social Security, unemployment insurance, veterans' benefits, the Department of Education--is unpopular with real people. And saying what makes sense out loud--raising some taxes and cutting defense, which is bigger than any of the previous items--is impossible because those, as we've established, run counter to Kyl's magical belief system.

Ezra Klein says, thinking about Kyl's answer, that a tax cut is no different from a spending increase when it comes to the fed's bottom line. Well, that's not exactly true--as the CBO has noted time and time again, extended aid to the unemployed has a multiplier effect on the economy (and therefore a positive effect on federal revenue, reducing the deficit) while tax cuts do not produce that result. So in fact, despite the protestations of Kyl and others that the only possible reason to extend unemployment is to be nice and charitable, the better reason is to move the economy forward and, consequently, reduce the deficit long-term.

(The chart here is from this paper by the CBO. Click for a larger image, and note that more aid to the unemployed is predicted to have an effect on the GDP five to seven times greater than cutting income taxes. Aid to states--like funds to hire back more teachers or to supplement Medicare--also beats tax cuts handily in terms of effect on the GDP.)

But back to taxes: The other problem with tax cuts during tough economic times, is that no one ever offers the converse, tax increases in good economic times. Indeed, in 2001 the Republicans trotted out their "experts," including Alan Rand Greenspan, who fretted about the negative effects of budget surpluses and insisted that tax cuts were the only way to deal with such a boom in the economy and federal revenue.

If the US ever gets out of its current funk, you can expect to hear the exact same case made again. Despite the fact that taxes will undoubtedly remain at historically low levels, once the economy is humming again the only tax policy we'll be allowed to debate is how much lower they can go. With a fairly sure bet to be made that cutting ("privatizing" or "personalizing") Social Security will be all the rage again, with calls to ramp up defense spending a pretty safe prediction as well.

None of that will do a thing for deficits or the debt.