Friday, March 28, 2008

WaPo on Candidates Tax Plans

The Washington Post has an article about the various candidates plans for taxes. While it is marginally positive in that the candidates are talking about keeping some of the existing tax rates, the WaPo analysis is rife with economic fallacies.

When President Bush pushed big tax breaks through Congress in 2001 and 2003, Sen. John McCain (R-Ariz.) joined Sen. Hillary Rodham Clinton (D-N.Y.) and other Democrats in opposing them as fiscally reckless. But now that McCain and Clinton are running for president, neither is looking to get rid of the cuts. Instead, they are arguing over which ones to keep.

The same is true of Clinton's rival for the Democratic nomination, Sen. Barack Obama (Ill.), who recently blamed the Bush tax cuts for driving the nation toward recession. But he, too, wants to preserve about half the cuts, and pile on new ones.

Fallacy #1: The Bush tax cuts are not to blame for the potential recession. The idea that depriving the government of tax revenue could cause a recession could only be uttered by a politician, all of whom believe that what they do in Washington is more important than what happens in the real world.

The direction of the tax debate is frustrating deficit hawks in Washington, who worry that none of the candidates is charting a course toward a balanced budget. Meanwhile, Bush and other politicians are telling voters alarmed by a sagging economy that keeping the cuts past their 2010 expiration date can help revive the nation's fortunes, a claim many economists say is nonsense.

Fallacy #2: Who are these "many economists" who say this is nonsense? How about some names and political affiliations. If the tax cuts are allowed to expire, tax rates will rise. If that is so, isn't it obvious that this would have a negative economic impact? I suppose an economist could argue that if tax rates rise, the result will be higher tax revenues and a lower deficit and that would have a positive effect, but higher revenues and a lower deficit are far from a certainty in that scenario.

Conceived during Bush's 2000 presidential campaign as a means to return what were then huge government surpluses to taxpayers, the cuts were approved by Congress in the midst of a recession, which worsened after the Sept. 11, 2001, terrorist attacks. Though the recession was mild, the recovery was sluggish and hampered by a deep decline in employment. Productivity ultimately rebounded robustly, but national savings plunged, and the country racked up a large trade deficit.

Fallacy #3: "The recovery was sluggish and hampered by a deep decline in employment."

Here's a chart of the unemployment rate:

Unemployment rose in the last recession but the rise was not dramatic or particularly bad compared to past recessions.

Why would tax cuts hurt the economy? Because their one very clear effect was to increase the budget deficit. Combined with spending on the wars in Afghanistan and Iraq, and a huge new prescription drug benefit for Medicare recipients, the cuts helped drive the annual deficit to a peak of nearly $413 billion in 2004. Last year, it dwindled to $162 billion. But the nation's cumulative debt has nearly doubled since Bush took office and now exceeds $9 trillion.

Fallacy #4: The tax cuts "one very clear effect was to increase the budget deficit". That is not clear at all. Tax revenues between 2003 and 2006 increased by 35%. As a percentage of GDP tax revenues increased from 16.5% to 18.4%. Unfortunately, spending rose even faster. So what is the cause of the budget deficit? Tax cuts or excessive spending?

Government spending is the problem. As I have written about here before, lower tax rates can support spending that is in the historical range of the US withoug budget deficits. Hong Kong spends a similar amount as a percentage of GDP, has much lower tax rates and runs a budget surplus. Again, the problem is spending, not tax rates.

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