In my earlier post, I catalogued some quotes from high Bush Administration officials asserting the Laffer claim that a cut in US tax rates stimulates income so much that the Treasury ends up taking in more revenue than before.   I didn’t then quote in detail the extensive statements made by the Director of Office of Management and Budget, Joshua Bolten, in July 2005.    

Director Bolton’s statements are of particular interest for several reasons.     First, by 2005 it had become obvious to any objective observer that (1) the record budget surplus inherited by the Bush Administration had been quickly converted into a record budget deficit, and that (2) the aggressive Bush tax cuts were a major cause of that swing (as was the sharp acceleration in federal spending, both domestic and international, relative to the 1990s).  Second, while the utterings of President Bush himself can in general perhaps be dismissed as not to be taken seriously,  Bolten was the professional whose job is to be responsible for the integrity of the budget process.  (Indeed, he is a higher-quality civil servant than some in the Bush Administration who have been quick to “bolt on” crazy ideological propositions to what should be serious positions.)

Here is what the OMB director had to say about the Laffer proposition:

“And with all those economic gains, we are also seeing more revenues coming into the Federal Treasury.  We have arrived at this point largely because of this President’s and this Congress’ pro-growth policies, especially tax relief.  Those policies have strengthened the economy, which is now producing better-than-expected revenues.”  –   Testimony of Joshua B. Bolten, Mid Session Reivioew of the President’s FY 2006 Budget Requst, Committee on the Budget, U.S. House of Representatives, page 1, para. 3.

And lots more:
“The tax cuts proposed by the President and enacted by Congress are not the [budget] problem.   They are, and will be, part of the solution…Had Congress not enacted the President’s three tax relief packages, moreover, the economy would be substantially weaker than it is…The most effective way to lower future deficits is to grow the economy.  And the President’s tax packages have been well designed to do precisely that.”

“…all economists, I think will agree very strongly that when you reduce taxes, put more money back into the economy, that has a feedback effect in the economy that causes growth and in turn increases receipts.  And being able to measure those receipts, to see how much better the government’s fiscal situation is as a result of the tax cuts would be something I’d very much like to include in the numbers….We think we’ve done the right things by making the tax cuts to restore the economy to growth, because what got us into the difficulty deficit situation in the first place is the flagging growth, flagging receipts in the economy.  We think the best way back is to restore the economy to growth, and restore receipts that correspond to it…. ”

Q: “…you’ve got a substantial drop in the deficit [forecasted] in 2005…”
A:  “…there are other factors involved, and one of them is the ‘03 tax cut.”

–  Press Briefing by OMB Director Josh Bolton, The White House, July 15, 2003.

Following up on my preceding post, I will here document who has said what.    

High officials in the Reagan Administration apparently did subscribe to the Laffer Hypothesis:
•         Reagan himself: “…our kind of tax cut will so stimulate the economy that we will actually increase government revenues…” July 7, 1981 speech 1/
•         His Secretary of the Treasury, Don Regan, even after events had falsified the proposition to the satisfaction of most observers, wrote of his “very strong opinion that a tax cut would produce more revenue than a tax increase.”2/
   Also:  “The increase in revenues should be financed not by new and higher taxes, but by lower tax rates that would produce more money for the government by stimulating higher earnings by corporations and workers…” (p.173).  

Similarly, high officials during the Bush era have also have been quoted saying that tax cuts, via faster growth, lead to higher tax revenues:
•         President George W. Bush :    “The best way to get more revenues in the Treasury is not raise taxes, slowing down the economy, it’s cut taxes to create more economic growth. That’s how you get more money into the U.S. Treasury.” –  July 24, 2003.
•         OMB Director Joshua Bolten, press conference July 2003;       & WSJ, Dec. 10, 2003
•         Majority Leader Tom DeLay: “We, as a matter of philosophy, understand that when you cut taxes the economy grows, and revenues to the government grow.”  NYT, 3/31/04.
•         Treasury Secretary John Snow, Congressional testimony, Feb. 7, 2006:  “Lower tax rates are good for the economy and a growing economy is good for Treasury receipts.”
•         CEA Chair Ed Lazear, press conference 2/12/07, “revenues have come in…higher than we predicted…because the economy has grown at a rate higher than we predicted…[T]he tax cuts…[were] at least in part responsible for making the economy grow.”

Most leading Republican economists who served as chief economic advisers to Presidents Reagan and Bush during their tax cutting frenzies, however, do not subscribe to the Laffer Hypothesis, and did not compromise their beliefs while in office.  Three examples:

•         Martin Feldstein:   “I objected therefore to those supply-siders like Arthur Laffer who argued that a 30 percent across-the-board tax cut would also be self-financing because of the resulting increase in incentives to work.”3/
•         Glenn Hubbard:   “Although the economy grows in response to tax reductions… it is unlikely to grow so much that lost tax revenue is completely recovered by the higher level of economic activity.”4/   
•         Greg Mankiw:    “Subsequent history failed to confirm Laffer’s conjecture that lower tax rates would raise tax revenue.  When Reagan cut taxes after he was elected, the result was less tax revenue, not more.” 5/  

1/  Feldstein, American Economic Policy in the 1980s (U. Chicago Press) 1994, p.21.
2/ Regan, For the Record (St. Martin’s Press: New York) 1988, (p.214).
3/  American Economic Policy in the 1980s ( U. Chicago Press) 1994, p.24 . 
4/   Economic Report of the President (Government Printing Office) 2003, p.57-58.
5/   Principles of Economics (Dryden) 1998, p. 166.

I thought it would be useful to get all this into the record, since some observers have claimed that Reagan and Bush never subscribed to the Laffer hypothesis, while others have inaccurately accused Feldstein, Hubbard and Mankiw of selling out on this score.

So Arthur Laffer – still arguing the improbable “supply side” proposition that cutting income tax rates generally raises total tax revenue – is apparently now a special adviser to John McCain.   And McCain has taken on a big consignment of the snake oil, to Greg Mankiw’s dismay.   The political temptation for a Republican candidate to promise both lower tax rates and higher revenues is irresistible.   The policy-makers who cut taxes when Ronald Reagan and George W. Bush, respectively, came to power subscribed to this claim.  Remarkably, at the same time, the economists who were the chief economic advisers to Reagan and Bush during these tax cuts disavow the proposition that they increase revenue (Murray Weidenbaum, Martin Feldstein, Glenn Hubbard, Mankiw…) .    Almost all serious economists – let us say Ph.D. economists  – disagree with this proposition, with only a microscopic handful of exceptions like Laffer.   Indeed some of the advisers who defend the Reagan and Bush economic policies claim that this formulation of supply side economics is a caricature, and was not the true rationale of the tax cuts.   This wishful thinking is directly at odds with quotes from the presidents themselves and their Treasury secretaries and other economic officials, to the effect that tax cuts stimulate income so much as to produce more tax revenue.  Laffer is not a straw man.  (See my next post.)

Even more interesting, the academic defenders of the Republican tax cuts often offer a proposition that is diametrically opposed to the defense offered by their political masters.  This is the famous “starve the beast” hypothesis:  the claim that if you deprive the government of tax revenue, it will reduce government spending, which is of course viewed as a worthy objective.    If this proposition were true, and the supply side hypothesis were also true, it would lead to the nonsensical proposition that Republican presidents should raise tax rates in order to reduce tax revenue (Laffer) and thereby reduce government spending (Starve the Beast).   I challenge some candidate to run on that platform !

As it happens, there is abundant empirical evidence against both the Lafferite hypothesis and the Starve the Beast hypothesis.     In other words, just because two propositions are diametrically opposed doesn’t mean they are not both wrong.  I hope that in this election campaign, the media do something they have failed to do in the past.   If McCain proposes extending the Bush tax cuts, he should at least be forced to choose between the Lafferite defense, which tends to be driven more by political expediency, and the “Starve the Beast” defense, which has more support among at least some reputable Republican economists.    Only then can the rest of us know which of the two propositions to refute.

Following up on my preceding post, I asked my colleague here at Harvard, Jeff Liebman, about the evidence on the effective marginal tax rate facing low-income workers.     (Professor Liebman is an expert in this area, which I am not.  Incidentally he is also an economic advisor to Barack Obama.)   Here is his response:

“Despite the EITC and child credit, the poverty trap is still very much a reality in the U.S.  A woman called me out of the blue last week and told me her self-sufficiency counselor had suggested she get in touch with me. She had moved from a $25,000 a year job to a $35,000 a year job, and suddenly she couldn’t make ends meet any more. I told her I didn’t know what I could do for her, but agreed to meet with her. She showed me all her pay stubs etc. She really did come out behind by several hundred dollars a month. She lost free health insurance and instead had to pay $230 a month for her employer-provided health insurance. Her rent associated with her section 8 voucher went up by 30% of the income gain (which is the rule). She lost the ($280 a month) subsidized child care voucher she had for after-school care for her child. She lost around $1600 a year of the EITC. She paid payroll tax on the additional income. Finally, the new job was in Boston, and she lived in a suburb. So now she has $300 a month of additional gas and parking charges. She asked me if she should go back to earning $25,000. I told her that she should first try to find a $35k job closer to home. Also, she apparently can’t fully reverse her decision to take the higher paying job because she can’t get the child care voucher back (the waiting list is several years long she thinks). She is really stuck. She tried taking an additional weekend job, but the combination of losing 30 percent in increased rent and paying for someone to take care of her child meant it didn’t help much either.

The question is what is the policy solution here. Means-tested transfers have to be phased out at some point, so there is no easy answer. I think there are three things we might be able to do — all of which would, as you say, be a better use of revenue than tax cuts for the rich. First, make child-related tax benefits equal for all families (now they are high at the bottom because of the EITC and high at the top because the dependent exemption is more valuable the higher the tax bracket you are in, and the dip in the middle raises marginal tax rates by 21 percent for a family with two kids — so eliminating the dip would get rid of this 21 percent portion of the effective marginal tax rate). David Ellwood and I analyze this first idea. Also Sawicky and Cherry have put forth a similar idea. Second, in designing universal health insurance, we need to be very careful not to phase out income-related premium subsidies over the same income range where all of these other benefits are being phased out. Third, implement a delay between income increases and rent increases in section 8 — allow people to save up a bit before they are hit with the rent increase (I believe I read that some states have been trying out something like this recently, but I am not up to date on these policies). There are some excellent papers that carefully model how the cumulative effects of the welfare system create a poverty trap.  But I don’t think either of these papers includes all of the factors facing the woman above — so they would probably indicate that she faced a 60 percent marginal tax rate rather than the 130% (or whatever it really is) rate that she actually faces.”

What do Milton Friedman, Ronald Reagan, and the current US Congress have in common with Joseph Stalin?

No, it’s not that they are dead.

Recently I appeared on one of those TV shows where a right-wing host interrupts the guest frequently. (Not that I had realized what it was. I had not heard of the guy, Glen Beck, and the producer had only told me they wanted me to talk about Washington’s reaction to new recession fears.)  On the show I said I thought it would be a good idea if the recipients of tax rebates this time around included lower-income Americans, at least those workers who did not make enough to pay income taxes, but who did pay payroll (social security) taxes. This would be in contrast to the last 7 years of tax cuts which have left these people out. The TV host’s reaction was “Welcome to the show Mr. Stalin.” A media watch site called Media Matters for America picked this up, as an egregious comment even by the standards of talk show hosts. Of course the Democratic and Republican leadership of Congress, with the encouragement of the White House, have decided to include precisely these lower-income workers in the tax cuts this time. So I guess they are Stalinists. And Milton Friedman originally proposed the negative income tax, which was enacted as the Earned Income Tax Credit, and became highly successful when expanded by Ronald Reagan (1986) and Bill Clinton (1993). Quite a few Stalinists around!

I think the serious point is that conservatives like to think that they are keenly aware of the adverse effect of marginal tax rates on work incentives. Effective marginal tax rates on lower-income Americans trying to lift themselves out of poverty can be higher than on ultra-wealthy Americans. Yet the fixation of the Republican party from 2001 to 2007 was to make sure that the tax cuts went largely to the upper end and that they excluded workers at the bottom. Incentives are a third argument for tax rebates at the lower end, in addition to the two more familiar arguments we have been hearing: (1) income distribution, and (2) lower-income Americans will spend the money, which is supposed to be the point of the new fiscal stimulus.