Thursday, October 25, 2007

No wisdom of crowds here - A devastating critique of supply side economics

I thought James Surowiecki was a lot smarter than his supposed critique of supply side economics demonstrates. Yet I won't accuse him of getting in the gutter with Paul Krugman. I'll wait for other partisans and true believers like Donald Luskin to respond. But I think it's worth pointing out that there are other components of the theory -- stable money supply or "inflation targeting," regulatory reform and tax reform that go hand-in-hand the tax cuts that draw all the fire and brimstone. Was it all a a a failure? Notwithstanding the counter-claims of inreased revenues, critiques such as Suroweicki's almost bring back the ancient question: Do taxes matter at all? (Unlike tendentioius critics, he answers in the affirmative) And if not, why do we spend so much money avoiding them on the song and and dance of tax preparers and confusing forms? And what did account for the largest peace time prosperity punctuated by two soft recessions? Here's Suroweicki:
This supply-side orthodoxy is striking in a couple of ways. First, it requires Republican politicians to commit themselves publicly to a position that is wrong—and wrong not as a matter of ideology or faith but as a matter of fact. Saying today that tax cuts will increase tax revenues is not like saying that bombing Iran constitutes a sensible foreign policy, or that education vouchers will wreck the public schools. It’s more like saying that the best way to treat sick people is to bleed them to let out the evil spirits. Second, despite the fact that the supply-side faith has no grounding in reality, within the Republican Party there is little room for dissent on the subject, as Jonathan Chait details in his new book, “The Big Con.” Last week, the blogger Megan McArdle wrote that she had a book review for an unnamed right-wing publication spiked because in it she dared suggest that, in the U.S., tax cuts decreased government revenues.

The cynical explanation for the persistence of the supply-side dogma is that it’s simply cover for cutting taxes for the rich. But the supply-side orthodoxy has flourished for other reasons, too. To begin with, the absurd idea that tax cuts pay for themselves is based on an idea that is not at all absurd, which is that tax rates can have an impact on people’s behavior. Increase taxes too much, and people may work less (since they get to keep less of the income they earn) and invest less (since their gains will be taxed more heavily), and so the economy will grow more slowly. The opposite can happen if you cut taxes. (How much of an impact tax rates have—and how high taxes have to get before they have an impact—is a subject of much debate in economics, but it’s inarguable that they do matter.) What supply-siders have done is start with that reasonable idea and extrapolate it to unreasonable lengths.
Given all this how would Mr. Surowiecki respond to Robert Lucas's recent remarks on the benefits of the Reagan tax cuts?
In the past 50 years, there have been two macroeconomic policy changes in the United States that have really mattered. One of these was the supply-side reduction in marginal tax rates, initiated after Ronald Reagan was elected president in 1980 and continued and extended during the current administration. The other was the advent of "inflation targeting," which is the term I prefer for a monetary policy focused on inflation-control to the exclusion of other objectives. As a result of these changes, steady GDP growth, low unemployment rates and low inflation rates -- once thought to be an impossible combination -- have been a reality in the U.S. for more than 20 years.

Both of these reforms work, in part, because they stabilize people's expectations about aspects of the future. The supply side tax cuts, in contrast to Keynesian on-again-off-again temporary tax cuts, are designed to be in place over the long run, and help to assure us that the returns to today's hard work and savings will not be taxed away tomorrow. Inflation targeting is a commitment that no matter what unpredictable shocks the economy is subjected to, the Fed will do what is needed to restore a fixed, target inflation rate and so maintain a "nominal anchor" to expectations.
If tax policies weren't responsible for the long boom, what are Suroweicki and Chait's explanations? Technology? Infrastructure? The Peace Dividend garnished by 1991's Iraqi Desert Storm? I don't know. But what I'd like to know from Suroweicki an answer to the following question: Is Robert Lucas a wingnut?

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