Tuesday, April 20, 2004

Barro v. Krugman

Here is a transcript of a conversation between economist Robert Barro and New York Times columnist/Democrat loyality Paul Krugman. (Link via Marginal Revolution). It's easy to skim, so I recommend reading it all.

Some interesting points:
Paul Krugman: That's right. The tax rate on the top bracket and what we're finding is that if that moves back and forth between 28%-40% which is roughly the range we're talking about, it doesn't seem to matter very much for the economy.
Essentially, Krugman is arguing that labor, at high income levels, is very inelastic, so it does not matter so much what marginal rates are, the quantity supplied remains the same. Austin Goolsbee (U Chicago prof.) found similar results in a recent paper.

Second point:
Paul Krugman: First thing to say just whether or not you approve of the policies, there is the honesty thing. Whatever it was that this policy was supposed to accomplish, the actual salesmanship was spectacularly dishonest. First of all, it has to have been dishonest because they had three different reasons for the same tax cut, each one of which was, you know, excluded the others. And there's a lot of just plain lying about who gets the direct benefits. You can talk about the indirect benefits but these have been tax cuts whose direct benefits, the major tax cut goes to people with very high incomes, consistently sold as being middle class, populist tax cuts which they've never been. By the way, you say it was a temporary tax cut in 2001. Actually it was the opposite.
Personally, I don't think people can handle the truth. The truth is that tax cuts are a lousy way to deal with downturns in the business cycle because they take so long to move through the system and are permanent. Instead, tax reform should only be structural, and from this perspective, Bush's reduction of the marginal rates on capital appreciation has been a long time coming. There is a reason that high tax countries like Sweden tax labor, not capital, and it is because it is very inefficient to tax capital.

Secondly, as is mentioned later in the article, it is true that deficits are the only mechanism that currently exists which curtails government spending, so arguments over whether raising taxes will close the deficits are dumb because there is *always* more spending in the wings/constituents demanding to be paid off. Deficits are a poor tool to restrict spending because 1) they focus on the government's *cash* position, not its actual long term liquidity and 2) they are painful when they lead to higher interest rates. In the current shouting match, 1) has largely been lost (don't hold your breath for Krugman to say that social security and medicare are unaffordable even if Bush did not cut taxes), while we have been mercifully spared 2). A direct effect of people demanding the government "do something" at every crises is that the government needs to create "crises" in order to "do anything", and if a short term cash deficit enables a structural reform, so be it. Ugly, yes, but this is policy we're talking about, not sausage manufacturing, so strong stomachs are manditory. Unfortunately, Bush has not used the current deficit to cut medicare and/or social security benefits, which is, in all honesty, the only fiscal game in town.


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