Tax Cuts

TAX CUTS….Conservative economists have long argued that when we consider the impact of tax cuts, we should score them “dynamically.” That is, since they believe that tax cuts stimulate economic growth, our estimates need to include not just the lost revenue from reducing the tax rate, but also the increased revenue caused by having a bigger economic pie to get our taxes from.

Brad DeLong is skeptical about this, and one of the reasons is that dynamic models assume that tax cuts are also accompanied by revenue cuts. That’s obviously not the position of the modern Republican party, so to assess the dynamic potential of the Bush tax cuts we have to consider three possibilities:

  1. Recognize that there is a chance that the tax cut will be reversed. Perhaps once again, as in the early 1990s, an unwillingness to cut spending combined with mounting debt and debt servicing costs changes the complexion of politics. I would have said that the chances of this are high given the 7% of GDP long-run fiscal deficit that America appears to have, and the unwillingness of any politician to propose cuts in the growth rates of Medicare and Social Security spending. But the chances of this have dropped since Kerry reached his peak bubble value of 80% on the Iowa Electronic Markets Tuesday afternoon.

  2. Recognize that there is a chance that there will be a long period of rising debt and debt burdens accompanied by cutbacks in spending shares as various institutional mechanisms force the legislature to face and try to meet the government budget constraint. We know what George W. Bush thinks of the pay-as-you-go mechanisms that restrained Congressional action so effectively in the 1990s: he thinks they are a joke: “You know what pay-go means? It means you pay–and [Kerry] goes and spends!” I would say that the chances of this have also dropped since Tuesday afternoon.

  3. Last, there is the remaining possibility: that the government budget constraint itself will take its own non-policy steps to make sure that it is met, and generate an Argentina-style meltdown. By the principle that probabilities sum to one, I conclude that the chances of this have risen since Tuesday afternoon.

In other words: Maybe taxes will go back up. Maybe spending will be reined in. Or maybe the economy will melt down. But one way or another the numbers will (eventually) add up.

So, since George Bush seems hellbent against raising taxes, and no president or Congress in modern history ? and most certainly not this one ? has shown any sustained interest in reducing spending, that means the odds of the United States turning into a mini-Argentina have risen now that Bush has won reelection. That’s a sobering thought for liberal hawks who voted for Bush because they figured his domestic policies, bad as they were, could always be reversed four years from now without too much harm being done to the country in the meantime. I sure hope they turn out to be right.