[Paleopsych] Economist: (Laffer) The budget deficit: Cocktail-bar calculations

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The budget deficit: Cocktail-bar calculations
http://www.economist.com/World/na/PrinterFriendly.cfm?Story_ID=4299097
5.8.18

    Are George Bush's tax cuts paying for themselves?

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    NOT many economists find fame in a cocktail lounge. But it was in just
    such a venue that Arthur Laffer in 1974 drew the "Laffer curve" on the
    back of a convenient napkin. The sketch, still more popular with
    politicians than economists, illustrated how lower tax rates, by
    spurring growth, might leave tax revenues undiminished. Tax cuts might
    pay for themselves.

    None of the weighty studies produced by the Congressional Budget
    Office (CBO) would fit on the back of a napkin. But the latest
    projections from the legislature's non-partisan budget-watcher have
    excited a few of Mr Laffer's fans. The federal budget deficit, the CBO
    reckons, will narrow to $331 billion this fiscal year (which ends on
    September 30th), from $412 billion the year before. Tom DeLay, the
    Republican majority leader in the House of Representatives, was quick
    to offer a Laffer-like explanation: "Lower taxes and spending
    discipline spur economic growth, which in turn cuts the deficit," he
    opined.

    In fact, spending discipline is still rather lacking. Government
    outlays will increase by $181 billion (or 8%) this year, a figure that
    does not include the cost of the pork-stuffed highway bill, signed by
    the president on August 10th. The fall in the deficit owes rather more
    to the other side of the ledger: tax revenues are set to grow by $262
    billion, or 14% this year. They will increase as a share of GDP for
    the first time under this tax-cutting president.

    Income taxes withheld from pay cheques account for some of the new
    revenues, but many of the gains are in more exotic areas. The
    government's take from such things as capital gains, payouts from
    pension funds, and "sole proprietorships" (one-man companies) should
    increase by 28% this year, the CBO reckons. Corporations are also
    making a strikingly handsome contribution to the state's coffers,
    paying $80 billion (or fully 42%) more than the year before. A third
    of this bounty seems to be due to the demise of a corporate tax break,
    which allowed firms to deduct up to half their investment costs from
    their taxable profits last year. But some $53 billion of it caught the
    CBO unawares, and remains unexplained.

    Is Mr DeLay right to attribute any of these gains to the seductive
    curves of supply-side economics? In December, Gregory Mankiw, who used
    to be chairman of Mr Bush's Council of Economic Advisers, and Matthew
    Weinzierl, a colleague at Harvard University, published a
    "back-of-the-envelope guide" to tax rates and revenues. Given the
    relatively low tax rates prevailing in America, they thought that tax
    cuts could not be entirely self-financing. But by their reckoning
    cutting taxes on labour would generate enough growth to recoup about
    17 cents on the dollar, and a tax cut on capital could pay for more
    than half of itself. The government would take a thinner slice of a
    bigger pie.

    Left out of these calculations is any guide to what happens when taxes
    are cut but spending is not. The budget deficits that ensue will tend
    to "crowd out" investment, slowing growth. The CBO calculates that
    every extra dollar of federal borrowing reduces investment in the
    economy by 36 cents.

    The White House, according to its latest forecast in July, now expects
    to leave a deficit of $162 billion by the time the president leaves
    office in 2009. But it assumes (absurdly) that Congress will not add a
    single dollar to its discretionary spending on anything except defence
    and homeland security from 2006 to 2010. It also leaves out of its
    projections any extra money for Iraq, Afghanistan or the war on
    terror.

    The CBO makes the opposite assumption. It assumes that by 2009, all of
    these missions will remain far from accomplished, costing the American
    taxpayer the same amount, in real terms, as they do today. Partly as a
    result, the CBO shows Mr Bush bequeathing a deficit of $321 billion to
    his successor.

    Though the CBO's outlook is substantially worse than the White House's
    over a five-year horizon, it improves dramatically over ten years.
    This is not because of some long-run Laffer curve; but because the CBO
    assumes that Mr Bush's tax cuts will expire, as scheduled (the bulk of
    them in December 2010). That looks extremely unlikely: no politician
    would allow it and Mr Bush is already trying to make them permanent.
    If that happens, it would add $349 billion to the deficit in 2015,
    plus an extra $83 billion in debt service costs.

    The CBO's job, says Douglas Holtz-Eakin, its director, is to forecast
    the economy and the budget, not Congress. It is required by law to
    assume that Congress will carry on doing what it currently does,
    adjusted only for inflation. "Everything we have presented today is
    going to be wrong," he confidently predicted as he unveiled his
    report. The same, of course, could be said of Mr Bush's projections.

References

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