Five Myths About the Bush Tax Cuts and the Scourge of Stimulus

In yesterday’s Washington Post, Brookings economist Bill Gale discusses these five myths about the tax cuts passed in 2001 and 2003:

1. Extending the tax cuts would be a good way to stimulate the economy.
2. Allowing the high-income tax cuts to expire would hurt small businesses.
3. Making the tax cuts permanent will lead to long-term growth.
4. The Bush tax cuts are the main cause of the budget deficit.
5. Continuing the tax cuts won’t doom the long-term fiscal picture; entitlements are the real problem.

I recommend the whole thing. You can look through nearly 6 years of my blogging and not find a single post in support of these tax cuts. Whatever is left of them should be allowed to expire, and Congress should make its tax policy changes in a deliberate fashion.

Of the five myths that Bill discusses, I continue to find the first to be the most frustrating. Here’s what Bill says about extending the tax cuts as a means of fiscal stimulus:

But a good stimulus policy can’t just be big; it should also offer a lot of bang for the buck. That is, each dollar of government spending or tax cuts should have the largest possible effect on the economy. According to the Congressional Budget Office and other authorities, extending all of the Bush tax cuts would have a small bang for the buck, the equivalent of a 10- to 40-cent increase in GDP for every dollar spent.

I don’t even think about tax policy in this way. I think the government should be only as large as it has to be to complete its essential functions. Given the required spending, taxes should be high enough to balance the budget over a business cycle. So I would never suggest a cut in tax rates without also suggesting a time frame over which the foregone revenue would be recouped.

In December 2008, I wrote:

If I had my druthers, the word “stimulus” would be expunged from public discussion, along with “bailout” and “rescue.” These words convey the idea that, because we have so mismanaged our economic and financial affairs, we are somehow able or entitled to conjure up additional funds out of thin air to fix our problems. There are two problems with this idea.

First, the purpose of government spending is to purchase goods and services that the government needs to meet its responsibilities, not to hand out resources to those who pandhandle most loudly for them. The reason to spend more in a recession is not to employ idle resources — it is to be able to stretch the taxpayers’ money further by getting a better price for its purchases because workers without jobs will work for less and owners of empty factories will charge less.

Second, there is no free lunch: the money we spend today is a loss to the Treasury, whether as “timely, temporary, and targeted” tax cuts that have no discernible impact; payments to delay bankruptcy for large, mismanaged entities, whether AIG or the Big 3; or the largest public works program since the interstate highway system. That loss to the Treasury must be made up at some future date, by later cohorts of taxpayers.

Fortunately, both of these problems can be overcome by focusing all new spending on investment rather than consumption and on public investment rather than private investment. By their nature, capital investments last for years or decades, so that there is a better chance that those who are paying for the spending are reaping its benefits. Public investment also meets the criterion that the spending goes for projects that are within the government’s responsibilities. Repairing roads today removes the need to repair them for a number of years. In 2005, the American Society of Civil Engineers released a report card in which it estimated that $1.6 trillion would be required over a five-year period to restore the nation’s physical infrastructure to good condition. If I had a target of $500 billion to spend, every dime would go for public infrastructure investments, and we’d still have quite a bit of work to do.

Shorter version: Buy what you need and only what you need. Given that we need trillions of dollars of public investment to meet the government’s essential functions, there is plenty of room for fiscal stimulus. Cutting taxes while leaving needs unmet makes no sense.