Paul Krugman: The Bush Tax Cuts and the Deficit

Much has been written here and elsewhere (here too) regarding the Bush tax cuts and the deficit. Many claim that the tax cuts didn't increase the deficit. Instead, the claim is that the tax cuts increased economic growth enough to bring about an increase in tax revenues and reduce the deficit. Let's see if Paul Krugman can help. Is there any evidence out there that can help to convince us one way or the other? Are tax cuts the answer to the deficit problem?

The Bush Tax Cuts and the Deficit, Paul Krugman, Money Talks, NY Times: ...Here are two pictures that may help show why claims that the tax cuts were good for the deficit are wrong. Chart 1 shows federal receipts as a percentage of ... G.D.P.... These receipts plunged starting in 2001, then made a partial – but only partial – recovery over the past year. It’s useful to bear in mind that estimates of the size of the Bush tax cuts put them at about 2 percent of G.D.P. The actual fall in revenue as a share of G.D.P. was much larger ... Even now, revenue is about 3 percent of G.D.P. below its peak...

So revenue as a share of GDP fell after the tax cuts? Why did that happen?

The most likely answer is that by the end of the 1990’s revenues were inflated by the stock market bubble ... When the bubble burst, revenue fell off. ... Back in 2001 ... I argued that predictions of big future surpluses, which were used to justify those [tax] cuts, were wrong – and one reason I gave was that federal revenues were inflated by the stock bubble, and would soon fall.

That explains the past, but the news stories on the deficit are about the present. What's been going on with revenues recently? Why have they been increasing?

Data from the Congressional Budget Office show that ... the revenue surge came from two places, profits taxes and “nonwithheld” income taxes. Profit taxes surged partly because profits themselves surged – this has been an economic recovery in which real wages for most workers have actually gone down, so that profits have gathered the lion’s share of the gains – but also because a temporary tax break instituted in 2002 expired. We don’t know for sure why nonwithheld income taxes surged, but the best guess is that it reflects a bounce in stock prices during 2003-4 and, probably, a bubble in housing. Both are one-time events...

I'm not convinced yet. Here's why. Suppose taxes are cut and GDP growth goes up by, say, 3%, and because of the robust growth in GDP suppose that taxes increase by 2%. Then wouldn't taxes as a percentage of GDP fall? Doesn't that undercut your argument above which relies upon the taxes as a percentage of GDP falling as a sign of falling revenues?

Well, no. ... [E]ven now real G.D.P. is considerably lower than most people thought it would be ... Chart 2 shows, for each quarter since the beginning of 2000, the average growth rate of real G.D.P. over the previous five years. At the end of the 1990’s, people thought that the economy would grow at ... more than 3 percent a year. In fact, economic growth since 2000 has averaged only about 2.5 percent... The bottom line is that there is nothing in the data to suggest that the Bush tax cuts have had a favorable effect on the budget deficit.

Then why are the claims that tax cuts reduced the deficit by increasing revenue so widespread?

The answer, of course, is that wiggle at the end of the line in Chart 1. Revenue is still low by historical standards, but it’s not as low as it was last year. And as a result, the budget deficit actually came down in fiscal 2005, albeit to a level that would have seemed shockingly high a few years ago...

But isn't that better? Shouldn't we be cheering the recent upswing in revenue?

Well, put it this way: if a student gets a D after a string of F’s, his performance has improved – but that doesn’t put him at the top of the class.

Given this and other evidence suggesting the same thing, I'm convinced.

Comments

[dryfly]

Then why are the claims that tax cuts reduced the deficit by increasing revenue so widespread? The answer, of course, is that wiggle at the end of the line...

Wrong answer... the reason the claims are so widespread is SELF INTEREST... most of the folks who are spreading the claim & making it so wide spread have a VESTED INTEREST in keeping taxes low... so they say all kinds of things like 'the deficit is getting smaller'... 'revenues are up'... 'the economy is improving'... and the best of all is 'deficits don't matter'.

But reality is they couldn't give a rats ass about the deficit as long as they hang on to their pile... after all they are safe behind their gated walls... so they think.

[Anon]

The American Jobs Creation Act of 2004 (was titled American Jobs Creation and Give Everyone a Pony Act, but name was changed in committee) allows corporations to repatriate the profits they have shifted overseas in recent years at a special low rate of 5.25% - that's right, not 35%, 5.25%.

So basically, a huge collectable pile of tax money has just been given away to corporations that were dodging the tax laws in the first place with gimmicky accounting.

Billions of dollars just got shifted back to U.S. firms. The U.S. government skimmed 5.25% instead of 35%. Of course this gives a massive boost, *this year only*, in corporate tax revenue, showing that tax revenues aren't that bad, the deficit isn't that bad, yadda-yadda-yadda. But it's all bullshit. This is a one-time collection. Next year: nothing. It's not a trend of anything.

I can't read Krugman anymore since the NYT is now charging, but hopefully he made this point in his column. Anyone using a one-time event to declare a trend is a propagandist or an idiot.

[gary lammert]

The Bush tax cuts, the Federal Reserve's lowering of fed fund rates to one percent,
and new lending practices such as interest only repayable loans feeding the housing bubble with further credit expansion via second mortgages, fueled an echo fractal equity growth series that is still over two trillion dollars less than its composite high in March 2000....

From the 23 October 2005 Economic Fractalist....

Google's Telltale EEG (Exclamation Exhaustion Gap) Spike Near
The Very End Of The Composite Market Second Decay Fractal

It is fitting that the current three year 30/75/60 weekly
fractal growth series, echoing in a smaller valuation manner, the
great fractal progression from October 1998 to March 2000's
sixty-eight year Wilshire high should end with an exhaustion gap of Google, the dominant high tech software company.

The exhaustion upped Google's PE ratio from 74 to 75. Google is a remarkable reference source. However, its collective innovations and the real utilities of those innovations for the global economy, like so much of the earlier tech stocks, are probably overestimated and overvalued. Its PE ratio of 75 with linear projections for even greater PE ratios and a technically very telling exhaustion gap to new highs this last Friday occurred in the setting of a lower high and saturated current composite market. This is an aged and decrepit market that is already near the end of its second decay fractal and
one that is being propelled by the afterburners and nearly exhausted fumes that represent the present historically cash poor mutual funds.

This set of circumstances should be Deja Vu satori for those
individuals and mutual fund managers who suffered 50 percent loses in the 2000 high PE high tech market. In 2000 alone Yahoo lost over 90 percent of its market value in 12 trading months.

The Wilshire 5000 equity valuation is ultimately and primarily fueled by the debt creation of the American consumer who in turn is dependent on American wages. The Wilshire remains the global bell weather equity composite index. The total cumulative value of the rest of the world equities roughly equals the value of the Wilshire 5000. The elusive but solvable solution for the Wilshire's primary fractal decay pattern will retrospectively be very simple. While the macroeconomy is complex, the summation equity valuation product and patterns are not. Equity valuations grow and decay and otherwise generally 'travel' in non complex maximally efficient fractals.

In the 1929 primary devolution, the DJIA first fractal decay base of 11 days was determined by a preceding rising base sequence of 4 plus days. The 1929 high was contained in the second decay fractal of 27 days, which was then followed by an additional third decay fractal of 27 days in the three fractal decay pattern of x/2.5x/2.5x: 11/27/27 days. For the primary 2005 devolution the first fractal decay base appears to follow a 9 day plus rising antecedent base. Inductively and extrapolating from the 1929 data, albeit with a single pattern for
extrapolation, a 23-24 day fractal sequence including the 3 August high appears to be the defining first fractal base of what will likely be an efficient nonlinear equity asset destructive devolution that will echo the 1858-1932 Second Grand Fractal first sub fractal.

The market equity valuations will grow only as long as growing money or credit is available for its support. At equity top saturation asymptotes smart money exits the equities and flows into debt instruments driving down interest rates. The debt market likewise travels in rather precise growth and decay fractals as investors, during a growth cycle compete and bid the instruments up, driving interest rates lower, and, thereafter, either exit the debt market or invest less when the interest rates are too low relative to other investment opportunities. This drives interest rates higher. In this way the debt market competes with the equity market for available money.

Friday 21 October 2005 was a generally unrecognized turning point for the composite Wilshire. Aside from Google's telltale exhaustion gap, two other important fractal developments occurred. The first was a completion of a 9/22-23/22-23 hourly maximal growth fractal: x/2.5x/2.5x for the Wilshire. Qualitative technicians and chartists would recognize this as a wedge formation. Even in a primary decay pattern there is integration of available money into elegant maximal growth growth fractals with small time units.

The other telltale occurrence was the completion of a three phase growth fractal for the ten year note TNX and 30 year bond TYX. The daily debt market growth fractal count is 18-19/47-48/36-37. On Friday 21 October investors actively competed for bonds and notes and money flowed into TNX and TYX, lowering interest rates. This money at least in part flowed from the cash strapped equity money pool. Compare the debt market's TNX and TYX valuation pattern from December
1996- October1998 with a superimposed and nearly identical sequence from June 2003 until present. Similar nodal patterns of money flows between debt and equities are repeating. Examine the fractal nodal low points dating from December 1996 going into October 1998. The last few months before October 1998 money rapidly exited equities and entered the debt market - dramatically lowering interest rates. That same dramatic pre October 1998 money exit from equities and flow into
debt instruments will either be starting in a few days ... or already began on 21 October.

The primary low is anticipated in about 40-55 trading days consistent with previous estimations. The current best estimation for the primary decay fractal pattern starts on July 7, 2005 for a 23-24/54 of 57-59/57-59 day sequence. The current pattern rhymes with the 1929 scenario. Using the simplest scenario, the primary low would occur in 4-5 plus 58 days or about 61-62 days. However, the terminal portion of the third and last 58-59 decay day fractal sequence is expected to form a base for the next sequence in a probable multimonthly growth sequence that will result in a cascading series of growth fractals with lower highs and ending in lower lows. With regards to the primary devolution a Fibonacci relationship with the 23-24 day first fractal base beginning 7 July 2000 would result in a
primary low in 37-40 days of this final 58 day decay sequence.
The minimal time interval to a primary low using the Fibonacci relationship would be 4-5 more days (54 of 58-59) plus 37 days equalling 40 days subtracting one day for double counting. A lower low is possible within the final 22 days of the 37 of 58 day final decay fractal sequence.

The current best estimation of the inverse grow of decay fractal is 15 of 15/ 38/ 15-24.

Expect nonlinearity of historical proportions. Gary Lammert
http://www.economicfractalist.com/

[anne]

Anon,

Mark has analyzed each column by Paul Krugman since the NYTimes began the Select service, and Brad DeLong has echoed :)

[anne]

http://www.calvorn.com/gallery/photo.php?photo=5753&u=99|2|...

Black-throated Blue Warbler (male)
New York City--Central Park, Lower Lobe.

Remember, this is fall migration :)

[anne]

http://www.calvorn.com/gallery/photo.php?photo=5735&u=4|9|...

Wilson's Warbler
New York City--Central Park, Lower Lobe.

Yes, they do warble....

[anne]

http://www.nytimes.com/2005/10/23/national/23PATIENT.html?ex=1287720000&en=c27be5e05268c0fd&ei=5090&partner=rssuserland&emc=rss

October 23, 2005

When Even Health Insurance Is No Safeguard
By JOHN LELAND

CAMBY, Ind. - Until the fourth trip to the hospital in 1998, Zachery Dorsett's parents thought their son was an average child who was having trouble getting over a passing illness. He was 7 months old, and it was his second case of pneumonia.

The Dorsetts, Sharon and Arnold, were concerned about Zachery's health, but they were not worried about the financial consequences. They were a young, middle-income couple, with health insurance that covered 90 percent of doctors' bills and most of the costs of prescription drugs.

Then the bills started coming in. After a week in the hospital, the couple's share came to $1,100 - not catastrophic, but more than their small savings. They enrolled in a 90-day payment plan with the hospital and struggled to make the monthly installments of nearly $400, hoping that they did not hit any other expenses.

But Zachery, who was eventually found to have an immune system disorder, kept getting sick, and the expense of his treatment - fees for tests, hospitalizations, medicine - kept mounting, eventually costing the family $12,000 to $20,000 a year. Earlier this year, the Dorsetts stopped making mortgage payments on their ranch house, in a subdivision outside Indianapolis, because they could not afford them. In March, they filed for bankruptcy.

"Zach was really mad at us when we told him we were going to lose the house," Mrs. Dorsett said. "We told him we had to make a choice: whether to pay for medical bills or the house."

She added: "I didn't want the kids to hate their father for working all the time, but I also didn't want them to think we were irresponsible. I was worried about Zach feeling guilty or his sister blaming him that she has to leave her friends. But whatever we gave up is a small price to pay for his health."

Never have patients had so many medical options to extend, enrich or alter their lives. But these new options are expensive, and with them has come a change for which many Americans - even those with health insurance - are financially ill prepared.

After decades in which private and government insurance covered a progressively larger share of medical expenses, insurance companies are now shifting more costs to consumers, in the form of much higher deductibles, co-payments or premiums. At the same time, Americans are saving less and carrying higher levels of household debt, and even insured families are exposed to medical expenses that did not exist a decade ago. Many, like the Dorsetts, do not realize how vulnerable they are until the bills arrive.

Lawyers and accountants say that for the more than 1.5 million American families who filed for bankruptcy protection last year, the most common causes were job loss and medical expenses. New bankruptcy legislation, which went into effect Oct. 17, requires middle-income debtors to repay a greater share of their debt.

The Fight for Solvency

The Dorsetts' filing came after years of accumulating relatively modest bills, often just co-payments on doctor visits or prescriptions. Almost since Zachery's birth, they had finished each year with more credit card debt than they had the year before. Even when they took out a second mortgage to pay off their credit cards, by the end of the year they were in debt again, with higher mortgage payments. And each year, their projected expenses were greater.

On a late summer morning, Mrs. Dorsett, now 32, sat with her son in Room 4013 at St. Vincent Children's Hospital in Indianapolis as a colorless infusion of immune globulin, a treatment made from blood plasma, dripped slowly into his left arm, supplying the antibodies that his immune system does not produce.

The monthly infusion, which has become a regular part of his childhood along with soccer practice and family camping trips, costs $54,000 a year, of which the Dorsetts will pay more than $5,000.

"My friends don't understand it," Mrs. Dorsett said, looking back at the family's relentless, inevitable process of insolvency. "They think, How could it get so bad so quick? Unless you have a sick kid, you don't know what it's like." ...

[Movie Guy]

Gary Lammert,

You're using more conversational language. Good. I understood most of your post.

1929, eh? Uh, oh. Is Jan 06 still the brick wall?

How does someone send you an email?

[calmo]

"Then why are the claims that tax cuts reduced the deficit by increasing revenue so widespread?"

I like dryfly's explanation: they'll say anything to keep their stash. Liars.
And pinheads.

Ok, and I thought anony's mention of the repatriotization of taxes on foreign earnings was timely, given the refusal to bump up the legal slave wage from $5.25/hr [or whatever miserable level it is --only been lower twice in the last 46 yrs]
But these guys (pk and mt) don't forget stuff like that. Do they?
[eg it was collected this year for many years in the past and so it might just register in those years not this one.]

I am cheered on by most here who think that 'D' is still too high. Those that think otherwise are too generous.
It may be the wiggle at the end of the line (03 onwards IIRC) when real estate values put a significant bulge in the GDP; making the normalized ratio Revenue/GDP...abnormal.
The deficit decreases because of a temporary revenue windfall from the housing market (as per PK). (Someone could look at the revenues collected ex personal capital gains and confirm this or they could wait till next year when these personal capital gains might look quite different and tax revenues alot worse.)

Ok Gary, don't get the idea that I'm condoning your dismissal of the concise post. [I can be led astray, but not to typepad limit.]

Last thing, engaging Mark's response WITH CAPITALS:

"I'm not convinced yet. Here's why. Suppose taxes are cut and GDP growth goes up by, say, 3% [THE OFFICIAL NUMBER IS 3.5% AND SOME BELIEVE IT] and because of the robust growth in GDP suppose that taxes increase by 2%. [SO REASONABLE] Then wouldn't taxes as a percentage of GDP fall? [WITH THOSE NUMBERS MAYBE, BUT THIS RELIES ON GDP, THE DENOMINATOR, BEING WELL BEHAVED] Doesn't that undercut your argument above which relies upon [IMPLIES? ASSUMES?] the taxes as a percentage of GDP falling as a sign of falling revenues?" [I THINK IT IS THE SLIPPERY GDP STAT]

If we play with some unreasonable numbers, maybe this becomes more clear (only for me maybe). Due to housing, tax revenues double. GDP records this growth, but because there other relatively under-performing industries (imagine that!), it only gains 10%. Tax revenue/GDP gains in this instance.
Next year housing values drop and tax revenue falls by 10%. GDP falls too but because a surprising amount of industries are connected to housing, GDP falls 20%. Tax revenue/GDP gains in this instance.

[ilsm]

Krugman wrote that tax cuts resulted in tax revenues declining as a percent of GDP.

This is opposite what the Laffer curve predicts. Laffer was a political hack whom the Reagan folks passed off as an economist.

Krugman also noted that the expected GDP gains and surpluses used to justify the cuts never came about. GDP since 2000 has grown 2.5 to 3% annually; they forecasted 5 to 6 % which was driven down by dot com and telecom bubbles bursting. Nominal GDP may have grown by 5 % but adjust for the reality of inflation and it is weak.

Aside from the busts, excess demand not covered by wages which fell rather than rose, Chinese, and third world labor garnered what domestic labor should have benefited from the stimulastive deficit and monetary actions.

The weak jobs creation, due to borrowing by the fed being satisified by Chinese slave labor facilitated by tying the Yuan to the dollar, mean income tax revenues from working people not benefited by the tax cuts did not go up.

The fed created huge numbers of dollars to cover the deficits, a credit glut met by the Chinese at the expense of the US economiy.

Yeah, our laboring class will sink to Pakistani levels.

[ob]

"Then wouldn't taxes as a percentage of GDP fall?"

I think that the answer is "No: By identity." But then, I'm 20 years out of Math.

GDP1 constant
GDP2 = GDP1 * gdp_growth_pct
TR1 constant
TR2 = TR1 * tr_growth_rate
TRPGDP1 = TR1/GDP1
TRPGDP2 = TR2/GDP2

Is there some gdp_growth_pct and tr_growth_rate : (gdp_growth_pct >
tr_growth_rate), such that TRGDP2 TRGPD2
TR1/GDP1 > TR2/GDP2
TR1/GDP1 > ( TR1 * tr_growth_rate ) ) / GDP1 * gdp_growth_pct
TR1/GDP1 > TR1/GDP1 * tr_growth_rate/gdp_growth_rate
1 > tr_growth_rate/gdp_growth_rate
gdp_growth_rate > tr_growth_rate