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Friday, May 19, 2006

Did the Bush Tax Cuts Increase Economic Growth?

Paul Krugman answers a question about the Bush tax cuts in Money Talks: Economy No Longer Defying Gravity. The question is based upon his latest column:

Alan Gertler, Reno, Nev.: I'm a scientist, not an economist, so I'm fairly naive when it comes to what drives the economy. My question is this: Have the tax cuts stimulated the economy as claimed (which I don't believe given the past cases of Reagan and Bush senior), or has it been the willingness of the government to continue massive spending by increasing our debt that has led to the growth of the economy?

Paul Krugman: It's actually neither. About the Bush tax cuts: the tax cuts of 2001 evidently didn't do the job; these days, the Bush people talk about the economy as if history began in the middle of 2003, after their SECOND wave of tax cuts.

But while the economy did start growing, finally, in 2003, the growth wasn't at all of the form you'd expect if tax cuts were responsible. The main tax cuts were on dividends and capital gains; supposedly this would make it easier for businesses to raise funds and invest. But business investment hasn't been the main driver of growth; in fact, businesses have been sitting on huge piles of earnings, reluctant to invest. Instead, the big driver was housing construction and consumer spending.

So what really happened? Low interest rates led to a housing boom that eventually turned into a housing bubble. High house prices made people feel richer, and they could borrow against the increased value of their homes, feeding consumer spending. Tax cuts had nothing to do with it.

That's a good, and often overlooked point about business investment after the tax cuts.

Update: The legislation for the 2003 tax cuts was signed on May 28, 2003. The vertical line in the following graph showing real non-residential fixed investment goes through the data point for the third quarter of 2003 (data):


    Posted by on Friday, May 19, 2006 at 01:55 PM in Economics, Policy, Taxes | Permalink  TrackBack (0)  Comments (41)


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