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Thursday, May 18, 2006

The Land of Make-Believe and False Comparisons

Bloomberg's John M. Berry looks at make believe and deception in the federal budget, and he catches the president and Senator Grassley making false comparisons while attempting to provide support for tax cuts:

Make-Believe, Deceit Are Behind Latest Tax-Cut, by John M. Berry, Commentary, Bloomberg: When Senator Jeff Bingaman stopped to get a cup of coffee on Capitol Hill..., he greeted a woman he knew, who replied, "Good Morning. Another beautiful day in the land of make believe." Later..., as the Senate debated the latest tax cut bill, the New Mexico Democrat observed, "...that sounds right."

Indeed. The official title of the bill, which President George W. Bush proudly signed..., is "The Tax Increase Prevention and Reconciliation Act of 2005." It cuts taxes by roughly $70 billion over the next 10 years. Nevertheless, Republican Senator Charles Grassley ... argued the legislation really only extends some parts of the tax code that have expired or would later. "So I don't want anybody to come over and say we are cutting taxes," Grassley said.

The new legislation is really a stop-gap measure that settles nothing for the longer term. Still, it reduces taxes significantly, and that's a tax cut except in the land of make believe. ... In another bit of make believe, the rates were set to expire in the first place because neither Bush nor a majority of the members of Congress was willing to own up to the amount of lost revenue if they were made permanent. ...

That type of deceit is still embedded in the new legislation for the same reason. .. all the other major tax cuts passed since Bush became president in 2001 will expire at the end of 2010, two years after he has left the White House. That is going to make fiscal policy a key issue for the presidential candidates of both parties. Are any of them going to tell the truth...?

Or are they going to pretend, as Bush and more than a few members of Congress have, that tax cuts pay for themselves...? That's what Bush strongly implied ... "You cut taxes and the tax revenues increase." "See, some people are going to say, well, you cut taxes, you're going to have less revenue," said Bush, setting up his straw man.

"No, that's not what happened. What happened was we cut taxes and in 2004, revenues increased 5.5 percent. And last year those revenues increased 14.5 percent... "And the reason why is cutting taxes caused the economy to grow, and as the economy grows there is more revenue..."

Notice the assumption that if taxes hadn't been cut, growth wouldn't have accelerated and revenue wouldn't have increased. Neither seems likely. In last week's debate, Grassley explicitly made that claim. "In the case of dividend and capital gains tax policy, the tax policy we adopted in 2003 is the reason we have created 5.2 million jobs,"...

That's ludicrous. ... There are lots of reasons why U.S. economic growth has been strong since 2003, including extremely low short-term interest rates put in place by the Federal Reserve. Nevertheless, Grassley said former Fed Chairman Alan Greenspan said that the 2003 tax policy "is responsible for the economic recovery we have had."

Greenspan approved of the lower rates on dividends and capital gains as a plus for growth. He never came close to saying that the lower rates were responsible for the economic recovery. Careless language on Grassley's part? No, just part of a long-running effort to deceive the American public.

With or without tax cuts, increases in government spending, or cuts in interest rates by the Fed, the economy will recover from a recession. Because simulative policies are generally put into place as economies go into recession, often near the trough of the recession, it's very likely that an observer will notice a recovery thereafter. Since the recovery follows the change in policy, it's easy to claim one caused the other whether or not causality actually exists.

To answer the question of how tax cuts affect tax revenues and the economy, you need to know how the economy would have behaved without the policy change, something that cannot be known with certainty. What we can do is use econometric techniques to assess what a typical recovery looks like and then assess how growth changes relative to the typical case when taxes are cut. When such exercises are performed carefully, the evidence that tax cuts increase tax revenue is hard to find (see Hamilton for some empirical evidence on this, Some Simple Fiscal Arithmetic for a simple numerical example, and PGL at Angry Bear for an intuitive description of the causality issue; in addition, see The Myth that Tax Cuts Pay for Themselves).

    Posted by on Thursday, May 18, 2006 at 01:53 AM in Budget Deficit, Economics, Policy, Politics | Permalink  TrackBack (0)  Comments (5)

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