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Saturday, May 12, 2007

Did Tax Cuts Fuel Economic Growth?

Did the tax cuts in 2001 and 2003 stimulate economic growth?

Pop Quiz: Did the Tax Cuts Bolster Growth?, by Daniel Altman, NY Times: Politicians from the president on down have lately been saying that the tax cuts passed in 2001 and 2003 were responsible for the quick growth of the economy starting in mid-2003. That growth has since tapered, but ... it’s worth asking — are they right?

I decided to pose that question to a large group of mainstream economists through an informal survey. The answer, in a nutshell, was no.... But there was a lot more to the story. ...

Last week, I sent e-mail messages to the 177 members of the National Bureau of Economic Research’s program on economic fluctuations and growth. ... The e-mail message had just one question:

“Which factor was most important for the economy’s growth from mid-2003 through the end of 2006?” It offered the economists five possible responses:

a. The tax cuts signed by President George W. Bush.
b. Pent-up demand following the recession, the corporate scandals and the invasion of Iraq.
c. Both (a) and (b) were important.
d. Neither (a) nor (b) was important; it was the regular business cycle.
e. There’s no way to tell now.

...Forty-nine economists responded to my message, including many of the best-known names in the field. Of these, only five, about 10 percent, said that the tax cuts were the most important factor in the economy’s growth.

Two were Nobel laureates known for their conservative views — Robert E. Lucas Jr. of the University of Chicago and Edward C. Prescott of Arizona State University. Two other professors, Martin S. Feldstein of Harvard and Gary D. Hansen of the University of California, Los Angeles, qualified their answers by mentioning other factors. ...

But the majority, 30 economists, answered neither or supplied an answer not listed. Robert E. Hall of Stanford wrote that “the U.S. economy recovered from every single recession it ever had, so the growth in 2003-2006 was generally part of the normal cyclical recovery.”

Several economists volunteered other factors, among which monetary policy was the most popular. “I can’t believe you left off the list: superlow interest rates caused by the Federal Reserve,” wrote Alan S. Blinder, a Princeton professor... Paul M. Romer of Stanford echoed Professor Blinder’s sentiments.

Robert J. Gordon of Northwestern University added: “I hope others tell you that your question is absurd, because it leaves out ... an unprecedented period of negative short-run interest rates...”

Some professors were just as adamant in ... arguing that changes in productivity had been responsible for the economy’s growth. “Productivity growth and financial innovation are the big stories of the 2000s,” said Kenneth S. Rogoff of Harvard. ... Erik Hurst of the University of Chicago said that “aside from the inventory correction in 2001, the growth in 2003-2006 was not that different than 1996-2000 (which had nothing to do with tax cuts or pent-up demand).”

And one economist said that most of the factors named, with the exception of the tax cuts, were part of the usual behavior that followed recessions. “Pent-up demand following a recession sounds like the regular business cycle,” wrote Robert J. Shiller of Yale. “Also, part of the regular business cycle is the Fed and the behavior of speculative markets.” ...

[M]ost of the respondents were unconvinced by the politicians’ claims about the benefits of tax cuts. In fact, one actually argued that the tax cuts hurt the economy. “The tax cuts, by increasing uncertainty about how impending fiscal imbalances will be resolved, probably hurt growth, if anything,” said Christopher A. Sims of Princeton. ...

A similarly contrary argument was suggested by Lee E. Ohanian of U.C.L.A. concerning the war in Iraq. “Large increases in military expenditures are almost always associated with rapid growth ..., but the size of the Iraqi conflict spending is quite small as a fraction of total income.”

Economics is not an exact science, even in hindsight. Indeed, economists rarely say that they’ve proved an empirical hypothesis. Rather, they say that a hypothesis can’t be ruled out. In that spirit, several answered that there was no way to say for sure which factors had caused the economy to grow. ...

I'm not sure whether those who believe the evidence supports the tax cut story are more or less inclined to answer an email survey, so I don't know in what direction the proportions might be tilted. But this seems to me to be a fair representation of the opinion among macroeconomists about the causes of economic growth in recent years, and the quotes are from economists well worth listening to.

    Posted by on Saturday, May 12, 2007 at 04:59 PM in Economics, Taxes | Permalink  TrackBack (0)  Comments (16)

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