A commenter at the blog, argued that Friedman's theory of tax cuts putting downward pressure on spending, failed in real life.
"rwe" responds
Margalis, the budget deficit as a percentage of GDP is only 2.4%, by no means an abnormally high level. In fact it is slightly less than it was 30 years ago--in 1978 the deficit was 2.7% of GDP. In that time we've has substantial tax cuts, first under Reagan and then under Bush. So the fact that the deficit has not increased means that expenditure has tracked revenue fairly closely over time. If you run a regression of expenditure on revenue over time you'll see that this is true.
Friedman's argument was that when the deficit starts to approach a high enough level (perhaps around 5% of GDP), it puts serious constraints on the ability of the Congress to increase expenditures. The pressure for spending restraint increases significantly. And that is indeed what has happened. Friedman has been proven correct.
Actually, though, what matters much more than the level of the deficit is the overall level of spending. In his famous cross-country growth regressions Robert Barro found some time ago that increases in government spending have a significant negative impact on economic growth.
Whether we finance our spending with taxes or borrowing is of secondary importance. Government borrowing tends to raise real interest rates somewhat, which dampens investment. But high taxes cause large deadweight losses, and it isn't at all clear a priori that the deficits cause more damage than tax increases. The capital gains tax increases Barak Obama proposes would be especially destructive.
The surest way to enhance long-run growth would be to cut taxes and spending. This would enhance incentives, eliminate deadweight losses and encourage saving and investment. And John McCain is much more likely to bring taxes and spending down than his Democratic rival.
Now if you can explain to me why I am wrong, I'll be happy to consider your arguments and your evidence. And of course, I'll be very interested to see what sort of result you got from your regression of expenditures on revenues.
Posted by rwe | April 23, 2008 2:06 AM
meganmcardle.theatlantic.com
Margalis, my friend, where are you? I'm still waiting for your proof. Or perhaps you've realized that you were wrong--that, in truth, government revenues do determine government spending over time.
Regardless, those interested in understanding better why McCain's economic policy of cutting taxes and spending would be better for the economy than Obama's policy of increasing taxes and spending might want to read the following from Robert Barro of Harvard (excerpted from his Business Week column in 2004):
"The main costs and benefits from the government's budget come from how much is spent -- whether on defense, roads, courts, health care, welfare, or pensions... The important point is that this debate involves levels of spending, not the budget deficit. Government outlays must be financed by taxes, and the economy performs better if the distortions from taxes are small. Examples of distortion are the negative effect of tax on work effort and investment and the time required to comply with tax laws. Taxes that distort the most are those with high marginal rates and those that fall on income from capital. HIGH MARGINAL TAX RATES ARE BAD, since they discourage effort, capital formation, and innovation... The tax reforms of the 1980s wisely cut marginal rates, and the 2003 tax law returned to this theme. Taxes on capital income -- such as the corporate income tax or taxes on dividends, interest, capital gains, and estates -- are harmful because they tax savings. These taxes motivate people to consume more today and less tomorrow. The 2003 cut on dividend tax helped reduce the rate on capital income. The federal income tax is not efficient: Marginal rates are high, and capital income is taxed... The government must decide how to tax and when to tax. By running a deficit, it shifts from collecting taxes today to collecting them tomorrow. Because a deficit does not change the total collected (in present value), there is a sense in which the deficit does not matter... The Reagan policies added a new dimension to the theory. Reagan wanted a smaller government, but he was initially more successful at halting the growth of taxes than at stopping the growth of spending. Budget deficits resulted, and the ratio of public debt to gross domestic product increased. Eventually, deficits and debt exerted enough pressure on Congress to curb spending. After trending up from the 1950s to the early '80s, the ratio of federal spending to GDP declined through the '90s. This pattern is clearest for spending outside of defense and interest. Thus, Reagan's method for curtailing government worked."
So we ought to cut taxes, cut sepnding and let the natural dynamic forces of the free market spur competition, innovation and growth. Whatever his failings, McCain is certainly friendlier to free trade and free markets than Obama, and is therefore more likely to implement policies that reduce inefficiencies and remove government obstacles to growth.
Posted by rwe | April 23, 2008 12:00 PM
meganmcardle.theatlantic.com |
