Not for Krugman:
Fuzzy thinking
Fuzzy Math: The Essential Guide to the Bush Tax Plan
Paul Krugman, W.W. Norton & Company, 2001, 112 pages.
reviewed by Edward Rombach
In his 1998 State of the Union address, President Clinton rhetorically asked Congress, “What should we do with this projected surplus? I have a simple four-word answer: Save Social Security first.” With this question, President Clinton set the terms of the current debate about the nation's retirement system. Since then the debate between Republicans and Democrats has recast itself in the throes of a recession with both parties now seeking to blame the other for the ever-shrinking surplus
Against this backdrop, Professor Paul Krugman of Princeton University and a columnist for the New York Times has emerged as the most vociferous press critic of President George W. Bush's fiscal policy. From these two precincts of power, Krugman has comforted those in Congress and the media who believe that good politics have trumped good economics.
His latest book “Fuzzy Math”, written during the 2000 presidential campaign and published in the early days of the new Bush administration is a short, easy-to-read primer on the political economy of our times. At the very least, Krugman does a decent job explaining federal revenues and expenditures for the great unwashed. However, this is about as objective as Krugman, the professor, gets in the entire book. What emerges is Krugman the polemicist.
Right from the outset, Krugman wastes no time attacking, as he always does, the notion of tax cutting as a fiscal policy tool. “Is the tax cut being proposed by George W. Bush a good idea? No. It is much too large, even given optimistic forecasts of future surpluses.” Having tipped his hand, Professor Krugman reassures the reader that his book “is not a diatribe.” If only it were so. Krugman cannot resist passing his data through an ideological filter – arguing that the Bush tax cuts are really nothing more than tax cuts for the rich.
Ironically, Krugman is disappointed the administration hasn't sold the tax cuts forthrightly. “So we have a remarkable scene: the administration, having committed itself to a plan that can be justified only in terms of supply-side ideology, never refers to that ideology in its efforts to sell the plan. We never hear the argument that tax cuts will produce an acceleration in the rate at which the economy's productive capacity grows.”
Kudos to Krugman! On this score he shares common ground with his philosophical opponents. For whatever its reasons, the timid Bush Administration failed to sell the tax cuts as a reputable supply-side solution. The argument was there to be made: Tax cuts are important, and remain so, because they provide the incentives for individuals to earn, save and invest enabling economic growth. Whether Krugman is facetious or not, the boldness of the pages from Reagan's playbook is worth copying. Krugman asks the same question supply-siders have asked: “If tax cuts are a good idea, why phase them in so slowly?” Why indeed?
Krugman's digression from this point is different because he never takes tax cuts seriously. In fact, he's willing to provide fodder for Jay Leno, the comedian: “...true believers in supply-side economics believe that they can make the boom continue by cutting taxes at the top. It's hard to see what in the evidence makes them believe that, but they do; call it faith-based economic policy.”
To Krugman, the politics of budget surpluses matter more than underlying economic issues. “Supply-siders believe in particular, that in proposing tax cuts we need not be worried about the effects of those cuts on the government's budget balance.”
What budget balance? The budget has been in a chronic surplus since 1998. The great story yet to be told has been that we have allowed the surplus to persist. Krugman ought to be reminded that government surpluses come at the expense of taxpayers. Moreover, there is mounting evidence to make the case that for the government to run a surplus, the private sector must run a deficit. (For more detail on this subject see “When the Government “Saves” More, We Save Less, News Link / Beacon Hill Vol. 3, No. 4 Summer 1999.)
In an attempt to pull the wool over the eyes of gullible readers, Krugman engages in a preposterous revisionist interpretation of the Reagan era. “The U.S. economy did not experience an acceleration of growth in its productive capacity after Reagan cut marginal tax rates in the 1980s; it did experience such an acceleration after Clinton raised that top marginal rate in the 1990's.”
Excuse me? Under Reagan's watch, US GDP doubled from $3 trillion to $6 trillion creating 18 million jobs. But according to the professor the growth rates of the 1980s can be attributed exclusively to the Federal Reserve Bank. “If you admit that monetary policy is a highly effective policy tool, you are very close to giving credit for the economic boom that started in late 1982 to the Fed's dramatic interest rate cuts the preceding summer, not to the tax cut pushed through by Ronald Reagan the year before.”
Believing he has seen the failure of supply-side economics, Krugman today pushes the central theme that the Bush tax cut is irresponsible because it is too big and costs the government too much, thus putting in jeopardy Social Security and Medicare surpluses. However, his alternative policy of setting aside $3.3 trillion in the so-called social security lock-box is itself a hoax. It is clear that Al Gore's favorite metaphor certainly animates Krugman.
“Any reform of Social Security will require additional money over and above the system's surplus, because any reform would involve paying off some of that implicit debt...Again and again we hear that by allowing young workers to put some of their payroll taxes into private investment accounts we can `Save Social Security'. In fact such accounts would undermine Social Security because the benefits owed to older Americans must be paid out of the same taxes.”
Krugman reminds the reader that Social Security benefits to retirees are funded from the payroll taxes of currently employed workers. He wonders what would happen if younger workers were to opt out of the system and invest their money themselves. “Who would pay the benefits to today's retirees?” he asks.
The answer is before him. Has Professor Krugman forgotten about the Social Security surplus? Why is it okay to use the surplus in the Social Security trust fund to buy back government debt from bondholders but not okay to allow workers to use some of that surplus to build up their own private retirement accounts? After four years of budget surpluses, two years of a foundering stock market and nearly a year of recession, one might think that policy makers would be able to connect the dots. Instead we get:
“Debt owned by the trust funds is debt not owed to the public; and the less debt the federal government owes to the public, the lower the burden of interest payments on the budget. So paying down the debt today will make it easier for the government to pay benefits to baby boomers a decade from now—-it will not have to raise taxes or cut benefits as much as it otherwise would.”
This argument calling for debt repayment, which supposedly frees the government from having to pay interest in the future, is the prevailing view among Democrats and unfortunately too many Republicans. However, this logic has a big hole in it. When the government buys back old high coupon debt at today's low interest rates, it must pay a significant premium over the par value of those bonds. The market value paid is simply the present value of all future cash flows on the bond, including periodic interest payments and principal at maturity. There is no way to wave a magic wand and make the interest payments go away. Instead of paying the interest gradually over time, the treasury-buy backs result in paying it off up front, all at once. There is no free lunch.
Aside from his pedantic sermons about how “irresponsible” the tax cuts are and why the government “can't afford” them, Krugman attributes dark motives to tax cutters. Thus, the reader must continually wade through statements like: “Whatever the reason, the arguments made for tax cuts have been startling in their intellectual dishonesty.” Or: “But what has happened since Bush moved to Washington—the deliberate misstatements and suppression of the facts—is, as far as I know, unprecedented in the history of American economic policy.”
Perhaps Professor Krugman should tune out all the fuzziness and think a little harder. President Clinton recast himself as a New Democrat in 1992 -- promising tax cuts for the middle class. Once in the White House he pivoted and levied the largest tax increase in American history upon the taxpaying public. As Krugman should know, that is still a tough act to follow.
Edward Rombach is a quantitative analyst in political economy and financial markets specializing in fixed income, foreign exchange and tax-risk management.
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