Monday, September 08, 2003

Re: Tax Cut Myths: Very interesting. I have a couple of minor disagreements to air on the myths. First, Myth #1, that deficits drive up interest rates. But deficits can put pressure on interest rates. Besides, I don't think many economically minded folks out there think there's a rock-solid deficit-to-interest-rate rule at work. Wesbury makes it sound as though this view is prevalent beyond the fringes.

Myth #2, that putting money in people's pockets is what counts. Wesbury says, as you quote, "A tax rebate must come from somewhere. If the government borrowed money to pay the rebate, then taxes would eventually be raised to pay it back." This requires the assumption that the stimulus fails. Repayment need not come from tax hikes if revenue grows based on the tax cut. The correlation of the two is anecdotally sound, if not axiomatic, so must be considered.

Myth #3, that sunset provisions are self-defeating. Not in the short-term, as Wesbury points out. But long-term is where the effects of tax policy are felt. Inventory may change in the short term, but hiring and capital investment are what the supply-siders want to see now, and sunsetting dampens the enthusiasm for that, if perhaps less than would be expected. (As Wesbury correctly notes, politicians who don't vote to extend past the sunset risk an electoral spanking, but that's not enough guarantee for a CFO.) See Wesbury's own note on Say's Law, which you quoted. Supply does create its own demand, but at what speed is it created? The fax machine was invented before the telephone, and look how long it took for the world to beat a path to that door.

Myth #4, that size is what matters in a tax cut. Sure, the effect of a tax cut is more important, in the long run. But size is easier to measure than effect, at least in the policy-making stage. Wesbury cites an example:

In 1997, the Clinton capital gains tax rate reduction was estimated to "cost" just $3.3 billion over five years. By any measure of absolute size, this was small. But its impact was huge. Venture capital investment soared by 400 percent and the stock market expanded at an annual average of over 20% for five consecutive years.
It's foolish, though, to say that this was all because of the capital-gains cut. Timing was important, and in this case the timing was incidental, if not accidental. I doubt anyone in the Clinton administration foresaw the tech boom, at least not as it turned out. This was fortuitous policy-making, but not much more, because there was already pressure on venture capital to get into the bio, dot-com, and telcom worlds. Besides, as it turned out, much of this was bubblicious anyway (remember "irrational exuberance"?) and not the sort of thing an interventionist economist would want to encourage. To take credit for the boom, then, by way of permissive tax policy, is to take some blame for the bust, which nobody in the administration ever did.

Myth #5 I have no problem with. Wesbury is right on.

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