“Two Views of Macroeconomic Policy: Evaluations of the President’s Economic Plans” was billed as a “joint lecture” rather than a debate, but the sleight of noun fooled no one. Robert J. Barro (far left), an economics professor at Harvard University and a senior fellow at the Hoover Institution, took up the cudgels for President Bush’s proposed $726 billion tax reform plan. Announced in January, the plan is now in overdrive mode as the White House tries to whip up support before Congress returns from its recess to debate the President’s latest effort to jumpstart the economy.
On the other side of the ring was Alan S. Blinder, a Princeton University economics professor and former member of President Clinton’s Council of Economic Advisors. Blinder also served as vice chairman of the Board of Governors of the Federal Reserve System from 1994 to 1996. The April 21 debate at Wharton was the third in the Ashish and Sapna Shah Speaker Series.
Barro went first, noting that the Bush tax reform package has two main parts. The first is accelerating the marginal tax rate cuts due to be phased in over the next half-dozen years under the 2001 Bush tax cuts. Most significant among these is the lowering of the highest income tax bracket from 38.6% to 35%.
The second chief component of the proposed tax reform package is eliminating the personal tax on dividend income.
Both these tax cuts would spur long-run economic growth and investment, Barro argued. In addition, the proposed tax plan would help expand the economy in the short run, as the Kennedy-Johnson tax cuts of 1963-1964 and the Reagan tax cuts of 1981-1983 and 1986 did. He acknowledged that the President is not likely to get his proposed cuts in full but that these were important steps in the right direction.
The traditional Democratic stimulus approach, on the other hand, was typically too Keynesian, he said, with too much emphasis on consumer demand and not enough on supply-side economics and productivity benefits.
With budget surpluses unlikely at least for the next decade, Barro addressed the concern that budget deficits would do “bad things” to the economy. Economic theory, he claimed, suggests that the impact of deficits on real interest rates and on investment is uncertain—and would, at any rate, be small. Real interest rates have fallen over the last three years, he added, not because of the shift from budget surplus to a deficit, but because of the end of the technology boom and the collapse of stock prices.
He highlighted the view that what’s important in structuring tax policy is keeping the goal of smaller government in sight. Shrinking federal revenues accomplishes this. Through the 1960s and 1970s, federal expenditures (excluding debt interest payments) represented an increasing proportion of GDP, a statistic that rose as social programs expanded. This trend peaked in the early 1980s, with the percentage now back down to the level it was at in the mid-1950s. Meanwhile, federal revenue as a percentage of GDP peaked around 1985, after Reagan had decided that a smaller government was in order.
In the late 1990s, Barro said, the move to a budget surplus led to an increase in government expenditures. When there were deficits, a central question was how to hold down Medicare costs. With a surplus, he observed, the discussion shifted to adding prescription drug benefits and mental health coverage. Bush’s proposed tax cut would reduce federal revenues as a percentage of GDP, thereby limiting expenditures and shrinking the size of government.
To the argument that the proposed tax cuts would fuel income inequality, since most of the cuts would go to the rich, he had a straightforward answer. “It’s a little hard to see otherwise,” he said. Those in the lower half of the income distribution paid almost no income taxes to the federal government in 2000, he noted. Meanwhile, the top 5% had 21% of family income and paid 66% of federal income taxes. “It’s not a good thing if half of the families, which are paying almost no income taxes, basically regard the income tax as free,” he cautioned. Any increase would therefore be seen as someone else’s burden, while reductions in the tax would never be seen as benefiting them.
“I think in general the federal government has gone too far in redistributing income from the rich to the poor,” he remarked.
Shake, Don’t Stir
When Blinder took the podium, he decried what he called the Bush administration’s “insistence that the right thing is to cut taxes no matter what.” That insistence, he said, is misplaced.
He noted that the administration wanted to cut taxes in boom times or in recession, in peacetime or in war, whether the economy ran a surplus or a deficit. “It seems to me that the remedy ought to show some relation to the condition of the patient,” he said.
In addition, he pointed out that the “nonsense principle that taxes should always be lower than they are” is in full swing and that the administration barely mentioned supply-side economics in its early days. Regarding the argument that lower taxes lead to smaller distortions in the economy, he agreed that that was true but noted that many other factors are more important for productivity growth. He added that “both productivity and investment did pretty well after the 1993 tax hikes,” despite the doomsday scenarios dragged out by opponents of President Clinton’s tax hike.
Fiscal policy should do three things, he said. It should provide short-run fiscal stimulus, it should encourage long-run fiscal discipline, and it should redistribute income sensibly through the tax code.
So how do Bush’s proposals stack up? The acceleration of the 2001 tax cuts would increase spending, would have a negligible impact on long-run discipline and would only be sensible to those who supported the 2001 cuts in the first place.
The dividend proposal would have only a small spending impact unless it pushed up stock prices significantly. Looked at through the lens of long-run fiscal discipline, the elimination of the dividend tax for individuals “rates poorly—and we don’t have a lot of revenue to give away,” he said. Moreover, it’s not the best way to fix up the tax code since it ignores the fact that some corporate income isn’t taxed at all, while other corporate income is taxed once, and still other corporate income is taxed twice.
Other parts of the proposed tax cuts, such as the enhanced incentives for savings, would not have a significant impact on the economy and were a minor part of the tax package, he noted.
Blinder didn’t disagree with all of the administration’s proposed changes. He conceded that the tax on dividends should probably be lower. At the same time, he asked, why are payroll tax and income tax not considered double taxation? Similarly, why eliminate the personal tax on dividends and not the corporate tax on dividends?
Overall, Blinder argued that President Bush’s tax reform plan is not very stimulative, that it would destroy the fiscal responsibility it took the United States 15 years to restore after Reagan’s 1981 tax cuts, and that the current tax proposal is pointedly regressive on both the expenditures side and the revenues side.
On the spending side of the ledger, he said, “our fiscal discipline in Washington has been lost.” To those who are against fiscal deficits without knowing why, he noted that there’s good reason—and it’s not because Polonius said so or because the Puritans founded America. The problem is real. Increased borrowing to finance the deficit pushes up real interest rates and crowds out investment, hurting spending. The result: less stimulus. The other main reason deficits aren’t great is that their long-run sustainability is an issue.
Blinder also took issue with another aspect of the Bush economic plan. With the baby boomer population aging, budget problems loom large after 2010, he said. The burden on the federal government is tremendous and the need for revenue will be intense. “Whatever budget condition we’re in will deteriorate [in 2010],” he pointed out. This represents a main challenge for fiscal policy.
He then went for the jugular. He noted that the United States is the least redistributive capitalist country in the world. Budget cuts tend to come from programs for the poor. The 2001 and 2003 proposals are regressive. “This is class warfare,” he noted. “It’s the haves against the have-nots.”
Referring to President Bush’s 2000 campaign, he asked, “Where’s the compassion? Where’s the conservatism?”
Barro responded that he’d never had much patience for the phrase. He preferred good old-fashioned Reaganomics. He noted that Blinder was always keen to redistribute income from the rich to the poor. He then went further with his case, arguing that in 1986 Reagan’s second tax cut didn’t go far enough in its effort to move from an income tax to a flat consumption tax. In Barro’s view, that was the goal.
According to Barro, Bush fils was determined to fix the three major mistakes his father made. The first concerned Iraq, the second was to never go the way of Bush pere’s 1990 tax increase, and the third—well, Barro wouldn’t say since it hasn’t happened yet. Presumably, that was a reference to the current Bush winning reelection in 2004.
One of the problems with the 2001 tax law, which Bush was now trying to fix, he added, was the phase-ins. When some of the tax cuts didn’t pass muster in their original form, the administration settled for their eventual phase-in over the next decade. Barro conceded that the phase-ins were a mistake from a supply-wide perspective, since they could have a contractionary impact as individuals try to defer income until the rate cuts go into effect, thus limiting spending.
The problem with macroeconomic scuffles, of course, is that it’s impossible to assign economic outcomes to particular policy decisions since so many variables affect the economy. So while Barro was quick to claim that Reagan’s tax cuts boosted productivity over the next two decades and led to improved U.S. economic performance, Blinder pointed out that the 1973-1995 period was a time of productivity slowdown. An acceleration of productivity growth took place in the late 1990s, after the tax hikes. That didn’t necessarily signal a causal relationship, he said, but the tax increase did not hurt the economy.
Congress will now have its say.