Where are the '60s Hippies Now that They're Needed to Fight Keynesianism?

Keynesian economic theory is the social-science version of a perpetual motion machine. It assumes that you can increase your prosperity by taking money out of your left pocket and putting it in your right pocket. Not surprisingly, nations that adopt this approach do not succeed. Deficit spending did not work for Hoover and Roosevelt is the 1930s. It did not work for Japan in the 1990s. And it hasn't worked for Bush or Obama.

The Keynesians invariably respond by arguing that these failures simply show that politicians didn't spend enough money. I don't know whether to be amused or horrified, but some Keynesians even say that a war would be the best way of boosting economic growth. Here's a blurb from a story in National Journal.

America's economic outlook is so grim, and political solutions are so utterly absent, that only another large-scale war might be enough to lift the nation out of chronic high unemployment and slow growth, two prominent economists, a conservative and a liberal, said today. Nobelist Paul Krugman, a New York Times columnist, and Harvard's Martin Feldstein, the former chairman of President Reagan's Council of Economic Advisers, achieved an unnerving degree of consensus about the future during an economic forum in Washington. ...Krugman and Feldstein, though often on opposite sides of the political fence on fiscal and tax policy, both appeared to share the view that political paralysis in Washington has rendered the necessary fiscal and monetary stimulus out of the question. Only a high-impact "exogenous" shock like a major war -- something similar to what Krugman called the "coordinated fiscal expansion known as World War II" -- would be enough to break the cycle. ...Both reiterated their previously argued views that the Obama administration's stimulus was far too small to fill the output gap.

Two additional comments. First, if Martin Feldstein's views on this issue represent what it means to be a conservative, then I'm especially glad I'm a libertarian. Second, Alan Reynolds has a good piece eviscerating Keynesianism, including a section dealing with Krugman's World-War-II-was-good-for-the-economy assertion.

Obama's Policy Failure, Part I

Former Senator Phil Gramm had a column last week in the Wall Street Journal that deserves two blog posts. This first post highlights Gramm's analysis showing that the U.S. has been very Keynesian compared to Europe, with numerous efforts to jump start the economy with deficit spending. But Senator Gramm hits the nail on the head, comparing America's tepid recovery with the better performance across the Atlantic.

During the average recovery since World War II, gross domestic product (GDP) surpassed the pre-recession high five quarters after the recession began. It has never taken longer than seven quarters. Yet today, after 11 quarters, GDP is still below what it was in the fourth quarter of 2007. The economy is growing at only about a third of the rate of previous postwar recoveries from major recessions. Obama administration officials such as Treasury Secretary Tim Geithner have argued that without their policies the economy would be worse, and we might have fallen "off a cliff." While this assertion cannot be tested, we can compare the recent experience of other countries to our own. ...There are 4.6% fewer people employed in the U.S. today than at the start of the recession. Euro zone countries have lost 1.7% of their jobs. ...This simple comparison suggests...that American economic policy has been less effective in increasing employment than the policies of other developed nations. ...While the most recent quarterly growth figures are just a snapshot in time, it is hardly encouraging that economic growth in the U.S. (1.7%) is lower than in the euro zone (4%), U.K. (4.8%), G-7 (2.8%) and OECD (2%).

Warren Buffett: Good Investor, Crummy Economist

Warren Buffett once said that it wasn't right for his secretary to have a higher tax rate than he faced, leading me to point out that he didn't understand tax policy. The 15 percent tax rates on dividends and capital gains to which he presumably was referring represents double taxation, and when added to the tax that already was paid on the income he invested (and the tax that one imagines will be imposed on that same income when he dies), it is quite obvious that his effective marginal tax rates is much higher than anything his secretary pays. Though he is right that his secretary's tax rate is much too high.

Well, it turns out that Warren Buffett also doesn't understand much about other areas of fiscal policy. Like a lot of ultra-rich liberals who have lost touch with the lives of regular people, he thinks taxpayer anger is misguided. Not only does he scold people for being upset, but he regurgitates the most simplistic Keynesian talking points to justify Obama's spending spree. Here's an excerpt from his hometown paper.

Taxpayer anger against President Barack Obama and Congress is counterproductive because policy makers took measures including deficit spending to stimulate the economy, billionaire investor Warren Buffett told CNBC. ...“I hope we get over it pretty soon, because it’s not productive,’’ Buffett said. “We will come back regardless of how people feel about Washington, but it is not helpful to have people as unhappy as they are about what’s going on in Washington.” ...“The truth is we’re running a federal deficit that’s 9 percent of gross domestic product,” Buffett said. “That’s stimulative as all get out. It’s more stimulative than any policy we’ve followed since World War II.”

About the only positive thing one can say about Buffett's fiscal policy track record is that he is nowhere close to being the most inaccurate person in the United States, a title that Mark Zandi surely will own for the indefinite future.

More Evidence of the Failed Stimulus

Not that we need more evidence, but here are two new items confirming the absurdity of thinking that bigger government is stimulus. First, we have a story from Los Angeles revealing that the city only created 55 jobs with $111 million of stimulus funds. This translates to a per-job cost of $2 million, which is a grossly inefficient rate of return. But this calculation is incomplete because it doesn't measure how many jobs would have been created if the money was left in the productive sector of the economy. Moreover, it's also important to consider long-term costs such as the fact that Los Angeles now has more overhead, which will exacerbate the city's fiscal problems.

The Los Angeles City Controller said on Thursday the city's use of its share of the $800 billion federal stimulus find has been disappointing. The city received $111 million in stimulus under American Recovery and Reinvestment Act (ARRA) approved by the Congress more than year ago. "I'm disappointed that we've only created or retained 55 jobs after receiving $111 million," says Wendy Greuel, the city's controller, while releasing an audit report. ...The audit says the numbers were disappointing due to bureaucratic red tape, absence of competitive bidding for projects in private sectors, inappropriate tracking of stimulus money and a laxity in bringing out timely job reports.

Our second item is a new study from two scholars who find that the cash-for-clunkers program was a total failure. Just as anybody with an IQ above room temperature could have predicted, the overwhelming effect of the program was to encourage people to change when they purchased cars. There was no long-term positive impact on any economic variable.

A key rationale for fiscal stimulus is to boost consumption when aggregate demand is perceived to be inefficiently low. We examine the ability of the government to increase consumption by evaluating the impact of the 2009 “Cash for Clunkers” program on short and medium run auto purchases. Our empirical strategy exploits variation across U.S. cities in ex-ante exposure to the program as measured by the number of “clunkers” in the city as of the summer of 2008. We find that the program induced the purchase of an additional 360,000 cars in July and August of 2009. However, almost all of the additional purchases under the program were pulled forward from the very near future; the effect of the program on auto purchases is almost completely reversed by as early as March 2010 – only seven months after the program ended. ...We also find no evidence of an effect on employment, house prices, or household default rates in cities with higher exposure to the program.

The lesson from the cash-for-clunkers program also can be applied to other temporary programs. Good tax cuts, for instance, become gimmicks when they are temporary. This doesn't mean there is no positive effect on incentives from a payroll tax holiday, temporary expensing, or a two-year extension of the 2001/2003 tax cuts, but the overwhelming impact is to alter the timing of economic activity rather than the level of economic activity.

The Cato Institute - America's Best Think Tank

Okay, I'm biased, but Cato stood up against the so-called stimulus when others were quiet. Cato was against Obamacare, even back when it was called Romneycare. Now, we're leading the fight on restraining Leviathan. The image below is our full page ad on cutting wasteful programs, agencies, and departments - and asking Obama to fulfill his promise on reducing needless spending. Click here for a full-size version.

Overwhelming Evidence for Less Government Spending

Alberto Alesina of Harvard's economics department summarizes some of his research in a column for today's Wall Street Journal. He and a colleague looked at fiscal policy changes in developed nations and found very strong evidence that spending reductions boost growth. This, of course, contrasts with the lack of evidence for the Keynesian notion that growth is stimulated by a bigger burden of government spending.

Politicians argue for increased stimulus spending, as opposed to spending cuts, on the grounds that it would speed up economic recovery. This argument might have it exactly backward. Indeed, history shows that cutting spending in order to reduce deficits may be the key to promoting economic recovery. ...recent stimulus packages have proven that the "multiplier"—the effect on GDP per one dollar of increased government spending—is small. Stimulus spending also means that tax increases are coming in the future; such increases will further threaten economic growth. Economic history shows that even large adjustments in fiscal policy, if based on well-targeted spending cuts, have often led to expansions, not recessions. Fiscal adjustments based on higher taxes, on the other hand, have generally been recessionary. My colleague Silvia Ardagna and I recently co-authored a paper examining this pattern, as have many studies over the past 20 years. Our paper looks at the 107 large fiscal adjustments—defined as a cyclically adjusted deficit reduction of at least 1.5% in one year—that took place in 21 Organization for Economic Cooperation and Development (OECD) countries between 1970 and 2007. ...Our results were striking: Over nearly 40 years, expansionary adjustments were based mostly on spending cuts, while recessionary adjustments were based mostly on tax increases. ...In the same paper we also examined years of large fiscal expansions, defined as increases in the cyclically adjusted deficit by at least 1.5% of GDP. Over 91 such cases, we found that tax cuts were much more expansionary than spending increases. How can spending cuts be expansionary? First, they signal that tax increases will not occur in the future, or that if they do they will be smaller. A credible plan to reduce government outlays significantly changes expectations of future tax liabilities. This, in turn, shifts people's behavior. Consumers and especially investors are more willing to spend if they expect that spending and taxes will remain limited over a sustained period of time. On the other hand, fiscal adjustments based on tax increases reduce consumers' disposable income and reduce incentives for productivity. ...Europe seems to have learned the lessons of the past decades: In fact, all the countries currently adjusting their fiscal policy are focusing on spending cuts, not tax hikes. Yet fiscal policy in the U.S. will sooner or later imply higher taxes if spending is not soon reduced. The evidence from the last 40 years suggests that spending increases meant to stimulate the economy and tax increases meant to reduce deficits are unlikely to achieve their goals. The opposite combination might.

Alesina's research echoes the findings in dozens of other studies, a few of which are cited in this Center for Freedom and Prosperity video I narrated.

Keynes Was Wrong on Stimulus, but the Keynesians Are Wrong on Just about Everything

Dana Milbank of the Washington Post wrote this weekend that critics of Keynesianism are somewhat akin to those who believe the earth is flat. He specifically cites the presumably malignant influence of the Cato Institute.

Keynes was right, and in this case it's probably for the better: Keynes didn't live to see the Republicans of 2010 portray him as some sort of Marxist revolutionary. ...These men get their economic firepower from conservative think tanks such as the Cato Institute... What's with the hate for Maynard? Perhaps these Republicans don't realize that some of their tax-cut proposals are as "Keynesian" as Obama's program. There's a fierce dispute about how best to respond to the economic crisis -- Tax cuts? Deficit spending? Monetary intervention? -- but the argument is largely premised on the Keynesian view that government should somehow boost demand in a recession. ...With so much of Keynesian theory universally embraced, Republican denunciation of him has a flat-earth feel to it. ...There is an alternative to such "Keynesian experiments," however. The government could do nothing, and let the human misery continue. By rejecting the "Keynesian playbook," this is what Republicans are really proposing.

Milbank makes some good points, particularly when noting the hypocrisy of Republicans. Bush's 2001 tax cuts were largely Keynesian in their design, which is also one of the reasons why the economy was sluggish until the supply-side tax cuts were implemented in 2003. Bush also pushed through another Keynesian package in 2008, and many GOPers on Capitol Hill often erroneously use Keynesian logic even when talking about good policies such as lower marginal tax rates.

But the thrust of Milbank's column is wrong. He is wrong in claiming that Keynesian economics works, and he is wrong is claming that it is the only option. Regarding the first point, there is no successful example of Keynesian economics. It didn't work for Hoover and Roosevelt in the 1930s. It didn't work for Japan in the 1990s. It didn't work for Bush in 2001 or 2008, and it didn't work for Obama. The reason, as explained in this video, is that Keynesian economic seeks to transform saving into consumption. But a recession or depression exists when national income is falling. Shifting how some of that income is used does not solve the problem.

This is why free market policies are the best response to an economic downturn. Lower marginal tax rates. Reductions in the burden of government spending. Eliminating needless regulations and red tape. Getting rid of trade barriers. These are the policies that work when the economy is weak. But they're also desirable policies when the economy is strong. In other words, there is no magic formula for dealing with a downturn. But there are policies that improve the economy's performance, regardless of short-term economic conditions. Equally important, supporters of economic liberalization also point out that misguided government policies (especially bad monetary policy by the Federal Reserve) almost always are responsible for causing downturns. And wouldn't it be better to adopt reforms that prevent downturns rather than engage in futile stimulus schemes once downturns begin?

None of this means that Keynes was a bad economist. Indeed, it's very important to draw a distinction between Keynes, who was wrong on a couple of things, and today's Keynesians, who are wrong about almost everything. Keynes, for instance, was an early proponent of the Laffer Curve, writing that, "Nor should the argument seem strange that taxation may be so high as to defeat its object, and that, given sufficient time to gather the fruits, a reduction of taxation will run a better chance than an increase of balancing the budget."

Keynes also seemed to understand the importance of limiting the size of government. He wrote that, "25 percent taxation is about the limit of what is easily borne." It's not clear whether he was referring to marginal tax rates or the tax burden as a share of economic output, but in either case it obviously implies an upper limit to the size of government (especially since he did not believe in permanent deficits).

If modern Keynesians had the same insights, government policy today would not be nearly as destructive.

End of the Road for the "Green Jobs" Scam?

Like other forms of so-called stimulus spending, the money devoted to supposed "green" energy programs has been a net drain on the economy. This is hardly a surprise, particular since the much-trumpeted Spanish experiment turned out to be a flop, destroying two jobs elsewhere in the economy for every green job created. But what is surprising is that the political crowd in Washington seems to be getting the message. The Washington Times reports that even the left if backing away from flushing more money down this hole.

Noticeably absent from President Obama's latest economic-stimulus package are any further attempts to create jobs through "green" energy projects, reflecting a year in which the administration's original, loudly trumpeted efforts proved largely unfruitful. The long delays typical with environmentally friendly projects - combined with reports of green stimulus funds being used to create jobs in China and other countries, rather than in the U.S. - appear to have killed the administration's appetite for pushing green projects as an economic cure. ...Peter Morici, a business professor at the University of Maryland, said much of the green stimulus funding was "squandered." "Large grants to build green buildings don't generate many new jobs, except for a few architects," he said. "Subsidies for windmills and solar panels created lots of jobs in China," but few at home. ...Despite the massive infusion of government funding in recent years, renewable technologies have captured only a tiny share of the energy market and remain heavily dependent on government funding to be viable. Because of the need to constantly renew government funding, private investors remain skittish about committing to new projects.

Obama's Stimulus Means Redistribution from Poor to Rich

This New York Post chart shows that the already-bloated federal workforce expanded since the downturn began. And since compensation for federal bureaucrats is twice the average for other workers, it certainly seems like Obama is playing a perverse game of class warfare - particularly since ordinary Americans pay the price when so-called stimulus spending drains money from private capital markets and misallocates resources.

Obama's New Stimulus Schemes: Same Song, Umpteenth Verse

Like a terrible remake of Groundhog Day, the White House has unveiled yet another so-called stimulus scheme. Actually, they have two new proposals to buy votes with our money. One plan is focused on more infrastructure spending, as reported by Politico.

Seeking to bolster the sluggish economy, President Barack Obama is using a Labor Day appearance in Milwaukee to announce he will ask Congress for $50 billion to kick off a new infrastructure plan designed to expand and renew the nation’s roads, railways and runways. ...The measures include the “establishment of an Infrastructure Bank to leverage federal dollars and focus on investments of national and regional significance that often fall through the cracks in the current siloed transportation programs," and “the integration of high-speed rail on an equal footing into the surface transportation program.”

The other plan would make permanent the research and development tax credit. The Washington Post has some of the details.

Under mounting pressure to intensify his focus on the economy ahead of the midterm elections, President Obama will call for a $100 billion business tax credit this week... The business proposal - what one aide called a key part of a limited economic package - would increase and permanently extend research and development tax credits for businesses, rewarding companies that develop new technologies domestically and preserve American jobs. It would be paid for by closing other corporate tax loopholes, said the official, speaking on condition of anonymity because the policy has not yet been unveiled.

These two proposals are in addition to the other stimulus/job-creation/whatever-they're-calling-them-now proposals that have been adopted in the past 20 months. And Obama's stimulus schemes were preceded by Bush's Keynesian fiasco in 2008. And by the time you read this, the Administration may have unveiled a few more plans. But all of these proposals suffer from the same flaw in that they assume growth is sluggish because government is not big enough and not intervening enough. Keynesian politicians don't realize (or pretend not to realize) that economic growth occurs when there is an increase in national income. Redistribution plans, by contrast, simply change who is spending an existing amount of income. If the crowd in Washington really wants more growth, they should reduce the burden of government, as explained in this video.

The best that can be said about the new White House proposals is that they're probably not as poorly designed as previous stimulus schemes. Federal infrastructure spending almost surely fails a cost-benefit test, but even bridges to nowhere carry some traffic. The money would generate more jobs and more output if left in the private sector, so the macroeconomic impact is still negative, but presumably not as negative as bailouts for profligate state and local governments or subsidies to encourage unemployment - which were key parts of previous stimulus proposals. Likewise, a permanent research and development tax credit is not ideal tax policy, but at least the provision is tied to doing something productive, as opposed to tax breaks and rebates that don't boost work, saving, and investment. We don't know, however, what's behind the curtain. According to the article, the White House will finance this proposal by "closing other corporate tax loopholes." In theory, that could mean a better tax code. But this Administration has a very confused understanding of tax policy, so it's quite likely that they will raise taxes in a way that makes the overall tax code even worse. They've already done this in previous stimulus plans by increasing the tax bias against American companies competing in world markets, so there's little reason to be optimistic now. And don't forget that the President has not changed his mind about imposing higher income tax rates, higher capital gains tax rates, higher death tax rates, and higher dividend tax rates beginning next January.

All that we can say for sure is that the politicians in Washington are very nervous now that the midterm elections are just two months away. This means their normal tendencies to waste money will morph into a pathological form of profligacy.

New York Times Seeks Higher Taxes on the "Rich" as Prelude to Higher Taxes on the Middle Class

In a very predictable editorial this morning, the New York Times pontificated in favor of higher taxes. Compared to Paul Krugman's rant earlier in the week, which featured the laughable assertion that letting people keep more of the money they earn is akin to sending them a check from the government, the piece seemed rational. But that is damning with faint praise. There are several points in the editorial that deserve some unfriendly commentary.

First, let's give the editors credit for being somewhat honest about their bad intentions. Unlike other statists, they openly admit that they want higher taxes on the middle class, stating that "more Americans — and not just the rich — are going to have to pay more taxes." This is a noteworthy admission, though it doesn't reveal the real strategy on the left. Most advocates of big government understand that it will be impossible to turn America into a European-style welfare state without a value-added tax, but they don't want to publicly associate themselves with that view until the political environment is more conducive to success. Most important, they realize that it will be very difficult to impose a VAT without seducing some gullible Republicans into giving them political cover. And one way of getting GOPers to sign up for a VAT is by convincing them that they have to choose a VAT if they don't want a return to the confiscatory 70 percent tax rates of the 1960s and 1970s. Any moves in that direction, such as raising the top tax rate from 35 percent to 39.6 percent next January, are part of this long-term strategy to pressure Republicans (as well as naive members of the business community) into a VAT trap.

Shifting to other assertions, the editorial claims that "more revenue will be needed in years to come to keep rebuilding the economy." That's obviously a novel assertion, and the editors never bother to explain how and why more tax revenue will lead to a stronger economy. Are the folks at the New York Times not aware that both economic growth and living standards are lower in European nations that have imposed higher tax burdens? Heck, even the Keynesians agree (albeit for flawed reasons) that higher taxes stunt growth.

The editorial also asserts that, "Since 2002, the federal budget has been chronically short of revenue." I suppose if revenues are compared to the spending desires of politicians, then tax collections are - and always will be - inadequate. The same is true in Greece, France, and Sweden. It doesn't matter whether revenues are 20 percent of GDP or 50 percent of GDP. The political class always wants more. But let's actually use an objective measure to determine whether revenues are "chronically short." The Democrat-controlled Congressional Budget Office stated in its newly-released update to the Economic and Budget Outlook that federal tax revenues historically have averaged 18 percent of GDP. They are below that level now because of the economic downturn, but CBO projects that revenues will climb above that level in a few years - even if all of the 2001 and 2003 tax cuts are made permanent. Moreover, OMB's historical data shows that revenues were actually above the long-run average in 2006 and 2007, so even the "since 2002" part of the assertion in the editorial is incorrect.

On the issue of temporary tax relief for the non-rich, the editorial is right but for the wrong reason. The editors rely on the Keynesian rationale, writing that, "low-, middle- and upper-middle-income taxpayers...tend to spend most of their income and the economy needs consumer spending" whereas "Tax cuts for the rich can safely be allowed to expire because wealthy taxpayers tend to save rather than spend their tax savings." I've debunked Keynesian analysis so often that I feel that I deserve some sort of lifetime exemption from dealing with this nonsense, but I'll give it another try. Borrowing money from some people in the economy and giving it to some other people in the economy is not a recipe for better economic performance. Economic growth means we are increasing national income. Keynesian policy simply changes who is spending national income, guided by a myopic belief that consumer spending somehow is better than investment spending. The Keynesian approach didn't work for Hoover and Roosevelt in the 1930s, it didn't work for Japan in the 1990s, and it hasn't worked for Obama. And it doesn't matter if the Keynesian stimulus is in the form of tax rebates. Gerald Ford's rebate in the 1970s was a flop, and George W. Bush's 2001 rebate also failed to boost growth. Tax cuts can lead to more national income, but only if marginal tax rates on productive behavior are reduced so that people have more incentive to work, save, and invest. This is an argument for extending the lower tax rates for all income classes, but it's important to point out that the economic benefits will be much greater if the lower tax rates are made permanent.

Last but not least, the editorial asserts that, "The revenue from letting [tax cuts for the rich] expire — nearly $40 billion next year — would be better spent on job-creating measures." Not surprisingly, there is no effort to justify this claim. They could have cited the infamous White House study claiming that the so-called stimulus would keep unemployment under 8 percent, but even people at the New York Times presumably understand that might not be very convincing since the actual unemployment rate is two percentage points higher than what the Obama Administration claimed it would be at this point.

A Spending Quiz from the "Rebel Economist"

My former Heritage Foundation colleague has returned to youtube.com with a video asking taxpayers whether examples of government waste are true or false.

When Keynesians Attack, Part II

I'm still dealing with the statist echo chamber, having been hit with two additional attacks for the supposed sin of endorsing Reaganomics over Obamanomics (my responses to the other attacks can be found here and here). Some guy at the Atlantic Monthly named Steve Benen issued an critique focusing on the timing of the recession and recovery in Reagan's first term. He reproduces a Krugman chart (see below) and also adds his own commentary.

Reagan's first big tax cut was signed in August 1981. Over the next year or so, unemployment went from just over 7% to just under 11%. In September 1982, Reagan raised taxes, and unemployment fell soon after. We're all aware, of course, of the correlation/causation dynamic, but as Krugman noted in January, "[U]nemployment, which had been stable until Reagan cut taxes, soared during the 15 months that followed the tax cut; it didn't start falling until Reagan backtracked and raised taxes."

This argument is absurd since the recession in the early 1980s was largely the inevitable result of the Federal Reserve's misguided monetary policy. And I would be stunned if this view wasn't shared by 90 percent-plus of economists. So it is rather silly to say the recession was caused by tax cuts and the recovery was triggered by tax increases.

But even if we magically assume monetary policy was perfect, Benen's argument is wrong. I don't want to repeat myself, so I'll just call attention to my previous blog post which explained that it is critically important to look at when tax cuts (and increases) are implemented, not when they are enacted. The data is hardly exact, because I haven't seen good research on the annual impact of bracket creep, but there was not much net tax relief during Reagan's first couple of years because the tax cuts were phased in over several years and other taxes were going up. So the recession actually began when taxes were flat (or perhaps even rising) and the recovery began when the economy was receiving a net tax cut. That being said, I'm not arguing that the Reagan tax cuts ended the recession. They probably helped, to be sure, but we should do good tax policy to improve long-run growth, not because of some misguided effort to fine-tune short-run growth.


The second attack comes from some blog called Econospeak, where my newest fan wrote:

I’m scratching my head here as I thought the standard pseudo-supply-side line was that the deficit exploded in the 1980’s because government spending exploded. OK, the truth is that the ratio of Federal spending to GDP neither increased nor decreased during this period. Real tax revenues per capita fell which is why the deficit rose but this notion that the burden of government fell is not factually based.

Those are some interesting points, and I might respond to them if I wanted to open a new conversation, but they're not germane to what I said. In my original post (the one he was attacking), I commented on the "burden of government" rather than the "burden of government spending." I'm a fiscal policy economist, so I'm tempted to claim that the sun rises and sets based on what's happening to taxes and spending, but such factors are just two of the many policies that influence economic performance. And with regard to my assertion that Reagan reduced the "burden of government," I'll defer to the rankings put together for the Economic Freedom of the World Index. The score for the United States improved from 8.03 to 8.38 between 1980 and 1990 (my guess is that it peaked in 1988, but they only have data for every five years). The folks on the left may be unhappy about it, but it is completely accurate to say Reagan reduced the burden of government. And while we don't yet have data for the Obama years, there's a 99 percent likelihood that America's score will decline.

This is not a partisan argument, by the way. The Economic Freedom of the World chart shows that America's score improved during the Clinton years, particularly his second term. And the data also shows that the U.S. score dropped during the Bush years. This is why I wrote a column back in 2007 advocating Clintonomics over Bushonomics. Partisan affiliation is not what matters. If we want more prosperity, the key is shrinking the burden of government.

Obama's Stimulus Highway Signs, Adjusted for Truth-in-Advertising

I don't like wasteful government spending, but it really adds insult to injury when politicians use my tax dollars for political propaganda. A nauseating example of this practice are the highway signs highlighting how projects are funded by the so-called stimulus. In my young and reckless days, they would have been ideal targets for vandalism. Now that I'm just an old grouch, I mutter under my breath.

So I was very happy to see this amusing image appear on my twitter feed.

When Keynesians Attack

If I was organized enough to send Christmas cards, I would take Richard Rahn off my list. I do one blog post to call attention to his Washington Times column and it seems like everybody in the world wants to jump down my throat. I already dismissed Paul Krugman's rant and responded to Ezra Klein's reasonable attack. Now it's time to address Derek Thompson's critique on the Atlantic's site.

At the risk of re-stating someone else's argument, Thompson's central theme seems to be that there are many factors that determine economic perfformance and that it is unwise to make bold pronouncements about policy A causing result B. If that's what Thompson is saying, I very much agree (and if it's not what he's trying to say, then I apologize, though I still agree with the sentiment). That's why I referred to Reagan decreasing the burden of government and Obama increasing the burden of government. I wanted to capture all the policy changes that were taking place, including taxation, spending, monetary policy, regulation, etc.Yes, the flagship policies (tax reduction for Reagan and so-called stimulus for Obama) were important, but other factors obviously are part of the equation.

The biggest caveat, however, is that one should always be reluctant to make sweeping claims about what caused the economy to do X or Y in a given year. Economists are terrible forecasters, but we're not even very proficient when it comes to hindsight analysis abourt short-run economic fluctuations. Indeed, the one part of my original post that causes me a bit of guilt is that I took the lazy route and inserted an image of the chart from Richard's column. Excerpting some of his analysis would have been a better approach, particularly since I much prefer to focus on the impact of policies on long-run growth and competitiveness (which is what I did in my New York Post column from earlier this week and also why I'm reluctant to embrace Art Laffer's warning of major economic problems in 2011).

But a blog post is no fun if you just indicate where you and a critic have common ground, so let me know identify four things about Thompson's post that rubbed me the wrong way.

1. To reinforce his warning about making excessive claims about different recessions/recoveries, Thompson pointed out that someone could claim that Reagan's recovery was associated with the 1982 TEFRA tax hike. I've actually run across people that think this is a legitimate argument, so it's worth taking a moment to explain why it isn't true. When analyzing the impact of tax policy changes, it's important to look at when tax changes were implemented, not when they were enacted (data on annual tax rates can be found here). Reagan's Economic Recovery Tax Act was enacted in 1981, but the lower tax rates weren't fully implemented until 1984. This makes it a bit of a challenge to pinpoint when the economy actually received a net tax cut. The tax burden may actually have increased in 1981 since the parts of the Reagan tax cuts that took effect that year were offset by the impact of bracket creep (the tax code was not indexed to protect against inflation until the mid-1980s). There was a bigger tax rate reduction in 1982, but there was still bracket creep, as well as previously-legislated payroll tax increases (enacted during the Carter years). TEFRA also was enacted in 1982, which largely focused on undoing some of the business tax relief in Reagan's 1981 plan. People have argued whether the repeal of promised tax relief is the same as a tax increase, but that's not terribly important for this analysis. What does matter is that the tax burden did not fall much (if at all) in Reagan's first year and might not have changed too much in 1982. In 1983, by contrast, it's fairly safe to say the next stage of tax rate reductions was substantially larger than any concomitant tax increases. That doesn't mean, of course, that one should attribute all changes in growth to what's happening to the tax code. But it does suggest that it is a bit misleading to talk about tax cuts in 1981 and tax increases in 1983. One final point. The main insight of supply-side economics is that changes in the overall tax burden are not as important as changes in the tax structure. As such, it's also important to look at which taxes were going up and which ones were decreasing. This is why Reagan's 1981 tax plan compares so favorably with Bush's 2001 tax plan (which was filled with tax credits and other policies that had little of no impact on incentives for productive behavior).

2. In addition to wondering whether one could argue that higher taxes triggered the Reagan boom, Thompson also speculates whether it might be possible to blame the tax cuts in Obama's stimulus for the economy's subsequent sub-par performance. There are two problems with that hypothesis. First, a substantial share of the tax cuts in the so-called stimulus were actually new spending being laundered through the tax code (see footnote 3 of this Joint Committee on Taxation publication). To the extent that the provisions represented real tax relief, they were much more akin to Bush's non-supply side 2001 tax cuts and a far cry from the marginal tax-rate reductions enacted in 1981 and 2003. And since even big tax cuts have little or no impact on the economy if incentives to engage in productive behavior are unaffected, there is no reason to blame (or credit) Obama's tax provisions for anything.

3. Why doesn't anyone care that the Federal Reserve almost always is responsible for serious recessions? This isn't a critique of Thompson's post since he doesn't address monetary policy from this angle, but if we go down the list of serious economic hiccups in recent history (1974-75, 1980-82, and 2008-09), bad monetary policy inevitably is a major cause. In short, the Fed periodically engages in easy-money policy. This causes malinvestment and/or inflation, and a recession seems to be an unavoidable consequence. Yet the Fed seems to dodge any serious blame. At some point, one hopes that policy makers (especially Fed Governors) will learn that easy money policies such as artificially low interest rates are not a smart approach.

4. Thompson writes, "Is Mitchell really saying that $140 billion on Medicaid, firefighters, teachers, and infrastructure projects are costing the economy five percentage points of economic growth?" No, I'm not saying that and didn't say that, but I have been saying for quite some time that taking money out of the economy's left pocket and putting it in the economy's right pockets doesn't magically increase prosperity. And to the extent money is borrowed from private capital markets and diverted to inefficient and counter-productive programs, the net impact on the economy is negative. Thompson also writes that, "Our unemployment picture is a little more complicated than 'Oh my god, Obama is killing jobs by taking over the states' Medicaid burden!'" Since I'm not aware of anybody who's made that argument, I'm not sure how to respond. That being said, jobs will be killed by having Washington take over state Medicaid budgets. Such a move would lead to a net increase in the burden of government spending, and that additional spending would divert resources from the productive sector of the economy.

The moral of the story, though, is to let Richard Rahn publicize his own work.

With Tax Increases Looming, CBO Does About-Face and Frets about Deficits and Debt

Like the swallows returning to Capistrano, the Congressional Budget Office follows a predictable pattern of endorsing policies that result in bigger government. During the debate about the so-called stimulus, for instance, CBO said more spending and higher deficits would be good for the economy. It then followed up that analysis by claiming that the faux stimulus worked even though millions of jobs were lost. Then, during the Obamacare debate, CBO actually claimed that a giant new entitlement program would reduce deficits. Now that tax increases are the main topic (because of the looming expiration of the 2001 and 2003 tax bills), CBO has done a 180-degree turn and has published a document discussing the negative consequences of too much deficits and debt.

...persistent deficits and continually mounting debt would have several negative economic consequences for the United States. Some of those consequences would arise gradually: A growing portion of people’s savings would go to purchase government debt rather than toward investments in productive capital goods such as factories and computers; that “crowding out” of investment would lead to lower output and incomes than would otherwise occur. ...a growing level of federal debt would also increase the probability of a sudden fiscal crisis, during which investors would lose confidence in the government’s ability to manage its budget, and the government would thereby lose its ability to borrow at affordable rates. ...If the United States encountered a fiscal crisis, the abrupt rise in interest rates would reflect investors’ fears that the government would renege on the terms of its existing debt or that it would increase the supply of money to finance its activities or pay creditors and thereby boost inflation.

At some point, even Republicans should be smart enough to figure out that this game is rigged. Then again, the GOP controlled Congress for a dozen years and failed to reform either CBO or its counterpart on the revenue side, the Joint Committee on Taxation (which is infamous for its assumption that tax policy has no impact on overall economic performance).

Obama's Jobs Fantasy

In a column in today's New York Post, I mock White House unemployment calculations and then explain why companies are not anxious to hire more workers.

The White House last year released a supposedly scientific analysis that claimed to show that adopting the "stimulus" bill would cut unemployment. Indeed, the report specifically estimated that the unemployment rate today would be down to 7.5 percent. Something obviously went wrong. The actual unemployment rate is 9.5 percent, a statistic that doesn't include the millions who've given up looking for work or can only find part-time jobs. What were President Obama's biggest mistakes? ...the bigger stumbling block is the folks in the White House seem to have no clue how the real-world economy works. Critics have noted that the Obama Cabinet sets the record for the lowest-ever level of private-sector experience. That doesn't necessarily mean people who don't understand how and why jobs are created -- but that seems to be the case with this administration. Let's start with two common- sense observations. First, businesses are not charities. They only create jobs when they think that the total revenue generated by new workers will exceed the total cost of employing those workers. In other words, if it's not profitable to hire workers, it's not going to happen. ...Unfortunately, almost everything Washington's done the last 18 months has sent the opposite message. The "stimulus" boosted federal spending, thus draining funds from private-capital markets and diverting resources from the productive sector of the economy. The main jobs that it "saved" were employees of state and local governments -- shielding the public sector from pain even as it inflicted more agony on the private sector. ...The health-care law is a cornucopia of new taxes, mandates and regulations -- directly increasing the cost of hiring new employees (as well as of keeping old ones on). By telling employers that the cost of hiring is set to rise sharply in the years ahead, it makes them far more cautious about hiring. ...Investors, entrepreneurs and other job creators also look into the future. If they think economic conditions will improve and that they can make money by expanding employment, they're more likely to take that risk. But what's happening in Washington gives them little reason to feel optimistic. A big challenge is that tax rates are going to rise. The 2001 and 2003 tax cuts are scheduled to expire as the ball drops in Times Square on New Year's Eve. This means higher income-tax rates, higher dividend-tax rates, more double-taxation of capital gains and a reinvigorated death tax. Each provision will increase the cost of productive behavior and specifically make it more expensive to provide the capital needed for job creation. ...The good news is that the economy is creating some jobs. This is to be expected -- the private sector is naturally self-correcting and capable of withstanding lots of bad policy. It takes a lot of missteps in Washington to keep an economy in recession. The bad news is that the United States is gradually becoming a European-style welfare state. This means that we'll have growth in most years, but it will be tepid growth. It means jobs will be created -- but probably not enough to move the unemployment rate from its unacceptably high level. To get truly robust job creation, we need to stop growing government and start getting it out of the way.

Obamanomics and my Seven Steamy Nights with the Gals from Victoria's Secret

The White House is claiming that the so-called stimulus created between 2.5 million and 3.6 million jobs even though total employment has dropped by more than 2.3 million since Obama took office. The Administration justifies this legerdemain by asserting that the economy actually would have lost about 5 million jobs without the new government spending.

I've decided to adopt this clever strategy to spice up my social life. Next time I see my buddies, I'm going to claim that I enjoyed a week of debauchery with the Victoria's Secret models. And if any of them are rude enough to point out that I'm lying, I'll simply explain that I started with an assumption of spending -7 nights with the supermodels. And since I actually spent zero nights with them, that means a net of +7. Some of you may be wondering whether it makes sense to begin with an assumption of "-7 nights," but I figure that's okay since Keynesians begin with the assumption that you can increase your prosperity by transferring money from your left pocket to your right pocket.

Since I'm a gentleman, I'm not going to share any of the intimate details of my escapades, but I will include an excerpt from an editorial in today's Wall Street Journal about the Obama Administration's make-believe jobs.

President Obama's chief economist announced that the plan had "created or saved" between 2.5 million and 3.6 million jobs and raised GDP by 2.7% to 3.2% through June 30. Don't you feel better already? Christina Romer went so far as to claim that the 3.5 million new jobs that she promised while the stimulus was being debated in Congress will arrive "two quarters earlier than anticipated." Yup, the official White House line is that the plan is working better than even they had hoped. We almost feel sorry for Ms. Romer having to make this argument given that since February 2009 the U.S. economy has lost a net 2.35 million jobs. Using the White House "created or saved" measure means that even if there were only three million Americans left with jobs today, the White House could claim that every one was saved by the stimulus. ...White House economists...said the unemployment rate would peak at 9% without the stimulus (there's your counterfactual) and that with the stimulus the rate would stay at 8% or below. In other words, today there are 700,000 fewer jobs than Ms. Romer predicted we would have if we had done nothing at all. If this is a job creation success, what does failure look like? ...All of these White House jobs estimates are based on the increasingly discredited Keynesian spending "multiplier," which according to White House economist Larry Summers means that every $1 of government spending will yield roughly $1.50 in higher GDP. Ms. Romer thus plugs her spending data into the Keynesian computer models and, presto, out come 2.5 million to 3.6 million jobs, even if the real economy has lost jobs. To adapt Groucho Marx: Who are you going to believe, the White House computer models, or your own eyes?

Obama's Fiscal Fantasyland

That's the title of Richard Rahn's new column in the Washington Times, which discusses the delusional Keynesian policy being advocated - in America and around the world - by the current administration. As Richard explains, the evidence is overwhelming that government spending does not promote prosperity.

In the face of the unprecedented congressional spending binge, President Obama has been asking Congress to spend even more. Not content with actively promoting the eventual bankruptcy of the United States, Mr. Obama is urging foreign leaders also to increase their government spending - which is truly bizarre. Look at the facts. All of the major European countries have been increasing government spending and deficits at unsustainable rates. The talk for the past couple of months has been about which countries would follow Greece in going over the financial cliff. Responsible economists, financial leaders and, most important, the markets have been telling European leaders they must cut government spending. ...The president still seems to believe in the imaginary world of spending multipliers - whereby each dollar of additional spending results in something in the order of $1.40 in additional output. Proponents of such ideas normally refer to themselves as Keynesians (followers of the ideas of John Maynard Keynes, 1883-1946). ...The Keynesians and socialists have run hundreds of experiments around the world for the past 70 years, inducing governments to try to spend themselves into prosperity. It doesn't work. In the 1970s, Keynesian prescriptions led to "stagflation" in the U.S. and many other countries. It was only when Ronald Reagan, Margaret Thatcher and eventually many other leaders (using the ideas of F.A. Hayek and Milton Friedman) reversed course by cutting tax rates and curtailing spending growth that their economies began to grow rapidly without inflation. Mr. Obama seems to have never learned these lessons, and some of his advisers, who once understood what works and what doesn't, seem to have forgotten. By nature, people like to spend other people's money, and too many in Congress loved what was billed as Keynesian economic theory because it gave them a rationale to be irresponsible spenders.

Big-Business Lobby Group Supports So-Called Stimulus and Obamacare and then Has Gall to Complain about Big Government

Regular readers of this blog know that big corporations often are enemies of free markets and individual liberty. So it is hardly suprising to know that the Business Roundtable, a lobby representing CEOs of major companies, supported the wasteful and ineffective stimulus pprogram in 2009 and the bloated new healthcare entitlement in 2010. Big companies, after all, are quite proficient at working the system to obtain unearned wealth and to rig the rules against smaller competitors.

What is surprising, however, is that representatives of that organization now have the chutzpah to complain about a "hostile environment for investment and job creation." Equally galling, the group has published a document called "Policy Burdens Inhibiting Economic Growth." We've all heard the joke about the guy who murders his parents and then asks the court for mercy because he's an orphan. The Business Roundtable has adopted that strategy, except this time taxpayers are the butt of the joke.

Here's an excerpt from the Washington Post report:

The chairman of the Business Roundtable, an association of top corporate executives that has been President Obama's closest ally in the business community, accused the president and Democratic lawmakers Tuesday of creating an "increasingly hostile environment for investment and job creation." Ivan G. Seidenberg, chief executive of Verizon Communications, said that Democrats in Washington are pursuing tax increases, policy changes and regulatory actions that together threaten to dampen economic growth and "harm our ability . . . to grow private-sector jobs in the U.S." ...The final straw, said Roundtable president John Castellani, was the introduction of two pieces of legislation, now pending in Congress, that the group views as particularly bad for business. One, a provision of the administration's financial regulation overhaul, would make it easier for shareholders to nominate corporate board members. The other would raise taxes on multinational corporations. The rhetoric accompanying the tax proposals has been particularly harsh, Castellani said, with Democrats vowing to campaign in this fall's midterm elections on a platform of punishing companies that move jobs overseas. ...Seidenberg polled the members of the Business Roundtable and a sister organization, the Business Council. The result was a 54-page document, delivered to Orszag on Monday, chock full of bullet points about actions taken or considered by a wide array of executive agencies, including the White House Middle Class Task Force and the Food and Drug Administration. "We believe the cumulative effect of these proposals will help defeat the objectives we all share -- reducing unemployment, improving the
competitiveness of U.S. companies and creating an environment that fosters long-term economic growth," Seidenberg wrote in a cover letter for the document, titled "Policy Burdens Inhibiting Economic Growth."