Stimulate the Beast
Paul Krugman has finally gotten around to answering a question I’ve been asking for a long time. Unfortunately—and weirdly—his answer is rooted in a mistaken Republican theory of politics.
The question is this: Why Krugman hasn’t pushed for fiscal stimulus in the form of tax cuts? Krugman’s done a lot of excellent work beating back the deficit scolds. He obviously believes that the economy would perform better if we ran a bigger fiscal deficit but he’s always stopped short of supporting the only politically viable path to deficit expansion: tax cuts.
As both Cullen Roche and I pointed out back in 2011, Republicans would be willing to accept higher deficits if they are the result of tax cuts rather than spending increases. They might even be willing to accept spending increases in exchange for tax cuts. In fact, that kind of “grand bargain” is what Republicans have agreed to a number of times in the not so distant past.
Both Cullen and I were hopeful that Krugman would actually be able to change the terms of the budget debate by supporting tax cuts. But he never did.
Over at the New Republic, Ryan Cooper recently revived this argument:
So if the center, especially including President Obama, can be persuaded to drop their deficit obsession (and again, it’s hardly possible to overstate how badly this debate has been lost), we could trade tax cuts for some austerity relief, like re-extending unemployment benefits and food stamps. And, it’s important to note, both spending increases and tax cuts count as austerity relief. Tax cuts, especially on the rich, aren’t very good stimulus, but they still put money into people’s pockets.
But the main point is to shift ground for negotiation. This strategy of “tax cuts for more spending” has been suggested many times in the past few years and gone nowhere. But before that, it had been the basis for many successful bipartisan deals, including expanding Medicaid in the 1980s and the CHIP program in the 1990s.
Krugman’s response explains why he never came around to supporting tax cuts:
I don’t buy it, basically because I believe you need to play the political economy long game. Starve the beast is still out there as a strategy; conservatives still push tax cuts in part because they expect, probably rightly, that this will tilt the balance toward cuts in the safety net the next time the deficit becomes a big issue. Don’t you think federal spending would be significantly higher now if the Bush tax cuts had never been passed?
Krugman’s right that a lot of conservatives still believe in the “starve the beast” strategy. But he’s wrong when he says that it’s “probably right.” It’s probably wrong.
As I explained a couple of years ago, the history of taxes and spending suggests that government is a beast that doesn’t starve.
Falling revenues are typically accompanied by rising spending; while rising revenues are accompanied by falling spending. In other words, the “beast” of government spending doesn’t require a meal of taxes to grow. It thrives, in fact, on a starvation diet. Government is a hunger artist.
This point was made back in 2004 in a Brookings Institute paper by Peter Orszag and William Gale.
“The ‘starve the beast’ strategy may simply not work as a political equilibrium. We have in mind that policy-makers jointly go through periods of fiscal restraint and fiscal largesse, and the restraint or largesse occurs simultaneously on both the tax and spending sides. That is, periods of fiscal largesse tend to generate declines in taxes and increases in spending (as shares of gross domestic product). Periods of fiscal discipline tend to provide declines in spending and increases in taxes.”
The Cato Institute’s William Niskanen pointed out that the starve-the-beast theory was wrong in a paper published in 2002. I can’t find a link to that paper at the moment, but Niskanen described his findings in this 2004 Cato report:
In a professional paper published in 2002, I presented evidence that the relative level of federal spending over the period 1981 through 2000 was coincident with the relative level of the federal tax burden in the opposite direction; in other words, there was a strong negative relation between the relative level of federal spending and tax revenues. Controlling for the unemployment rate, federal spending increased by about one-half percent of GDP for each one percentage point decline in the relative level of federal tax revenues.
In 2006, both Jonathan Rauch and Jonathan Chait wrote about Niskanen’s findings (although Chait’s article has vanished from the internet) and set off a pretty big debate. National Review responded here, Greg Mankiw here, Mark Thoma here, Brad DeLong here, and Ramesh Ponnuru here.
While Niskanen’s idea was pretty controversial when it was first put forth, it appears to have withstood the test of time. Last year, it received a revival of sorts when it was positively cited by Bruce Bartlett in the New York Times and Andrew Ferguson in the Weekly Standard.
I assume Krugman is aware of the Niskanen and Orszag papers, although I haven’t been able to find any direct evidence he’s read them. If he has, it would be great for him to explain why he isn’t persuaded by them.
There’s a lot at stake here. If the “starve the beast” theory is wrong, there’s no reason why Democrats and progressives shouldn’t join Republicans and conservatives in crafting a tax-cut based stimulus package. And it’s truly weird to imagine that what might be preventing the progressives from pushing for a job-creating stimulus package is a myth created by Republicans.