While reading reactions to Stanford economist John Taylor’s op-ed in the Financial Times last week, I kept running into the phrase “deficits caused by tax cuts”; one liberal commentator after another wrote that Taylor forfeited his right to complain about the Obama administration’s trillion-dollar deficits when he called for Bush’s tax cuts to be made permanent. Some also criticized Taylor’s arithmetic, arguing that he deliberately or accidentally overstated the rate of inflation it would take to return to a pre-Obama ratio of debt-to-GDP in ten years’ time. And Paul Krugman devoted his Friday column to the subject of Taylor’s stated fear that U.S. policymakers will try to inflate away the massive debt they are incurring. According to Krugman, that fear is unfounded.
Krugman also repeated the charge of inconsistency (he didn’t mention Taylor by name, but the implication was clear): “[I]t’s hard to escape the sense,” he wrote, “that the current inflation fear-mongering is partly political, coming largely from economists who had no problem with deficits caused by tax cuts but suddenly became fiscal scolds when the government started spending money to rescue the economy.”
There’s that odd phrase again — odd because one could just as easily say that all our recent deficits were caused by excessive spending, and not by tax cuts. Most advocates for lower taxes (including myself) also think the government should spend much less than it does. In other words, we do not have “no problem” with the fact that policymakers like to have their tax-cut cake and eat it, too. The way Taylor’s critics characterize the debate makes it impossible to resolve; whether deficits are “caused” by excessive spending or insufficient taxation depends on a subjective conception of the proper role of government. For instance, a conservative might say that taxation is forever insufficient to pay for the government that most liberals want.
Beyond the philosophical point, Taylor responds that his critics have distorted his position on taxes. “I did write a piece in the Journal in November about the importance of permanent tax cuts,” Taylor says. But his piece wasn’t about tax rates, per se. It was about what kind of tax relief works best to grow the economy. Tax cuts work as stimulus only to the extent that people can count on them to provide greater returns on work and investment going forward. Taylor argued that temporary tax relief was ineffective and that uncertainty over the looming expiration of the Bush tax cuts was hindering economic growth. “I was criticizing the Bush stimulus of February ’08 and suggesting that Obama should not increase any taxes. Obviously, that’s not a tax cut in the sense that they’re criticizing me for.”
Keynesians like Krugman scoff at this logic. For them, tax policy is not about long-term incentives. It’s about temporarily putting money in people’s pockets in the hopes that they’ll go out and spend it, then taking it out of their pockets once the economy gets going again. In his Journal piece, Taylor called this thinking “old-fashioned” and “largely static” — not adequate to the “complex dynamics of a modern international economy.”
Keynesians also believe that government spending is the appropriate way to stimulate the economy during recessions, but Taylor argues that these theories do not even begin to explain the spending binge Obama is embarking upon. “To turn this issue into a partisan one is quite a mistake,” he says. “Even if we all agree that you need to have a large deficit this year and maybe next year — I don’t, but suppose we did — no one would say we should have these large deficits five, seven, ten years from now.”
As Taylor pointed out in the piece that caused such a furor last week, the Congressional Budget Office projects the federal debt to reach 82 per cent of GDP in ten years, up from 41 percent at the end of 2008. Taylor did some simple arithmetic to show that, without deep spending cuts, taxes would have to go up by 60 percent, or the price level would have to double, in order to bring the debt-to-GDP ratio back down. “A 100 percent increase in the price level,” Taylor wrote, “means about 10 percent inflation for 10 years.”