Politics & Policy

No, Senator Kaine, Tax Cuts Did Not Cause the Great Recession

(Dreamstime image: Oleksandr Zheltobriukh)
To argue otherwise is to put politics before policy.

In Tuesday’s vice-presidential debate, Tim Kaine repeated a new economic theory brought to the national stage by Hillary Clinton in the first presidential debate: that the Bush tax cuts of 2003 somehow caused the Great Recession. 

In advancing this assertion, neither Clinton nor Kaine mentioned government-subsidized housing (the traditional conservative explanation for the Great Recession) or excessive financial leverage on Wall Street (the traditional liberal explanation). Indeed, their argument is new, and it needs to be fact-checked. 

First, with respect to theory, no mainstream school of economic thought — Keynesian, classical, or monetarist — supports the view that tax relief can create recessions in the short-run.

The Keynesian view argues that deficit-financed tax cuts such as those passed in 2003 under Bush should provide stimulus to the economy by encouraging spending. Tax cuts provide such stimulus through boosting post-tax incomes, thus giving people more money to spend, which creates more economic activity and income for others. This idea is what is traditionally known as the Keynesian fiscal multiplier, and it was a fundamental motivation of the 2009 stimulus package. It’s an idea the Clinton-Kaine theory about the Great Recession rejects.

Many economists further argue that tax cuts which benefit the poor and middle-class deliver a bigger jolt to the economy, since such poorer individuals tend to spend a higher fraction of their incomes. The Bush tax cuts of 2003 slashed rates for all tax brackets, but even if they had been geared solely to the rich, Keynesian theory would suggest that they would produce a stimulative impact on the economy, although a significantly diminished one.

The classical and monetarist views argue that only permanent reductions in taxes have a positive impact on wealth in the long-run. The Bush tax cuts expired after eight years, so classical and monetarist economists could debate whether they count as a temporary fiscal shock or not. But neither school believes that tax cuts have a negative effect on economic activity. (It’s important to note that income and wealth inequality are a separate matter.)

The only plausible economic theory that could support the Kaine-Clinton argument is that deficit-financed tax cuts create recessions by expanding public debt to the point of fiscal insolvency, as happened in Greece. But that’s not what happened in the Great Recession of 2008–2009. 

Just as mainstream economic theory offers no support for the idea that the Bush tax cuts were responsible for the recession, empirical work on the impact of tax cuts in isolation suggests that they almost always boost consumption and economic activity to varying degrees.

University of Michigan economist Matthew Shapiro has found that over the last decade, tax cuts ranging from the initial tax-rate reductions enacted in 2001 under President Bush to the 2009 payroll-tax cuts under President Obama boosted economic activity to varying degrees. (It’s easy to forget that the American Taxpayer Relief Act of 2012, signed into law by Obama after the fiscal-cliff negotiations, actually retained nearly all of the Bush tax cuts for those making less than $400,000 per year, only increasing marginal rates on those making more than that.)

Few argue (and rightly so) that any of these tax cuts are self-financing. Quite the opposite: The continuing trend whereby the government takes in less than it spends has led to perennial deficits for 15 years. Perhaps such deficits could create fiscal drag on growth in the future, but that will only come in the form of higher taxes and lower growth, which again goes to show that tax cuts do not directly spur recessions.

#related#The Clinton campaign’s flawed theory of the Great Recession bears many resemblances to the false argument spouted by Bernie Sanders in the primaries: that the repeal of Glass-Steagall created the financial crisis. Both theories propagate a lie — in Sanders’s case, the debunked idea that reinstating Glass-Steagall would have broken up the investment banks or commercial lenders that nearly brought down the system — meant to castigate a particular group for political gain.

But while Sanders could ultimately be dismissed as a radical with no shot at power, Hillary Clinton may very well be our next president, so when she argues that tax cuts cause recessions, her argument can’t be allowed to stand. It’s the latest in a series of political maneuvers meant to slander the other party at the expense of honest policy discussion, and she shouldn’t be allowed to get away with it.

— Jon Hartley is an MBA candidate at the Wharton School of the University of Pennsylvania, an economics contributor for Forbes and the co-founder of Real Time Macroeconomics LLC.

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