Beltway blindness

Alan Reynolds
Posted: Aug 20, 2004 12:00 AM

In a remarkable trilogy of editorials, The Washington Post took a "fresh look" at the Bush tax cuts of 2001-2003. "The Bush administration's fiscal policy has been grinding on for three years," they wrote, "producing few concessions or apologies." Unsurprisingly, this "fresh look" merely "reinforced our view that these cuts are a mistake." Not any specific tax cut, mind you, but every one of them is decreed a mistake. Yet there were two "concessions or apologies" that undermine that conclusion.

 The most startling concession was to see The Washington Post finally admit supply-side economics works: "Lower tax rates on wages do boost the labor supply; lower tax rates on investment may boost savings; more labor and more capital mean more economic output."

 The Washington Post also admits privatization of Social Security works. "Social Security privatization could reduce long-term deficits," according to the editorial. "The nation should not be deterred by the transition costs," it continues. "Privatization could also stimulate economic growth, boosting tax revenues and so strengthening the nation's fiscal prospects via a second route. By converting the payroll tax into contributions to personal accounts, government could reduce the tax burden on workers, thereby boosting incentives. Moreover, private accounts would boost national savings."

 Unfortunately, these insights were lost while rushing back into the comfort zone of conventional (Keynesian) economics, in which every economic policy is primarily judged by its impact on the Federal purse. Faster economic growth and Social Security privatization were described as desirable, for example, only to the extent that they might help pay for a much bigger government.

 The Congressional Budget Office last estimated the budget deficit at about zero by 2014. But The Washington Post prefers unofficial projections from Alan Auerbach of U.C. Berkeley, and two former Clinton officials, Bill Gale and Peter Orszag of the Brookings Institution. This trio assumes not a single feature of the 2001-2003 tax cuts is allowed to expire as scheduled in 2009-2011, as though the president's talk about making it all "permanent" could somehow bind every future Congress. They also assume the Alternative Minimum Tax will be greatly emasculated, although there is no apparent legislative rush to do that. Such assumptions help lift their deficit estimate to 3.5 percent of GDP in 2014.

 The Washington Post says, "If the economy grows by just under 4 percent a year, rather than just under 3 percent as assumed in the projection, the deficit in 2014 would come to a far less alarming 0.5 percent of GDP." But it quickly forgot tax rates matter, arguing that growth close to 4 percent requires "a rare and fleeting miracle." Specifically, "productivity gains of 2.7 percent per year between 1996 and 2000 ... drove the economy's growth rate up to 4 percent." Actually, the economy's growth exceeded 4 percent from 1983 to 1989 largely because "lower (marginal) tax rates on wages do boost the labor supply." Besides, productivity over the past year is up 4.7 percent.

 When it comes to Social Security privatization, The Washington Post clearly admits it would boost the economy. Yet the editors complain it "would boost the government's tax take by only around 1.5 percent of GDP." They also figure it would save "only" 1 percent of GDP on the spending side. That adds up to 2.5 percent of GDP -- the size of next year's deficit -- yet the editors make it sound like small change. Why? Because those Berkeley-Brookings estimates "put the size of the deficit in 2040 at 20 percent of GDP."

 To find out what the budget deficit will really look like in 2040, we might just as well ask any three people from a homeless shelter. The Berkeley-Brookings projections blithely assume spending on Social Security, Medicare and Medicaid will actually be allowed to rise endlessly -- from 8.1 percent of GDP in 2004 to 23.3 percent in 2080.  If other spending remained relatively unchanged (no new health care schemes), paying all those benefits would mean the ratio of federal tax to GDP would have to rise from an average of 18.4 percent over the past 40 years to more than a third. Since there are no immediate plans to do that, the authors bemoan their fabricated 75-year "fiscal gap." What they actually demonstrate is the looming bankruptcy of Social Security and Medicare.

 Basing its "fresh look" on this incredible vision of future federal spending, The Washington Post concludes, "Two factors overwhelmingly explain the looming budget crisis. The first is the rising cost of servicing the national debt: In 2004, this comes to 1.4 percent of gross domestic product; by 2040, it will have shot up to 11.9 percent. The second is the growth in health programs for the old and poor." 

 If you start out assuming spending on Social Security and Medicare can and will claim and ever-increasing share of GDP, then you are bound to end up "projecting" a big increase in the national debt and therefore in the interest paid on that debt. Drop the underlying assumption that ever-increasing transfers from young to old are actually feasible, and this alleged crisis turns out to be assumed rather than proven.

 The Washington Post editors decry "the waste that follows from a system in which doctors decide when care is necessary." If you'd rather have some bureaucrat decide whether your health care is necessary, Sen. Kerry may have a plan you'll like. The editorial also cites an internist who thinks "expensive regions are expensive because they have lots of hospitals and doctors." Perhaps you could cut a better deal in North Carolina, where frivolous class-action suits have driven many medical specialists away. With no doctors or hospitals at all, it would be even cheaper.

  Finding disagreement disagreeable, economists of the conventional school seek refuge from debate by asserting that "most economists" or "many studies" agree with them. The Post uses this technique to claim many unnamed studies (presumably by the same three authors) find the beneficial effects of lower tax rates are offset by negative effect of larger deficits. But "lower tax rates ... mean more economic output" -- which also means more income to be taxed. If the combined effect of a larger tax rate and a larger tax base is to leave revenues unchanged or larger, then any theoretical negative impact of deficits on national saving (which remain unproven) are simply beside the point.

 The Washington Post also relies on the conventional consensus by claiming, "Every plausible vision of the future suggests that government is going to grow as a share of the economy." Any dissent thus becomes, by definition, an implausible vision of the future. Federal spending declined from 23.5 percent of GDP in 1983 to 18.4 percent in 2000 -- scarcely proof of an inexorable upward trend. In a representative government, the future size of government spending and taxes is supposed to be decided by elections, not by editorial writers.

 In reality, as opposed to projections, there is no chance at all that young workers will vote to tax themselves twice as heavily just to subsidize everyone older than 65. As Martin Feldstein notes, Kerry's real alternative to Social Security privatization is to slash future Social Security benefits by 27 percent on average -- and by 80 percent if you put away a decent pension. Privatization would be a far better alternative for young and old, partly for reasons The Washington Post explained. Yet their editorial misdirected a comment at Bush that would have been better aimed at Kerry's do-nothing posture on Social Security -- namely, that "leaders are supposed to think responsibly about the future, not shrug their shoulders."