Politics vs. Economics, II
By Arnold Kling
(Note: this continues the discussion from Politics vs. Economics.)
Another topic on which politics and economics can be separated is “supply-side tax cuts.” The meaning of this phrase has changed somewhat over the years.
During the Reagan era, a supply-side tax cut was a cut in tax rates that would yield an increase in tax revenues. Whether or not President Reagan’s tax cuts produced this result is an interesting issue that is outside the scope of this post.
Today, supply-siders seem to argue that even a tax cut that does not increase revenues is a supply-side gain. From the standpoint of economics, this is difficult to support.
The point can be made using one relationship that everyone agrees on, which is that more investment increases aggregate supply. Other than that, all that is needed is a simple accounting identity, one which holds for Hayek as much as for Keynes. That is,
S + T = I + G + (X-M)
where S=savings, T=tax revenues, I=investment, G=government spending, and (X-M)=the trade balance.
So, what does a tax cut do to aggregate supply if we hold constant savings, government spending, and the trade balance?
The answer is: tax cuts are bad for the supply side. Lower T means lower I, which reduces aggregate supply.
This is really basic stuff. I would absolutely flunk any first-year macro student who didn’t get it. I tend to doubt that Kudlow gets it.
Politically, however, I sided with Kudlow in favor of tax cuts. My support for tax cuts, which is fading with each passing month, was based on the assumption that government spending would be reduced by about as much as tax revenues. The combined effect on supply of an equal reduction in tax revenues and government spending can be–and probably would be–positive.
Some economists, including Gary Becker and Milton Friedman, made the political assumption that lower tax revenue would lead to lower government spending. Instead, the political dynamic seems to be that the passage of the tax cuts has taken away President Bush’s leverage to control spending. It’s like if you run out and buy a sports car, and then your spouse asks if a home redecoration project is affordable. How can you say no?
But that is politics. Politics is messy. Reasonable economists can differ about politics. But I am idealistic enough to believe that good economists do not let their political views drive their economic analysis. Moreover, I believe that most of the time, differences about economic beliefs are not the driving factor in political differences among well-trained economists. I think that it is possible to keep the two dimensions separate.
(This is closely related to the philosopher’s distinction between “is” and “ought,” or Milton Friedman’s distinction between positive and normative economics.)
This whole issue came up, ironically enough, on the civility plea thread!