Krugman, Mankiw, DeLong on the Romers' "tax changes have very large effects on output"

Memo to Paul Krugman. By Philip I. Levy
AEI, Tuesday, January 27, 2009

Allow me to introduce myself: I'm a Bad Faith Economist. At least, that's Paul Krugman's contention in the New York Times yesterday. He argues that opponents of the stimulus plan are all dastardly dissemblers, scheming to sabotage a new New Deal that would otherwise save the economy.

The stimulus package is an unwieldy monster weighing in at over $800 billion. It includes new spending projects, aid to state governments, and proposed tax cuts. It is the new spending projects that spark this particular debate. Krugman's logic is as follows: if any arguments against the spending are flawed, then all must be flawed. That certainly makes a critic's job easier, so let me adopt his approach for the moment and deal with his tactics on taxes.

Krugman says we should "write off anyone who asserts that it's always better to cut taxes than to increase government spending." I agree. I don't know of any critics who are asserting that, but there must be some out there. Krugman dismisses them by arguing that air traffic control is useful. Again, I agree.

He then proceeds: "Meanwhile, it's clear that when it comes to economic stimulus, public spending provides much more bang for the buck than tax cuts." For those who are not well-versed in the rules of classical rhetoric, the phrase "it's clear that…" means "I am about to make an assertion that I strongly believe but would be very hard to prove." In fact, there is a raging debate about whether tax cuts or public spending do more to revive a troubled economy. One side of this debate--see Greg Mankiw, especially here--argues that tax cuts are superior, while another side--see Brad DeLong, especially here--argues that tax cuts and spending are roughly equal. They're both arguing about this 2007 paper co-authored by the incoming Chair of President Obama's Council of Economic Advisers, Christina Romer. In it, she and her husband, David Romer, conclude that "tax changes have very large effects on output."

For a fair fight between those touting tax cuts and those supporting spending, they compare a tax cut today to a spending boost today. If one compared a tax cut now to spending years down the road, then it would be no contest-–tax cuts would win. In fact, that's pretty much the choice we face. According to press reports of an unreleased CBO study, only $26 billion of $355 billion in new spending would occur in the current fiscal year. Another $110 billion would come in Fiscal 2010. That's less than 40 percent of the total by September 2010. Those numbers are so low because it's very hard to find and fund that many worthwhile projects that quickly. Democrats have countered with much higher percentages, but those generally include the tax cuts and the aid to states, which are not really at issue.

Now, there may be a lot to be said for a new electricity grid and renovated highways, even if they don't show up until next decade. But those plans should be judged on their merits, with hearings and all the other trappings of democratic deliberation. They shouldn't be rammed through as emergency stimulus.

It is also misleading to imply that one must favor either tax cuts or the proposed spending projects right now. I don't believe that either holds the key to economic recovery. At the heart of our current crisis lie a downward spiral in the housing sector and a near collapse of our financial sector. There are plans that address these root causes, but they are likely to be expensive. Without such action, a fiscal boost is unlikely to save the day. With such action, a fiscal boost (beyond what is already in the works) may be unnecessary and unaffordable.

One might almost ask whether Dr. Krugman is being intentionally misleading with his piece, but I would not stoop so low as to question his motives. I am perfectly willing to accept that he is putting forward his flawed arguments in good faith.

Philip I. Levy is a resident scholar at AEI.