Wednesday, June 22, 2011

Michael Boskin in the WSJ. Another Conservative Economist Fails Econ 101

Why Can’t Economics Produce Better Economists?

The Dismal Political Economist has previously documented the lack of understanding of basic economics and noted how even comedian Jay Leno is a lot smarter than a lot of economists.  Now we have Michael J. Boskin, an economist with high credentials Chairman of the Council of Economic Advisers, Economics Professor at Stanford, Senior Fellow at the Hoover Institution (oops, that kind of gives it away, doesn’t it) writing economic gibberish in the Wall Street Journal.

Mr. Boskin writes about

and gets most of it wrong.  Here are his five lessons on how to reduce the deficit, and why he apparently has not learned his lessons.

  1. Cut Spending $5.00 for every $1.00 in tax increases.  Now this prescription goes against basic economic theory.  Cutting spending and raising taxes are both polices which will reduce growth and increase unemployment above what it otherwise would have been.  However, in raising taxes the economy does not suffer as large a negative reaction as cutting spending. 

For example, if spending is cut by $100 billion, there is $100 billion less in total demand. If taxes are raised by $100 billion, then total spending might not fall by $100 billion.  Consumesr may replace some of the lost income by liquidating and spending savings.  So raising taxes, particularly on high net worth tax payers who have wealth with which to maintain spending is what economic theory would say is the best way to reduce the deficit, best in that the negative impact is reduced.

To justify his positon Mr. Boskin says

In a comprehensive study of post-World War II fiscal consolidations in developed economies published last year by the National Bureau of Economic Research, economists Alberto Alesina and Silvia Ardagna conclude that successful deficit reduction averaged $5 to $6 in spending cuts for every $1 of tax hikes. Higher taxes more often led to recession.

Now this study is multi-national and it is beyond the scope of this posting to comment extensively (say thank you to The Dismal Political Economist) on it. It is important to know that

 The countries included in the sample are: Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Japan, Netherlands, New Zealand, Norway, Portugal, Spain, Sweden, Switzerland, United Kingdom ,and United States.

 The Dismal Political Economist feels that the most recent U. S. experience is more appropriate then say fiscal policy in Switzerland. That experience was the Clinton tax increase on high income individuals which reduced the deficit and brought a period of economic growth.  A study based in part on what happened in mostly European countries 30 years ago does not seem all that relevant.

  1. Control Spending with Enforceable Procedures.  The simple fact is that the Congress, including both parties ignores any enforceable procedures.  Most recently were Republicans, who exempted tax cuts from the deficit reduction process.  What this really does if enacted is automatically cut critical social support programs, and relieves some of the political consequences ("We had no choice, it was automatic cuts").

  1. Be Wary of Baseline Gimmicks.  Here Mr. Boskin talks about bracket creep, where higher inflation pushes a taxpayer into higher brackets.  Apparently Mr. Boskin is unaware of the fact that for many years the tax brackets are indexed.

  1.   Watch Out for Unintended Consequences.   Mr. Boskin calls for higher taxes on low income individuals,

We need both a broader base of economic activity and a larger fraction of the population financing government spending if we are to preserve a prosperous capitalist democracy.  

Because low income individuals cannot replace lost disposable income from wealth, taxing them would have the most negative impact of any tax increase.

  1. Tackle Fundamentals.    We need changes that compound and cumulate over time, especially in Social Security and Medicare which is saying cut Social Security and Medicare. 

The how, why and by how much is left to the reader’s imagination.

Sorry Mr. Boskin, only at the Hoover Institution do you get a passing grade in Economics 101.

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