Greg Mankiw Cries Wolf Again

April 12th, 2010 by alexm

Greg Mankiw is one of my favorite economists because he helps confirm one of my favorite biases.

Most of us who went to MIT tend to be a bit dismissive of the quality of instruction at “that school up the road” where Mankiw teaches (and where it’s easier than it should be to get an A). The disingenuous nature of the links he posts on his blog repeatedly confirm my bias that spending $50k a year on an MIT education was a much better value than dropping a few more thousand on a diploma from Harvard. I don’t know whether he doesn’t bother to read the papers behind the links he posts, or whether he intends to deceive his readers, cackling maniacally as he types. Either way, I get to feel smug every couple weeks.

This weekend’s gem was a link to a Washington Post article listing five myths about your taxes. Sandwiched in between a set of kind of insightful points came “myth” number three: “Higher taxes could eliminate the federal deficit.”

The ”myth” claims that the federal government would need to raise tax rates by almost 40% to reduce the deficit to 3% of our GDP in 2015. 40%!!! That’s HUGE!

It sounds terrifying, like the federal government has exploded in size and become completely unmanageable since Obama took office. Unlike the Clinton years in which the government actually ran a surplus, and the relatively lean Bush years, where the deficit hovered around 3% of GDP, the authors of the article imply that something fundamental has changed in the past year.

It doesn’t quite pass the sniff test. Laying aside the hyperbole in the title of the “myth” – (clearly, if the government decided to confiscate everything, the deficit would be eliminated), it seems strange that the mere fact that we had the audacity to elect a black president during a recession has made it so that there’s no way, ever, to get the deficit under control again without gutting the federal government.

And as usual, when Greg links to an article with a “striking” conclusion (as he puts it), a deeper reading of the paper behind it shows that the “myth” section, as written, is either an accidental misrepresentation of the truth or outright dishonesty.

The relevant data appears in a table on page 13 of the report. The context of the estimates is mentioned in the text of the paper, but nowhere to be found anywhere in the article Greg pointed to.

It turns out that needing to raise income taxes by almost 40% in order to reduce the deficit to 3% of GDP is actually not based on US tax law but, um, based on a big giant fantasy tax code.

The authors of the study present data for what tax law changes would do under a variety of different assumption sets. The 40% figure is from the “administration baseline deficit” – the numbers that the Obama administration published explicitly to show how terrible the fiscal conditions they inherited from George W. Bush’s administration were. These aren’t numbers that the administration expects to have happen, they’re numbers that, let me repeat, they released JUST to show just how god-awfully the Bush administration ran things (with Greg Mankiw as one of their economic advisors).

This set of numbers assumes that a Democratic President with a Democratic Congress will, all of a sudden, decide to make all of the Bush tax cuts, which they OPPOSED, permanent. That’s never going to happen.

The authors of the paper use this case to provide data for what would happen if there’s too much political fallout from letting the tax cuts expire during a recession. If, on the other hand, the tax cuts (40% of which went to the highest-earning 1% of households, tax cuts that Greg Mankiw helped push) expire as planned, and the rest of the current tax law is maintained as it is currently written, guess what the deficit will be as a percentage of GDP in 2015.

3.1% of GDP. Without doing a single thing to tax law, let alone passing a 40% tax increase. Just by leaving tax law exactly like it is, the budget deficit will be only 0.1% more of GDP than the article’s target in 2015. To reach that target, the federal government would need to collect $43 billion extra in revenue.

However, the authors of the study used information from before when the new health-care bill was signed into law. Fortunately, the new health-care bill (which Greg opposed) takes care of $16 billion of the $43 billion shortfall. So we’re left with $27 billion left to raise. Guess what the real tax increase needed to get the deficit to GDP from current tax law is?

Not 40%. Not 4%. Not even 0.4%.

0.2%. Whup-de-friggin do.

Of course, while I’m being more up-front at this point than the authors of the article, that’s not the whole story either. The Obama administration may decide to extend some of the Bush tax cuts permanently, and the threshold for the alternative minimum tax will almost surely be raised before 2015. So there may need to be more changes in the distribution of the tax code.

But the idea that Congress needs to pass a 40% tax increase in order to keep spending at the same levels is just absurd.

One more note: why target a deficit of 3% of GDP (as the Obama administration is) instead of completely eliminating the federal deficit? The answer is that the size of the national debt in a vacuum is just a number. What matters for interest rates and for the long term outlook is national debt as a percentage of GDP. And when annual deficits are approximately 3% of GDP, economic growth means that the national debt won’t be increasing as a percentage of GDP – basically, we could run at an average of 3% of GDP deficit forever, with no harm done.

Sorry for the lack of profanity this time around ;)

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