Wednesday, September 28, 2011

The Wimpy Way to Deficit Reduction

"I'll gladly pay you Tuesday for a Hamburger today," Wimpy of Popeye fame is often quoted as saying. The implication of course, was that Wimpy was never going to come up with the cash on Tuesday. With the Gang of Twelve meeting the last two days, but apparently having no comment on their actual discussions, Rodger Hedgecock helpfully summarized things today. The Democrats will offer three dollars of future spending cuts for a dollar of tax increases today. The Republicans will be split between this "bipartisanship" approach and those who want to stand firm on any tax rises. It reminded me of Wimpy's proposition. Rodger reminded us that this is the standard Democratic trick, used against George H.W. Bush when he reneged on his "no new taxes" pledge. The spending cuts never come.

But why can't the Republicans reverse this game. We'll give you a dollar in tax rises tomorrow for three dollars of spending cuts today. Now Grover Norquist might start screaming that we shouldn't vote for any tax increases, ever. But he needs to understand my methods. First, as a matter of good politics, if we don't at least promise modest tax rises to pay for the coming spending cuts, then we will lose the political battle. The Economist makes this argument persuasively in this week's leader. Second, this presents an opportunity to reform the tax code. We should back load a phase out of all deductions and all of the other special goodies in the tax code. We should offset some of the increased revenue with lower marginal tax rates, which would be permanent. Third, if spending cuts and entitlement reforms produce the economic recovery that I expect, we can later vote for even lower marginal rates, in effect cancelling the tax hikes. Finally, we can argue that tax hikes now would harm the economy, so they have to be back loaded.

I have always believed that no tax hikes are needed to balance the budget. But sometimes the packaging is very important in selling the plan. Phasing out the deductions after giving people warning is a fair way to reform the tax code and reduce cronyism. Further, if we calculated decreases in the marginal rates that were exactly offset by the phase out of deductions in a static analysis, it would actually result in revenue growth for two reasons. First, the inefficiencies that are caused by hiding income would be wrung out of the system, resulting in greater growth than static analysis would predict. Second, because people would not have ingenious means of hiding income, but marginal rates were actually lower, reported income would rise.

The deficit commission can easily achieve the $1.2 trillion in cuts over ten years if such an approach were taken. The hard part would be to get the Democrats to go along, but I think the public would like it.


  1. The Democrats aren't trying to trick you, they are merely trying to prevent trillion dollar economic shocks. Yes, the classical model presumes that producers and consumers adjust automatically, but its known that things don't move that fast (remember the oil shock?). Pulling the whole fiscal punch bowl away immediately would cause a deeper recession.

  2. I guess we have forgotten the enormous growth of wasted spending that the Democrats pushed down our throats from 2007 to 2010. We need to go back to 2008 levels of spending immediately or a deeper recession will be the least of our problems. Capitalism works by more efficiently using resources. Every dime the government spends reduces economic activity by a factor of 4 or 5.

    The multiplier effect for private investment of your own money is 4:1 or 5:1 depending upon the study. The multiplier effect for government spending of other people's money is 1:1 or 1.1:1.


  3. A factor of 4 or 5? what is this cloud-kookoo land? If there is so much economic growth to be had then why are interest rates so low? (its not just the fed, the natural rate of interest is believed to be quite low, especially considering the relatively low rate of inflation.) Crowding out does occur-when the economy is actually moving

    Also, love the 'forced down our throats' rhetoric, concerning and extra $500 billion in spending between the last bush year and first obama year imposed by a...democratically elected government. I didn't know bridges and roads counted as 'wasteful'.