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Krugman Defends Indefensible in Critique of “Voodoo Economics”

By: Scott Hodge

In a column today titled “Voodoo Economics, the Next Generation,” New York Times columnist Paul Krugman warns that if Republicans take over the Senate, they could “impose their will on the Congressional Budget Office, heretofore a nonpartisan referee on policy proposals.” As a result of this meddling, Krugman says, “we may soon find ourselves in deep voodoo.”

Of course, the voodoo Krugman is raising red flags about is voodoo economics—the moniker George H.W. Bush gave to Ronald Reagan’s supply-side taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. policies during the 1980 presidential primaries to deride the contention that cutting top marginal tax rateThe marginal tax rate is the amount of additional tax paid for every additional dollar earned as income. The average tax rate is the total tax paid divided by total income earned. A 10 percent marginal tax rate means that 10 cents of every next dollar earned would be taken as tax. s would pay for themselves.

While it is certainly true that many supply siders have mistakenly given the impression that all tax cuts pay for themselves, Krugman seems to be implying three indefensible notions:

  1. That changes in tax policy don’t affect individual and business behavior in ways that effect the economy;
  2. That the conventional, or “static,” method of modeling the effects of tax changes used by the Joint Committee on Taxation (not the CBO as Krugman erroneously suggests) are more accurate than dynamic models. Static models assume that tax changes—no matter how large—don’t effect the level of GDP while dynamic models attempt to simulate those effects; and,
  3. That members of Congress should not be informed of the economic consequences of their fiscal policy decisions before they vote on legislation.

As I said in my testimony last August before the Subcommittee on Select Revenue Measures of the House Ways and Means CommitteeThe Committee on Ways and Means, more commonly referred to as the House Ways and Means Committee, is one of 29 U.S. House of Representative committees and is the chief tax-writing committee in the U.S. The House Ways and Means Committee has jurisdiction over all bills relating to taxes and other revenue generation, as well as spending programs like Social Security, Medicare, and unemployment insurance, among others. :

Despite the criticism, what dynamic scoringDynamic scoring estimates the effect of tax changes on key economic factors, such as jobs, wages, investment, federal revenue, and GDP. It is a tool policymakers can use to differentiate between tax changes that look similar using conventional scoring but have vastly different effects on economic growth.   is really about is accuracy, credibility, and having tools that guide us toward tax policies that promote economic growth and steer us away from policies that reduce living standards.

By contrast, conventional static analysis leaves lawmakers in the dark about the economic consequences of their tax choices. That is economic malpractice.

Relying on static scoringStatic scoring (conventional scoring) is an estimation method that, unlike dynamic scoring, assumes that tax changes have no impact on taxpayer behavior and thus have no effect on important macroeconomic measures like GDP, investment, and jobs. This provides a one-dimensional perspective about the effects of tax changes. turns tax reform into an exercise in arithmetic, rather than an exercise in promoting policies that raise peoples’ living standards and the health of the private economy.

It is probably pretty intuitive to most laymen that different types of tax cuts will have different effects on the economy, as will different types of tax increases. For example, a $10 billion cut in the corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax. rate would have a bigger impact on the economy than a $10 billion tax creditA tax credit is a provision that reduces a taxpayer’s final tax bill, dollar-for-dollar. A tax credit differs from deductions and exemptions, which reduce taxable income, rather than the taxpayer’s tax bill directly. for purchasing electric cars. And as a result of the increased growth generated by the corporate rate cut, it would seem equally likely that new tax revenues would be generated—perhaps not enough to fully offset the revenues lost by the rate cut, but some measurable amount. But the static scoring that members of Congress are provided with by the JCT shows each of these policies as having zero impact on GDP and, thus, zero effect on boosting tax revenues.

On the flip side, dynamic scoring should also be a welcome tool for those who believe the government needs more tax revenues. After all, if your goal is to raise more revenue for the government, you should want to do so in a way that maximizes the tax take with the least amount of impact on the economy. Clearly, a weaker economy produces less revenue. Most people would agree that raising $20 billion by closing targeted tax loopholes would likely have a smaller effect on the economy than a $20 billion increase in tax rates on capital investment. But conventional scoring methods don’t provide members of Congress with this kind of information.

Krugman concludes by chiding members such as Rep. Paul Ryan for wanting to use magic asterisks to fill in the budget gaps supposedly caused by believing that tax cuts pay for themselves. But the same could be said for those who used magic multipliers to justify President Obama’s $831 billion “stimulus” spending bill under the implausible belief that borrowing money from our children (or the Chinese) would boost the economy and effectively “pay for” the cost of borrowing that money.

Congress should have the benefit of realistic dynamic scoring for both tax and spending policies. Everyone knows that the conventional “static” models used by the agencies that advise members of Congress are wrong. Moving to more reality based modeling techniques cannot undermine the credibility of CBO or JCT because the rigid adherence to obsolete methods already has.

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