Wednesday, March 16, 2016

Just to be Fair - Let's Beat Up Trump's Proposals Too

Unlike the other candidates, Trump’s proposals are backed up with very few specifics. In some sense, serious critics have very little tinder to start their fires.

By far the biggest of Trump’s proposals is a series of tax reforms that amount to very large tax cuts.


A problem of sorts with Republican proposals over the last few decades has been a ridiculous sales pitch — supporters are sold a story that tax cuts will “pay for themselves” when even conservative economists can’t support any conclusion even close to that. All of these proposals (or actions in the case of Bush II’s tax cuts) amount to back door plans to increase government borrowing to offset reduced tax revenue.

Yes, there is something called a Laffer curve which says that cutting rates when they are already low will reduce tax revenue. That makes sense. It also says that if cutting rates when they are already high will increase tax revenue. That also makes sense: it’s because the tax rate is a discouragement, and cutting it creates more taxable economic activity. That’s the theory. The empirical evidence is that almost all tax rates are way below the level where behavior would switch. There are some exceptions, usually involving taxes on one-time purchases or sales of assets. But for most taxes most of the time, you should assume that cutting rates will cut revenue. Unfortunately, Republican politicians have bought wholesale into the part of the argument they like (that cutting tax rates raises tax revenue) and ignored the evidence that this result is just not common at all.


What Republicans should pay more attention to is something called Ricardian equivalence (this is related to a newer result in finance known as the Modigliani-Miller theorem). The evidence is that how governments finance themselves — either through taxes or borrowing — is Ricardian equivalent. This means it doesn’t matter, and also the corrolary that the size of the deficit doesn’t matter.

When people first hear of Ricardian equivalence the think it sounds crazy. Let me explain why it’s not. The way the government pays for the stuff it provides is either with taxes or with borrowing. What Ricardian equivalence says that when evaluating a program, how it’s paid for doesn’t make any difference to its effectiveness. When you put it that way, it makes a lot of sense.

A useful analogy is buying vegetables or illegal drugs. Let’s presume the first is good for you, and the second one is bad. For the government, tax revenue is their income, and deficits are their borrowing. So the analogous choice for a person is whether to pay for something out of cash you received as income, or to charge it. Would you ever tell someone that vegetables are less good for you if you charge them? Or would you tell someone that illegal drugs are less harmful if you pay for them with cash? Of course not. If that analogy works for you, then it shouldn’t make a difference whether a government program is financed by tax revenues or deficit borrowing.

That’s actually a useful thing if you’re predisposed to liking smaller government. Because it says that all you really ought to think about is not how big or how small the government budget, deficit, debt, or taxes are … but just whether the program the money is being spent for is a good one or not. I think a lot of the public would benefit from thinking that way.

But honestly, I don’t think anyone involved in government likes smaller government. So, while Republicans say they want smaller government, when they’re in power they seem to be pretty good at making it bigger. For example, a Republican President and Republican-dominated Congress passed passed Medicare Part D (providing subsidization for seniors to afford pharmaceuticals). That’s a fairly liberal/progressive program to be added by the people who claim they want smaller government. Oh … and in case you had any doubts … they were paying for wars in Iraq and Afghanistan at the same time.

So Republicans cover their tracks by saying they want to cut taxes. And for a lot of people, reducing the pain of government taxes is hard to differentiate from reducing the size of government.

Except that Ricardian equivalence means that to be in favor of cutting taxes without cutting spending is to also be in favor of more borrowing.

To go back to the analogy, the Democrats are saying “more vegetables for everyone, all the time, and the government will pay for it”. And the Republicans are saying “more vegetables for everyone, but just when we’re in power, and government will pay for it” … “oh … and … um … the vegetables will be better for you if we pay for them with a credit card”. Then the whole Laffer curve bit amounts to justifying the credit card purchases because you get points you can use to buy even more vegetables (when, really, we’re all supposed to know that the points are a way to take away the sting of spending your money, and not a worthwhile financial objective in and of themselves).


Lastly, I think everyone should always, everywhere, be in favor of simplifying the tax code. Republicans tend to push this more than Democrats. That’s a good thing, but it’s hard to quantify how useful it is.


This is all important because when the Republicans make concrete proposals, they’re usually about tax rates, and when Republicans are criticized the basis is often the amount of borrowing the government does. Ricardian equivalence should be part of that conversation, and it is at some levels, but not in common public discussion.

So, what can we say about Trump’s proposals?

Here’s a piece from The New York Times entitled "Analysts Question Viability of Deep Tax Cuts Proposed by Republican Candidates" from which I drew this chart:

16-02-22 NYT capture about Republican tax cut proposals

Most of the article is about the size of the projected cuts to tax revenue: “By most estimates of the outside groups, the costliest plan is Mr. Trump’s.”

Do note that The Times does make the Ricardian equivalence argument, but it doesn’t use that name:

“I believe by cutting taxes and simplifying the tax code, we will grow our economy and create more taxpayers rather than more taxes,” Senator Marco Rubio of Florida has said.

Tax policy groups agree generally, but only if the revenue losses are offset by budget savings that avoid piling up more debt that would be counterproductive to spurring the economy.

“The candidates need to present real specifics for how they would address our record levels of debt,” said Maya MacGuineas, the president of the bipartisan Committee for a Responsible Federal Budget.

“Massive tax cuts and few specifics for what spending to reduce will only make the challenges much worse,” she added. “And miraculous growth projections and ‘waste, fraud and abuse’ are just not credible solutions.”

Now, here’s a much larger analysis of all Trump’s proposals from the Committee for a Responsible Federal Budget, a bipartisan think tank. It’s pretty detailed, but if you parse it out, by far the biggest economic proposal of Trump’s it the tax cuts. So it’s fair to stay relatively focused on that.

Trump has also argued that he’d like to balance the government’s budget. Think about that: 1) the government budget is already in deficit (so it’s partially financed by borrowing), and 2) Trump wants to cut taxes (which will require even more borrowing), so 3) he’s implicitly stating that he wants to cut spending. Now that we’ve gotten to the heart of the matter, the useful question is by how much?

But … wait for it … Trump has also said there’s some categories of spending that he won’t cut. He wants more spending for veterans and immigration, so no cuts there. But he doesn’t want to cut anything for seniors, which takes Social Cecurity and Medicare off the table. And he won’t cut defense either. Here’s the chart:

The result is on the right: Trump is arguing for cutting 60-80% of everything else.

Of course, he can’t say that, because no one would vote for that.

And, I actually doubt that he means it. What politicians do is throw out policy proposals and hope that no one actually does the analysis I’ve just reported here.

Now, obviously, economic growth could make all of this possible. But the estimates are that Trump’s proposals would collectively require sustained real GDP growth rates of about 11% per year. Compare that with Sanders’ estimates assuming sustained real GDP growth rates of 5.3% per year to pay for his proposals.


Paul Krugman, the Nobel Prize winning economist, who writes a column for The New York Times, is a solid Democrat/Progressive on the leftish side of their spectrum.

He’s written about how he’s conflicted about the Democrats proposals because they’re so disconnected from reality. (He says worse things about the Republicans) but his own Democrats are making him feel conflicted.

Anyway, he has a great metaphor about this. He says that Clinton is proposing to give voters a unicorn, and Sanders is proposing to give them a magic unicorn.

You probably shouldn’t believe either one of them. And you probably shouldn’t prefer the magic unicorn because … you’re never going to get any unicorn at all. And … oh my gosh … if Sanders’ numbers are supported by a math mistake, then it’s more like the Sanders is offering a unicorn that he says is magical because the unicorn already appeared to him and told him to say that.

The Ricardian equivalence argument implies that choosing between the Republicans is more innocuous: along the lines of each candidate is offering a differently colored unicorn. No doubt, Trump’s unicorn would be aggressively colored in bold hues of red and blue stripes, with white stars. And when Trump (or others) starts making outlandish claims about cutting taxes and balancing the budget and not cutting most spending … then their unicorn is far more magical than Sanders.

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