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Krueger Tries and Fails to Disguise an Anti-Growth Tax Plan in Keynesian Garb

Posted By J.D. Foster, Ph.D. On January 13, 2012 @ 3:41 pm In Economics | Comments Disabled

The remarks of Alan Krueger, chairman of Obama’s Council of Economic Advisers, [1] asserting that taxing the rich can spur economic growth demonstrate that he and the Administration are nothing if not consistent in their mistakes.

Krueger says that there is growing income inequality in the United States, that this growing inequality contributes to slowing economic growth, and that raising taxes on the wealthy to offset some of this growing income inequality would actually stimulate the economy in the near term. While income inequality in the United States is growing, the growth in inequality is far less than it appears at first blush because of income mobility—today’s rich are often not tomorrow’s rich, and today’s poor are not necessarily tomorrow’s poor.

These, however, are well-trod paths of discussion and beside the point of Krueger’s “contribution,” which is to try to find a new happy-face justification for raising taxes that would otherwise be expected to slow the economy. Krueger’s two cents’ worth is his assertion that raising taxes on the wealthy would not slow the economy but would actually stimulate job growth. While this appears a new idea, it is in fact nothing more than a reheated, repacked dish of the same Keynesian thinking that gave us the failed Obama stimulus program.

The assumption behind the Obama–Keynesian approach is that the economy isn’t creating enough jobs because consumers and businesses are not spending enough—so the gap should be filled through increases in government deficit spending. What this approach leaves out—its fatal flaw—is that government must borrow the funds it deficit-spends, and this borrowing reduces private spending as much as government deficit spending increases. It is yet another free-lunch theory, and the old adage remains true even under President Obama: There’s no such thing as a free lunch.

Krueger’s novel extension of Keynesian theory is the proposition that raising taxes on the rich helps the economy because the rich have a nasty (in Krueger’s view) habit of saving a higher proportion of their income. What Krueger leaves out of the discussion is that if government does not spend the proceeds of these higher taxes on the wealthy by cutting taxes for other Americans or spending the money, then the policy is contractionary, not expansionary, whether one is a Keynesian or a supply-sider.

In the Obama–Keynesian economic model, shrinking deficits put downward pressure on job growth, just as rising deficits supposedly create jobs. Since the deficit is expected to fall in 2012 to about $1 trillion from its lofty 2011 height of about $1.3 trillion, if the Administration really believed the theory it touts, it would be very worried about a renewed recession. No such worries are in evidence, raising doubts about how much they really believe their own theory.

Giving Krueger the benefit of the doubt, let us assume government spends the revenues acquired by raising taxes on the rich. The government has then taken a dollar out of the economy, part of which would have been spent on consumption and part of which would have been saved, made available to the capital markets, and lent to someone who would use the saving. A dollar is taken out of the economy through taxes; a dollar has been put into the economy through spending; and total spending in the economy is unchanged. Once again, the fiscal alchemy of Keynesian spending falls apart, because it ignores the basic function of capital markets to efficiently and swiftly intermediate or shift savings from those who save to those who need the funds now for consumption or investment.

Suppose, instead, that under the Krueger model, the policy is a tax-revenue-neutral policy of higher taxes on the wealthy and lower taxes for everyone else. Again, the wealthy spend less and save less, while the beneficiaries of the tax cut spend more and save more. On balance, national saving falls, because as Krueger notes, the wealthy tend to save more of their income. On this much, at least, we can all agree.

Does less saving mean a stronger economy? Certainly not in the long run, but also not in the short run. Once again, the fiscal alchemy of Keynesian stimulus is on display. There is now less personal saving following the tax hike on the wealthy, which means less saving to intermediate through the financial markets and less investment by businesses. The character of total demand shifts away from investment and toward consumption, but total demand is unchanged.

Of course, all this ignores entirely the powerful negative economic effects that arise from the increase in disincentives to work, save, and invest from higher taxes on the wealthy, much of which means higher taxes on the small-business job creators President Obama claims to praise. Somehow, these incentive effects—which were widely understood and accepted only a few years ago, with only the magnitudes in dispute—have now been entirely forgotten by the Obama Administration’s economists in their pursuit of an ideologically driven, economically counterproductive tax hike.


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URL to article: http://blog.heritage.org/2012/01/13/krueger-tries-and-fails-to-disguise-an-anti-growth-tax-plan-in-keynesian-garb/

URLs in this post:

[1] Alan Krueger, chairman of Obama’s Council of Economic Advisers,: http://www.whitehouse.gov/sites/default/files/krueger_cap_speech_final_remarks.pdf

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