Austan Goolsbee on the Bush tax cuts, a payroll-tax holiday and what he'd do with $700 billion
Austan Goolsbee was the Robert P. Gwinn Professor of Economics at the University of Chicago Booth School of Business and is currently serving as staff director and chief economist on the President's Economic Recovery Advisory Board and as the chair of the Council of Economic Advisers. We spoke this morning about the Bush tax cuts, using a payroll-tax holiday for stimulus, how to spend $700 billion and what to look for in 2011. A lightly edited transcript follows.
Ezra Klein: You guys attack the Republicans for pushing unaffordable tax cuts, but even your plan would add $3 trillion to the deficit over the next 10 years. How can we afford that?
Austan Goolsbee: Look at the decade the middle class has had, where middle-class incomes fell by $2,000 during an economic boom -- a first in our history. That was followed by the worst recession since 1929.I don’t think, in that environment, you can afford to balance the budget on the back of the middle class. You have to address the long-term fiscal challenges facing the country through the bipartisan commission in some bipartisan way.
EK: But indefinitely? Why not do two or three or four years? That way, when it’s time to let them go, you can do so with a veto, rather than requiring 60 votes in the Senate.
AG: I’m not an expert political strategist. I’m just a policy guy. I think the long-term squeeze on the middle class is the most pressing problem facing the sustained growth of the country. But the main way we’re going to balance the budget is ask the middle class to pay for it? You can’t look at the economic performance of the middle class over the last 10 years and think that’ll work.
EK: But on the point of middle-class incomes, the Congressional Budget Office looked at the question and concluded that extending the tax cuts indefinitely would lower incomes by 2020. In other words, it would actually hurt the economy.
AG: As you know, behind any statement like that is some model. In their model, they’ve made an assumption of what deficits do to the interest rate, and my understanding is they’re assuming a relatively significant impact. We’ve had a major deepening of the world capital market in recent years, and so the impacts of tax cuts on the interest rate may not be as big as they’re assuming. If you take a step back, the underlying fiscal crisis facing the country is driven by health-care inflation and entitlement spending. And so we need some outcome from the fiscal commission. But the center of that effort can’t be balancing the budget on the back of the middle class.
EK: The CBO also said that extending all of the tax cuts, including those for income over $250,000, would do less damage to the economy than just extending the middle-class tax cuts. Obviously you disagree, but why?
AG: Having been a major player in, and studied the academic evidence on, how people respond to changes in tax rates, I don’t think the old-style argument that high-income people have big responses to small changes in tax rates is warranted by the evidence. Even a casual look at our experience in the '90s and the 2000s suggests that high-income marginal tax rates aren’t the primary drivers of growth. Bill Clinton raised rates on exactly this group that we’re talking about, and it did not have a significant negative impact on the growth of the country. Then, in the 2000s, we cut high-income tax rates by as much as they’ve ever been cut, and we certainly did not experience a massive renaissance in economic growth. There should be a higher burden of proof on people saying that rates going up by four points on income above $250,000 will have a huge negative effect.
EK: When we talk about the tax cuts, there tend to be a few arguments that get rolled together. One is that it’s good for the middle-class to have some tax relief. Another is that the cuts encourage economic growth, which was the original argument from the Bush team. And then there’s the question of short-term stimulus. Are they good stimulus?
AG: Virtually every analysis that exists on the impact of various kinds of tax cuts on restarting the economy shows that very high-income tax cuts are dead last on any measure. The evidence is overwhelmingly clear that if you had $700 billion to spend to try and get the growth rate up, you would not spend it on that.
EK: Where would you spend it?
AG: The fundamental uncertainty in the business world is about where the economy will go in the short run. It’s uncertainty about demand. Knowing there won’t be a tax increases on 98 percent of people is a start. But that’s outside your $700 billion package. The president’s proposal to cut small business taxes and make credit available to them, to encourage R&D investment in the U.S., the tax credit for business investing and plant building, and the infrastructure investment, I think that’s a very reasonable place to invest the money. I don’t know if that’s exactly $700 billion, but it’s far more directly beneficial to the economy than is just handing out $700 billion to very high-income people. We need to be easing the uncertainty for businesses worried about demand, not easing the uncertainty for a person making $500 million a year who is worried they’ll have to pay a bit more in taxes.
EK: What about a payroll-tax holiday of some sort?
AG: We passed the HIRE Act, which was a payroll-tax incentive for businesses that hired new workers. As with any tax policy, you want your goal to be not to spend a lot of tax revenue subsidizing things people were already going to do. The good side is that focusing on the middle class, on companies trying to encourage investment in this country. That makes sense. The president’s view was to try and encourage investment. That’s why we went with the R&D credit, business investment incentives and infrastructure investment in our proposal.
EK: There’s been some evidence coming out lately that when a country needs to balance its budget, spending cuts are better than tax hikes. We’ve seen this from Alesina at Harvard, from the IMF and from the CBO. Do you think that’s right?
AG: People are getting way out in front of the evidence on this. Those comparative studies are mainly on very small economies, nations that are 1/50th or 1/100th the size of the U.S. And what little countries did to deal with their imbalances are frequently not available for giant economies like the U.S. or Japan. More intense research shows that the primary way countries get out of fiscal holes is by increasing their growth rate. To posit that you have to either substantially cut spending or raise taxes belies the fact that what really matters is debt-to-GDP. In the U.S., we’ve often reduced that ratio without running surpluses by getting the growth rate up. The growth rate is a critical component of fiscal sustainability. The fiscal policy you can sustain depends on how big your GDP growth is.
EK: Looking at 2011, what are you optimistic about? What are you worried about?
SG: As Warren Buffett has said, in 1900, the Dow was at 50. In the intervening decades, we had World War I, a depression, World War II, flu pandemics, oil shocks, Vietnam. A lot of really major, negative things happened. And yet, by 2010, the Dow is at 10,000. The ultimate generative capacity of the U.S. economy is based on innovation, the quality of our workforce, the vibrancy of our markets, and how entrepreneurial our people are. And those things remain. We also have going for us the normal self-correcting mechanisms of recessions. People need to replace their cars, to get married, have children. Those underlying trends are in our favor. Second, the president has done a lot of things over the past few years to stop the freefall in the economy, which worked, and encourage the private sector to stand up, which we’ve done a lot on and have to keep pushing on.
Housing is a concern. Prices seem to have stabilized, but it remains a troubled area as there are a lot of vacant houses. State fiscal situations are very precarious. We’ve had eight months of private-sector job growth after 20 months of losses, but it’s getting balanced off by the trouble in state and local employment. In the first three months of this year, the data were coming in better than expected. Then there was the crisis in Europe, which shook confidence and the markets. The developed world remains in a tough spot. So international growth remains a concern for our exports.
The business cycle in the 2000s was driven by consumer spending faster than income growth and residential housing investment, and that was unsustainable. And so we’re trying to point to an older-style of recovery that’s business-investment driven, where consumption growth is proportional to income, and then a push on exports. Those three things can sustain a boom, but on each of those, there are reasons to be optimistic, but there are dangers. For the exports, if there’s no growth out of Europe, that’ll be a concern. On the investment side, there’s money on the sidelines, but there’s an uncertainty that demand isn’t there. And I’m optimistic on proportional consumption growth, as we had a pretty dramatic increase in the savings rate.
Photo credit: Bill O'Leary/The Washington Post.
| October 6, 2010; 4:02 PM ET
Categories: Economic Policy, Interviews
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