Just last week, I made fun of Paul Krugman after he publicly said that a fake threat from invading aliens would be good for the economy since the earth would waste a bunch of money on pointless defense outlays.

Yesterday, there were rumors that Krugman stated that it would have been stimulative if the earthquake had been stronger and done more damage, but he exposed this as a prank (though it is understandable that many people — including me, I’m embarrassed to admit — initially assumed it was true since he did write that the 9-11 terrorist attacks boosted growth).

 But while Krugman is owed an apology by whoever pulled that stunt, the real problem is that President Obama and his advisers actually take Keynesian alchemy seriously.

And since President Obama is promising to unveil another “jobs plan” after his vacation, that almost certainly means more faux stimulus.

We don’t know what will be in this new package, but there are rumors of an infrastructure bank, which doubtlessly would be a subsidy for state and local governments. The only thing “shovel ready” about this proposal is that tax dollars will be shoveled to interest groups.

The other idea that seems to have traction is extending the current payroll tax holiday, which lowers the “employee share” of the payroll tax from 6.2 percent to 4.2 percent. The good news is that the tax holiday doesn’t increase the burden of government spending. The bad news is that temporary tax rate reductions probably have very little positive effect on economic output.

Lower tax rates are the right approach, to be sure (particularly compared to useless rebates, such as those pushed by the Bush White House in 2001 and 2008), but workers, investors, and entrepreneurs are unlikely to be strongly incentivized by something that might be seen as a one-year gimmick. Though I suppose if the holiday keeps getting extended, people may begin to think it is a semi-durable feature of the tax code, so maybe there will be some pro-growth impact.

In any event, we will see what the President unveils next month. I’ll be particularly interested in how his supposed short-run jobs proposal fits in with his long-run plan for dealing with red ink. He has been advocating for a “balanced approach” and “shared sacrifice” – but that’s Obama-speak for higher taxes, and we know that’s a damper on job creation and new investment.

As you can tell, I’m not optimistic. The best thing for growth would be to get the government out of the way. The Obama White House, though, thinks bigger government is good for the economy.

This stimulus video was produced last year and was designed for another jobs plan concocted by the Administration, but the message is still very appropriate.

Is Obama Really Going to Propose Another Keynesian Stimulus? is a post from Cato @ Liberty - Cato Institute Blog

I’ve poked fun at Paul Krugman for his views on health care and British fiscal policy, and I’ve semi-defended him about unemployment subsidies and housing bubbles.

Now it’s time for some more mockery.

Back in 2001, Paul Krugman received some much-deserved criticism for stating that the 9/11 terrorist attacks would be stimulative for the economy.

He committed the “broken-window” fallacy, explained more than 150 years ago by a famous French economist, Frederic Bastiat.

Breaking a window at the local bakery, Bastiat explained, might generate business for the town glazier, but only at the expense of some other merchant, like a tailor, who would have benefited if the baker didn’t have to spend money on a new window.

In other words, the destruction of wealth is not good for an economy. At best, it makes us poorer and then shifts how current income is allocated. This is why Bastiat wrote (perhaps predicting the emergence of Krugman):

There is only one difference between a bad economist and a good one: the bad economist confines himself to the visible effect; the good economist takes into account both the effect that can be seen and those effects that must be foreseen.

But we have to give Krugman credit for a bizarre form of ideological consistency. He is willing to advocate bigger government, no matter how sloppy the reasoning or how quirky the rationale.

His latest outburst was to say on CNN how wonderful it would be for the economy if the people of earth mistakenly thought we were on the verge of an alien invasion, which would lead to lots of military spending.

He even cited an episode of Twilight Zone to justify his assertions. I’m surprised he didn’t also mention the 1996 film, Independence Day.

As I wrote in a previous blog post, this is one of those moments when your only response is to say “wow.” This is even worse than when Keynesians assert that it would be stimulative to pay people to dig holes and fill them in again.

For those who want more info on why government spending does not boost the economy in the short run, here’s my video on Keynesian economics.

And if you want to know why government spending does not boost the economy in the long run, here’s a video looking at some empirical evidence about economic performance and the size of the public sector.

Paul Krugman Meets E.T. is a post from Cato @ Liberty - Cato Institute Blog

Someone called Stephen Metcalf writes at Slate of his horror at finding in “an otherwise quite groovy loft” in New York’s SoHo “not one but two copies of something called The Libertarian Reader.” Given that he manages to lump not just Paul Ryan and South Park but Sarah Palin into the libertarian basket, you can appreciate his dismay.

Metcalf puts Robert Nozick at the center of his argument, understandably enough. My colleague Tom Palmer says that academic critics almost always cite one chapter of one book, Nozick’s Anarchy, State, and Utopia, and declare that they have grappled with libertarian ideas. Still, it’s a good book and worth grappling with, and it did have an impact, as Metcalf notes:

I like to think that when Nozick published Anarchy, the levee broke, the polite Fabian consensus collapsed, and hence, in rapid succession: Hayek won the Nobel Prize in economics in 1974, followed by Milton Friedman in ’75 [1976], the same year Thatcher became Leader of the Opposition, followed by the California and Massachusetts tax revolts, culminating in the election of Reagan, and … well, where it stops, nobody knows.

I’ll leave it to my more learned colleagues to analyze how successfully Metcalf actually deals with Nozick’s arguments. I just want to note one thing here. Like many other critics of libertarianism, Metcalf triumphantly announces:

How could a thinker as brilliant as Nozick stay a party to this? The answer is: He didn’t. “The libertarian position I once propounded,” Nozick wrote in an essay published in the late ’80s, “now seems to me seriously inadequate.”

Yes, yes, yes. It gets repeated a lot: “Even Nozick renounced libertarianism.” If it were true, it’s not clear what it would mean. Libertarianism is true, or not, whether or not Paul Krugman or Russell Kirk believes it, and whether or not Robert Nozick believes it. The idea stands or falls on its own. But as it happens, Nozick did “stay a party” to the libertarian idea. Shortly before his death in 2002, young writer Julian Sanchez (now a Cato colleague) interviewed him and had this exchange:

JS: In The Examined Life, you reported that you had come to see the libertarian position that you’d advanced in Anarchy, State and Utopia as “seriously inadequate.” But there are several places in Invariances where you seem to suggest that you consider the view advanced there, broadly speaking, at least, a libertarian one. Would you now, again, self-apply the L-word?

RN: Yes. But I never stopped self-applying. What I was really saying in The Examined Life was that I was no longer as hardcore a libertarian as I had been before. But the rumors of my deviation (or apostasy!) from libertarianism were much exaggerated. I think this book makes clear the extent to which I still am within the general framework of libertarianism, especially the ethics chapter and its section on the “Core Principle of Ethics.”

So Nozick did not “disavow” libertarianism. Indeed, Tom Palmer adds a point that

David Schmidtz told at a forum about Schmidtz’s book from Cambridge University Press, Robert Nozick, held October 21, 2002 at the Cato Institute. According to David, Nozick told him that his alleged “apostasy” was mainly about rejecting the idea that to have a right is necessarily to have the right to alienate it, a thesis that he had reconsidered, on the basis of which reconsideration he concluded that some rights had to be inalienable. That represents, not a movement away from libertarianism, but a shift toward the mainstream of libertarian thought.

Metcalf’s criticisms of libertarianism will have to stand on their own, as will libertarianism itself. He doesn’t have Nozick on his side. As for Metcalf’s final complaint that advocates of a more expansive state have been “hectored into silence” by the vast libertarian power structure, well, I am, if not hectored, at least stunned into silence.

P.S. Matt Welch notes that if Metcalf doesn’t have Nozick on his side, at least he has Ann Coulter.

Misunderstanding Nozick, Again is a post from Cato @ Liberty - Cato Institute Blog

London was just hit by heavy riots as part of a protest against the “deep” and “savage” budget cuts of the Cameron government. This is not the first time the UK has endured riots. The welfare lobby, bureaucrats, and other recipients of taxpayer largesse are becoming increasingly agitated that their gravy train may be derailed.

The vast majority of protesters have been peaceful, but some hooligans took the opportunity to wreak havoc. These nihilists apparently call themselves anarchists, but are too ignorant to understand the giant disconnect of adopting that title while at the same time rioting for bigger government and more redistribution. My anarcho-capitalist friends must be embarrassed by the potential linkage with these hooligans.

Speaking of rage, Paul Krugman is equally dismayed with Prime Minister David Cameron’s ostensibly penny-pinching budget. Summoning the ghost of John Maynard Keynes, Krugman asserts that such frugality is misguided when an economy is still weak and people are unemployed. Indeed, Krugman argues that the UK economy is weak today precisely because of Cameron’s supposed austerity.

Not surprisingly, the purpose of his argument is to discourage similar policies from being adopted in the United States.

Here’s part of what Krugman wrote as part of his column on “The Austerity Delusion.”

Austerity advocates predicted that spending cuts would bring quick dividends in the form of rising confidence, and that there would be few, if any, adverse effects on growth and jobs; but they were wrong. …Like America, Britain is still perceived as solvent by financial markets, giving it room to pursue a strategy of jobs first, deficits later. But the government of Prime Minister David Cameron chose instead to move to immediate, unforced austerity, in the belief that private spending would more than make up for the government’s pullback. As I like to put it, the Cameron plan was based on belief that the confidence fairy would make everything all right. But she hasn’t: British growth has stalled, and the government has marked up its deficit projections as a result.

At first I wondered if Krugman was playing an April Fool’s joke, but this is consistent with his long-held views about the magical impact of government spending. Besides, his piece is dated March 25, so I think we can safely assume he actually believes that Cameron’s supposed budget cutting is crippling the UK’s recovery.

There are two problems with Krugman’s column. The obvious problem is his unwavering support for Keynesian economics. I’ve addressed that issue here, here, here, here, and here, so I don’t feel any great need to rehash all those arguments. I’ll just ask why the policy still has adherents when it failed for Hoover and Roosevelt in the 1930s, failed for Japan in the 1990s, failed for Bush in 2008, and failed for Obama in 2009.

But the really amazing thing is that both Krugman and the rioters are wrong, not just in their opinions and ideology, but also about basic facts. Government spending has skyrocketed in the United Kingdom in recent years. Spending is even increasing at about double the rate of inflation in the current fiscal year. But don’t believe me. Look on page 102 of the UK’s latest budget.

Maybe that’s austerity to the looters and other protestors who think they have an unlimited claim on the production and income of other people, but it’s hard to see how a 4 percent increase in spending can be characterized as “brutal” and “vicious” spending cuts.

Moreover, Cameron has been a disappointment on the tax issue. He left in place Gordon Brown’s election-year, 10-percentage point increase in the top income tax rate. But then he imposed an increase in the VAT rate and implemented a higher capital gains tax.

To be sure, Cameron’s budget promises a bit of fiscal restraint in upcoming years, with spending supposedly growing at about 1 percent annually over the next three years. That would actually be somewhat impressive, roughly akin to what Canada and Slovakia achieved in recent decades. But promises of future spending restraint (which may never materialize) surely are not the same as present-day austerity.

One final comment: While I obviously disagree with much of what Krugman wrote, he does make some sound points. Many Republicans and Democrats claim that changes in deficits and debt have a big impact on interest, for instance, but Krugman correctly notes that there is no evidence for this assertion. Nations such as Portugal and Greece may face high interest rates, but that’s because investors don’t trust those governments to pay their debts, not because those states’ borrowing is having an impact on credit markets.

English Riots, Faux Austerity, and Krugman’s Fairy Tale is a post from Cato @ Liberty - Cato Institute Blog

Nathan Gardels at the Huffington Post writes (emphasis added):

No one — least of all someone like myself who has experienced the existential terror of California’s regular tremors and knows the big one is coming here next — would minimize the grief, suffering and disruption caused by Japan’s massive earthquake and tsunami.

But if one can look past the devastation, there is a silver lining. The need to rebuild a large swath of Japan will create huge opportunities for domestic economic growth, particularly in energy-efficient technologies, while also stimulating global demand and hastening the integration of East Asia.

But as French political economist Frédéric Bastiat noted, destruction isn’t stimulative because it cannot create wealth:

Bastiat on the Japanese Tsunami is a post from Cato @ Liberty - Cato Institute Blog

When it became clear that President Obama would make “competitiveness” a theme of his SOTU address, I looked forward to seeing Paul Krugman’s statement pointing out how much nonsense that is. Here he is, after all, in his excellent 1997 book, Pop Internationalism (MIT Press):

…International trade, unlike competition among businesses for a limited market, is not a zero-sum game in which one nation’s gain is another’s loss. It is [a] positive-sum game, which is why the word “competitiveness” can be dangerously misleading when applied to international trade.

Sure enough, President Obama’s speech last night was peppered with references to “the competition for jobs,” “new jobs and industries take root in this country, or somewhere else, “the competion for jobs is real,” etc. And of course there was a healthy dose of the usual mercantalist obsession with exports.

Although written before the President’s address was delivered, what would Paul Krugman 2.0 think of this sort of talk? The title of his column Sunday was certainly encouraging: “The Competition Myth.” But the substance of the column went in a … er… different direction from that which I had anticipated/hoped:

…talking about “competitiveness” as a goal is fundamentally misleading. At best, it’s a misdiagnosis of our problems. At worst, it could lead to policies based on the false idea that what’s good for corporations is good for America…

So what does the administration’s embrace of the rhetoric of competitiveness mean for economic policy?

The favorable interpretation, as I said, is that it’s just packaging for an economic strategy centered on public investment, investment that’s actually about creating jobs now while promoting longer-term growth. The unfavorable interpretation is that Mr. Obama and his advisers really believe that the economy is ailing because they’ve been too tough on business, and that what America needs now is corporate tax cuts and across-the-board deregulation. [emphasis mine]

In other words, Krugman’s objections to the “competitiveness” rhetoric are based on his fear that it will lead to policies favorable to corporations, not that the whole concept is flawed.

[Disclaimer: the above is by no means an exhaustive analysis of the problematic parts of the column]

I yield to no-one in my admiration for Paul Krugman, trade economist. He made a real contribution to the discipline I’ve loved since I was a teenager. But Paul Krugman, columnist…not so much.

Krugman (Both of Them) on Competitiveness is a post from Cato @ Liberty - Cato Institute Blog

Today POLITICO Arena asks:

Post-Tucson will campaign trail rhetoric change in any discernible way? Should it change? What phrases or words should be considered out of bounds? Or is that approach a way of silencing legitimate criticism of political candidates?

My response:

Post-Tucson campaign trail rhetoric won’t change because, as Charles Krauthammer put it brilliantly in yesterday’s Washington Post, fighting and warfare are routine political metaphors for obvious reasons: “Historically speaking, all democratic politics is a sublimation of the ancient route to power — military conquest. That’s why the language persists,” why we speak of “battleground states” or “targeting” opponents.

That doesn’t mean that no charge is “out of bounds.” It’s perfectly all right for Sarah Palin to “target” 20 potential swing districts — Democrats do the same. And her use yesterday of “blood libel,” as Alan Dershowitz explains, is entirely acceptable too. What is out of bounds is the kind of scurrilous charges we’ve seen from The New York Times, the Paul Krugmans, E.J. Dionnes, Jonathan Alters, and their ilk, that the Tea Party and the political discourse around it contributed to the Arizona shooting — when there isn’t a shred of evidence to support that, and every indication that a lone mentally disturbed individual was responsible.

But far deeper issues are at play here, and they’re brought out in a penetrating piece by Daniel Henninger in this morning’s Wall Street Journal, “Why the Left Lost It.” He points first to the devastating, potentially sea-changing midterm elections — “Republicans now control more state legislative seats than any time since 1928” – which “came atop the birth of a genuine reform movement, the tea parties.” And the debt crises, state and federal, that animate the Tea Party pose a mortal threat to a liberal agenda that stretches back at least to Goldwater.

As Henninger writes, the divide between today’s left and its conservative opponents “is deep, and it will never be bridged. It is cultural, and it explains more than anything the ‘intensity’ that exists now between these two competing camps.” Read it.

Behind the Political Rhetoric Are Profound Differences is a post from Cato @ Liberty - Cato Institute Blog

Keynesian economic theory is the social science version of a perpetual motion machine. It assumes that you can increase your prosperity by taking money out of your left pocket and putting it in your right pocket. Not surprisingly, nations that adopt this approach do not succeed. Deficit spending did not work for Hoover and Roosevelt is the 1930s. It did not work for Japan in the 1990s. And it hasn’t worked for Bush or Obama.

The Keynesians invariably respond by arguing that these failures simply show that politicians didn’t spend enough money. I don’t know whether to be amused or horrified, but some Keynesians even say that a war would be the best way of boosting economic growth. Here’s a blurb from a story in National Journal.

America’s economic outlook is so grim, and political solutions are so utterly absent, that only another large-scale war might be enough to lift the nation out of chronic high unemployment and slow growth, two prominent economists, a conservative and a liberal, said today. Nobelist Paul Krugman, a New York Times columnist, and Harvard’s Martin Feldstein, the former chairman of President Reagan’s Council of Economic Advisers, achieved an unnerving degree of consensus about the future during an economic forum in Washington. …Krugman and Feldstein, though often on opposite sides of the political fence on fiscal and tax policy, both appeared to share the view that political paralysis in Washington has rendered the necessary fiscal and monetary stimulus out of the question. Only a high-impact “exogenous” shock like a major war — something similar to what Krugman called the “coordinated fiscal expansion known as World War II” — would be enough to break the cycle. …Both reiterated their previously argued views that the Obama administration’s stimulus was far too small to fill the output gap.

Two additional comments. First, if Martin Feldstein’s views on this issue represent what it means to be a conservative, then I’m especially glad I’m a libertarian. Second, Alan Reynolds has a good piece eviscerating Keynesianism, including a section dealing with Krugman’s World-War-II-was-good-for-the-economy assertion.

Where are the ’60s Hippies Now that They’re Needed to Fight Keynesianism? is a post from Cato @ Liberty - Cato Institute Blog

Back in August of 2007, I issued a challenge to Jesse Larner, who blogs at HuffingtonPost.  One week later, Larner took up my challenge in a post that I’ve just finished reading.

Larner very graciously admitted to a couple of misstatements, and I must reciprocate.  I wrote, “I challenge Larner to show where a Cato scholar … describes America’s as a ‘free-enterprise system of health care.’”  Sure enough, Larner found an oped where one of my colleagues wrote, “I live in a country with a free-market health-care system.”  Obviously, I disagree with that claim.  But Larner was right, and I will have to look into this.

A few remaining areas of disagreement:

• I wrote that Larner “claims that people don’t die on waiting lists in Canada’s health care system.”  Larner responds: “Actually, that’s not what I claimed. I claimed that people don’t often die on waiting lists.”  Canada’s Supreme Court writes that “in some serious cases, patients die as a result of waiting lists for public health care.”  Is some as many as often?  I hope not.
• Larner: “the Canadian system has problems … [but] it worked better before a series of conservative provincial governments began to de-fund it.”  This isn’t the first time that advocates of socialized medicine have blamed its shortcomings on politicians who (supposedly) oppose socialized medicine.  But it is an inherent feature of such systems that they will inevitably fall into the hands of whatever viable political parties exist in that nation.  As I explained to Paul Krugman, “Unless you have a plan to abolish Republicans, they’re part of your plan.”
• Larner writes: “a public health care plan is a public good.”  Public good is an economic term with a specific meaning.  A public health care plan is not a public good.
• Larner: “is Cannon saying that we do not have rationing in the US?”  Hardly.
• Larner: “In a free-market system, what mechanisms would prevent insurers from cherry-picking their customers, and denying coverage to those who are likely to require expensive treatment?”  The question presumes that insurance should do something that insurance cannot do: insure the uninsurable.  In this chapter of the Cato Handbook on Policy, I explain the (amazing) things that health insurance can accomplish, and why “health insurance markets are completely justified in not covering preexisting conditions.”
• “So here’s my challenge to Cannon: show me a way that a true free-market system can provide decent coverage to everyone, regardless of ability to pay, without rationing.”  Elsewhere in his post, Larner acknowledges this is an impossible task.  In this magazine article, I explain that there is no way to reform health care that can guarantee that no patients will fall through the cracks.  In this Cato paper, I explain how a free market would minimize the number of people who do.
• “Cannon is not in favor of universal coverage as a social right.” True, that.  “As a libertarian, he doesn’t even recognize the concept of social rights.”  I believe it was Friedrich Hayek who said there’s no better way to strip a word of its meaning than to place the word “social” in front of it.  Try it yourself .  I suggest using words like security, contract, justice, responsibility…

My Overdue Response to Jesse Larner is a post from Cato @ Liberty - Cato Institute Blog

In a very predictable editorial this morning, the New York Times pontificated in favor of higher taxes. Compared to Paul Krugman’s rant earlier in the week, which featured the laughable assertion that letting people keep more of the money they earn is akin to sending them a check from the government, the piece seemed rational. But that is damning with faint praise. There are several points in the editorial that deserve some unfriendly commentary.

First, let’s give the editors credit for being somewhat honest about their bad intentions. Unlike other statists, they openly admit that they want higher taxes on the middle class, stating that “more Americans — and not just the rich — are going to have to pay more taxes.” This is a noteworthy admission, though it doesn’t reveal the real strategy on the left.

Most advocates of big government understand that it will be impossible to turn America into a European-style welfare state without a value-added tax, but they don’t want to publicly associate themselves with that view until the political environment is more conducive to success. Most important, they realize that it will be very difficult to impose a VAT without seducing some gullible Republicans into giving them political cover. And one way of getting GOPers to sign up for a VAT is by convincing them that they have to choose a VAT if they don’t want a return to the confiscatory 70 percent tax rates of the 1960s and 1970s. Any moves in that direction, such as raising the top tax rate from 35 percent to 39.6 percent next January, are part of this long-term strategy to pressure Republicans (as well as naive members of the business community) into a VAT trap.

Shifting to other assertions, the editorial claims that “more revenue will be needed in years to come to keep rebuilding the economy.”  That’s obviously a novel assertion, and the editors never bother to explain how and why more tax revenue will lead to a stronger economy. Are the folks at the New York Times not aware that both economic growth and living standards are lower in European nations that have imposed higher tax burdens? Heck, even the Keynesians agree (albeit for flawed reasons) that higher taxes stunt growth.

The editorial also asserts that, “Since 2002, the federal budget has been chronically short of revenue.” I suppose if revenues are compared to the spending desires of politicians, then tax collections are – and always will be – inadequate. The same is true in Greece, France, and Sweden. It doesn’t matter whether revenues are 20 percent of GDP or 50 percent of GDP. The political class always wants more.

But let’s actually use an objective measure to determine whether revenues are “chronically short.” The Democrat-controlled Congressional Budget Office stated in its newly-released update to the Economic and Budget Outlook that federal tax revenues historically have averaged 18 percent of GDP. They are below that level now because of the economic downturn, but CBO projects that revenues will climb above that level in a few years – even if all of the 2001 and 2003 tax cuts are made permanent. Moreover, OMB’s historical data shows that revenues were actually above the long-run average in 2006 and 2007, so even the “since 2002″ part of the assertion in the editorial is incorrect.

On the issue of temporary tax relief for the non-rich, the editorial is right but for the wrong reason. The editors rely on the Keynesian rationale, writing that, “low-, middle- and upper-middle-income taxpayers…tend to spend most of their income and the economy needs consumer spending” whereas “Tax cuts for the rich can safely be allowed to expire because wealthy taxpayers tend to save rather than spend their tax savings.”

I’ve debunked Keynesian analysis so often that I feel that I deserve some sort of lifetime exemption from dealing with this nonsense, but I’ll give it another try. Borrowing money from some people in the economy and giving it to some other people in the economy is not a recipe for better economic performance. Economic growth means we are increasing national income. Keynesian policy simply changes who is spending national income, guided by a myopic belief that consumer spending somehow is better than investment spending. The Keynesian approach didn’t work for Hoover and Roosevelt in the 1930s, it didn’t work for Japan in the 1990s, and it hasn’t worked for Obama.

And it doesn’t matter if the Keynesian stimulus is in the form of tax rebates. Gerald Ford’s rebate in the 1970s was a flop, and George W. Bush’s 2001 rebate also failed to boost growth. Tax cuts can lead to more national income, but only if marginal tax rates on productive behavior are reduced so that people have more incentive to work, save, and invest. This is an argument for extending the lower tax rates for all income classes, but it’s important to point out that the economic benefits will be much greater if the lower tax rates are made permanent.

Last but not least, the editorial asserts that, “The revenue from letting [tax cuts for the rich] expire — nearly $40 billion next year — would be better spent on job-creating measures.” Not surprisingly, there is no effort to justify this claim. They could have cited the infamous White House study claiming that the so-called stimulus would keep unemployment under 8 percent, but even people at the New York Times presumably understand that might not be very convincing since the actual unemployment rate is two percentage points higher than what the Obama Administration claimed it would be at this point.

New York Times Seeks Higher Taxes on the ‘Rich’ as Prelude to Higher Taxes on the Middle Class is a post from Cato @ Liberty - Cato Institute Blog

I turn 41 this summer (thank you for the condolences). Along with the well wishes of family and friends, I received an unexpected gift from NY Times writer Paul Krugman: this column in which he bashes people who are critical of Social Security in its current form or who worry about its ability to deliver expected benefits.

At first glance, the column hardly seems like a gift: it’s long on pointless insults, short on thoughtful discussion, and misleading. But it offers such a poor defense of the Social Security status quo that I suspect readers will be more skeptical of the program after seeing the column, not less. Hence, Krugman’s gift.

He writes:

Social Security has been running surpluses for the last quarter-century, banking those surpluses in a special account, the so-called trust fund. The program won’t have to turn to Congress for help or cut benefits until or unless the trust fund is exhausted, which the program’s actuaries don’t expect to happen until 2037 — and there’s a significant chance, according to their estimates, that that day will never come.

OK, 2037 — no worries. Except that, as I said, I turn 41 this summer, which means I’ll turn 67 and qualify for full Social Security benefits in mid-2036. The very next year, the Social Security trust fund will be exhausted, according to the “intermediate” scenario contained in the most recent Social Security Trustees Report, available here (see Section IV-B and Appendix E). The program will still pay out some benefits — but less than 3/4s of what it now promises. So what happens then? That’s not a good question if you’re my age or younger.

But suppose you’re not my age or younger. Suppose you’re 10 years older than me, and will have collected 10 years of benefits by 2037. Don’t feel smug — you’ll be asking “So what happens next?” when you’re 77. That’s not a good question at your age, either. 

In fairness to Krugman, the Trustees Report considers different Social Security cost scenarios, the most optimistic of which projects that the trust fund will not be fully exhausted over the 75-year period the report considers. Krugman says there’s “a significant chance” this will be the case, but my (admittedly quick) skim of the report suggests it’s more just “a chance.”

One quick aside about the 2037 exhaustion date: when Krugman wrote this column in 2005, the Trustees’ intermediate scenario projected that the trust fund would last until 2042. In five years’ time, that date has grown 10 years closer. Not good.

Krugman writes that, if the trust fund does run out, Social Security can maintain its benefits using money transferred into the program by Congress from elsewhere in the federal budget. In fact, Congress will have to direct money from elsewhere to Social Security much earlier than 2037. Under the Trustees’ intermediate scenario, beginning in 2018 the amount of money Social Security pays out in old-age benefits each year will be greater than what the public pension program takes in in payroll taxes. (The Disability Insurance component of Social Security is in even worse shape, according to the Trustees, such that the program overall will go in the red in 2015.) To cover the difference, Congress will have to begin paying off the treasury bonds that currently comprise Social Security’s trust fund in order to provide the promised benefits. (In fact, Congress will have to do that this year because, as a product of the recession, Social Security obligations are greater than revenues. Hopefully, the economy will rebound and give the program a few years’ respite before transfers become an annual necessity, though the pessimistic scenario predicts no such respite.)

Krugman is unconcerned by these transfers, dismissing those who worry about them as engaging in “three-card monte.” His column doesn’t acknowledge that these transfers would need to occur at a time when Congress will be scrambling to cover other growing costs: similar deficits in Medicare, obligations to the ever-growing federal debt, and Medicaid’s increasing burden on federal and state governments. I worry that future taxpayers will not be amenable to having so much of their tax money directed to retirees (who refused to reform Social Security when they could have done so at relatively lower cost) rather than to government services for current taxpayers.

Krugman ends the column criticizing the proposal to reduce Social Security’s cost by raising the age at which retirees become eligible for full benefits. As part of an adjustment that began in 2002, retirees must now wait until age 66 to receive full benefits; beginning in 2021, the age requirement will slowly be raised until it reaches 67 in 2027. (Retirees will still be able to take reduced benefits at 62.) Some have suggested raising the full-benefit age to 70. Krugman says that would be unfair:

America is becoming an increasingly unequal society — and the growing disparities extend to matters of life and death. Life expectancy at age 65 has risen a lot at the top of the income distribution, but much less for lower-income workers. And remember, the retirement age is already scheduled to rise under current law. So let’s beat back this unnecessary, unfair and — let’s not mince words — cruel attack on working Americans.

There is something to what Krugman says. From 1980 to 2000, life expectancy at birth for the poorest decile (i.e., 10%) of the U.S. population increased from 73.0 years to 74.7 years, while life expectancy for the wealthiest decile increased from 75.8 years to 79.2 years. (The disparity in life expectancy between the top and bottom decile groups does decline to 1.6 years at age 65, which is up from 0.3 years in 1980. H/T to Dr. Daniel Coyne at the Washington University in St. Louis School of Medicine.)

But inequality in Social Security benefits would exist whether the eligibility age is 65, 66, or 70. Because Americans are required to participate in Social Security, and because all Americans become eligible for full retirement benefits for the rest of their lives at a single threshold age, then the longer-lived wealthy will receive more in benefits than the shorter-lived poor no matter what that threshold is. This is the product of having a one-size-for-all public pension plan (with lousy benefits). The way to address this inequality problem is through Social Security choice.

As I wrote at the beginning, Krugman’s column should leave thoughtful and informed readers more concerned about Social Security, not less. He couldn’t have given me a better present.

A Birthday Gift from Paul Krugman is a post from Cato @ Liberty - Cato Institute Blog

Measured in constant 2005 dollars, real federal revenues rose from $968.4 billion in 1970 to $1,197.6 billion in 1980 and to $1508.7 billion in 1990.   In other words, the cumulative real revenue gain was 23.7% under the high and rising tax rates of the 1970s, and 26% under the dramatic reduction in tax rates of the 1980s.

Paul Krugman recently looked at these same figures through his logarithmic Kaleidoscope, and concluded that “the revenue track under Reagan . . . is exactly what you would expect to see if supply-side economics were just plain wrong: revenues are permanently reduced relative to what they would otherwise have been.”

Financial Times columnist Martin Wolf was so awed by Krugman’s creative artwork that he imagined “the theory that cuts would pay for themselves has proved altogether wrong.”

Notice that Krugman starts his trend with 1970, which was a year of recession and falling revenue.  If he had instead measured real revenue growth between the cyclical peaks of 1969 and 1979, the overall increase would have dropped to 19.5%.  Note too that Krugman ends his trend with 1981 rather than 1980, while suggesting 1981 was part of the glorious Carter years:

The Carter years, contrary to legend, were not a period of economic stagnation and falling revenue because high tax rates were strangling the economy; there was a nasty recession starting in 1979, largely thanks to an oil shock, but overall growth was respectable.

The comment is strange.  There was no recession in 1979, nasty or otherwise.  And non-energy inflation topped 11 percent that year – before oil prices peaked in early 1980.

The continually accelerating inflation during the Carter years, 1977 to 1980, pushed more and more families into higher and higher tax brackets.  It also resulted in brutal taxation of illusory, nominal capital gains and ephemeral inventory profits.   As a percentage of GDP, federal taxes soared from 17.1% of GDP in 1976 to 19% in 1980 and 19.6% in 1981.   Does that really look like a sustainable trend that President Reagan interrupted for no good reason?

Paul Krugman on Carter and Reagan: Wrong Again is a post from Cato @ Liberty - Cato Institute Blog

Rep. Paul Ryan (R-WI) ably defends his “Roadmap for America’s Future” in today’s Washington Post.  He doesn’t mention Paul Krugman’s attacks thereon, nor should he.  (To read why, consult The Atlantic‘s Megan McArdle and Ted Gayer of the Tax Policy Center.)

I haven’t officially weighed in on the health-care aspects of the Roadmap, but hope to do so in the near future.  For the moment, I’ll use Ryan’s oped to stress a distinction that is crucial to thinking clearly about health care costs.

Ryan writes of the dangers of an un-reformed Medicare program (emphasis added):

Under an ever-expansive, all-consuming central government, costs will be contained with Washington’s heavy hand imposing price controls, slashing benefits and arbitrarily rationing seniors’ care.

While those forms of government rationing may reduce spending, that’s not the same as reducing costs.  On the contrary, those rationing measures may increase health care costs.

Suppose Medicare set its prices for hip and knee replacements so low that no medical-device manufacturer would provide the hardware and no surgeon would perform the procedures.  Medicare spending on hip and knee replacements would fall.  But costs may rise: more seniors would be walking around — or not walking around — in severe pain.  Pain and reduced mobility are costs, even if they don’t show up in the federal budget or household budgets.  (Indeed, those costs would be so severe that overall Medicare spending could rise as seniors bought more wheelchairs, sought treatment for pressure sores, etc.).  This is the main reason conservatives criticize Canada’s Medicare system and the British National Health Service: reducing health care spending often increases costs.

I therefore request universal compliance with Cannon’s First Rule of Economic Literacy: Never say costs when you mean spending.

Paul Ryan’s Roadmap, and the Difference between Costs and Spending is a post from Cato @ Liberty - Cato Institute Blog

I’m still dealing with the statist echo chamber, having been hit with two additional attacks for the supposed sin of endorsing Reaganomics over Obamanomics (my responses to the other attacks can be found here and here). Some guy at the Atlantic Monthly named Steve Benen issued a critique focusing on the timing of the recession and recovery in Reagan’s first term. He reproduces a Krugman chart (see below) and also adds his own commentary.

Reagan’s first big tax cut was signed in August 1981. Over the next year or so, unemployment went from just over 7% to just under 11%. In September 1982, Reagan raised taxes, and unemployment fell soon after. We’re all aware, of course, of the correlation/causation dynamic, but as Krugman noted in January, “[U]nemployment, which had been stable until Reagan cut taxes, soared during the 15 months that followed the tax cut; it didn’t start falling until Reagan backtracked and raised taxes.”

This argument is absurd since the recession in the early 1980s was largely the inevitable result of the Federal Reserve’s misguided monetary policy. And I would be stunned if this view wasn’t shared by 90 percent-plus of economists. So it is rather silly to say the recession was caused by tax cuts and the recovery was triggered by tax increases.

But even if we magically assume monetary policy was perfect, Benen’s argument is wrong. I don’t want to repeat myself, so I’ll just call attention to my previous blog post which explained that it is critically important to look at when tax cuts (and increases) are implemented, not when they are enacted. The data is hardly exact, because I haven’t seen good research on the annual impact of bracket creep, but there was not much net tax relief during Reagan’s first couple of years because the tax cuts were phased in over several years and other taxes were going up. So the recession actually began when taxes were flat (or perhaps even rising) and the recovery began when the economy was receiving a net tax cut. That being said, I’m not arguing that the Reagan tax cuts ended the recession. They probably helped, to be sure, but we should do good tax policy to improve long-run growth, not because of some misguided effort to fine-tune short-run growth.

The second attack comes from some blog called Econospeak, where my newest fan wrote:

I’m scratching my head here as I thought the standard pseudo-supply-side line was that the deficit exploded in the 1980’s because government spending exploded. OK, the truth is that the ratio of Federal spending to GDP neither increased nor decreased during this period. Real tax revenues per capita fell which is why the deficit rose but this notion that the burden of government fell is not factually based.

Those are some interesting points, and I might respond to them if I wanted to open a new conversation, but they’re not germane to what I said. In my original post (the one he was attacking), I commented on the “burden of government” rather than the “burden of government spending.” I’m a fiscal policy economist, so I’m tempted to claim that the sun rises and sets based on what’s happening to taxes and spending, but such factors are just two of the many policies that influence economic performance. And with regard to my assertion that Reagan reduced the “burden of government,” I’ll defer to the rankings put together for the Economic Freedom of the World Index. The score for the United States improved from 8.03 to 8.38 between 1980 and 1990 (my guess is that it peaked in 1988, but they only have data for every five years). The folks on the left may be unhappy about it, but it is completely accurate to say Reagan reduced the burden of government. And while we don’t yet have data for the Obama years, there’s a 99 percent likelihood that America’s score will decline.

This is not a partisan argument, by the way. The Economic Freedom of the World chart shows that America’s score improved during the Clinton years, particularly his second term. And the data also shows that the U.S. score dropped during the Bush years. This is why I wrote a column back in 2007 advocating Clintonomics over Bushonomics. Partisan affiliation is not what matters. If we want more prosperity, the key is shrinking the burden of government.

Last but not least, I try to make these arguments to the folks watching MSNBC.

When Keynesians Attack, Part II is a post from Cato @ Liberty - Cato Institute Blog

If I was organized enough to send Christmas cards, I would take Richard Rahn off my list. I do one blog post to call attention to his Washington Times column and it seems like everybody in the world wants to jump down my throat. I already dismissed Paul Krugman’s rant and responded to Ezra Klein’s reasonable criticism. Now it’s time to address Derek Thompson’s critique on the Atlantic‘s site.

At the risk of re-stating someone else’s argument, Thompson’s central theme seems to be that there are many factors that determine economic performance and that it is unwise to make bold pronouncements about Policy A causing Result B. If that’s what Thompson is saying, I very much agree (and if it’s not what he’s trying to say, then I apologize, though I still agree with the sentiment). That’s why I referred to Reagan decreasing the burden of government and Obama increasing the burden of government — I wanted to capture all the policy changes that were taking place, including taxation, spending, monetary policy, regulation, etc. Yes, the flagship policies (tax reduction for Reagan and so-called stimulus for Obama) were important, but other factors obviously are part of the equation.

The biggest caveat, however, is that one should always be reluctant to make sweeping claims about what caused the economy to do X or Y in a given year. Economists are terrible forecasters, and we’re not even very proficient when it comes to hindsight analysis about short-run economic fluctuations. Indeed, the one part of my original post that causes me a bit of regret is that I took the lazy route and inserted an image of the chart from Richard’s column. Excerpting some of his analysis would have been a better approach, particularly since I much prefer to focus on the impact of policies on long-run growth and competitiveness (which is what I did in my New York Post column from earlier this week  and also why I’m reluctant to embrace Art Laffer’s warning of major economic problems in 2011).

But a blog post is no fun if you just indicate where you and a critic have common ground, so let me identify four disagreements that I have with Thompson’s post:

(1) To reinforce his warning about making excessive claims about different recessions/recoveries, Thompson pointed out that someone could claim that Reagan’s recovery was associated with the 1982 TEFRA tax hike. I’ve actually run across people who think this is a legitimate argument, so it’s worth taking a moment to explain why it isn’t true.

When analyzing the impact of tax policy changes, it’s important to look at when tax changes were implemented, not when they were enacted (data on annual tax rates available here). Reagan’s Economic Recovery Tax Act was enacted in 1981, but the lower tax rates weren’t fully implemented until 1984. This makes it a bit of a challenge to pinpoint when the economy actually received a net tax cut. The tax burden may have actually increased in 1981, since the parts of the Reagan tax cuts that took effect that year were offset by the impact of bracket creep (the tax code was not indexed to protect against inflation until the mid-1980s). There was a bigger tax rate reduction in 1982, but there was still bracket creep, as well as previously-legislated payroll tax increases (enacted during the Carter years). TEFRA also was enacted in 1982, which largely focused on undoing some of the business tax relief in Reagan’s 1981 plan. People have argued whether the repeal of promised tax relief is the same as a tax increase, but that’s not terribly important for this analysis. What does matter is that the tax burden did not fall much (if at all) in Reagan’s first year and might not have changed too much in 1982.

In 1983, by contrast, it’s fairly safe to say the next stage of tax rate reductions was substantially larger than any concomitant tax increases. That doesn’t mean, of course, that one should attribute all changes in growth to what’s happening to the tax code. But it does suggest that it is a bit misleading to talk about tax cuts in 1981 and tax increases in 1983.

One final point: The main insight of supply-side economics is that changes in the overall tax burden are not as important as changes in the tax structure. As such, it’s also important to look at which taxes were going up and which ones were decreasing. This is why Reagan’s 1981 tax plan compares so favorably with Bush’s 2001 tax plan (which was filled with tax credits and other policies that had little or no impact on incentives for productive behavior).

(2) In addition to wondering whether one could argue that higher taxes triggered the Reagan boom, Thompson also speculates whether it might be possible to blame the tax cuts in Obama’s stimulus for the economy’s subsequent sub-par performance. There are two problems with that hypothesis. First, a substantial share of the tax cuts in the so-called stimulus were actually new spending being laundered through the tax code (see footnote 3 of this Joint Committee on Taxation publication). To the extent that the provisions represented real tax relief, they were much more akin to Bush’s non–supply side 2001 tax cuts and a far cry from the marginal tax-rate reductions enacted in 1981 and 2003. And since even big tax cuts have little or no impact on the economy if incentives to engage in productive behavior are unaffected, there is no reason to blame (or credit) Obama’s tax provisions for anything.

(3) Why doesn’t anyone care that the Federal Reserve almost always is responsible for serious recessions? This isn’t a critique of Thompson’s post since he doesn’t address monetary policy from this angle, but if we go down the list of serious economic hiccups in recent history (1974-75, 1980-82, and 2008-09), bad monetary policy inevitably is a major cause. In short, the Fed periodically engages in easy-money policy. This causes malinvestment and/or inflation, and a recession seems to be an unavoidable consequence. Yet the Fed seems to dodge any serious blame. At some point, one hopes that policy makers (especially Fed governors) will learn that easy-money policies such as artificially low interest rates are not a smart approach.

(4) Thompson writes, “Is Mitchell really saying that $140 billion on Medicaid, firefighters, teachers, and infrastructure projects are costing the economy five percentage points of economic growth?” No, I’m not saying that and didn’t say that, but I have been saying for quite some time that taking money out of the economy’s left pocket and putting it in the economy’s right pockets doesn’t magically increase prosperity. And to the extent money is borrowed from private capital markets and diverted to inefficient and counter-productive programs, the net impact on the economy is negative. Thompson also writes that, “Our unemployment picture is a little more complicated than ‘Oh my god, Obama is killing jobs by taking over the states’ Medicaid burden!’” Since I’m not aware of anybody who’s made that argument, I’m not sure how to respond. That being said, jobs will be killed by having Washington take over state Medicaid budgets. Such a move would lead to a net increase in the burden of government spending, and that additional spending would divert resources from the productive sector of the economy.

The moral of the story, though, is to let Richard Rahn publicize his own work.

When Keynesians Attack is a post from Cato @ Liberty - Cato Institute Blog

I seem to have touched a raw nerve with my post earlier today on my International Liberty blog,  comparing Reagan and Obama on how well the economy performed coming out of recession. Both Ezra Klein and Paul Krugman have denounced my analysis (actually, they denounced me approving of Richard Rahn’s analysis, but that’s a trivial detail). Krugman responded by asserting that Reaganomics was irrelevant (I’m not kidding) to what happened in the 1980s. Klein’s response was more substantive, so let’s focus on his argument. He begins by stating that the recent recession and the downturn of the early 1980s were different creatures. My argument was about how strongly the economy rebounded, however, not the length, severity, causes, and characteristics of each recession. But Klein then cites Rogoff and Reinhardt to argue that recoveries from financial crises tend to be less impressive than recoveries from normal recessions.

That’s certainly a fair argument. I haven’t read the Rogoff-Reinhardt book, but their hypothesis seems reasonable, so let’s accept it for purposes of this discussion. Should we therefore grade Obama on a curve? Perhaps, but it’s also true that deep recessions usually are followed by more robust recoveries. And since the recent downturn was more severe than the the one in the early 1980s, shouldn’t we be experiencing some additional growth to offset the tepidness associated with a financial crisis?

I doubt we’ll ever know how to appropriately measure all of these factors, but I don’t think that matters. I suspect Krugman and Klein are not particularly upset about Richard Rahn’s comparisons of recessions and recoveries. The real argument is whether Reagan did the right thing by reducing the burden of government and whether Obama is doing the wrong thing by heading in the opposite direction and making America more like France or Greece. In other words, the fundamental issue is whether we should have big government or small government. I think the Obama Administration, by making government bigger, is repeating many of the mistakes of the Bush Administration. Krugman and Klein almost certainly disagree.

Responding to Paul Krugman and Ezra Klein is a post from Cato @ Liberty - Cato Institute Blog

Paul Krugman dismisses concerns that the Obama administration’s fiscal and regulatory policies are fostering uncertainty in the business community, and thus inhibiting job growth and an economic recovery.

My Cato colleagues and I have been citing this “regime uncertainty” for a while now, and it is gaining mainstream acceptance as evidenced by a recent Washington Post editorial.

I have pointed to surveys of small businesses conducted by the National Federation of Independent Business. The businesses surveyed continually cite the combination of government taxes and regulations as their “single most important problem.”

However, Krugman looks at the NFIB’s most recent survey and comes away with a different conclusion:

Or read through the latest survey of small business trends by the National Federation for Independent Business, an advocacy group. The commentary at the front of the report is largely a diatribe against government — “Washington is applying leeches and performing blood-letting as a cure” — and you might naïvely imagine that this diatribe reflects what the surveyed businesses said. But while a few businesses declared that the political climate was deterring expansion, they were vastly outnumbered by those citing a poor economy.

This is the chart from the survey that Krugman is referencing:

Considering the depth and length of the recession, the fact that “economic condition” is the runaway leader isn’t surprising. But I wonder how many of the businesses citing “economic conditions” are happy with the “political climate.” I doubt very many. Notice that zero respondents said that the political climate was a “good time” to expand. Couple that with the plurality who said this isn’t a good time to expand due to economic conditions and you get an indictment of the administration’s interventionist policies that Krugman has supported.

Krugman continues:

The charts at the back of the report, showing trends in business perceptions of their “most important problem,” are even more revealing. It turns out that business is less concerned about taxes and regulation than during the 1990s, an era of booming investment. Concerns about poor sales, on the other hand, have surged. The weak economy, not fear about government actions, is what’s holding investment down.

Interestingly, Krugman ignores the chart that immediately precedes the trends in business perceptions: the “single most important problem” respondents currently face. It is definitely more revealing:

Thirty percent of respondents said their single most important problem is “Poor Sales.” “Taxes” and “Government Regulations and Red Tape” come in second and third place at 22 percent and 13 percent respectively. Combining the two, the biggest problem facing small businesses according to respondents is government.

Krugman waves the government problem away by pointing out that taxes and regulations ranked higher in the 1990s when the economy was strong. However, he ignores the trend. Concern about taxes and regulations trended lower as the 1990s moved into the 2000s, but have been trending higher in the last couple of years.

Take a look at the trend chart that includes taxes:

The tax outlook improved as the Clinton and Bush administrations cut taxes and the federal budget was brought under control. Rising tax concerns could be explained by future expectations of higher taxes to pay for Bush and Obama’s profligacy. Additionally, states have been raising taxes during the recession to make up for budget shortfalls. Future expectations of higher taxes to pay for the unfunded liabilities of state and local employee benefits could also be a consideration.

Also note how much higher taxes rank than financing. Yet, it seems that most media outlets believe credit unavailability is the chief problem facing businesses. Indeed, the president has been pushing a $30 billion package to increase lending to small businesses. But businesses don’t need more subsidized credit backed by taxpayers — they need relief from the president’s agenda.

Paul Krugman and Regime Uncertainty is a post from Cato @ Liberty - Cato Institute Blog

An insightful op-ed in yesterday’s Financial Times by Raghu Rajan (who will be presenting his latest book soon here at Cato), apparently was too much for Paul Krugman to bear.  What was Rajan’s great crime that so upset Krugman?  Rajan, correctly, pointed out that US policies, such as Fannie Mae and the Community Re-investment Act, were direct contributors to the financial crisis and that bankers shouldn’t be blamed for simply reacting to perverse government incentives.

Now Krugman cannot bear to see CRA and Fannie questioned.  He claims that Rajan is relying on some blind faith that has been disproven by all thinking people.  Krugman offers two points (his supposed “facts”) that prove Fannie Mae and CRA are innocent.

First, he argues that the bad lending was done not by banks covered by CRA, but by non-banks that were exempt from CRA.  Now in Krugman’s defense, there is a grain of truth to this.  For instance, up until its purchase of a thrift, Countrywide, the largest subprime player, was not covered by CRA.  However, comparing Countrywide to say Bank of America, which was covered by CRA, misses a crucial point:  these non-CRA lenders were selling their loans to Fannie and Freddie, who were getting housing goal credit for those loans.  For instance, 25% of Fannie’s whole loan purchases were from Countrywide.  So rather than, as Paul claims that CRA didn’t matter, what the comparison shows is that the GSE housing goals were more damaging than CRA.

Krugman tries to cover this base by claiming that Fannie and Freddie were “sidelined by Congress” during the worst years of the boom.  As someone who spent the boom years as staff on the Senate Banking Committee, I found that claim to be insane.  For every Senator Shelby who tried to sideline the GSE’s, there was 10 Senators Sarbanes, Dodd and Schumer who pushed the GSEs to do more.  Krugman needs to move past empty assertions and offer some, any, evidence that Congress sidelined Fannie and Freddie.

What evidence he does offer is to show that during the boom, the percent of the market that was securitized by Fannie/Freddie fell, while the percent securitized by the private-label market increased.  Krugman has that fact correct, yet he misses a critical point.  That increase in private-label securities was being funded/purchased by Fannie and Freddie.

As my chart illustrates, the more involved were Fannie and Freddie in purchasing subprime MBS, the more the subprime market grew.  During the bubble years, Fannie and Freddie were the largest single source of liquidity for the subprime market.  And the chart doesn’t even take into account all the subprime whole loans being purchased by the GSEs.

Sadly Krugman has his facts on CRA wrong as well.  I point the reader to Ed Pinto’s work in this area, as well as my post on CRA from a few months ago.

We have little hope of avoiding a future financial crisis if we do not undo all the perverse government incentives for irresponsible lending.  Krugman’s presentation of selective and misleading data only makes true and meaningful reform all the more difficult.

Krugman’s Fannie Mae Fantasyland is a post from Cato @ Liberty - Cato Institute Blog

Prof. Paul Krugman asserts in his New York Times column of May 31st that “Both textbook economics and experience say that slashing spending when you’re still suffering from high unemployment is a really bad idea — not only does it deepen the slump, but it does little to improve the budget outlook, because much of what governments save by spending less they lose as a weaker economy depresses tax receipts.”

While Prof. Krugman and most other fiscalists believe this to be self-evident, it is not.  Indeed, this fiscalist dogma fails to withstand the indignity of empirical verification.  Prof. Paul Krugman’s formulation fails to mention the state of confidence.  This is an important oversight.  As Keynes himself put it: “The state of confidence, as they term it, is a matter to which practical men pay the closest and most anxious attention.”

By ignoring the confidence factor, economic theory can lead to wildly incorrect conclusions and misguided policies.  Just consider naive Keynesian fiscal theory — the type presented (as Prof. Krugman notes) in textbooks and embraced by most policymakers and the general public.  According to Keynesian theory, an expansionary fiscal policy (an increase in government spending and/or a decrease in taxes) stimulates the economy, at least for a year or two after the fiscal stimulus.  To put the brakes on the economy, Keynesians counsel a fiscal contraction.

A positive fiscal multiplier is the keystone for Keynesian fiscal theory because it is through the multiplier that changes in the budget balance are transmitted to the economy.  With a positive multiplier, there is a positive relationship between changes in the fiscal deficit and economic growth: larger deficits stimulate growth and smaller ones slow things down.

So much for theory.  What about the real world?  Suppose a country has a very large budget deficit.  As a result, market participants might be worried that a further loosening of fiscal conditions would result in more inflation, higher risk premiums and much higher interest rates.  In such a situation, the fiscal multipliers may be negative.  Fiscal expansion would then dampen economic activity and a fiscal contraction would increase economic activity.  These results would be just the opposite of those predicted by naive Keynesian fiscal theory.

The possibility of a negative fiscal multiplier rests on the central role played by confidence and expectations about the course of future policy.  If, for example, a country with a very large budget deficit and high level of debt (estimated U.S. deficit and debt levels as a percentage of GDP for 2010 are 10.3% and 63.2%, respectively) makes a credible commitment to significantly reduce the deficit, a confidence shock will ensue and the economy will boom, as inflation expectations, risk premiums and long-term interest rates decline.

There have been many cases in which negative fiscal multipliers have been observed.  The Danish fiscal squeeze of 1983-86 and the Irish stabilization of 1987-89 are notable.  The fiscal deficits that preceded the Danish and Irish fiscal squeezes were clearly unsustainable, and risk premiums and interest rates were extremely high.  Confidence shocks accompanied the fiscal squeezes, and with negative multipliers in play, the Danish and Irish economies took off.  (Evidence from the U.S. is presented in an article by Professors Jason E. Taylor and Richard K. Vedder which appears in the current May/June 2010 issue of the Cato Policy Report.)

Margaret Thatcher also made a dash for confidence and growth via a fiscal squeeze.  To restart the economy in 1981, Thatcher instituted a fierce attack on the British deficit, coupled with an expansionary monetary policy.  Her moves were immediately condemned by 364 distinguished economists.  In a letter to the Times of London, they wrote a knee-jerk Keynesian (Prof. Krugman-type) response: “Present policies will deepen the depression, erode the industrial base of our economy and threaten its social and political stability.”  Thatcher was quickly vindicated.  No sooner had the 364 affixed their signatures than the economy boomed.  People had confidence in Britain again, and Thatcher was able to introduce a long series of deep free-market reforms.

While Prof. Krugman’s authority is weighty, his arguments and evidence are slender.

Prof. Krugman Is Wrong, Again is a post from Cato @ Liberty - Cato Institute Blog

Last week Paul Krugman seized on the Gulf oil spill as another occasion to bash libertarians in general and the great Milton Friedman in particular. On Friday David skewered the Times columnist over his odd rhetorical ploy of treating politicians’ failure to follow Friedman’s principles as a refutation of those principles. Now economist Alex Tabarrok at Marginal Revolution reports that Krugman also completely misunderstands the current set of laws governing oil spill liability:

The Oil Pollution Act of 1990 (OPA), which is the law that caps liability for economic damages at $75 million, does not override state law or common law remedies in tort (click on the link and search for common law or see here). Thus, Milton Friedman’s preferred remedy for corporate negligence, tort law, continues to operate and there is no doubt that BP’s potential liability under common law alone would be in the billions of dollars.

…The point of the OPA was not to limit tort law but to supplement it.

Tort law, as traditionally understood, could only be used to recover damages to people and property rather than force firms to pay cleanup costs per se. Thus, in the OPA as I read it — and take the details with a grain of salt since I’m not a lawyer–there is no limit on cleanup costs. Moreover, the OPA makes the offender strictly liable for cleanup costs which means that if these costs are proven the offender must pay them regardless (there are a few defenses, such as an act of war, but they are unlikely to apply). The offender is also strictly liable for up to $75 million in economic damages above and beyond cleanup costs. Thus the $75 million is simply a cap on the strictly liable damages, the damages that if proven BP has to pay regardless. But there is no limit, even under the OPA, on economic damages in the event that BP failed to follow regulations or is otherwise shown to be negligent (same as under common law).

The link Krugman supplies, and perhaps the source of his error, was this Talking Points Memo item baldly describing “the maximum liability for oil companies after a spill” as “a paltry $75 million.” Even the most passing acquaintance with the aftermath of real-world oil spills should have been enough for Krugman and TPM author Zachary Roth to realize that liability for assessments to this one federal rainy-day fund is but one component, perhaps but a minor one, of liability for overall spill damage. And even as regards this one specialized federal fund, Krugman and Roth got it wrong, as a glance at the May 1 edition of Krugman’s own paper would have revealed:

When a rich and well-insured company like BP is responsible for the spill, the government will seek reimbursement of what it spends on cleanup from the company and its insurers.

So Krugman’s post not only strained to take a cheap shot at libertarians, but also thoroughly botched a factual background that it would have been easy enough for him to have looked up. Other that that, it was fine.

Krugman and Oil Spills, cont’d is a post from Cato @ Liberty - Cato Institute Blog