Paul Krugman goes off the rails again

Paul Krugman

With the debate over the taxes intensifying between House Republicans and the White House as part of the “fiscal cliff” negotiations, Paul Krugman weighed in yesterday floating the idea raising tax rates to 91%, back to levels seen in the 1950s. His rant is based on digs at conservatives and the same old “fairness” drivel that has been used by the Left since the 2001 and 2003 tax cuts were passed.

Most of us who read Krugman’s missive probably laughed it off. After all, this is the guy who, in the wake of the tsunami in Japan last year, said that the disaster would spur economic growth. He said the same of 9/11 when it occured. Krugman also called for a fake alien invasion to ramp up government spending, which he believed would have helped the economy. This, of course, defies a rule of economics called the “broken window fallacy.” But that’s just an example of Krugman’s crazier side.

Over at Cato @ Liberty, Brink Lindsey took Krugman’s tax idea head on:

[A] few years back I wrote a paper entitled “Paul Krugman’s Nostalgianomics.” It’s true that the quarter-century after World War II was a kind of Golden Age for the American economy, with rapid productivity growth matched by strong income gains across the socioeconomic spectrum. But it doesn’t follow that the economic policies of that era are a good model for us now — any more than China’s spectacular growth in recent decades means that we would grow faster if we just instituted rampant corruption and oppressive autocracy.

As I noted in that earlier paper:

Krugman’s analysis here rests on a crude conflation of correlation and causation. It is true that, all thing being equal, we should expect better economic policies to generate better economic performance. But in the real world, all things are seldom equal; thus strong performance is not always reliable evidence of good policies.

Economic performance is a function of both economic policies and the underlying conditions for growth. When conditions are highly favorable (as, in China’s case, when relative backwardness creates the possibility for rapid catch-up growth), even fairly bad policies (like China’s) can produce good results. And it turns out that the conditions in the United States during the early post-WWII decades were highly favorable indeed.

Here again, from my earlier paper:

But several factors were especially conducive to strong performance at that time. There was a pent-up demand for goods and services after the privations of the Great Depression and the mobilization of World War II. There was also a pent-up supply of new products that couldn’t be brought to market during the depression and war years. That pent-up supply was augmented by technological and organizational breakthroughs accelerated by the imperatives of total war. Big advances in transportation, communications, and air conditioning stimulated catch-up growth in the underdeveloped South and underpopulated West. And rapid upgrades in human capital (first explosive growth in high school graduates, then explosive growth in college graduates) doubtless helped to spur productivity gains.

When conditions for growth become less favorable, performance deteriorates and pressure builds for new policies. Which is exactly what we saw in the 1970s: stagflation, followed by the dismantling of price and entry controls in the transportation, energy, financial, and communications sectors and a steep drop in marginal tax rates. Together with disinflationary monetary policy, those reforms helped to unleash the Long Boom of the ’80s and ’90s.

Lindsey contends that the slow growth we’re currently seeing economy is reminiscent of the 1970s, which is why Krugman’s idea would likely have disasterous affects. Additionally, James Pethokoukis points out that Krugman is even outside what many economists on the Left have been pushing, also noting that higher tax rates
“a) assumes the rich won’t respond to higher rates by changing work habits or engaging in tax avoidance, b) it assumes zero long-term impact on behavior by sharply higher rates, c) it assumes Americans prefer want government to take as much income as possibly from the rich and redistribute it to the non-rich.”

Also, the “Laffer curve” comes into play, as Pethokoukis explains:

Look at the natural experiment that just happened in Great Britain. Its Independent Fiscal Oversight Commission—which reviews all of the budgetary assumptions—just ruled that cutting the top rate of tax from 50% to 45% was revenue neutral, implying the revenue maximizing rate is in that range.

And while Krugman is supposedly a Keynesian, his views are far off base compared John Maynard Keynes actually wrote. For example, Keynes wrote, “25 percent [of GDP] as the maximum tolerable proportion of taxation.” If you account for all levels of government in the United States, the tax burden is 27.3% of GDP (2008 numbers).

Keynes also wrote, “[A] reduction of taxation will run a better chance than an increase of balancing the budget.” Keynes likened this to a “manufacturer who, running at a loss, decides to raise his price, and when his declining sales increase the loss, wrapping himself in the rectitude of plain arithmetic, decides that prudence requires him to raise the price still more.”

We may not like school of economics, but what Keynes wrote sounds reasonable compared to what Krugman is writing today.

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