Refuting Voodoo Economics with Juju Economics

As the Bush tax cuts are set to expire, some Republicans have begun down the difficult road of arguing that they should be extended, while saying that we also need to reduce the deficit. Back in the 1980s, the idea that lower taxes could lead to more government revenue was pejoratively referred to as "Voodoo Economics." Of course, President Reagan embraced this theory, relying on the idea of the Laffer Curve to argue that decreasing taxes would not only be good for the economy, but would also increase government revenue. Economist Paul Krugman worries that Voodoo economics is returning, but in doing so introduces another magical theory of his own, which we'll call Juju economics.

In his New York Times column today, Krugman explains the theory behind Voodoo economics, that cutting taxes increases government revenue. He then continues:

It's not true, of course. Ronald Reagan said that his tax cuts would reduce deficits, then presided over a near-tripling of federal debt.

Surely, Krugman must understand that his argument here is neither fair nor accurate. Did Voodoo economics work? Here's a chart showing tax revenues, spending and the deficit during the 1980s, in inflation adjusted dollars (based on data from the Tax Policy Center):

Reagan tax spend deficit.PNG

Focus on the blue line first. Taxes revenues did, in fact, initially dip in the early 1980s. But by 1985 they increased to a higher level than they were before Reagan took office. The deficit, however, remained higher that entire time, so Krugman is technically right. But that's not the point. The deficit rose because Reagan also spent an awful lot more money, a large portion of which went to defense. Lower tax rates would have, in fact, lowered the deficit, if Regan had left spending constant. Unfortunately, he didn't.

But then Krugman introduces the progressive version of Voodoo economics, which I'll label Juju* economics:

When Bill Clinton raised taxes on top incomes, conservatives predicted economic disaster; what actually followed was an economic boom and a remarkable swing from budget deficit to surplus.

Krugman has a Noble Prize. He's an unusually intelligent man. So it's hard to imagine that he really believes what this statement implies -- that by raising taxes Clinton stimulated the economy. Clinton benefitted from being at the right place at the right time. The Internet boom would have occurred with or without his tax increase. At the time, there wasn't really anywhere better for the boom to take place than the U.S., given its infrastructure, universities, and concentration of technophiles. Clinton would have really had to screw things up to drive the technologists from Silicon Valley to, say, Manchester.

Clinton happened to raise taxes at exactly the right time to create a surplus -- when a historic technological advance was on the verge of occurring, which created enormous wealth. The Internet boom occurred in spite of the Clinton tax policy, not because of it. If Clinton were to have taken the helm in 2009, and tried the same thing, the results would have been much, much worse.

Moreover, part of the reason why Clinton had so much success in turning the deficit into a surplus comes not only from more tax revenue, but because spending only increased 10% from 1992 to 2000. Yet, during Reagan's term, spending rose by 22% (1980 compared to 1988). If Reagan kept spending under control like Clinton with a 10% increase, then the deficit, in fact, would have declined to just $11.5 billion in 1988 (It was $171 billion in 1980.). (For those who were wondering, George W. Bush increased spending by 33%, 2000 compared to 2008. All these numbers are adjusted for inflation.)

If Krugman wants to argue that Clinton collected more in taxes than Reagan, then that's a valid point. But it's not correct to say that tax revenues permanently declined during the Reagan administration due to his tax cuts. It's also misleading to blame those cuts on the deficit increasing, when additional spending played a major role. Moreover, Republicans would surely argue that the Clinton years would have been even more prosperous if he hadn't raised taxes. Indeed, a budget surplus doesn't stimulate economic growth.

Republicans can't have their cake and eat it too, however. They should focus more on cutting spending if they want deficit reduction without hurting economic growth through tax increases. That might not be easy over the next year or two, but when the economy recovers, deep spending cuts paired with modest tax declines could do the trick. Of course, this will require Republicans to get serious and act boldly to cut the federal government's size if they get the power back in Washington.

* Okay, Juju isn't a perfect complement to Voodoo, but the word itself just works so well. It's defined as the magical power attributed to an object venerated superstitiously and used as a fetish or amulet by tribal peoples of West Africa.