Must-Read:

1. Paul Krugman is right…
2. If you think Paul Krugman is wrong, see #1…

Paul Krugman (2009): The Obama Gaps: “The bottom line is that the Obama plan is unlikely to close more than half of the looming output gap, and could easily end up doing less than a third of the job…

…Why isn’t Mr. Obama trying to do more? Is the plan being limited by fear of debt? There are dangers associated with large-scale government borrowing…. But it would be even more dangerous to fall short in rescuing the economy. The president-elect spoke eloquently and accurately on Thursday about the consequences of failing to act—there’s a real risk that we’ll slide into a prolonged, Japanese-style deflationary trap—but the consequences of failing to act adequately aren’t much better.

Is the plan being limited by a lack of spending opportunities? There are only a limited number of “shovel-ready” public investment projects…. But there are other forms of public spending, especially on health care, that could do good while aiding the economy in its hour of need. Or is the plan being limited by political caution?… Keep the… price… below the politically sensitive trillion-dollar mark… inclusion of large business tax cuts, which add to its cost but will do little for the economy… [as] an attempt to win Republican votes in Congress.

Whatever the explanation, the Obama plan just doesn’t look adequate to the economy’s need. To be sure, a third of a loaf is better than none. But right now we seem to be facing two major economic gaps: the gap between the economy’s potential and its likely performance, and the gap between Mr. Obama’s stern economic rhetoric and his somewhat disappointing economic plan.

Should-Read: Yes, it’s a grift. The only question is: who inside the Republican coalition is being grifted here?

Paul Krugman: Schroedinger’s Tax Hike: “The Senate bill… tries to be long-run deficit-neutral… by offsetting huge corporate tax cuts with higher taxes on individuals…

By 2027 half the population, and most of the middle-class, would see taxes go up. But those tax hikes are initially offset by a variety of temporary tax breaks…. Republicans are arguing that those tax breaks won’t actually be temporary…. But they also need to assume that those tax breaks really will expire in order to meet their budget numbers.

So the temporary tax breaks need, for political purposes, to be both alive and dead…. For now, they want to hold it all in suspension. Once upon a time you wouldn’t have imagined they could get away with it. Now…

Should-Read: Alexander William Salter and Daniel J. Smith: Political Economists or Political Economists? The Role of Political Environments in the Formation of Fed Policy Under Burns, Greenspan, and Bernanke: “We analyze the writings and speeches of… Arthur Burns, Alan Greenspan, and Benjamin Bernanke…

…as they transitioned to becoming chairman of the Fed. The tension between their previously stated views and their subsequent policy stances as chairman of the Fed, suggest that operation within political institutions impelled them to alter their views. Our findings offer additional support for incorporating the concerns of political economy into monetary models and structures…

Should-Read: To my knowledge, the Tax Foundation has never provided an answer to Paul Krugman’s critique that their “long run” takes not 10 years to arrive but 30:

Paul Krugman: The Transfer Problem and Tax Incidence: “These days, what passes for policymaking in America manages to be simultaneously farcical and sinister, and the evil-clown aspects extend into the oddest places…

…The actual economics of corporate tax incidence… [has] an intersection with international economics that… isn’t being [much] appreciated in the current discussion…. [In the] equaliz[ation of] after-tax rates of return in the long run… the long run is pretty darn long… return equalization should take decades….

Harberger… a closed economy with a fixed stock of capital… a tax on profits would fall on capital, basically because the supply of capital is inelastic. The modern counterargument is that we now live in a world of internationally mobile capital…. For a small economy facing perfect capital markets, the elasticity of capital supply is infinite… so any changes in corporate tax rates must fall on other factors, i.e. labor. Most analysis of tax incidence nonetheless allocates only a small fraction of the corporate tax to labor, for three reasons. First, a lot of corporate profits are… rents on monopoly power, brand value, technological advantages…. Third… rates of return probably aren’t equalized even in the long run…. I’m fine with all that….

I think it’s also important to ask exactly how inflows of capital that equalize rates of return are supposed to happen…. Suppose the US were to cut corporate tax rates…. How would the capital stock be increased? One does not simply walk into Mordor unbolt machines in other countries from the floor and roll them into America the next week. What we’re talking about is a process in which U.S. investment exceeds U.S. savings–that is, we run current account deficits–which increases our capital stock over time…. Exporters and importers don’t know or care about S-I; they respond to signals from prices and costs. A capital inflow creates a trade deficit by driving up the real exchange rate, making your goods and services less competitive. And because markets for goods and services are still very imperfectly integrated–most of GDP isn’t tradable at all–it takes large signals, big moves in the real exchange rate, to cause significant changes in the current account balance….

How much stronger does the dollar get?… The knowledge that we’re looking at a one-time adjustment limits how high the dollar can go, which limits the size of the current account deficit, which limits the rate at which the U.S. capital stock can expand, which slows the process of return equalization. So the long run in which returns are equalized can be quite long indeed…. I assume Cobb-Douglas production, with a capital share of 0.3. The capital-output ratio is about 3, implying an initial rate of return of 0.1. And the modelers at the Fed tell us… a 10 percent rise in the dollar widens the trade deficit by about 1.5 percent of GDP…. Assuming I’ve done the algebra right, I get a rate of convergence of… percent of the deviation from the long run eliminated each year… a dozen years to achieve even half the adjustment…. Openness to world capital markets makes a lot less difference to tax incidence than people seem to think in the short run, and even in the medium run…

Should-Read: Ned Phelps: Nothing Natural About the Natural Rate of Unemployment: “A compelling hypothesis is that workers, shaken by the 2008 financial crisis and the deep recession that resulted…

…have grown afraid to demand promotions or to search for better-paying employers–despite the ease of finding work in the recently tight labor market. A corollary hypothesis is that employers, disturbed by the extremely slow growth of productivity, especially in the past ten years, have grown leery of granting pay raises–despite the return of demand to pre-crisis proportions…. This does not mean there is no natural unemployment rate, only that there is nothing natural about it. There never was.

Should-Read: I’m really not surprised that the only economist out of 42 willing to believe this is from Robber-Baron Crony-Capitalism Stanford University. But I am embarrassed for my profession that there is even one:

Justin Wolfers: @justinwolfers on Twitter: “The University of Chicago surveyed 42 leading economists and found exactly one who believes the Republican claim that their tax bill will grow the economy. http://www.igmchicago.org/surveys/tax-reform-2”

His comment doesn’t suggest he spent much time thinking about it:

A reduced corporate tax reduction is likely to grow GDP. Whether the overall tax plan is distributionally fair is another matter.

So does Darrell Duffie not believe in the government budget constraint? The right one-sentence is not Duffie’s but rather: “An unfunded tax cut that increases the deficit in an economy near full employment is likely to slow the growth of GDP”.

I would be interested in a further explanation from him: Why is it that we should think that the substitution effect should dominate the income effect here, and that consumption plus net exports is likely to fall rather than rise? But I don’t suppose I am likely to get a coherent one.

Should-Read: Stan Collender: GOP Tax Bill Is The End Of All Economic Sanity In Washington: “The GOP tax bill will increase the federal deficit by $2 trillion or more over the next decade (the official estimates of $1.5 trillion hide the real amount with a witches’ brew of gimmicks and outright lies)…

…The GOP’s insanity is compounded by its moving ahead without having any idea of what this policy will actually do to the economy. The debates… took place before the Congressional Budget Office’s analysis and, if it really exists, the constantly-promised-but-never-seen report from the Treasury on the economics of this tax bill…. The GOP tax bill may be enacted without anyone who votes for it having any understanding of the damage it could do…. On top of everything else, there is no reason to rush this debate….

If the GOP tax bill is enacted, Congress and the president this year will give up almost all ability to deal with the U.S. economy for at least a decade even when, as almost certainly will happen, there’s a downturn. No one else will be able to fulfill this role. That’s almost a textbook definition of economic insanity…

Should-Read: It is now almost forty years since Tennessee Senator Howard Baker characterized Republican fiscal policy as a “riverboat gamble”—where if you lose, you don’t pay up but instead abandon ship, jump overboard, and swim to shore. It is more than 35 years ago since Reagan OMB Director David Stockman said, of the Republican members of congress’s understanding of fiscal policy: “nobody understands these numbers”. I say it reminds me of fratboys who haven’t done the reading winging it in a budget simulation course.

And I do find myself resenting former Bush CEA Chairs Eddie Lazear’s and Glenn Hubbard’s endorsements of this “unworkable mess”, in the words of their colleague Greg Mankiw. They owe the country better:

Paul Krugman: Tax Cuts, Growth, and Leprechauns: “The Tax Policy Center released its macroeconomic analysis of the House tax cut bill…

…TPC is not impressed: their model says that GDP would be only 0.3 percent higher than baseline in 2027, and that revenue effects of this growth would make only a tiny dent in the deficit. But… focusing on GDP is itself misleading, because we’re a financially open economy with a lot of foreign ownership already, and a large part of the alleged benefit of corporate tax cuts is that they will supposedly draw in lots of foreign investment…. I’ve been trying a back-of-the-envelope estimate of the difference leprechaun economics (so named because Ireland is the ultimate example of a country where national income is much less than GDP, because of foreign corporations) makes to the analysis…. For 2027 I get $60 billion in reduced GNI relative to GDP… 0.2% of GDP.

Remember, TPC estimates the extra growth in GDP at 0.3%. So according to the back of my envelope, leprechaun economics—extra payments to foreigners—basically wipe out all of that growth. And let me say that I am not entirely clear, given this result, why there should be any dynamic revenue gains. Given how scrupulous TPC normally is, they probably have an answer. But as far as I can see there’s no obvious reason to believe that dynamic scoring helps the tax cut case at all, not even a little bit. I’m sure that people can improve on my back-of-the-envelope here. But for now, it looks to me as if, properly counted, these tax cuts would do nothing for growth.

Must-Read: I remember when Martin Wolf was the very smart, very reality based, but very sincere and committed Tory. (He would probably say that he still is such.) Yet now his shrillness is up to 11 on the 10-point Krugman scale…

And the owl was once the baker’s daughter:

Martin Wolf: A Republican tax plan built for plutocrats: “How does a political party dedicated to the material interests of the top 0.1 per cent of the income distribution win and hold power in a universal suffrage democracy?…

…That is the challenge confronting the Republican party. The answer it has found is “pluto-populism”. This is a politically successful, but dangerous, strategy… [that has] brought Donald Trump to the presidency. His failure might bring someone more dangerous, more determined, to power. This matters to the US and, given its power, to the wider world…. About 45 per cent of the tax reductions in 2027 would go to households with incomes above $500,000…. This simply is reform for plutocrats…. The bill might also increase the cumulative fiscal deficit by about $1.5tn over the coming decade…. In all, then, this is a determined effort to shift resources from the bottom, middle and even upper middle of the US income distribution towards the very top, combined with big increases in economic insecurity for the great majority.

How, one must ask, has a party with such objectives successfully gained power?… Find intellectuals who argue that everybody will benefit from policies ostensibly benefiting so few…. Second… abuse the law… give wealth the overriding role in politics… suppress the votes of people likely to vote against plutocratic interests, or even disenfranchise them…. Third… foment cultural and ethnic splits… the “Southern strategy”…. Yet this is too limited a view of the strategy.

More interesting is the echo of the antebellum South itself. The pre-civil war South was extremely unequal, not just in the population as a whole, which included the slaves, but even among free whites…. Peter Lindert and Jeffrey Williamson note, “Any historian looking for the rise of a poor white underclass in the Old South will find it in this evidence.” The 1860 census also shows that the median wealth of the richest 1 per cent of Southerners was more than three times that of the richest 1 per cent of Northerners. Yet the South was also far less dynamic. The South was a plutocracy. In the civil war, whose stated aim was defence of slavery, close to 300,000 Confederate soldiers died. A majority of these men had no slaves. Yet their racial and cultural fears justified the sacrifice. Ultimately, this mobilisation brought death or defeat upon them all. Nothing better reveals the political potency of identity.

A not dissimilar threat arises for today’s plutocrats. The economics and politics of pluto-populism have stoked cultural, ethnic and nationalist anger in the party’s base…. If the current tax bills get through, the tensions within the US are almost certain to get worse. Latin American inequality leads to Latin American politics. The US the world once knew is drowning in a tide of unconscionable and apparently unlimited greed. We are all now doomed to live with the unhappy consequences.

As I said yesterday: Eddie Lazear, Glenn Hubbard, what do you imagine that you are doing?