I said yesterday that the Bush tax cuts are actually tax shifts.  But that was
being kind, once we take into account tax roughening, Bush’s tax
cuts are tax increases.

Deficits caused by tax cuts can reduce the total tax burden if they are used to smooth taxes.  Too see why remember that holding tax revenues constant it’s better to spread taxes across as many goods as possible.  The first penny of apple taxation causes you to stop consuming the marginal apple – the one that was barely worth its price anyway.  Raise apple taxes a bit more and you stop consuming apples whose value far exceeds their price.  Better to lose one marginal apple and one marginal orange than two apples the second one of which was really valuable.

The same thing is true of labor.  The first dollar of wage tax causes you to cut back on the last hour of work, but your wage on that last hour was barely worth the lost leisure time anyway so the first dollar of tax doesn’t create too much waste.  Raise taxes more, however, and you cut into valuable infra-marginal hours.  It’s better, therefore, to spread taxes over time periods – as Arrow taught us, the future is just a different set of goods.

Unfortunately, today’s deficits are tax roughening rather than tax smoothing.  Even with big cuts in Medicare and Social Security, taxes will rise.  Smoothing taxes now requires higher taxes and lower spending.  Unfortunately we have had tax cuts and spending increases and thus the tax stream has become rougher and the total tax burden has increased.

Several years ago in an op-ed I wrote:

I favor a much smaller government but I do not favor the Bush tax cut.
Or, to be more precise, I would support a tax cut if one had been
proposed. But so far President Bush has neither proposed nor
implemented a tax cut–only a tax shift.

Brad DeLong nicely explains the difference:

I, full professor Brad DeLong, am having lunch with lecturer Dariush Zahedi
today. After lunch, I presume Dariush will say we should split the bill–$10
each. Suppose I say: "That isn’t fair. Berkeley pays you less (a lot less: what
we do to our lecturers is shameful) than it pays me. I should lay out more cash
for this lunch. How about this: I put down $5 cash, you put down $0, and we put
the balance on your credit card. That would be fairer, wouldn’t it?"

Dariush would then be an unhappy camper. He would think–correctly–that I
was mocking him.

Back in 2000 the U.S. government was running a surplus of some $200 billion a
year–a broadly appropriate fiscal policy, given the state of the business cycle
and the looming health care costs dilemma. Today we’re running a deficit of
$300-$400 billion a year. Relative to what would be a sane, reality-based, and
appropriate fiscal policy, the Bushies are putting $500-$600 billion this year
on our collective national credit card. That bill will come due: somebody has to
pay it. To pretend that it won’t…well, that would be the equivalent of me telling Dariush that only cash matters:
that when we talk about who paid for lunch, we should count only cash put down
now, and we shouldn’t count the fact that his credit card bill will show an
extra $15 due next month.

Sure, as John Kenneth Galbraith argued, advertising can encourage people to buy things that may not make them happy.  The solution to the advertising problem, however, is not less advertising but more.  A society with a lot of advertising is a society in which advertising is not very powerful. In any case, the competitive cacophony of the market place where the very
desperateness of the advertisers is itself an advert for their
impotence is no real danger. 

The real danger is not from Madison Avenue.  At the very worst, when Madison Avenue tells us how white our shirts can be, we end up with lighter pockets but whiter shirts.  It’s political advertising, which often creates social images that fuel the politics of hatred, where the real danger lies.  Even in the best of democracies, political advertising is nowhere near as competitive as in the market for deodorant and the product being sold is much more dangerous.    

Around the world, reserves of US dollars and Treasury securities have more than doubled over the past 5 years.  It’s nice for us when we get to buy goods and pay in paper but what will happen when we face reserve reverse?  And why, asks Eduardo Porter, do poor countries continue to fund our consumption?

The amount that poor countries are giving up by holding low yield Treasuries is not inconsiderable.  Larry Summers calculates that India has reserves in excess of those required for prudent insurance in the realm of 100 billion dollars – if invested in higher paying assets those reserves could raise Indian GDP by 1-1.5%, more than double the amount that India spends on health care.

It’s interesting how new ideas are often tried first in out-of-the-way places.  Here’s Pablo Halkyard from the World Bank’s Private Sector Development Blog.