Posted 9:40 AM by Robert

A Final Note On The Most Recent Krugmania

It's a real steeplechase race, but perhaps the most fatuous criticism of Alan Greenspan that Paul Krugman releases in his most recent column may be this:

And [Mr. Greenspan] can't make the supply-side claim that tax cuts actually increase revenues, when just two years ago he argued for a tax cut to reduce the surplus.

Contrary to this most recent blast of Krugmania, Mr. Greenspan will have no trouble whatsoever before Congress, and he will not have to be opaque or gnostic to answer any of the silly questions Professor Krugman has ginned up in his column. Specifically, if Mr. Greenspan is asked, he can say that when he previously proposed that taxes be reduced to reduced the surplus he had a big tax cut in mind - one that would more than compensate for the supply side simulative effects. That is: he was then proposing a tax rate to the left of what might be called the "Laffer Point". But now he is advocating a smaller tax cut - one that will activate the supply side effect and raise tax receipts in the long run. In other words he can say that he views the President's proposed reduced tax rate to still be to the right of the Laffer Point. He could even say that additional tax cuts may be appropriate in the future.

Mr. Greenspan might also point out that the structure of these particular proposed tax reductions is especially likely to create long term stimulative effects - as Milton Friedman and others have noted. The elimination of the almost universally condemned "double taxation" of dividends will eliminate a substantial incentive for public companies to incur excessive debt and retain earnings for which they are not the best users. Further, rapid and permanent repeal of the "death" or "inheritance" tax will eliminate incentives for assets to be sold at the time of death, rather than the efficient time. So it is all the more reasonable to expect that this tax cut will increase long term revenue while previous proposals might only have reduced the surplus.

Contrary to the Krugmania version, the "supply side" argument posits only that at some point increasing tax rates suppresses economic activity and therefore tax receipts. One might call the rate of taxation at which tax receipts begin to go down the "Laffer Point." Professor Krugman doesn't like "supply side" theory, but here's a proof that the Laffer Point must exist that even Professor Krugman should be able to understand: Assume for the sake of argument that effective tax rates are set at 100% of wealth and income. Then nobody will engage in meaningful economic activity and tax receipts will be zero. So there must be a Laffer Point. There. Easy stuff, even for Professor Krugman.

Professor Krugman thinks that Mr. Greenspan is confined by intellectual honesty to always arguing that tax cuts increase tax receipts. But Mr. Greenspan is as aware as anyone that if tax rates are continuously reduced towards zero eventually tax receipts will be reduced, too. Here's a proof that Mr. Greenspan may keep written on his shirt cuff which even Professor Krugman should be able to grasp: Assume for the sake of argument all tax rates are reduced to zero. There will be no tax receipts, and zero is less than what the government collects now. There. Wasn't that easy? Professor Krugman should be confident that Mr. Greenspan - who is really pretty clever - has not overlooked this argument.

So Mr. Greenspan can hold his head high, his reputation and the national solvency secured!

No sweat.