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Bush, Krugman, and the Market

August 22, 2001Steve Piraino

Tags Calculation and KnowledgeMonetary TheoryOther Schools of Thought

Fuzzy Math. By Paul Krugman. (W.W. Norton and Company, May 2001, 112 pages) $17.00.

You are probably familiar with the recently passed Bush tax bill.  You may also be familiar with Paul Krugman of Princeton University (formerly of M.I.T.), whose "New Keynesian" musings appear regularly on The New York Times editorial page.  Recently, Krugman published his own critique of the Bush tax cut in a short, popular book entitled Fuzzy Math.

To the author’s credit, this book is brief, well-organized and tightly argued. Instead of aggressively pushing his own left-of-center political views onto the reader, Krugman spends most of the book exposing inconsistencies in the Bush administration’s tax-cut sales pitch. He summarizes his own conclusions rather nicely:

Bush and his people . . . are radically understating the cost of their plan while overstating the money available to pay that cost. They have pretended that a plan that mainly cuts taxes for the extremely well off is basically a middle-class tax cut . . . And they have falsely sold the plan as an appropriate answer to a short run economic slowdown, when it is almost perfectly designed not to deal with that sort of problem.

Much of this book is difficult to criticize on its own terms, as all of Krugman’s claims have some merit.  The Bush tax cut probably is less progressive and more "costly" than the Bush administration would have us believe.  And, if anything, Krugman is not skeptical enough about the antirecessionary merits of using a tax cut to put money into consumers’ pockets.

This does not mean, however, that there is not a legitimate case for reducing taxes. As Krugman himself says, ". . . there is a case for tax cuts . . . though it is not the case the Bush administration is making." Unfortunately, the "legitimate case" that Krugman makes (and rejects) is weak and incomplete.

The "correct" case for tax cuts, Krugman argues, is that tax cuts are a way to "induce people to work harder, save more, and take bigger risks." He then goes on to dismiss this case on the grounds that these benefits are unlikely to be dramatic. While superficially plausible, this analysis obscures the very essence of taxation and its costs.

It is true that heavy taxation causes a variety of behavioral distortions, such as discouraging work, innovation, and investment. However, these distortions are not the costs of taxation, as Krugman suggests. They are the means that individuals employ to reduce the costs of taxation as much as possible. Furthermore, taxes are not costly because they reduce production; taxes are costly because they force individuals to consume a mix of goods that is less desirable from the standpoint of their own subjective preferences. This happens for two reasons.

First, individuals behave differently in order to avoid paying a certain tax. As a result, goods that are taxed are underproduced. It is irrelevant whether or not the resulting mix of goods involves less labor, risk-taking, and investment than the mix of goods that would be produced on the free market. The important point is that the new mix is inferior to the old mix in relation to individual wants.

Second, taxes transfer the command over resources from the private sector to the public sector. This is costly from the standpoint of individual wants. In the private sector, waste is minimized through the discipline of profits and losses. In the public sector, however, politicians acquire resources based on their ability to speak in public, smear opponents, and reward well-organized pressure groups. As a result, the spending projects financed by taxation generally bear little, if any, relation to the desires of consumers. Value-productive private ventures are starved of capital so that a whole host of useless or nearly useless "public goods" can be (over)produced.

Consider, for example, the state of Massachusetts’s infamous Big Dig transportation project (now running some $12 billion over budget), or the interstate highway splurge of the 1950s, or the pork-laden federal space program. Private investors would never pony up the extravagant sums that were necessary to fund these dubious projects, yet the list of public boondoggles goes on and on.

Krugman’s book makes essentially no attempt to defend politics as a means of resource allocation, making only the blithe assertion that "it’s a value judgment, but I don’t accept the idea that our government is too big and should be made much smaller." Krugman has the right to his own value judgments, but economics does have something positive to say about the market system—and that is that all parties necessarily benefit from the rights to voluntary exchange and association.

This system stands in sharp contrast with the current political system, wherein resources are allocated with almost boundless disregard for consumers’ wants.  Whatever else can be said for such a system, the science of economics offers little or nothing to recommend it.  If the Bush tax cuts bring us miles, yards, or even inches further from this system, a sound understanding of economics clearly strengthens, not weakens, their appeal.


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