Tuesday, May 11, 2010

Mundell on debt and taxes.

Reason's Peter Suderman applauds Kevin Williamson for his critique of supply-side economics.

Here's a useful analysis by Jude Wanniski from 2000, summarizing the supply-side view of tax rate cuts and the deficit:

Mundell, the 1999 Nobel Laureate in economics . . . provide[d] the intellectual underpinnings for the Reagan personal income tax cuts of 1981. The tax cut need only produce sufficient economic growth so added revenues would be able to pay the interest on the bonds floated to finance the tax cut. In the 1980 campaign, George Bush called this “voodoo economics,” but it is the same rationale used in private enterprise. If a business can issue debt to finance an expansion of a product line, it need only sell enough at a profit to service the debt. Anything else is gravy, but the equity markets will not punish it as long as it does well enough to cover interest.

Opponents of the Reagan policies to this day blame the ensuing budget deficits on his tax cuts, but one need only observe that the deficits were accompanied by declining interest rates on government bonds to see the wisdom of Mundell’s hypothesis. The investment made in lower tax rates in the Reagan years — and the bipartisan tax cuts of 1997 — produced the economic growth responsible for the “profits,” or budget surpluses, that have emerged today.

To solve the longer-term problem of actuarial deficits in Social Security and Medicare, at least a portion of the projected near-term surpluses should be devoted to lowering those tax rates on capital and labor that are higher than they need to be. Only if the amount of capital available to labor is increased by 50% over the next 20 years will it be possible for two workers instead of three to provide for a pensioner. Merely paying down the debt will not accomplish that goal.

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