The Misleading Nature of the Republican-Democratic Economic Debate


After the weak third quarter GDP growth number, the debate over the U.S. economy between supply-side pro-Republican economists and left-wing Democratic economists has again intensified.

First out was Cesar Conda in NRO with an article that appears to have been written before the actual release. The article contained the expected supply-side spin, arguing essentially that the numbers were a mere blip and that the economy is really fundamentally very strong. This, he claims, is a result of Bush’s tax cuts.

Left-liberal economist PGL replied to this on the Angry Bear blog. He pointed out that average growth under Bush have been less than 2.5%, below the historical average. This, he claims, proves that the Bush tax cuts have had no positive effects.

Yet this debate by partisan Republican and partisan Democratic economists’ rests on two false premises. First, that the only thing Bush has done is to cut taxes. Second, that tax and fiscal policy are the only thing that affects the economy.

We know from sound economic theory that tax cuts will have a positive effect on the economy. We don’t know from theory alone just how big that effect is, but studies tend to show that the effect is not insignificant. With regards to the Bush tax cuts, there is also strong evidence that they contributed to increased dividend payout and therefore more efficient allocation of capital.

But while the effects of the tax cuts are clearly positive, supply-siders often exaggerate just how big the effects are. Dividend payout and other positive effects from the tax cuts simply haven’t increased sufficiently to raise growth by more than perhaps a few tenths of a percent.

Moreover, while Bush has cut (current) taxation, he have also sharply increased government spending. And the higher budget deficit this produces will have a “crowding-out” effect on investments that will lower growth. The negative effects from the increased budget deficit have probably cancelled out the positive effects from the tax cuts.

But the biggest fallacy in this debate is that it does not recognize the destabilizing effects of Alan Greenspan’s monetary policies. That the economy was so weak during the first year of Bush’s term wasn’t really Bush’s fault. Nor was it really Clinton’s fault. It was the result of the bursting of the tech stock bubble, a bubble created by Greenspan’s inflationary monetary policies. Similarly, the 2003–2006 boom was the result of the housing bubble created by Greenspan’s inflationary monetary policies.

That bubble is now showing signs of bursting, which is why the economy was so weak during the third quarter and why it may soon fall into a recession. This will inevitably be blamed on Bush. But while we can blame Bush for a lot of bad things (like the debacle in Iraq), it really won’t be his fault. And it will certainly not be the fault of his tax cuts. It will be Greenspan’s fault.

But because the Republican defenders of the tax cuts refuse to recognize the negative effects from the spending increases and Greenspan’s monetary policies, tax cuts will appear discredited when the economy sinks into a recession.

November 1, 2006