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Taxes, Part Two


Taxes, Part Two #1120

Feed Date: July 11, 2003

Glenn Hubbard and Martin Baily

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Additional funding is provided by the Lynde and Harry Bradley Foundation, the John M. Olin Foundation, the Bernard and Irene Schwartz Foundation, and the Smith Richardson Foundation.

Hello, Iím Ben Wattenberg. Arguing about taxes is as old as the hills. But in todayís struggling economy, taxes are the root issue of American politics. President George W. Bush has made cutting taxes the core of his domestic agenda since his first day on the job. His critics, mostly Democrats, donít like tax cuts, at least not Bushís version. A battle royal has ensued. Will tax cuts help the economy? Who should get them and how much? Can anyone make sense of it all?

Ben: Well uh, welcome back to uh, Think Tank, uh, Glen Hubbard and Martin Bailey. Letís go back into a little history. Did the uh, Reagan Tax cut of the early Nineteen Eighties, did that get the economy back on track?

Martin: In...in one respect it helped stimulate the economy, which had fallen into a deep recession. We hit almost ten percent unemployment in Nineteen Eighty-two uh, and the tax cuts worked as a Keynesian Stimulus to get the economy growing, but the goal here was to have an effect on the supply side to get productivity growing and that really did not happen. We had sluggish productivity growth after Nineteen Seventy-three and that lasted all the way until Nineteen Ninety-five, so in terms of stimulating uh, productivity growth in our economy, no, it did not work.

Glenn: I wouldnít quite agree that, because the tax cuts did, in fact, stimulate business formation. Many studies have suggested they improved environment for risk-taking and for work effort, so in that sense they had effects, but I think the biggest such tax change was more in the middle of that decade and the Tax Reform Act of Nineteen Eighty-six.

Ben: Uh, Martin, I...I wanted to get uh, back to uh, to one question, um, which is this. Is the idea of supply side economy...supply side economics, which used to be laughed at as sort of a zany idea, now regarded as something within the economics community as something that deserves serious consideration?

Martin: Well, the...the Laugher Curve when the claim that tax cuts would pay for themselves I think is still not taken seriously and I heard Glen say that he did uh, agree with that. So that part of supply side economics is not taken seriously.

Ben: Will you...will you Laugher Curve?

Martin: The Laugher Curve said that as taxes get higher and higher and higher, eventually tax revenues start to decline and that is actually a correct statement. The part that people do not agree with is whether in the U.S. economy as it currently is whether by cutting taxes you could actually get an increase in revenues, and I think most economists would say, no, that is not the case. Now if you ask, do taxes affect uh, behavior of individuals, of companies, of the economy, yet and I think almost everybody would say, yes, and...and is the supply side response, the productivity, the output, is that important? Yes, I think all economists would agree with that.

Glenn: Well, see I think it depends what you mean...I never used the word supply side in professional circles. I...I suspect very few academic economists do. To me, this is about do incentives affect behavior. Much of my own work as an economist suggests that is true. Itís true of very many economists, so I think in that sense the answer is yes. I think the notion that tax cuts pay for themselves is something that economists really never entertained, so it depends on what you mean by...by supply side.

Ben: Is it possible...many people are talking about, well, in the Nineteen Eighties were interesting, the Nineteen Nineties are interesting, but we really are in the middle of a fundamental uh, economic change not only in America but also in the world. What...what do all think about that?

Glenn: I think there are at least two aspects to that. One, we are at a situation in our own economy where given weak economic situation here and in the rest of the world...

Ben: I mean unemployment has been rising here.

Glenn: Unemployment has been rising. The fact that we have um, the rest of the world not growing very rapidly and the fact that interest rates are already very low uh, in the United States suggests that activist tax policy, large tax cuts may well be in order. That is a lesson we learned from the Japanese experience uh, about a decade ago.

Ben: The Japanese have not done very well after telling everybody that they and the uh, four tigers, Taiwan and uh, South Korea were...

Glenn: Correct. Japan...

Ben: ...the model for the world. The Japanese just went right into the tank and have not been able to get out.

Glenn: The Japanese fiscal and monetary policy has not been supportive of a recovery in Japan. The other thing, the situation in the world it seems to me makes clear right now is that itís very hard to have applause with one hand clap, and the American economy is the only hand trying to clap and for situations like the current account deficit or the problems in raising global growth, we have to have a message and say early and often that the rest of the world needs to grow too, not just for them but for us.

Martin: Well, I agree with much of what Glen said. I think we do need to get uh, Japan and Europe growing in order to really have a healthy world economy and healthy world economy is very much in the interest of the U.S. It would be easier for us to recover now if Europe was stronger and Japan was stronger. Let me make uh, another comment though. Remember that uh, the era of...of sort of the...one of the heydays of globalization was the Nineteen Nineties. This was a period when we did see a substantial acceleration of productivity growth in the U.S. under the taxes that were in effect then and we got an explosion of entrepreneurship in the Nineteen Nineties under the tax regime that existed then.

Ben: It was too much though, which caused the so-called (word not understood?).

Martin: Well uh, that was sort of excess would could uh, we could like uh, a little bit more of now. We had uh, lots of jobs, lots of investment, lots of productivity growth, lots of GDP growth. Those things arenít so uh, arenít so bad.

Ben: The...the unemployment...the unemployment...the unemployment level weíre seeing now while as Glen points out unemployment is growing, itís a little over six percent as we are speaking here. Uh, just about ten, fifteen years ago that was regarded as normal, you know uh, what of uh...a full running economy has. Is that correct?

Martin: Yes. Uh, we...we seem to have seen a change in our economy that we can sustain lower rates of unemployment that had been thought possible without inflation. In fact, thereís more concern today about deflation than inflation. Uh, I think part of that has to do with globalization. Iím a big fan of globalization. I think the exposure of uh, the U.S. economy uh, to best practice companies around the world where itís uh...

Ben: Uh, Bush is uh...is a big fan of globalization and yet he...when it comes to certain political issues in West Virginia or in Louisiana, uh, heís right out there being...being a protectionist. I mean, do you get that?
Martin: Yes.

Glenn: Let me...let me...Iím not gonna let you go on that one, but I...I want to come back to this point.

Ben: I donít...I donít want you to let me go. I want to hear where you guys disagree.

Glenn: I think this...structural productivity growth in the United States has likely accelerated and that I...explains in part that the fact that we have seen a weaker labor market. The economyís potential to grow is very fast and if we canít have demand growing that fast, weíll see a weak labor market. I donít uh, give all the credit to globalization. In fact, I would give a lot of the credit to institutions in the American economy that allocate labor and capital very, very efficiently. I think your...your comment on the President on globalization may be a little bit of a cheap shot. After all, the President uh, was able to get approval for trade promotion authority...

Ben: Me give...give a cheap shot?

Glenn: Uh, well or a less expensive shot shall we say.

Ben: All right.

Glenn: Because the Presidentís getting trade promotion authority was something that previous administrations have not been able to do and is a big advance in negotiating trade agreements.

Ben: So...so he was horse-trading? He...he was doing some things that were of a protectionist ilk in order to get this...the possibility of...of real uh...

Glenn: I like almost any economist who you can sit with that do not believe that steel tariffs are in the national interest. It would be hard for me to imagine you could find an economist...

Ben: And you would agree with that?

Martin: I would agree with that.

Glenn: I would say that. I think the political choice for the President was about trade adjustment and about his bet on the likelihood of getting trade promotion authority. These are political issues and I...I wouldnít presume to question his judgment on that uh, although I do think steel tariffs are at the American economy.

Martin: I do think that uh...I would like to see more uh, global initiative coming from this administration. I think itís very important that we have uh, a round, a so-called 'Doha' round where weíre gonna try to push forward on trade liberalization.

Ben: Doha in Qatar, the...in Qatar. In Qatar, that peaceful area of the world that weíre all uh, talking about.

Martin: Yeah, but itís not really relevant where the meeting is stationed. What we...what we need to do is try to improve trade relations between us and Europe which have gotten very fractured and uh, I would hope to see some initiatives there to try and improve that uh, situation, and itís certainly not on...on our side or all on the European side. The European sides have done some things that I think uh, all three of us would not uh, would not agree with.

Ben: The...the Europeans for example will not accept our bio-engineered food. Is that correct?

Martin: Thatís correct.

Ben: What do you think of that?

Martin. Uh, I understand the popular opinion behind that, but I think the WTO, which is the organization that regulates trade.

Ben: Thatís the World Trade Organization.

Martin: The World Trade Organization.

Ben: To which we belong.

Martin: To which we belong and to which Europe belongs and it says that there has to be some scientific basis before you exclude certain products, and uh, I think weíve made the case but...successfully before the WTO that said thereís not a scientific basis to exclude those products. Theyíre also proposing to do something else which is to take all chemicals that are sold in uh, in Europe and have them subject to new rounds of testing. Thatís gonna be a challenge for European companies, but itís a tremendous challenge for American companies trying to sell into Europe and thereís a great concern that will be a protectionist measure. So, now there are things that the U.S. does that Europe doesnít like. I want to see us try to get together uh, with the rest of the world and particularly with Europe and improve those trade relationships.

Glenn: I think thatís precisely what the administration is...is trying to do. Uh, Ambassador Zellick, our trade representative in the United States has been extremely active in pursuing the goals of the Doha Round and in trying to negotiate free trade agreements uh, around the country and around the world. Itís certainly the case that the U.S. has led in relations with Europe. For example, it was the President who said, look, we shouldnít have the export subsidies that were in the foreign sales corporation rules. Thatís a big deal between us and Europe, and itís the President whoís tried the Congress to change.

Ben: But thereís...thereís...thereís talk now of a free trade zone with the Caribbean. Is that right? Where labor costs must be what, a tenth of what they are in the United States, and then people in the United States uh, who are gonna lose those jobs complain bitterly about it. They think what are we doing, giving away the store, giving away all our jobs. How do you...how do you answer that?

Glenn: Well, in the first place...

Ben: How do you...how do you answer that?

Martin: I donít think trade uh, hurts American jobs. Trade has expanded very, very rapidly. During the...the Nineteen Nineties we had millions, well over twenty million jobs. The notion that joining NAFTA or that opening up trade in the end hurts jobs is simply not born out by the facts. It may hurt particular jobs in particular industries, and uh, thatís uh...but we have a pretty flexible labor market here in the United States. So I think we can maintain full employment with free trade. I think we...most economists would agree with that.

Glenn: I...wait a minute...I...I agree with that a hundred percent and two more things. One, American consumers benefit a great deal from the lower prices and the increased choice the trade makes possible, and the point that Martin I think had made earlier about productivity. The competition from abroad stimulates productivity growth in the United States, and again, that raises our wages and our living standards. We win as a country from trade.

Ben: So...so youíre...youíre both uh, pro-free trade?

Martin: I am pro-free trade. I do think itís uh, helpful to have some kind of trade adjustment uh, assistance, and uh, there are some proposals. Uh, to do that, there have been things passed to that to ease the translation who may have lost their jobs due to trade to help them find...get new training and find uh, other jobs, but basically I think uh, like most economists we are uh, free traders.

Ben: Look; you two fellows were each chairman of the Council of Economic Advisors, you for President Clinton, you for President George W. Bush. What is wrong with the American economy now? Not the way your Presidentís saw it, but the way you now see it. What...why...why have we had relatively low growth? Why do they keep saying, well, next quarter itís gonna grow more, and next quarter itís gonna grow more, and next quarter itís gonna grow more, and we still have what is described as very anemic growth? Now suppose you were not only Chairman of the Council of Economic Advisors but the President and the Congress all rolled into one and you could sit there and pontificate and say, hereís what I want to do and hereís what we should do.

Glenn: Well, if I could I...Iíd...Iíd like to got back to your...your premise. Iíll answer your question but Iíd like to...to push on the premise a little bit. If...if I had sat with you a couple of years ago and told you that I was clairvoyant and I could see the recession, September Eleventh, corporate accounting scandals, and then ask you to predict what the effect on the economy would be. If you were like me at that time, if youíd ask me that question, I would have said that things were really going to be absolutely terrible. We, in fact, have had a downturn in the economy but not nearly one of the size that could have been expected, and I think that speaks to the enormous resilience and flexibility in the American economy and that is a huge success story we should forget. We are going through a period of weakness in the economy after a period in which we did have excesses built up in the late Nineteen Nineties, uh, particularly accumulating too much capital. I think an important role for policy if...if I were pontificating as you put it would be to assume a risk management role and say what can we do as policymakers to try to smooth out this adjustment. To me, that would involve very significant monetary accommodation and that we have seen.

Martin: Can I speak to the question of whatís uh...whatís wrong with the economy and uh, what should we uh, do about it?

Ben: At...at length sir, at length.

Martin: I do think the fundamentals of this economy are very good. We appear to be continuing on the path of faster productivity growth.

Ben: And...and you would have said that under President Clinton or under President Bush, is that right?

Martin: I think this economy uh, is...is really a very strong economy. The basic nature and structure of this economy, the private sector of this economy, the workers of this economy are very strong and the fundamentals are still strong. Iím much more hopeful about this economy than I am about Europe uh, or Japan. So I think that the...

Ben: Why?

Martin: Because we have very uh, flexible labor market. We have a lot of entrepreneurship. Uh, I think we have uh, the right incentives uh, built into the system to encourage people to...to take risks.

Ben: Arenít the Europeans moving in that direction, albeit slowly?

Martin: Theyíre moving in that direction, but theyíve got quite uh, a long way to go. The difficult in Europe is that not only are taxes very high but if you decide not to work uh, you get uh, an income support level which really discourages people from looking uh, for new jobs.

Ben: Let me open uh, a fresh topic for a moment. These corporate scandals uh, Enron and the like, Global Crossing, whatever, were these men doing this crooks?

Martin: Well, Iím not in a position to be uh, a judge, but it certainly looks like it on the face of it. It was tremendous pressure to uh, show faster and faster a profit growth, and uh, they...they cooked the books. Thatís...thatís the way it certainly seems, and I think whatís perhaps worst is that the accountants that...

Ben: I mean, with...with...with malice and forethought saying I know Iím doing something illegal and Iím going to do something illegal.

Martin: Well, youíre asking uh, me for legal evidence and Iím an economist and so I...I donít know the nature of the legal evidence but certainly it looks very much as if they were knowingly uh, cooking the books on the face of it. Weíll have to see as the trials play out whether there was, in fact, legal culpability, but we certainly, I think, lost a lot of confidence and one of the reasons this economy is...is uh, still weak, one of the reasons that the stock market uh, took such a dive uh, was that there was a loss of confidence um, in uh, corporate reporting and thatís something that had to be addressed and I think uh, gradually has been addressed, although I think thereís some more to do there in terms of restoring confidence uh, in investors that when they look at uh, balance sheet statements, when they look at profit statements, theyíre actually seeing whatís...whatís really going on in the company.

Ben: Which was pretty nasty stuff?

Martin: Which was pretty nasty stuff.

Glenn: Yeah, I think this is the key point from an economic perspective. The U.S. has had the most liquid capital markets in the world. Thatís a big advantage.

Ben: What...what does that mean, liquid?

Glenn: Uh, that itís very easy to buy and sell securities and value them in the United States because people have had confidence in what those securities represent. Thatís good for companies. It makes it easy, cheaper to raise money. Itís good for us as investors. We know what weíre getting, and itís a good value. So when management does the wrong thing as may have happened in some of these cases.

Ben: May...may have or you think...?

Glenn: Well, again, I canít pass judgment on criminal cases. Iím...Iím not a judge but to...to the extent thereís fraud in these cases.

Ben: And there...and there seems to be.

Glenn: And there certainly seems to be. That would certainly call into question confidence and financial markets. Two policy questions out of that I think are particularly interesting. One is the need to promote transparency and accountability. We have now a new law, the Sarbanes-Oxley Law thatís designed to do that. Weíll how well it does, but second, and I think somewhat under appreciated is the role that the tax code played in a lot of this, that a lot of the transaction that go companies into trouble drew their breath from the tax code, discriminating between debt and equity on the one hand, dividends and capital gains on the other hand. Uh, these are situations that the tax code made even worse.

Martin: I...I think itís a stretch to blame the tax code for what happened in Enron or Global Crossing. These were uh, companies or managers that were doing the right thing and were trying to make a lot of money uh, for themselves, but I think itís...I think itís a stretch.

Glenn: I...I donít think you heard me...I donít think you heard me correctly M

Martin. Iím certainly not excusing bad behavior, but the tax code has created these incentives, by the way, for perfectly legal transactions under current accounting rules that would mislead shareholders.

Martin: But under the current uh, proposal under the tax package, weíre gonna tax capital gains at fifteen percent, so as compared to ordinary income, which will be taxed at higher rates. So even under what is being proposed now, weíre inviting uh, individuals or companies to move money around to transfer from ordinary income to capital gains. So weíre not solving that problem.

Glenn: But thatís...but thatís...thatís disingenuous, because weíre also cutting dividend tax rates, so net/net the current position, letís be sure weíre clear on this, is an improvement over current law in terms of tax laws.

Ben: Isnít...isnít there...I...I...something caught my eye some...some months ago that a uh, a dividend tax cut would mean that more companies would pay dividends and that would uh, create more confidence in the economy because people would not be so much uh, uh, under the spell and under the trance of...of what this valuation was and that valuation was, but they would actually be getting green cash money every quarter and that for that reason uh, the...this is a good idea?

Martin: Well, I think we do need an increase in improvement in business confidence and consumer confidence. Where theyíre reducing the...the dividend tax is gonna be the thing that restores confidence uh, where youíre suggesting it might be. I havenít seen any evidence to suggest that thatís gonna be a major ingredient in improving confidence in our current economy. You know, we have had the terrorist attacks as uh, as Glen said. Weíve had the corporate accounting scandals. We do need to get back on track on that. I...I donít see it necessarily as coming from dividends. It might help a little bit but not much.

Glenn: I...I think that itís probably the largest single positive step policy could have taken. The Presidentís plan to eliminate double taxation would have reduced the cost of capital for investment by twenty-five percent. I canít imagine another tax change that could be more on point especially in an economy where the weakness comes from business investment.

Ben: All right. Now finally um, which party assuming the economy continues to...I hate all these uh, words, but stumble along or grow slowly for the next uh, till the next election. Is this going to be blamed on President Bush? The...the Democrats are claiming, well, it started...the actual slow growth and the recession started right after Bush became President. Is that a fair...?

Glenn: Well, first of all, thatís not even fair of course, because the market is peaking in the Spring of Two Thousand. Industrial production is peaking in the summer of Two Thousand. These donít sound like during the Bush administration.

Ben: Peak...peaking meaning that they came down before Bush became President?

Glenn: Right. But that to me is not really the issue. I donít think individual Presidents overmuch responsible for booms or busts.

Ben: But Democrats and politicians and Republicans, they all make that case all the time.

Glenn: I...I...I canít make the political case for you as to which party might be advantaged. What I can tell you is that a big motivation behind the fiscal policies that have been undertaken since the President came into office are to address these concerns, but I...I canít tell you which partyís gonna be advantaged.

Martin: Well um, the...the...as I mentioned before, we do have business ups and downs, and they do occur and I agree with Glen that we probably should attribute over much of uh, any particular up or down to what...what the President does, but I think the Presidentís important as much as anything else to give and the whole economic team is important to give Americans a sense of confidence that the right polices are gonna be followed and that the economy is uh, gonna grow. I think we did see that in the Nineteen Nineties with uh, with Bob Ruben and under the leadership of uh, President Clinton and the economy did very, very well over a very long period of uh, time. Iím uh, Iím pro the American economy doing well. Iím not uh, too much interested in the partisan issue, so I hope this economy recovers strongly but it is up to the President, his economic team, to get people confidence that thatís gonna happen.

Ben: Okay. On that note gentlemen, weíve uh, covered the waterfront. Thank you very much uh, Martin Bailey, former chairman of the Council of Economic Advisors under President Clinton and Glen Hubbard, former chairman of the Council of Advisors under President George W. Bush, and thank you. Please remember to write us via e-mail. Itís what makes our program better. For Think Tank, Iím Ben Wattenberg.

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Funding for this program is provided by...
(Pfizer) At Pfizer, weíre spending over five billion dollars looking for the cures of the future. We have 12,000 scientists and health experts who firmly believe the only thing incurable is our passion. Pfizer, life is our lifeís work.

Additional funding is provided by the Lynde and Harry Bradley Foundation, the John M. Olin Foundation, the Bernard and Irene Schwartz Foundation, and the Smith Richardson Foundation.

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