KRWG

Don't Trust Politicians With Economic Theory

Dec 3, 2017

Credit Dr. Chris Erickson

Commentary: Economic theory can be like a magical coat of invisibility for politician. A theory that justifies a favored policy can disarm the opposition and allow passage. The problem is that very often these magical theories involve magical thinking with little connection to reality.

In the 1960s, for example, Kennedy administration official Walter Heller, drunk on Keynesian economics, put forward the concept of fine tuning. The idea was that by turning the nobs of economic policy—a little higher tax rate here, a little more government spending there, a more money growth over there—and one could eliminate business cycles.

Both Heller’s fine tuning as well as the Keynesian consensus on which it was based were blown from the water by events of the 1970s, in particular, the supply side shocks of the OPEC oil price spikes. But even before OPEC provided Keynesian demand side ideas to be inadequate, many among the economics profession, especially Milton Friedman, but others as well, called bogus on Heller.

Friedman took great glee in calling out the Keynesians for their hubris in thinking that they knew enough to eliminate business cycle. And even if the Keynesians did know enough, Friedman further argued, the Keynesians would not be able to persuade congress to act in a timely manner. The whole fine tuning thing was magical thinking.

Flash forward to the 1980s. Reagan advisor and supply sider Arthur Laffer proposed his famous curve, which argued that a decrease in tax rates will increase economic activity sufficient to generate enough new tax revenue to offset the tax cuts. A massive tax cut could result in revenue increases.

Laffer curve did not survive the course of events. The Reagan tax cuts turned the 1980s not into a paradise of budget surpluses, but into an era of rising debt. Indeed, Reagan’s tax policy converted a near forty-year tend of falling debt-to-gdp to a raising trend.

Laffer’s supply side ideas were widely ridiculed at the time. They implied a large response to the tax cuts by workers that was not credible. Reagan himself realized that his original tax cuts had gone too far. He signed several tax increases, including the Tax Equity and Fiscal Responsibility Act of 1982, probably the largest peace time tax increase in U.S. history. He felt compelled to sign these laws precisely because the deficit reducing revenues promised by Laffer turned out to just as magical as had the ideas of the Keynesians.

Both Heller on the left and Laffer on the right having something in common, which is that they espoused economic theory that were comforting to the politicians who they served. Their theories disarmed the opposition and enabled the passage of policies desired by the economists’ political allies. At this point, picture in your mind the Church Lady saying, “Oh, how convenient

Now flash forward to today. Perhaps not surprising this administration, current proposals are are justifying their tax plan with a hodgepodge of magical theories. A little Keynesian pixie dust here; a little supply sider love potion there. It will stimulate the economy. It will generate enough economic activity to reduce the deficit.

There is a proverb to beware Greeks baring gifts else it may be a Trojan horse. There should be a similar proverb to beware of politicians using convenient economic theories as they may be trying to pass a law that is bad policy.

Christopher A. Erickson, Ph.D., is a professor of economics at NMSU. Back in the day, he was among the economists who predicted that the Reagan tax cuts would balloon deficits. The opinions expressed may not be shared by the regents and administration of NMSU. Chris can be reached at chrerick@nmsu.edu