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Krugman's Appraisal of the 'Obama-McConnell Tax-Cut'

Monday, 13 Dec 2010 | 1:33 PM ET
Paul Krugman
Joe Kohen | WireImage | Getty Images
Paul Krugman

When Paul Krugman refers to the administration's proposed tax policy as the "Obama-McConnell Tax-Cut", that phrase alone signals more than just a policy disagreement. It's becoming a kind of short hand on the left for dissatisfaction with Barack Obama.

Krugman believes the current proposal will give the economy a "short-term boost": Unfortunately, he also believes that a short-term boost is woefully inadequate to fix problems on the scale we are now experiencing.

In Krugman's analysis, the sugar high of tax cuts simply isn't going to cut it:

He explains: "The root of our current troubles lies in the debt American families ran up during the Bush-era housing bubble. Twenty years ago, the average American household’s debt was 83 percent of its income; by a decade ago, that had crept up to 92 percent; but by late 2007, debts were 130 percent of income. All this borrowing took place both because banks had abandoned any notion of sound lending and because everyone assumed that house prices would never fall. And then the bubble burst. What we’ve been dealing with ever since is a painful process of 'deleveraging': highly indebted Americans not only can’t spend the way they used to, they’re having to pay down the debts they ran up in the bubble years. This would be fine if someone else were taking up the slack. But what’s actually happening is that some people are spending much less while nobody is spending more—and this translates into a depressed economy and high unemployment. "

If you guessed that Krugman's description sounds like a long-term problem—for which he would recommend a long-term solution—you'd be correct:

"What we’ve been dealing with ever since is a painful process of

“deleveraging”: highly indebted Americans not only can’t spend the way they used to, they’re having to pay down the debts they ran up in the bubble years. This would be fine if someone else were taking up the slack. But what’s actually happening is that some people are spending much less while nobody is spending more—and this translates into a depressed economy and high unemployment. What the government should be doing in this situation is spending more while the private sector is spending less, supporting employment while those debts are paid down.

And this government spending needs to be sustained: we’re not talking about a brief burst of aid; we’re talking about spending that lasts long enough for households to get their debts back under control. The original Obama stimulus wasn’t just too small; it was also much too short-lived, with much of the positive effect already gone"

It also sounds expensive— but Krugman believes that the risks of inaction outweigh the costs:

"But wouldn’t it be expensive to have the government support the economy for years to come? Yes, it would—which is why the stimulus should be done well, getting as much bang for the buck as possible. "

But the core of Krugman's disagreement with the administration goes to his assessment of the probability of the tax cuts success in creating substantial stimulus.

He explains: "Which brings me back to the Obama-McConnell deal. I’m often asked how I can oppose that deal given my consistent position in favor of more stimulus. The answer is that yes, I believe that stimulus can have major benefits in our current situation—but these benefits have to be weighed against the costs. And the tax-cut deal is likely to deliver relatively small benefits in return for very large costs. The point is that while the deal will cost a lot—adding more to federal debt than the original Obama stimulus—it’s likely to get very little bang for the buck. Tax cuts for the wealthy will barely be spent at all; even middle-class tax cuts won’t add much to spending.

And the business tax break will, I believe, do hardly anything to spur investment given the excess capacity businesses already have. "

He makes his calculus crystal clear: "The question, then, is whether a year of modestly better performance is worth $850 billion in additional debt, plus a significantly raised probability that those tax cuts for the rich will become permanent. And I say no.

Presumably, the Obama team, with whom Krugman acknowledges disagreement, believes otherwise.

The administration would seem to believe that the $850 billion will have more than a short-lived one-time effect on the economy.

Of course, the point of stimulus—in the form of tax cuts or additional government spending—is to encourage growth in the longer term. Whether the tax cuts will have that desired impact —if they will be enough to create a processional effect that becomes a self-reinforcing cycle—remains to be seen.

The tax cut proposal appears poised to pass.

Let's hope Mr. Krugman is wrong.

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