The United Statesis famous for its ability to innovate. Aspiring fiscal conservatives around theworld thus might be interested in learning four tricks that Americanpoliticians commonly use when promising to cut taxes while simultaneouslyreducing budget deficits.
These are hard promises to keep, for the simple reason that a budgetdeficit equals government spending minus tax revenue. But, each of the fourtricks has been refined over three decades. Indeed, they first acquired theircolorful names in the early years of Ronald Reagan’s presidency: the “magic asterisk,” the “rosyscenario,” the Laffer hypothesis, and the “starvethe beast” scenario. As shop-worn asthese tricks are, voters and journalists still fallfor them, so they remain useful tools for anyone posing as a fiscalconservative.
The first term was coined by Reagan’s budget director, David Stockman.Originally, it was an act of desperation, because the numbers in the 1981budget plan did not add up. “We invented the ‘magic asterisk,’”Stockman wrote in The Triumph of Politics in 1986. “If we couldn’t findthe savings in time – and we couldn’t – we would issue an IOU. We would call it ‘Future savings to beidentified.’”
Ever since, the magic asterisk has become a familiar American device.Recent examples include the recommendation of theSimpson-Bowles commission – tasked in 2010 with charting a fiscal-consolidation path – to cut realspending growth by precise amounts, without saying where the cuts would bemade. US presidential candidate Mitt Romney’s spending plans contain the same conjuring trick. So, too, his plan to eliminateenough tax expenditures to offset the $5 trillion in revenue lost from cutting marginal tax rates by 20%, while refusingto say which tax loopholes he would close.
As Election Day nears, the pressure on a candidate to be more specificgrows. The conjurer thus resorts to the rosyscenario: since he cannot find enough tax loopholes to eliminate, hemust claim that what he meant by closing the revenue gap was that strongereconomic growth will bring in the additional revenue.
Here, Murray Weidenbaum, the chairman of Reagan’s first Council ofEconomic Advisers, deserves the credit for inventing what he called “perhaps mymost lasting legacy.” In its early years,the Reagan administration forecast 5% income growth (twice the long-runaverage), in order to imply in its projections a boost to revenues big enoughto make up for its many tax cuts. Since then, candidates of both major US politicalparties have relied on rosy scenarios.
Indeed, overly buoyant, official growthforecasts are a fact of life in almost all of a sample of 33 countries,contributing to overly optimisticbudget forecasts.European governments are particularly biased. From 1991 to 2010, for example, Italy forecastgrowth rates at the three-year horizon that were, on average, 2.3 percentagepoints above what was actually achieved.
In the Republican primaries last year, candidate Tim Pawlenty assumed a 5%growth rate to make his own plan work. He was allbut laughed out of the race. Romney probably cannot get away with thissleight-of-hand, either. The press asks, “Why should we believe that thegrowth rate will magically accelerate just because you become president? Wherewill this GDP come from? It sounds like pulling arabbit out of a hat.”
Right on cue, it istime for the famous Laffer hypothesis – theproposition, identified with the economist Arthur Laffer and “supply-sideeconomics,” that reductions in tax rates are like magic beans: they sostimulate economic growth that total tax revenue (the tax rate times income)goes up rather than down.
One might think that the Romney campaign would not resurrect so discredited atrick. After all, two of his main economic advisers, Glenn Hubbard and GregMankiw, have both authored textbooks in which they argue that the Lafferhypothesis is incorrect as a description of US tax rates. Mankiw’s book, in itsfirst edition, even called proponents of thehypothesis “charlatans.”
Each Republican presidential candidate since Reagan has had good economicadvisers who disavow the Laffer hypothesis.Yet, time and again, the president (or candidate), his vice president (orrunning mate), and his political aides eventually rely on Laffer’s flawedargument. And they, not academic economists, formulate policy. Hubbard andMankiw advised former President George W. Bush in his first term, when he cuttaxes and transformed a record surplus into a record deficit.
The final trick, “starve the beast,” typically comes later, if and whenthe president has enacted his tax cuts and discovers that smoke and mirrors do nottrump reality. He cannot find enough spending to cut (the magic asterisk has disappeared up the conjurer’s sleeve);the acceleration in GDP is nowhere to be seen (the rosy scenario having vanished);and tax revenues have not grown (no rabbit in the Laffer hat).
The audience is now told that losing tax revenue and widening the budgetdeficit was the plan all along. The performer explains that the deficit is allthe fault of congress for not cutting spending and that the only way to tame the beast is to raise the budget deficitbecause “Congress can’t spend money it doesn’t have.” This trick never works either, ofcourse. Congress can, in fact, spend money it doesn’t have, especially if thepresident has been quietly sending it budgets that call for just that.
By the time the crowd realizes that it has been conned,the magician has already pulled off thegreatest trick of all: yet another audience that came to see the deficit shrinkleaves the theater with the deficit biggerthan before.