Economic Reporting Review
August 2, 1999
By Dean Baker
Tax Cuts | Germany | China | South Korea | Outstanding Stories
Tax Cuts
"Business Gets Big Breaks in Tax Bill"
Dan Morgan
Washington Post, July 24, 1999, page A1
"Seeking Common Ground on Federal Tax Cut"
Richard W. Stevenson
New York Times, July 25, 1999, Section 1 page 18
"Clinton Attacks `Reckless' Size of Tax Cut"
Tom Kenworthy
Washington Post, July 25, 1999, page A4
"Clinton Aids Say He Would Veto Tax-Cut Compromise With GOP"
William Branigin
Washington Post, July 26, 1999, page A5
"White House Says No to $500 Billion Tax-Cut Proposal"
Joel Brinkley
New York Times, July 26, 1999, page A1
These articles discuss the debate over the tax cuts proposed by Republicans in Congress. Like
previous coverage of this issue (see ERR, 7/19/99 and 7/26/99), these articles do not discuss
the size of the proposed tax cuts either in reference to the size of the economy or to total
federal spending. There are very few people, even among the relatively well educated readers
of these papers, who are in a position to assess the magnitude of either the $800 billion tax cut
proposed by the Republicans, or the $300 billion ceiling for tax cuts suggested by President
Clinton.
The U.S. Gross Domestic Product (GDP) is projected to total approximately $101 trillion over
this ten-year period, which means that the proposed Republican tax cut is equal to 0.8 percent
of GDP. It is equal to approximately 4.2 percent of projected federal spending over this
period. The ceiling proposed by President Clinton is equal to approximately 0.3 percent of
GDP or 1.6 percent of projected federal spending over this period.
This information may have left readers better able to assess the extent to which the Republican
tax cut proposal "threatens our ability to secure Medicare and Social Security and pay down
our national debt," as claimed by White House economic advisor Gene Sperling in the Brinkley
article. By standard economic measures, the cumulative economic effect of paying down the
debt by $800 billion over the next ten years would probably be too small to even measure
accurately.
It is also worth noting that the projections of large budget surpluses over this period assume big
cuts in discretionary spending measured as a share of GDP. In the baseline projections, this
category of spending falls from 6.6 percent of GDP in 1999 to just 5.0 percent of GDP in
2009, a reduction of nearly 25 percent. Discretionary spending includes most federal spending
on education, research and development, the criminal justice system, infrastructure and the
military. This point is important not to overlook, as the first Post article seems to, when it
asserts that these are not "tight budgets."
Some of the characterization of the tax cuts in these articles is also questionable. For example,
the Stevenson article claims that the Republicans "want the tax reductions to be spread more
broadly," noting that President Clinton has suggested limiting tax cuts to promoting savings or
subsidizing the purchase of health care insurance. It is not clear that the Republican tax cut
would necessarily help a larger group of people. The proposed income tax cuts will provide
little or no benefit to close to 50 percent of taxpayers. The proposed cuts in the capital gains
and inheritance taxes will almost exclusively benefit high income households. Since tens of
millions of low- and middle-income families could gain from the tax subsidies proposed by
President Clinton, it is possible that his tax cuts will actually benefit a larger portion of the
population.
A chart accompanying the Stevenson article reflects a disproportionate concern with the fate of
upper-income households. The chart presents the impact of the tax cuts on five representative
families. The lowest family listed in the chart is $35,000. More than 40 percent of households
have incomes under this level. The chart includes two types of families with incomes of
$75,000, one with an income of $200,000, and one with an annual income of $1 million.
Approximately one quarter of all households earn $75,000 or more.
"Budget Economics, Politics Collide"
George Hager
Washington Post, July 28, 1999, page E1
This article discusses the possible economic effect of the Republican tax cut proposal. The
article seriously misrepresents the economic issues at stake. The whole discussion assumes that
the tax cuts will provide an additional stimulus to the economy in future years compared with
the current year. Actually, even if the tax cut went into effect, the budget surplus is projected to
increase (measured as a share of GDP) over the next decade. This means that the federal
budget will be providing less stimulus to the economy in coming years than it does at present.
The effect of the tax cut would be to reduce some of the drag associated with a growing a
government surplus. Increased government spending (above baseline levels) would have the
same effect.
The article also implies that this money could have a significant effect on interest rates, savings
and growth if it were used to pay down the debt. Standard economic models indicate that the
cumulative effect of paying down the debt by the amount of the proposed tax cut would be to
raise GDP in the year 2010 by approximately 0.2-0.3 percent. This impact is too small even to
be measured accurately.
While the article presents the question of whether people save or consume their tax cut as the
central issue, the more important factor is its likely impact on the stock market. If it drives the
stock market still higher, which is the ostensible rationale of the proposed capital gains tax cut,
there is likely to be another spurt in consumption, as the rising stock market causes people to
feel wealthier. Most economists see the soaring stock market as the main factor behind the
decline in personal savings over the last decade. The savings rate was 5.0 percent of
disposable income in 1989. The savings rate is now negative, as the average household is
borrowing an annual amount equal to 1.1 percent of their disposable income.
See also "Outstanding Stories of the Week."
[Top]
Germany
"To Spur German Economy, Schroder Offers Veer to Right"
Roger Cohen
New York Times, July 25, 1999, Section 1 page 3
This article reports on a new economic plan put forward by the German government, which
would cut public pensions and unemployment benefits and lower taxes for corporations. The
article describes the plan as a "radical agenda of American-inspired changes aimed at making
Germany more nimble, less regulated, more entrepreneurial and less dependent on the state."
While this sort of rhetoric is used to justify the plan, the article does not indicate how it has
determined the government's true aims. Since the thrust of the plan is to cut benefits that
working people depend on, and to reduce the tax payments of corporations, it is at least
plausible that the aim of the plan is to redistribute income from workers to owners of capital.
According to data from the Bureau of Labor Statistics, Germany's rate of productivity growth
averaged 1.9 percent annually from 1990 to 1996 (the most recent period available), while
productivity growth in the United States averaged just 1.0 percent in these years. Virtually all
economists regard productivity growth as most important factor determining living standards.
The relatively poor record of the United States in this key category suggests that the German
government has picked a poor model if its goal is to make its economy more "nimble."
At one point, the article discusses the policies of Oskar Lafontaine, the government's former
Finance Minister, asserting that these "centered on raising wages to stimulate demand and
jump-start the economy." Actually, much of Lafontaine's efforts were devoted to getting the
European central bank to lower interest rates. Even though inflation in the European Union is
less than 1 percent and has been falling, the European Central Bank has kept the real interest
on short term loans at close to 2 percent.
By contrast, when the U.S. economy was slumping in 1992, Alan Greenspan allowed the real
interest rate in the United States to fall to zero, at a time when the inflation rate was close to 3
percent. Had Greenspan pursued the same sort of contractionary policies as the European
central bank, economic growth in the United States would have almost certainly been much
slower over the last seven years, and the unemployment rate would be considerably higher
today. This point was made by many of the world's most prominent economists in a paper
issued last year. (See "An Economists' Manifesto on Unemployment in the European Union,"
BNL Quarterly Review, 9/98.)
The article also comments on "a welter of grim statistics" produced by the German government
to support its new position. One of the statistics noted in the article was a large increase in the
share of unemployment due to long-term unemployment, from 9.6 percent in 1975 to more
than 36 percent today. The share of unemployment attributable to long-term unemployment
always rises whenever the overall unemployment rate rises. For example, in 1989, when the
unemployment rate in the United States averaged 5.3 percent, 9.9 percent of the unemployed
had been out of work for more than 26 weeks. By 1992, when the unemployment rate was
7.5 percent, 20.3 percent of the unemployed had been out of work for more than 27 weeks.
The other "grim statistic" noted in the article is that "the state's share of the economy has
jumped, from 39 percent in 1979 to almost 49 percent today." There may be ideological
reasons why the article views this as bad, but there is no economic reason why a large state
sector should be seen as necessarily bad. Some services can be more efficiently provided
through the government, such as parks, health care or military defense. There is nothing
necessarily negative about a country's decision to spend a larger portion of its output on these
services.
[Top]
China
"Amid Unrest, Chinese Face Ugly Reality: Deflation"
Mark Langer
New York Times, July 25, 1999, Section 1 page 8
This article presents an analysis of China's economic slowdown. Much of the discussion
contradicts standard economic analysis.
For example, the article asserts that consumers have cut back their spending due to economic
insecurity, and that China now has a household saving rate of 42 percent. It then comments "by
Western standards, consumer spending in China still looks fine. For a rapidly developing
country, though, the trend is disturbing." In fact, economists generally argue that the main
problem facing rapidly developing countries is a shortage of capital (i.e., savings). In this case,
the savings rate reported in the article implies that China faces no shortage of capital at all. By
standard economic theory, this means China should be in great shape.
The article goes on to say that "the most intractable problem is that there are simply too many
factories churning out everything from refrigerators to air conditioners to cars." The article then
argues that the Chinese government has to give more support to its private sector: "Like most
other economists, Mr. Xu said China could only stimulate consumer demand by supporting its
private sector."
If the article has diagnosed China's problem correctly as a shortage of demand, then there is a
much simpler path. The country could easily boost demand by raising wages. This would likely
happen, if instead of suppressing independent labor unions, the Chinese government decided to
support workers' right to organize. If workers had higher wages and more job security, they
would undoubtedly be willing to buy the large quantities of refrigerators, air conditioners and
cars that currently going unsold. Since the country is still running a trade surplus, and has a huge
savings rate, a wage-led increase in consumption should not pose any problem.
The article also makes an argument that China must have a rapid rate of economic growth
because its huge population requires considerable growth to absorb the increase in the size of
the labor force. The absolute size of the population is completely irrelevant in this equation; the
only factor that matters is its rate of population growth. China, with a population growing at a
rate of about 1 percent annually, could actually absorb its labor force growth with a
significantly slower rate of economic growth than a country like Mexico, where the population
is growing at a rate close to 2 percent annually.
It is worth noting that, even with the current slowdown, China's economy is still growing by
more than 4 percent annually. Mexico and other developing countries that have followed the
U.S./IMF model have never been able to sustain growth rates close to that level.
[Top]
South Korea
"Skepticism Over Korean Reform"
Stephanie Strom
New York Times, July 30, 1999, page C1
"Korean Output Surges"
Bloomberg News
New York Times, July 30, 1999, page C6
These articles report on the state of the South Korean economy. The first article discusses the
efforts of the South Korean government to bail out the Daewoo corporation, one of the
nation's largest corporate groupings. It asserts that this bailout will damage "the veneer of
economic rejuvenation in South Korea."
The second article reports that South Korea's industrial production is up 29.5 percent above
its year-ago levels. This number suggests that, in reality, South Korea is experiencing a very
rapid economic rejuvenation, regardless of what may be happening to its veneer.
At one point, the first article comments that South Korea's policy of extensive government
intervention is "blamed for contributing to South Korea's near disaster" in 1997. It is worth
noting that South Korea's economic development model produced average per capita GDP
growth of 7 percent annually from 1960 to 1994. While South Korea had been one of the
poorest nations in the world four decades ago, this growth has raised living standards in South
Korea to the point that they are now comparable to those of the poorer nations of western
Europe.
By contrast, the I.M.F. policies pursued in nations such as Brazil and Mexico have produced
slow rates of growth. The negative impact of South Korea's financial crisis in 1997 is relatively
trivial compared with its prior 35 years of sustained growth, and apparently its new burst of
growth in the last few months. The evidence suggests that even with this downturn, the Asian
"crony capitalist" model has been far more successful in raising living standards in developing
nations than the U.S./IMF model.
[Top]
Outstanding Stories of the Week
"Study Contradicts Foes of Estate Tax"
David Cay Johnston
New York Times, July 25, 1999, Section 1 page 18
This article reports on a new study on the estate tax. The study finds, contrary to claims of
opponents of the estate tax, that it is relatively cheap to administer, costing the government 2
cents for every dollar raised. The study also notes that family businesses worth less than $4.5
million and family farms worth less than $7.4 million can be passed on without being subject to
the tax. This means that very few family businesses would have to be sold in order to pay
inheritance tax.
"Tax-Cut Plans That Undermine the Progressive Income Tax"
Michael Weinstein
New York Times, July 29, 1999, page C2
This article discusses the Republican income tax proposal. It presents in some detail the
distributional consequences of the plan.
"National Parks, Strained by Record Crowds, Face a Crisis"
Michael Janofsky
New York Times, July 25, 1999, Section 1 page 1
This article reports on the problems faced by the National Park system as it tries to deal with a
rapidly growing number of visitors with a budget that is just keeping pace with inflation. This
budget squeeze makes it difficult to protect the ecology of the parks and the safety of the
visitors. Under the baseline budget projections, this situation is likely to get worse over the next
decade, as federal discretionary spending (the category of funding that supports the park
system) is projected to decline by nearly 25 percent measured as a share of GDP.
"Unions Need Not Apply"
Steven Greenhouse
New York Times, July 26, 1999, page C1
This article discusses the difficulties of organizing workers at high tech firms. It points out that
many of the workers at high tech firms do not have traditional jobs, working either as
independent contractors or as long-term temporary workers, where technically they are
employed by an employment agency.
"Beachbound N.C. Service Workers Spend Hours on the Bus"
Sue Ann Pressley
Washington Post, July 26, 1999, page A3
This article reports on the hours-long commutes that many workers experience to get to
low-paying jobs on North Carolina's Outer Banks. These workers live in depressed rural areas
of North Carolina, which have few jobs of any sort. The only available employment are
low-wage jobs in the tourist industry of the Outer Banks, which can be more than a two-hour
commute each way.
[Top]
Dean Baker is a senior research fellow at the Preamble Center and at the Century Foundation.
Recent articles can be found on the websites of the New York Times and Washington Post.
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