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No one expects great insights from the people who write on economic issues on the Post's opinion pages, but Fareed Zakaria's latest piece is an extraordinary exercise in confusion. Zakaria is anxious to tell us that tax cuts "don't work," but he never tells readers what he means by "work."
The story on tax cuts is pretty simple: people either spend the money or they save it. Whether or not tax cuts "work" will depend on the extent to which they do one or the other and the extent to which we want them to do one or the other. The latter point is key.
When the economy is very weak, like the present (also in 2001-2003), then we would like to see additional demand. If we give people big tax cuts and they then spend the money, then this is exactly what we would want to see. The increased consumption provides a boost to demand and leads to more growth and jobs.
In the current downturn, an analysis by my colleague David Rosnick indicates that 50-70 cents of each dollar of tax cuts were spent. Zakaria's piece seems to imply that spending was close to zero. This claim would seem absurd on its face given that many households are living on the edge and would not have the option to save their tax cuts even if they wanted to.
Of course, this doesn't mean tax cuts are an especially effective form of stimulus. If the government were to spend money on teachers, roads or in other areas, then 100 cents on the dollar are directly added to the economy. Most of what is paid out is respent. So the story is that tax cuts "work" in this context, just not very well.
The other question is whether tax cuts "work" when the economy is not in a downturn. Both the Reagan and Bush tax cuts were sold as supply-side tax cuts. They would give people more incentive to work and invest. For the latter to be the case we would want people to save their tax cuts. However, it seems that people generally spend their tax cuts.
It would be very difficult to make the case that either the Reagan or Bush tax cuts worked as a spur to investment. Investment fell sharply as a share of GDP in the 80s from the 70s and in the 00s from the 90s. While there were other factors that can explain both declines, clearly the tax cuts could not have had much of a positive effect on investment given its fall in both cases.
It is not clear how Governor Romney is pitching his tax cut. His explanation seems to vary by the day and the audience. If Zakaria wanted to write a piece that was useful for readers he might have tried to clarify what he meant by "work," unfortunately all we get here is a story that essentially says that Zakaria doesn't like tax cuts.
The print version of the piece refers to the "Simpson-Bowles commission's plan." Of course there was no commission plan since no proposal received the necessary majority to be approved. The web version correctly identifies the plan as simply being the proposal of the commission's co-chairs former Senator Alan Simpson and former Morgan Stanley director Erskine Bowles. It's good to see that the web version got this right although it is unfortunate that many people will read the incorrect print version.
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Tax cuts can be "leaky" in a global economy. If the dollar is too strong, much of the spending goes to imports, which don't do as much for domestic labor.
The proximate problem is high domestic unemployment. Fix domestic unemployment and demand will take care of itself. Tax cuts can as easily be spent outside the domestic economy. Tax cuts can be spent on capital that replaces labor. Undirected tax cuts do not necessarily address unemployment.