Wall Street Week: Jan. 31, 2003: Krugman vs. Barro on the Bush economic plan

SYNOPSIS: Krugman debates Robert Barro of Harvard on the new Bush tax cut

GEOFF COLVIN: So who's right about President Bush's big tax cut proposal? Is it a massive sop to the rich? Or is it a program for jobs and growth that has worked before and will work again? Rarely has the economic debate been more polarized -- and in this economy, the stakes are high. Two superstar economists join us to sort it out. From Princeton, NJ, Paul Krugman is professor of economics at Princeton. As a columnist for the New York Times he is one of the most vehement critics of President Bush's economic plan. From Watertown, Mass., Robert Barro is professor of economics at Harvard. He is a supporter of the plan and has been consulted by the White House about it. Gentlemen, welcome. Bob, I'll start with you. Professor Barro, no one seems to dispute that the plan's immediate benefits would go mostly to well-off Americans. In a slow down like this, those are not primarily the people who need immediate help. Why does this plan do good things for the people who need help now?

ROBERT BARRO: I think it's primarily a plan about getting the economy moving, both in the short run and also in the long run. And even though I haven't been a fan of some of the Bush administration policies in the past, I think this is a really good plan. I think it's actually the best thing to come out since the Reagan tax plan of 1986. And I mean that as a good thing, because I think that was a very good plan, the 1986 one.

COLVIN: Professor Krugman, what he's saying is that cutting taxes worked terrifically at that time. It produced a huge boom in the economy and apparently in the markets. Why isn't it a good idea now?

PAUL KRUGMAN: Well, a couple of things. First, this plan seems to be an answer to some other question. What we have is a short-run slowdown, and we've got a plan that does very little in the short run. It gives less than 10 cents on the dollar in the next year. It's a plan that is budget-busting at a time when the deficit seems to be really exploding. It's a very odd thing. It's like my old math professor used to say when you gave a wrong answer: He'd say "Save that answer. I might ask that question sometime." I think a lot of people are baffled. Nobody thinks that this is a short-run stimulus plan. Even Alan Greenspan, who has been very supportive of Bush, doesn't think it's a short-run plan. So what is it?

COLVIN: Well, it's a good point...

BARRO: I think it's really important to have a plan that works both in the short run and in the long run. And the way this plan works is partly, in terms of the dividend exclusion, it's a good idea in terms of spurring investment, and it does it both in the short run and also in the long run in terms of promoting growth. And the second main part of the plan is accelerating the marginal income tax rate cuts. I think that's particularly important for incentives. And I think it was a problem that the rate cuts were being phased in according to the 2001 law, and it's really better to do it all at once.

KRUGMAN: You know, when you listen to...

COLVIN: Go ahead, Paul. Jump right in.

KRUGMAN: You know, people talk as if the period from '92 to 2000 was a period when people weren't working hard, people weren't investing, productivity wasn't growing because the incentives weren't there. It seems like we have a lot of incentives in this system already. What we have right now is a shortfall in demand. People aren't spending enough, and what we've got is a plan that really does almost nothing about this. And meanwhile, of course, it's an enormous expense. The administration's own estimate -- we're now told we don't know how they get this -- is that this thing is going to add half a million jobs in the next year. Now you take that or leave that, but a $674 billion plan for 500,000 jobs, even with fuzzy math that's more than $1 million per job. Something is wrong here.

COLVIN: Well, but it's going to go for longer than just this one year, right?

KRUGMAN: Well, yeah, but then the question is, if we're thinking about the long run, we've got to ask ourselves how are we going to pay for this thing? We've already seen surpluses give way to deficits. This thing, because of the arithmetic, compound interest and all that, is going to leave us with $900 billion of extra debt by ten years from now, just about when the Baby Boomers start hitting the Social Security system and Medicare. You know, I agree that actually if there were no costs, if there were no tradeoffs, it might be worth doing something about dividend taxation, but...

COLVIN: Well, Professor Krugman, let me ask you this. In fact, let me ask both of you this. Because if what we have is a short-term slowdown, isn't there an argument to be made that in fact the federal government can do little or nothing about that?

KRUGMAN: Well, I don't know that Robert says, but...

BARRO: Well, I'm surprised that Paul doesn't actually applaud the budget deficits in that respect, because I think most economists believe that you want to have deficits in times of emergencies, which are mainly times of recession and times of war. And actually I think we're in both of those situations now or likely to be. So in that sense it makes perfect sense to have a shortfall of federal revenues at this point.

KRUGMAN: Yeah, but then why have a plan in which most of it doesn't take place until five years, 10 years out? I mean I agree, and in fact what you want look, if you want the clearest and presentest danger -- bad grammar -- but if you want the thing that's most alarming here, it's the fiscal crisis of the states, which is both a problem because essential services are about to be cut and because state cutbacks, state and local government cutbacks are actually going to hammer the economy just in the middle of this ongoing recession. Amazingly, there's not a penny of aid for state governments in this plan. What are they thinking about?

BARRO: Look, I don't think you can think about the state government crisis by cutting into it in 2002, 2003. You have to look at what happened earlier. The fact is there was a boom in the economy starting in the mid-'90s, a high tech boom which particularly resulted in a tremendous in-flow of capital gains revenue. That was the main factor behind the federal surplus growing throughout the '90s, and it was the main factor about the state governments having so much money to spend, and most of the state governments spent it with great eagerness. So I think they created the crisis.

COLVIN: Let's move on to another very important part of this, which is the proposed cut in the dividend tax. Professor Barro, you're a supporter of this I know. We know that of course that would benefit primarily people who receive large amounts of dividends. In fact there was some statistics recently showing that, for example, Phil Knight, the CEO of Nike, would save $14 million a year if we eliminated the dividend tax. Charles Schwab might save $4 million a year. But the typical person who receives little or no dividends would receive very little. Do you think it's a good idea anyway?

BARRO: I tend to look at this kind of proposal in terms of what's going to help the economy in terms of making it grow. I don't primarily look at it in terms of what is it going to do the distribution of income. And I actually think that the administration is looking at this proposal primarily in terms of what's going to spur investment, what's going to spur economic growth. And one of the worst things about our tax system is the way we treat capital income. It's actually double- and triple-taxed. It makes no sense to have a tax at the corporate level, have it again when the money is given to individuals in the form of dividends. So this is partly a proposal to make the tax system work better in the long run to promote efficient investment and better corporate structure, and I think those are both important objectives.

KRUGMAN: I think we've got to weigh in here a little bit. Double taxation is a neat slogan. If you actually look at it, it's more like one and a quarter taxation, because only about half of the formal corporate tax rate actually gets paid because there are so many loopholes in the system, and only about half of dividends actually pay taxes, because most people own their stock through things like 401(k)s that are already sheltered. So, yeah, there is an issue there. There's a little bit, you know, in a perfect world where you didn't have to worry about budget deficits, I might try to do something about this. If I was looking, even if I wanted to fix the tax system -- you ask where are the biggest, the biggest incentive problems in the tax system; they're not here. They're actually down at the bottom of the income distribution. They're at where the working poor pay what amount to very high marginal tax rates because of the way the system works. If you were going to do a project that's going to increase the budget deficit, that's where you'd want to do it. Now you might say, "Oh, we shouldn't think about distribution," but you know it's amazing how this administration unerringly, every single proposal delivers the bulk of its benefits to people who are very, very well off.

COLVIN: Guys, we're just about out of time, but I want to get from both of you very briefly how investors should think about the President's proposal.

KRUGMAN: Run for the hills.

COLVIN: Professor Barro?

BARRO: I think investors should look at it as a positive measure. I think it will be favorable to corporate investment. I think it will be favorable at the individual level in terms of the marginal tax rates declining.

COLVIN: I wish we didn't have to leave it there, but we do have to leave it there. Paul Krugman and Robert Barro, thank you so much.

Originally broadcast, 1.31.03