The President, the deficit, and Keynesian theory

During last week’s scare session on the sequester, the president said something very revealing about himself (via Peter Kirsanow):

Lay offs and pay cuts means (sic) that people will have less money to spend at local businesses. That means lower profits. That means fewer hires. So every time that we get a piece of economic news over the next month, next two months, next six months, or as long as the sequester’s in place, we’ll know that that news could have been better if congress had not failed to act. (Emphasis added.)

This paragraph reveals, in a nut shell, how the president sees the economy. “Local businesses” don’t make decisions on their own. Their “profits” and “hires” are driven solely by consumer demand, and nothing more. This is known as the Keynesian school of economics. Under the Keynesian theory, the economy is driven entirely by what consumers, businesses, and government spend (otherwise known as aggregate demand). In particular, government spending benefits the economy through purchases and hires, with that money rippling through the economy multiple times over (in fact, the measure of this rippling is called the “multiplier effect”). The more direct the spending is, the larger the effect.

This last part is critical to the Keynesian theory, because it explains Keynesian politics. For Keynesians, government spending is always better than consumer spending (because consumers save some, that money “leaks” out of the economy). Thus, tax cuts, which under the Keynesian school effects only consumption, is never better than government spending. Likewise, tax increases are always less damaging than spending cuts. Thus, Keynesian adherents are drawn towards permanently growing government, and an ever expanding tax burden.

Of course, there is much that Keynesian theory completely ignores – such as the incentives firms face when they choose to do business. Because Keynes himself was rebelling against a pre-Depression “Walrasian” consensus, he ignored much of the microeconomic theory regarding how businesses respond to costs. Due to this, there are no impediments to production in the Keynesian world; it reacts to demand, period.

As one might expect, Keynesian theory had no response to the events of the 1970s, where dramatic increases in resource costs had dramatic effects on business production (a.k.a., aggregate supply). It was to bridge this dramatic gap in economic theory that the “supply-side” school was born. Supply-siders focused on uncertainty, taxes, regulations, and other cost to businesses, and how they impact both production decisions at the microeconomic level and growth at the macroeconomic level.

In short, the taxes that Keynesians felt were least troubling (income and investment taxes, because they do not affect consumption directly) were exactly the ones supply-siders found most troubling (because they reduced the incentives to provide capital to business, and thus increased business costs of financing). Other taxes and regulations that would impact mainly firms were of great concern to supply-siders, but largely thought benign by Keynesians.

In short, the economic arguments that divide the two parties are largely driven by these differences in economic views. Naturally, the government-friendly Democrats move more towards Keynesianism, while business-friendly Republicans drift closer to supply-siders.

Moreover, this explains, at least in part, the president’s insistence on new tax hikes despite the old tax hikes only coming two months earlier. For this president, tax hikes are always better than spending cuts.

It’s not about cynical politics or tactics (or, to be precise, not just those); the president really believes this stuff.

Cross-posted to the right-wing liberal


17 thoughts on “The President, the deficit, and Keynesian theory

  1. what happens when supply-side tax cuts end up causing a structural deficit? Seems to me the cuts-taxes – starve the beast is the cart before the horse if the end result is a structural deficit and long term debt.

    Paul Ryan is the only guy who’s dared to talk about supply-side balanced budgets and look at how long it will take (assuming all his supply-side presumptions actually work) to actually balance the budget.

    All those years before the budget actually balances – we add more debt so by the time the Ryan Budget actually reaches balance, it is 2030-2040 and we have 20-40 trillion worth of debt.

    Name 3 OCED/industrialized countries that successfully operate long-term solely on supply-side economics.

    isn’t this a theory and ideology more than it is a real practice in the real world?

    even Ronald Reagan had to increase taxes after it became apparent that he cut too deeply and was headed into deficit.

    1. The key is to adjust rates to the point where it incentivies economic behavior that results in the most revenue. Too high a rate or too low a rate will have the same effect. When you hit that sweet spot on the Laffer Curve (yes, I said it), you get maximum revenue as well as robust economic activity (which in turn also reduces the need for government social spending since more people are employed and earning better wages.)

    2. you’re counting the FICA tax revenue which is not general fund revenue. It’s dedicated to SS only. The link I have you shows this clearly

      DOD is about 1/2 of national defense spending. National Defense includes DOD, Homeland Security, the VA, NASA military satellites, DOE ship reactors and nuke weapons, etc.

      here’s the facts – we take in 1.3T in individual and corporate income taxes.

      that’s a fact.

      we spend about a trillion dollars on National Defense. That’s a fact

      both are easily referenceable in any CBO budget report that shows data from 2000 on. page 9 table 1-1

      Actual 2012

      individual income taxes = 1.131T
      Corporate income taxes= .242B
      Social Insurance taxes= 845B

      the social insurance is FICA … add the other two nimrod and
      what do you get?

      next you want to Google the National Military Budget and find the
      section that details the expenditures beyond DOD that are spent
      for national defense.

      as I said… we have way too much sound-bite propaganda and not near
      enough dealing with the basic facts and a LOT of it seems to come from
      folks who bill themselves as “conservatives”.

      these are the facts… we have about 1.3T in general revenues to spend on non-FICA expenditures.

    3. re: the Laffer curve…

      what happens when you hit that “sweet spot” and you still have a deficit and you can’t clear it just by cutting entitlements?

      what do you do then?

  2. Reagan’s and Bush’s tax cuts increased revenue. The deficits increased because of increased (mostly domestic and entitlement) spending. Deficits were on the decline after Bush’s tax cuts became effective in 2003 until the Democrats took over Congress in 2007.

    Robert Reischauer, the Democrat who ran the Congressional Budget Office in the 1970s, noted that increased deficits in the Reagan era were mostly due to Congressionally-mandated increases in entitlement spending enacted under Carter.

    1. Reagan actually increased taxes after he saw the deficit form…. Bush and company said “deficits don’t matter”. big difference.

      the deficits started BEFORE Obama took office and got worse when the economy tanked and revenues dropped.

      Remember. Obama does not spend a dime. Congress does.

      defense spending DOUBLED from 2000 to 2009.

      right now we spend 1.0T on “defense” and our non-FICA general revenues are about 1.3T. Any way you cut it – we can’t pay for the spending even if we completely zeroed out the entitlements.

      Reagan got more tax revenues by reforming the tax code. Current GOP say that you can’t use revenues from tax code reform – to buy down the deficit/debt.

      there is one GOP proposal for a balanced budget. It comes from Ryan and it does not balance until well in 2030. All that time between now and 2030+, we continue to have deficits adding to the debt. How much will the debt be by then?

      there is no feasible way to get to a balanced budget with cuts only to entitlements… that’s a reality.

      the supply side folks say – we can get more revenues by cutting taxes even more but they don’t have any plan B if revenues drop even further and the deficit gets worse.

      I would posit that this is not “conservatism”. this is nuttiness.

      If Reagan were here today – he’d be run out of the party.

    2. here’s the tables from 1962-2017:

      National Defense went from about 300 billion to over 660 billion from 2000-2008 … and that spending continues – has not been cut.. it goes forward every year via a Continuing Resolution – that a majority of the GOP does vote for

      to be fair – Medicare goes from 200 billion to 430 billion in that same timeframe. other entitlements also increase similarly from 154 – 354.

      so both categories effectively doubled in about 10 years – true. but they BOTH doubled and you cannot balance the budget by just cutting entitlements.

      and that’s the problem with the “we have a spending problem and we must cut spending”.

      I don’t see numbers from those who say this. And the reason why is that the numbers – if you actually look at real numbers, the “cut” numbers don’t work. the math don’t work.

      so my question has always been – how do we reach a balanced budget without cutting EVERYTHING .. AND adding some revenue?

      remember – our total amount of taxes received right now is about 1.3T.

      you do the math.

  3. Larry,
    You’re getting wrapped up in the Laffer Curve, which is only a small part of the larger supply-side school. Even so, hardly anyone would say that income tax cuts can pay for themselves *and* ever-increasing spending.
    Furthermore, arguing about said spending (i.e., defense) makes it clear that you’re more interested in scoring political points than arguing the economic theory.

    Finally, I would note that several Mediterranean countries are trying to balance their budgets the Keynesian way (with large tax hikes and small, if any, spending cuts). The results have been…less than stellar.

    1. DJ – no laffer curve here.. I’m just talking about the reality of the numbers and how we deal with them. And I’m willing to listen to any/all ideas about supply-side – AS LONG AS WE ACTUALLY DEAL with the deficits.

      when taxes were cut under Bush – and spending increased, there was no “Plan B” when we went into deficit – and we ruled out doing what Reagan did which was to boost revenues back up by reforming the tax code.

      Now we are saying, we’d use the revenues from tax reform to cut taxes further – while ignoring the structural deficit.

      I’m not about ideology here. I’m simply about how we balance – using real numbers – not theories.

  4. Larry,

    I’m not saying entitlement reform by itself will balance the budget; I’m certainly not above finding efficiencies in DoD. That said, we also need the revenue that comes from economic recovery, and that recovery will, IMHO, be impeded by tax increases.

    Again, from the Keynesian perspective, nothing I’m saying makes any sense. But if you ask me, Keynesianism itself doesn’t make sense….

    …and, to quote myself, “if you’re looking for a defense of Bush the Younger’s spending record, you’ve come to the wrong guy.”

    1. “… d that recovery will, IMHO, be impeded by tax increases.”

      how will you pay off the debt? I AGREE tax increased taxes depress the economy but the question is how will you pay off the debt?

      are you going to believe that “growth” in the next 20-30 years will pay it off?

      what I’m frustrated with is the ideology of this and the ignoring of the realities.

    2. It is best to balance the budgets with spending reductions and growth.

      I thought I had said that repeatedly.

      Once more, I don’t ring-fence any department from reductions.

    3. well’ve said it… but wheres the plan? The problem is right now we’ve got lots of folks that say something… but it don’t mean anything.

      how can we balance the budget and pay down the debt?

      where’s the plan to do that? we can’t get there by merely saying “yes we need to cut”.

      and that’s the problem I got these days with the so-called ‘conservatives’.

      they helped to blow up the budget and create 16T in debt and they’ve run away from it claiming that it’s wrong to raise the revenue needed to pay it off.

      that’s irresponsible in the extreme. We got to where we are right now because of this irresponsible attitude and now no one wants to own it – least of all those who call themselves “conservatives”.

  5. Larry, you did not refute anything I said. Note, no one is defending Bush’s spending record. If you are being critical of Bush, then you are saying that he was not conservative enough! You should remember also that Reagan never had Congress under full Republican control, or else there might have been a bit of a different story. However, under Bush and Reagan (and, for that matter, Clinton), revenues grew quite a bit after tax cuts. I agree that spending is a problem. Yes, the Paul Ryan initial plan to balance the budget dies not do so until 2030, but that is one plan more than what Obama has offered. From what I am hearing, Ryan is working on something to balance within ten years.

    Remember, you can’t be for a balanced budget and then claim that cuts are “too cruel.”

    1. not being critical of Bush. I note that Reagan was able to COMPROMISE to get real results if not all he wanted. I make that point specifically

      Revenues did not grow when the economy tanked. The reality is that right now we have about 1.3T in actual revenues. You do the math if you think cutting spending alone can get to a balanced budget. page 12 table 1-1

      look at the revenues for income taxes – individual and corporate.

      When I tell people that we have 1.3T in revenues, they don’t believe it because we apparently live in a sound-bite society these days and people are too lazy to look it up.

      look it up guy. 1.3T you tell me how this works when we are spending about 1T alone for national defense – which is DOD + Homeland Security, etc.

      that’s all I am after. how can we balance the budget with 1.3T in revenues?

      how much would we have to cut DOD/National Defense and entitlements to get down to 1.3T in revenues?

      Now.. I expect those folks who bill themselves as fiscal conservatives to KNOW this data AND to have a response to the spending vs revenues question. I do NOT expect tax&spenders to know or care but I DO expect those who say they are fiscal conservatives to know and to acknowledge the issue.

      Look at Mr. Ryan’s “budget”. Tell me how he gets it balanced and how long it takes. Is that a true fiscally conservative budget?

  6. Larry G,

    You should know better than to lie on the internet. There is always someone who is willing to look up your facts.

    So in the interest of pointing out the obvious: Below is the link to the GAO annual report for FY 2011. It is a little dated, but be assured the numbers are higher for 2012. And remember, not my numbers, not your numbers, but FACTS.

    This shows that tax reciepts were a net increase to 2.4 trillion (page ii). So please do not try to act like the feds are only getting 1.4 trillion when they are getting 2.4. (Actually 2.363, page xv)

    Further, DoD cost 640 Billion (That would be .64 trillion, since you are math challenged). See page 10 of the same report. So, to beat the dead horse, 2.4 minus .64 leaves 1.8 trillion dollars to fund the rest of the government.

    So, at least in 2011, you can not cut DoD (.64 trillion), not cut Social Security (.8 trillion), debt payments (.22 trillion) and not cut Veteran Affairs (.19 trillion) and still have .55 Trillion dollars for the rest of the government (.64 + .8 + .22 + .19 = 1.85 – 2.4 = .55 = 550 Billion Dollars).

    Which is not to say DoD should not be cut. It should. But keep the perspective and don’t just believe the numbers you read from CNN and the Democratic Underground. Even better, take a look at page 19, Table J.

    Research, it does a conversation good.

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