Four magic tricks for fiscal conservatives By Jeffrey Frankel October 22, 2012 – Project Syndicate

The is famous for its ability to As Election Day nears, the pressure on a can- innovate. Aspiring fiscal conservatives around didate to be more specific grows. The conjurer the world thus might be interested in learning thus resorts to the rosy scenario: since he can- four tricks that American politicians com- not find enough tax loopholes to eliminate, he monly use when promising to cut taxes while must claim that what he meant by closing the simultaneously reducing budget deficits. revenue gap was that stronger economic These are hard promises to keep, for the sim- growth will bring in the additional revenue. ple reason that a budget deficit equals gov- Here, Murray Weidenbaum, the chairman of ernment spending minus tax revenue. But, Reagan’s first Council of Economic Advisers, each of the four tricks has been refined over deserves the credit for inventing what he three decades. Indeed, they first acquired their called “perhaps my most lasting legacy.” In its colorful names in the early years of Ronald early years, the Reagan administration forecast Reagan’s presidency: the “magic asterisk,” the 5% income growth (twice the long-run aver- “rosy scenario,” the Laffer hypothesis, and the age), in order to imply in its projections a “starve the beast” scenario. As shop-worn as boost to revenues big enough to make up for these tricks are, voters and journalists still fall its many tax cuts. Since then, candidates of for them, so they remain useful tools for any- both major US political parties have relied on one posing as a fiscal conservative. rosy scenarios. The first term was coined by Reagan’s budget Indeed, overly buoyant official growth fore- director, David Stockman. Originally, it was casts are a fact of life in almost all of a sample an act of desperation, because the numbers in of 33 countries, contributing to overly optimis- the 1981 budget plan did not add up. “We in- tic budget forecasts. European governments vented the ‘magic asterisk,’” Stockman wrote are particularly biased. From 1991 to 2010, for in The Triumph of Politics in 1986. “If we example, Italy forecast growth rates at the couldn’t find the savings in time – and we three-year horizon that were, on average, 2.3 couldn’t – we would issue an IOU. We would percentage points above what was actually call it ‘Future savings to be identified.’” achieved. Ever since, the magic asterisk has become a In the Republican primaries last year, candi- familiar American device. Recent examples date Tim Pawlenty assumed a 5% growth rate include the recommendation of the Simpson- to make his own plan work. He was all but Bowles commission – tasked in 2010 with laughed out of the race. Romney probably charting a fiscal-consolidation path – to cut cannot get away with this sleight-of-hand, ei- real spending growth by precise amounts, ther. The press asks, “Why should we believe without saying where the cuts would be made. that the growth rate will magically accelerate US presidential candidate Mitt Romney’s just because you become president? Where spending plans contain the same conjuring will this GDP come from? It sounds like pull- trick. So, too, his plan to eliminate enough tax ing a rabbit out of a hat.” expenditures to offset the $5 trillion in revenue Right on cue, it is time for the famous Laffer lost from cutting marginal tax rates by 20%, hypothesis – the proposition, identified with while refusing to say which tax loopholes he the Arthur Laffer and “supply-side would close. economics,” that reductions in tax rates are isk has disappeared up the conjurer’s sleeve); like magic beans: they so stimulate economic the acceleration in GDP is nowhere to be seen growth that total tax revenue (the tax rate (the rosy scenario having vanished); and tax times income) goes up rather than down. revenues have not grown (no rabbit in the Laffer hat). One might think that the Romney campaign would not resurrect so discredited a trick. Af- The audience is now told that losing tax reve- ter all, two of his main economic advisers, nue and widening the budget deficit was the Glenn Hubbard and , have both plan all along. The performer explains that the authored textbooks in which they argue that deficit is all the fault of congress for not cut- the Laffer hypothesis is incorrect as a descrip- ting spending and that the only way to tame tion of US tax rates. Mankiw’s book, in its the beast is to raise the budget deficit because first edition, even called proponents of the hy- “Congress can’t spend money it doesn’t have.” pothesis “charlatans.” This trick never works either, of course. Con- gress can, in fact, spend money it doesn’t Each Republican presidential candidate since have, especially if the president has been qui- Reagan has had good economic advisers who etly sending it budgets that call for just that. disavow the Laffer hypothesis. Yet, time and again, the president (or candidate), his vice By the time the crowd realizes that it has been president (or running mate), and his political conned, the magician has already pulled off aides eventually rely on Laffer’s flawed argu- the greatest trick of all: yet another audience ment. And they, not academic , that came to see the deficit shrink leaves the formulate policy. Hubbard and Mankiw ad- theater with the deficit bigger than before. vised former President George W. Bush in his Jeffrey Frankel, a professor at Harvard University's first term, when he cut taxes and transformed a Kennedy School of Government, previously served as a record surplus into a record deficit. member of President Bill Clinton’s Council of Economic Advisers. He directs the Program in The final trick, “starve the beast,” typically International Finance and Macroeconomics at the US comes later, if and when the president has en- National Bureau of Economic Research, where he is a acted his tax cuts and discovers that smoke member of the Business Cycle Dating Committee, the and mirrors do not trump reality. He cannot official US arbiter of recession and recovery. find enough spending to cut (the magic aster-