Before going into this book, I would like to point out two aspects affecting the conclusions drawn in this book. One, which will be only too obvious to the reader soon enough, the author is NOT a proponent of the Bush Tax Plan, and two, the book was sent to press before the events of September 11, 2001. In regard to the first aspect, please keep in mind that Krugman uses facts and thus allows the reader to reach his or her own conclusions. As for the second aspect, well, in my opinion, this merely means that the book is vastly more optimistic than it should be.

Part I: Is Less More?
In this part of the book, Krugman shows us how the traditional voting patterns in our country did not happen in the 2000 election. In other words, “many people in the lower half of the income distribution…voted Republican; many people in the top few percent of the income distribution…voted Democratic.” He believes that this was due to “cultural reasons”, i.e. a desire for the good ole days when school shootings weren’t a common occurrence. During the debates we saw Bush speak in simple terms about improving society while Gore went off on mathematical tangents. I think it says something about the American people that Gore won the popular vote. (My own injection there.) According to Krugman, in order to get the Republican Party to support him, Bush Jr. “had to convince the Reagan loyalists, who felt that his father had let down the cause, that he was another Ronald Reagan, not another George Bush.” Steve Forbes, who was a contender for the Republican nomination, used just this argument about Bush Jr. According to Krugman, “It was in response to this challenge [by Forbes] that the Bush tax plan-not a flat tax, but a move in Forbes’s general direction-was introduced early in the campaign. The plan was not changed in any important way since then.” In the next chapter, Krugman discusses the overall agenda of the conservative party. “…an important reason why conservatives want to cut taxes is that they want to keep the federal government hungry; they don’t want money readily available to finance new programs, or even to maintain old ones.” Many conservatives “believe they can permanently alter the nation’s political economy, creating a self-reinforcing cycle of government downsizing…If you think about the conservative agenda this way, you can see immediately that it must go beyond tax cuts; ultimately it must go after our two big middle-class social programs, Social Security and Medicare, and either eliminate them or transform them into essentially private systems…But tax cuts are the first step, and you can see now why they are so central to conservatives and why getting his tax cut is so important to George W. Bush.”

The next chapter delves into the infamous Monetarists/Keynesian debate. For those who need a refresher course, in simplified language, Monetarists believe in fine-tuning the economy through the Federal Reserve, the most important tool being the interest rates. Keynesian’s believe fiscal policy is necessary to effect aggregate demand, the most important tool being government spending. As you can guess, Monetarists have generally been conservative while Keynesian’s have generally been liberal. Krugman explains why conservatives now subscribe to Keynesian doctrine and “extol the virtue of tax cuts and budget deficits as ways of fighting recession…political opportunism. If you admit that monetary policy is a highly effective policy tool, you are very close to giving credit for the economic boom that started in late 1982 to the Fed’s dramatic interest rate cuts the preceding summer, not to the tax cut pushed through by Ronald Reagan the year before. And that would detract from the Reagan legend, which plays such a critical role in conservative mythology.” Krugman goes on to state the pros and cons of monetary and fiscal policy to the extent that the reader becomes aware that he prefers monetary tools for fine-tuning the economy. The exception is what Keynes himself termed “liquidity trap”. This is a situation that happened in the US economy during the Depression and recently in Japan and is characterized by extremely low interest rates coupled with low aggregate demand. This is when, according to Krugman, we have a good argument for tax cuts. Could we be moving towards a “Liquidity Trap” right now? According to Krugman, most definitely. Is Bush’s tax plan therefore justified? Nope. According to Krugman, “the tax cut proposed by the Bush administration does not look anything like a recession-fighting measure. If the current slowdown were your main concern, you would want the tax to be ‘front-loaded’ – that is, you should deliver big tax breaks soon, when you want people to spend more, and not commit to offering huge tax breaks years later, when the economy may have recovered and be suffering from too much spending….the Bush tax cut is heavily ‘back-loaded – the initial tax breaks are very small, and the numbers don’t really get big until the second half of the decade…the administration has been reluctant to propose large immediate tax cuts, because that would push the already alarming long-run cost to the tax plan even higher.” This being the case, Krugman goes on to ask if there is possibly a “long-run justification for tax cuts”. In essence, can we improve the economy via the supply side. By focusing on supply side changes, rather than looking at tax cuts as a motivator to increase spending, i.e., increasing demand, we look at tax cuts as a motivator to “induce people to work harder, save more, and take bigger risks, thereby expanding the productive capacity.” According to Krugman, “supply-side economics” since the 1970’s has claimed “that tax reductions from the level currently prevailing in the United States would have enormous positive effects on the willingness of workers to work, investors to invest and so on. Supply-siders believe, in particular, that in proposing tax cuts we need not be worried about the effects of those cuts on the government’s budget balance. They insist that a tax take would actually rise…” There has been no historical evidence for this and when one argues the economic boom that took place after Reagan’s tax cut in 1981, well, that was a demand-side recovery! In fact, the numbers (growth rates between “business cycle peaks”) show that there were no appreciative supply-side effects during the “Reagan Expansion”.

On the other hand, “Capacity growth [supply-side growth] picked up a bit during the 1990’s…Bill Clinton introduced a clearly anti-supply-side policy in 1993: he engineered a substantial increase In the ‘top marginal rate’…This is the tax rate that supply-siders most want to reduce, because they think that it is the rate that discourages individuals from trying to become rich….In other words, it was Clinton, not Reagan, who presided over a true supply-side boom, an increase in the productive capacity of the economy.” In conclusion of Part I, we have a tax plan based on supply-side economics yet it is being sold to the public as having demand-side results!

Part II Follow The Money
Chapter 3 in the book takes a close look at the federal budget. The author makes a point at the outset of this chapter that a very miniscule portion of government revenue goes to foreign aid. He does this to dispel the popular belief that we could afford tax cuts if only we reduced spending on foreign aid. According to Krugman, “0.6 percent of the federal budget goes for foreign aid, and half of that consists of military assistance to our allies – that is, it really should be considered part of our defense budget.”

Krugman first takes a look at where government revenue comes from. The three major sources are of course, “the income tax, the payroll tax, and the corporate profits tax.” The biggest tax at this time, though payroll tax is running a close second, is income tax. During the 1980’s the gap between payroll and income revenue closed significantly. The reason for this was that “[d]uring the Reagan administration income tax rates were greatly reduced, while payroll tax rates went up sharply.” (The payroll taxes were increased in order to create a surplus in the Social Security and Medicare system that would be necessary when the “baby boomers” reached retirement. Experts recognized in the 80’s that when this time comes, the worker/retired ratio will be extremely low and will necessitate either appallingly high tax hikes or dissolution of the social insurance programs, i.e., those “baby boomers” seeing zilch of the money they put in all of their working life! There was a good reason Gore wanted to put this surplus in a “lockbox”! I’ve gotten ahead of myself & will get back to this issue later.)
Back to the discussion on income tax: Krugman states several reasons why the revenue from income tax rose rapidly during the 90’s. “Bill Clinton partially reversed the Reagan tax cut, raising tax rates on high-income taxpayers in 1993; the tax take also grew along with the economy”, which, remember, was experiencing a supply-side growth due largely to technology. “But there were two other reasons why the income tax has been providing Washington with a lot of revenue lately; growing income inequality and the booming stock market. Increasing income inequality is good for income tax revenue because the income tax is highly ‘progressive’.”

Remember that progressive taxes are those in which a person’s tax liability as a fraction of income rises with income, whereas a regressive tax is one in which tax liability as a fraction of income becomes less as incomes rise. A good example of a regressive tax is sales tax…though rich and poor pay the same amount, which is currently 8% in Tennessee, this tax liability as a fraction of income is inversely related to income.) According to Krugman, “About half of all income taxes are paid by families in the top 5 percent of the income distribution; between 1990 and 1999, while the real income of the average family rose only 15 percent, the real income of the top 5 percent rose 35 percent. Since the income of the families that pay most of the income tax grew much more rapidly than that of other families, it’s not surprising that income tax revenues has also grown much more rapidly than the economy as a whole.”

As for the payroll tax, “ [it is] levied on all employees at the rate of 15.3 percent; while part of it, which is dedicated to Medicare, is applied to all earnings, most of it applies only to earnings up to a maximum annual income [of] 76,000.” (Only half of this 15.3 percent shows up next to FICA on ones pay stub, the other half is paid by the employer, and you can bet that the employer considers this amount when determining the wage rate. Any economist worth his/her weight knows that the burden of this tax falls on the worker.) “A recent study by the Congressional Budget Office confirmed that 80 percent of families pay more in payroll taxes than they do in income taxes. On the other hand, for very affluent families the payroll tax…is a minor issue. Someone making a million dollars pays only a few percent of his income in payroll taxes, because aside from the Medicare component the tax applies only to the first $76,000 of that income. Meanwhile he is likely to pay more than 20 percent of his income in income taxes. “…[B]ecause the Bush tax plan cuts income taxes but leaves payroll taxes unchanged, it automatically gives its biggest benefits…[to] people with very high incomes.” The estate tax, which only kicks in on estates over $675,000 per person, is “a tax on the value of someone’s estate after he or she dies.” The Bush tax plan calls for eliminating this tax. Though this tax yields a very small proportion of revenue from taxes, “the elimination of the estate tax will account for almost a quarter of the total tax reduction.” The main argument for repealing this tax has been that it is a terrible burden on farms and family-owned businesses, which Krugman says is an urban legend. “Only a few percent of the estates that pay taxes include a family business. Furthermore…the exemption is doubled when a business or farm constitutes a large share of the property, and the law also allows inheritors of such businesses to defer tax payment for up to 14 years.”

Krugman goes on to how government revenue is spent: “About 11 percent of the federal budget goes to pay interest on the national debt….slightly less than 20 percent…excluding paying interest on the national debt” is spent on defense and other public goods. (Examples of public goods are roads & education.) “In 1995, the last year for which there is an official estimate, social insurance accounted for about 45 percent of federal spending other than interest payments….Means-tested programs account for about 13 percent of federal non-interest spending.” “The growth sector of the federal budget – now, and even more in the decade ahead – is in the area of middle-class social insurance.” (Social Security and Medicare are social insurance programs.)

According to Krugman, “…if you include retirement benefits for federal workers, benefits for veterans, and the large share of Medicaid that goes to the elderly poor, you find that about half of non-interest federal spending – and more than 60 percent of non-defense non-interest federal spending – goes to provide benefits to people over age 65.” The point that Krugman is trying to make is that if we follow the conservative agenda of reducing the size of government the cuts will have to fall on the elderly. In Chapter Four, Krugman discusses how we moved from a budget deficit to a budget surplus. (One thing I want to point out is, before going on to this discussion is in regard to a question asked by Krugman, “…will today’s black ink fade as quickly as yesterday’s red ink?” This question is already moot…the red pens are already back in service.)

In 1983, congress passed a huge increase in payroll taxes. As stated earlier, this move was intended to save the social insurance programs when the baby boomers retire. According to Krugman, “That almost forgotten tax increase is responsible for much of our current budget surplus, but the reasons behind the tax increase also explain why much of today’s surplus isn’t really a surplus.” Many people have the impression that Social Security is fully funded. This is not the case. The way Social Security currently works is the money workers put in are directly paid out to retired people. “…when you retire your pension will be paid out of taxes on younger workers. This system was a bit modified in 1983 – that’s what the payroll tax increase was about – but the assets of the Social Security system remain far less (about $9 trillion less) than what would be needed if it were to be ‘fully funded’ like an ordinary pension plan.” “…The effect of that tax increase [payroll] was that the Social Security system began, for the first time, to accumulate large amounts of money in its ‘trust fund’. According to current estimates, by the time baby boomers start to retire there will be about $3 trillion in the pot.” Basically what the forward-thinking payroll tax increase in 1983 did was stall a crisis in Social Security around the time baby boomers start to retire – 2011. But stall does not mean stop – estimates show that, even with this surplus and the interest it will earn, Social Security will be in crisis “somewhere around 2038”.

In regard to Bush’s grand idea of privatizing Social Security, “It makes no sense to talk about how much people could earn by withdrawing from Social Security and investing their own money without explaining first who is going to pay the system’s implicit debt.” (The money rightfully due to current retiree’s and those currently working who have put year’s worth of earnings towards Social Security.) According to Krugman, we would have to “add about $10 trillion to the trust fund” to make it fully funded! Another interesting point is that the reason our “real rate of return” on our contributions to Social Security are so low as compared to what we could get on stocks or bonds is part of our contribution “must in effect go to make interest payments on that huge but hidden debt.”
In conclusion to the surplus question, “In fiscal 2001 the government’s overall surplus is expected to be $280 billion; more than half of this will come from combined Social Security and Medicare surpluses…” The rest of the surplus was due, in large part, to the fact that “discretionary spending fell sharply as a share both of federal spending and of the economy as a whole.” The reason for this, you ask? The most important reason in Krugman’s mind was quite simply, “divided government…this meant that neither could easily push through pet projects.”

He also gives credit to the stock market, the economic growth due to technology and the changing distribution of income…”Between 1986 and 1999 average family income rose by 18 percent, but income among the top fifth rose 28 percent; income among the top 5 percent rose 46 percent, and income among the top one percent probably doubled. So income growth was concentrated among families in the highest tax brackets, thus pushing up revenues more rapidly than average income growth.”
As you may remember, Bush’s tax plan was framed based on the optimistic projection of a $5.6 trillion surplus over the decade, which was made by the Congressional Budget Office. (On January 23, 2002, I was watching CNN as they put up the new estimate by the CBO of the surplus for the decade ahead: $1.6 trillion!)

In Chapter six, Krugman discusses the tax cut plan based on this 10-year period even though, as he points out, 10 years is both too long to realistically forecast and too short to take the “baby boomer crisis” into account. Such forecasting is based on expected annual economic growth rate, stagnant medical costs and no policy changes. According to Krugman, if the CBO’s projection of economic growth is off by “even a few tenths of a percentage point…that alone could make its ten-year surplus projection wrong by a trillion dollars or more.” In regard to the CBO’s surplus projection, we need only to look at $2.7 trillion of this because the rest ($2.9 trillion) is the amount that Social Security and Medicare are projected to bring in. As previously stated, this should be considered a necessity, certainly not a surplus. Krugman takes a look at how the CBO comes up with $2.7 trillion: “…the CBO is supposed to project what would happen if the federal government continues to do more or less what it does now, not to build in a radical policy change. The way the CBO defines ‘maintaining current policy’ is to assume that there is no change in real discretionary spending….To see why this is an unreasonable way to define current policy, consider one example of a government program: air traffic control. Suppose that the federal government were to keep real spending on air traffic control constant for the next ten years, so that the number of controllers and the capacity of radar systems stayed the same for a decade. Would that feel like no change in policy, like a government whose role in the economy had not changed? Of course not. It would feel like a drastic cut in government services, because the same number of air traffic controllers would have to manage a greatly increased volume of air traffic.” If we were to correct the CBO’s projections so that spending on current policies would remain constant as a percentage of GDP (Gross Domestic Product), we would need to shave off another $1.0 trillion. “On taxes, the CBO takes an approach of strict literalism: it assumes that no new tax laws will be passed – including laws that simply renew tax provisions that have been renewed repeatedly in the past….In the past, expiring tax breaks have been renewed; if you make the more sensible assumption that Congress will do the same in the future, the predicted tax receipts will go down…$80 billion according to Auerbach and Gale.” (Auerbach is of the University of California, Berkley and Gale is of the Brookings Institution.)

Another aspect of the tax code that is assumed to stay constant is the alternative minimum tax, which currently affects only “about 1.5 percent of the population”. Due to the fact that this tax is not adjusted for inflation, it will inevitably fall on more taxpayers in the near future. According to Krugman, “Current estimates suggest that under current law, by 2010 about 15 percent of taxpayers will be paying AMT.” We can safely assume “that Congress will, one way or the other, adjust the AMT to prevent it from becoming so widespread a burden.” Auerbach and Gale estimate that this would shave off another “$130 billion” from the surplus. Krugman then goes on to discuss the high revenue as a result of the bull market on the NYSE. As you can guess, a bull market means more revenue in the form of capital gains tax. “…the CBO projection does assume that the revenue from capital gains taxes will taper off during the decade ahead – but that it will remain at levels that are very high by historical standards.” In the next chapter, Krugman once again discusses our Social Insurance Programs in light of this surplus: “…the minimum prudent federal surplus over the next decade is $3.3 trillion…This is a projection of the combined surplus that will be run by all of the federal government’s retirement trust funds.” (Well, that’s already gone!)

Part III Making The Cut
In Chapter Seven, Krugman takes a look at the three major components of Bush’s tax plan, which are as follows:
1.) Income Tax Reduction: By 2006, the plan would reduce all tax brackets as follows: 15% would stay at 15% except for a 10% tax rate for the first $6,000 per individual and $12,000 for couples. (This was the check you received in your mail some months back. Keep in mind that the majority of families either pay no income tax or fall into this income tax bracket.); 28% would fall to 25%; 31% would fall to 25%; 36% would fall to 33% and 39.6% would fall to 33%. ($300,000 or higher for a family with two children fall into the top tax bracket.)

2.) Expanded Child Credit: “The Bush plan would double this credit, to $1000 per child….it accounts for only about 12 percent of the cost of the plan.” 3.) Estate Tax Repeal: Besides this component accounting for about 25% of the total cost of the plan, “Recent Congressional estimates also suggest that eliminating the estate tax would have a large indirect cost to the Treasury, because it would offer wealthy individuals a number of new strategies for tax evasion.” (Read page 4 for a more detailed description of this tax.) As Krugman discussed in previous pages of the book, Bush’s tax plan is heavily “back-loaded”. In other words, it is slowly phased in with the real cost coming later in the decade. Krugman believes that one of the main reasons for this is to ameliorate the cost of the plan. Also, in regard to “back-loading”, “a dollar of tax cuts is, in general, considerably more than a dollar deducted from those ten-year surplus projections.”

“The reason is that if a dollar of surplus is used not to pay off debt but to offer a tax break, the government’s interest payments in future years will be higher than they would have been otherwise…When you do the arithmetic, you find that a dollar refunded to taxpayers this year subtracts about $1.80 from the ten-year surplus….when you include the impact of tax cuts on interest payments, that $1.6 trillion [income tax] cut actually consumes about $2 trillion of the projected surplus.”

(Krugman gives a much more detailed explanation of the surplus estimate in this chapter. However, I’ve decided to bypass this section since we now know that even Krugman’s estimate of the surplus was too optimistic.)

Krugman goes on to show us why Bush’s plan would necessitate raiding Medicare: “…Medicare officially consists of two programs. Part A, hospital insurance, is the program paid for with the payroll tax; it is also part of the program that is running a surplus, in preparation for the retirement of the baby boomers. Part B, supplementary medical insurance, is paid for by a mix of fees from Medicare recipients and general (not payroll) tax revenues. Part A has a trust fund; Part B does not…The Bush program calls for diverting some of the payroll taxes that have until now been reserved for Part A, and have been used to accumulate a trust fund, to pay for current Part B expenses. By reducing the amount of general revenue needed to support Part B, this would free up money for tax cuts…every dollar of money diverted from Part A to Part B is one dollar less saved to deal with the future medical expenses of the baby boomers.”

Krugman takes a look at who benefits from the tax cuts in the next chapter. We’ve all heard the “Typical” tax cut of $1,600 touted in the media, but, according to Krugman, “…barely one-tenth of the nation’s families would actually get as much as that ‘typical’ tax cut.” The following is an example he gives: “…suppose that the family’s income is…$30,000. Then it will pay only about $750 in income taxes under current law, although it pays more than $5,000 in payroll taxes. Under the Bush plan you can’t, except in some special cases, actually get back more than you pay in income tax; so for a family a bit poorer than the idealized ‘tax family’ the tax cut drops to $750, even if the family has the ideal number of adults and children.” He goes on to state that “the poor get nothing, and even the lower middle class gets only a token cut. The reason is that low-income families pay little or no income tax though they may pay plenty of payroll taxes, and so they get little break on rates and aren’t eligible for the full child credit. Meanwhile, the rich are also guaranteed a large cut, regardless of the composition of their families, because of that reduction in the rate on the top bracket from 39.6 to 33 percent.” (And remember…they pay a very small percentage of their income in payroll taxes for reasons discussed earlier.) “The top 1 percent category that has become the focus of much discussion consists of families with a minimum income of $373,000 and an average income of more than $1.1 million. According to the think tanks, these seriously rich families are the big winners from the Bush tax plan…the top 1 percent of taxpayers gets 45 percent of the total tax break.” Krugman gives us another interesting example: “…on average, families with an income of $35,000 per year would get tax reductions of around $600 per year, and that, on average, families with an income of $1,000,000 per year would get income tax breaks of around $25,000; add in the estate tax repeal and that last number becomes $50,000.”

In conclusion, “…the administration’s favorite sales pitch over the past few months – that the tax cut must be passed to stimulate a slowing economy – is at odds with the structure of the plan, which is heavily back-loaded and delivers very little money to the consumers in the near term.” It will be obvious to anyone familiar with Bush’s tax plan that it is a supply-side tax cut. “…what we are experiencing right now is a demand-side slowdown”

“At every stage of this debate Bush and his people have tried to obscure what they were really proposing. They have radically understated the cost of their plan while overstating the money available to pay that cost. They have pretended that a plan that mainly cuts taxes for the extremely well off is basically a middle-class tax cut, and they have misrepresented the size of the tax cut that middle-income families will actually receive. And they have falsely sold the plan as an appropriate answer to a short-term economic slowdown, when it is almost perfectly designed not to deal with that sort of problem. I can’t think of any previous administration that has tried to sell its economic plans on such false pretenses. It would be a shame, and a dangerous precedent, if they get away with it.”

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