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September 5, 2006
Op-Ed Columnist
1. New Europe’s Boomtown
By JOHN TIERNEY
Tallinn, Estonia
Philippe Benoit du Rey is not one of those gloomy Frenchmen who frets about the threat to
Gallic civilization from McDonald’s and Microsoft. He thinks international competition is good
for his countrymen. He’s confident France will flourish in a global economy — eventually.
But for now, he has left the Loire Valley for Tallinn, the capital of Estonia and the economic
model for New Europe. It’s a boomtown with a beautifully preserved medieval quarter along
with new skyscrapers, gleaming malls and sprawling housing developments: Prague meets
Houston, except that Houston’s economy is cool by comparison.
Economists call Estonia the Baltic Tiger, the sequel to the Celtic Tiger as Europe’s success story,
and its policies are more radical than Ireland’s. On this year’s State of World Liberty Index, a
ranking of countries by their economic and political freedom, Estonia is in first place, just ahead
of Ireland and seven places ahead of the U.S. (North Korea comes in last at 159th.)
It transformed itself from an isolated, impoverished part of the Soviet Union thanks to a former
prime minister, Mart Laar, a history teacher who took office not long after Estonia was liberated.
He was 32 years old and had read just one book on economics: “Free to Choose,” by Milton
Friedman, which he liked especially because he knew Friedman was despised by the Soviets.
Laar was politically naïve enough to put the theories into practice. Instead of worrying about
winning trade wars, he unilaterally disarmed by abolishing almost all tariffs. He welcomed
foreign investors and privatized most government functions (with the help of a privatization czar
who had formerly been the manager of the Swedish pop group ABBA). He drastically cut taxes
on businesses and individuals, instituting a simple flat income tax of 26 percent.
These reforms were barely approved by the legislature amid warnings of disaster: huge budget
deficits, legions of factory workers and farmers who would lose out to foreign competition. But
today the chief concerns are what to do with the budget surplus and how to deal with a labor
shortage.
Wages have soared thanks to jobs created by foreign companies like Elcoteq of Finland, which
bought a failing electronics factory and now employs more than 3,000 people making phones for
Nokia and Ericsson. Foreign investors worked with local software engineers to create Skype, the
Internet telephone service, and the country has become so Web-savvy that it’s known as Estonia.
“The spirit is so different here,” Benoit du Rey says. “If you come to the government here and
want to start a company, they’ll tell you, ‘Good, do it right now.’ Then you can work free
without being bothered by stupid things. Here I talk to my accountant once a month. In France,
for every seven or eight workers, you need one full-time worker just to fill out the forms for
taxes and other rules.”
It took him less than two weeks last year to start his company, Aruzza. Now he has employees
from five countries working on deals like importing Spanish ham, exporting Estonian sofas to
France and finding programmers in Tallinn to write software for a California company.
He is not a free-market purist — he likes the health care and social services provided by
countries like France. But to pay for their safety nets, he figures they need to cut regulations and
taxes so they can have robust economies like Estonia’s, which grew about 10 percent last year.
The growth over the past decade has produced so much unanticipated revenue that the tax rate is
being gradually reduced to 20 percent. Laar’s political rivals still complain that his flat tax
unfairly helps the rich, but as he notes, the level of income inequality in Estonia actually declined
during the past decade.
“People think a progressive tax system is fairer,” Laar says. “But in the real world rich people
find a way to avoid high taxes. With a flat tax, they stop worrying about sheltering their income
or working in the gray economy. There is less corruption because it’s easier to pay the tax.”
Since Laar started the revolution, the flat tax has been adopted by its Baltic neighbors and a halfdozen other countries, including Russia, Ukraine and Romania. Such radical reform is still taboo
in Western European countries like France, but they can’t seal their borders against this threat. If
they don’t go to Estonia for a lesson in economics, their enterprising citizens will make the trip
on their own.
April 6, 2007
Op-Ed Contributor
2. How Supply-Side
Economics Trickled
Down
By BRUCE BARTLETT
Great Falls, Va.
AS one who was present at the creation of
“supply-side economics” back in the 1970s,
I think it is long past time that the phrase be
put to rest. It did its job, creating a new
consensus among economists on how to
look at the national economy. But today it
has become a frequently misleading and
meaningless buzzword that gets in the way
of good economic policy.
Today, supply-side economics has become
associated with an obsession for cutting
taxes under any and all circumstances. No
longer do its advocates in Congress and
elsewhere confine themselves to cutting
marginal tax rates — the tax on each
additional dollar earned — as the original
supply-siders did. Rather, they support even
the most gimmicky, economically dubious
tax cuts with the same intensity.
The original supply-siders suggested that
some tax cuts, under very special
circumstances, might actually raise federal
revenues. For example, cutting the capital
gains tax rate might induce an unlocking
effect that would cause more gains to be
realized, thus causing more taxes to be paid
on such gains even at a lower rate.
But today it is common to hear tax cutters
claim, implausibly, that all tax cuts raise
revenue. Last year, President Bush said,
“You cut taxes and the tax revenues
increase.” Senator John McCain told
National Review magazine last month that
“tax cuts, starting with Kennedy, as we all
know, increase revenues.” Last week, Steve
Forbes endorsed Rudolph Giuliani for the
White House, saying, “He’s seen the results
of supply-side economics firsthand —
higher revenues from lower taxes.”
This is a simplification of what supply-side
economics was all about, and it threatens to
undermine the enormous gains that have
been made in economic theory and policy
over the last 30 years. Perhaps the best way
of preventing that from happening is to kill
the phrase “supply-side economics” and
give it a decent burial.
It’s important to remember that at the time
supply-side economics came into being,
Keynesian economics dominated
macroeconomic thinking and economic
policy in Washington. Among the beliefs
held by the Keynesians of that era were
these: budget deficits stimulate economic
growth; the means by which the government
raises revenue is essentially irrelevant
economically; government spending and tax
cuts affect the economy in exactly the same
way through their impact on aggregate
spending; personal savings is bad for
economic growth; monetary policy is
impotent; and inflation is caused by low
unemployment, among other things.
These beliefs led to many bad economic
policies. In particular, they lay at the root of
stagflation, that awful combination of high
inflation and slow growth that bedeviled
policy makers in the 1970s. Based on
insights derived from the Nobel-winning
economists Robert Mundell, Milton
Friedman, James Buchanan and Friedrich
Hayek, the supply-siders developed a new
program based on tight money to stop
inflation and cuts in marginal tax rates to
stimulate growth.
As the staff economist for Representative
Jack Kemp, a Republican of New York, I
helped devise the tax plan he co-sponsored
with Senator William Roth, a Delaware
Republican. Kemp-Roth was intended to
bring down the top statutory federal income
tax rate to 50 percent from 70 percent and
the bottom rate to 10 percent from 14
percent. We modeled this proposal on the
Kennedy-Johnson tax cut of 1964, which
lowered the top rate to 70 percent from 91
percent and the bottom rate to 14 percent
from 20 percent.
We believed that our tax plan would
stimulate the economy to such a degree that
the federal government would not lose $1 of
revenue for every $1 of tax cut. Studies of
the 1964 tax cut showed that about a third of
it was recouped, and we expected similar
results. Thus, contrary to common belief,
neither Jack Kemp nor William Roth nor
Ronald Reagan ever said that there would be
no revenue loss associated with an acrossthe-board cut in tax rates. We just thought it
wouldn’t lose as much revenue as predicted
by the standard revenue forecasting models,
which were based on Keynesian principles.
Furthermore, our belief that we might get
back a third of the revenue loss was always
a long-run proposition. Even the most rabid
supply-sider knew we would lose $1 of
revenue for $1 of tax cut in the short term,
because it took time for incentives to work
and for people to change their behavior.
When President Reagan proposed a version
of Kemp-Roth in 1981, every revenue
estimate produced by the Treasury showed
large revenue losses from its enactment,
based on standard models. The independent
Congressional Budget Office produced
figures that were almost identical.
Moreover, we were adamant that only
permanent cuts in marginal tax rates would
stimulate the economy. We thought that
temporary tax cuts, tax rebates, tax credits
and such were economically worthless, and
we strongly opposed them.
Today, hardly any economist believes what
the Keynesians believed in the 1970s and
most accept the basic ideas of supply-side
economics — that incentives matter, that
high tax rates are bad for growth, and that
inflation is fundamentally a monetary
phenomenon. Consequently, there is no
longer any meaningful difference between
supply-side economics and mainstream
economics.
There is no question in my mind that we
never could have overcome the stagflation
of the 1970s as quickly or with as little pain
as we did without the supply-side idea. But
supply-side economics has done its job, just
as Keynesian economics did in the 1930s.
Those who campaign as its champions are
fighting a fight long won — and it is time
for supply-side rhetoric to go, with its
essential truths embodied in mainstream
economics and its perversions discarded for
good.
Bruce Bartlett, an official under Presidents
Ronald Reagan and George H. W. Bush, is
the author of “Impostor: How George W.
Bush Bankrupted America and Betrayed the
Reagan Legacy.”
April 12, 2007
Economic Scene
3. In the Real World of Work and Wages,
Trickle-Down Theories Don’t Hold Up
By ROBERT H. FRANK
When asked why he robbed banks, Willie Sutton famously replied, “Because that’s where the
money is.” The same logic explains the call by John Edwards, the Democratic presidential
candidate, for higher taxes on top earners to underwrite his proposal for universal health
coverage.
Providing universal coverage will be expensive. With the median wage, adjusted for inflation,
lower now than in 1980, most middle-class families cannot afford additional taxes. In contrast,
the top tenth of 1 percent of earners today make about four times as much as in 1980, while those
higher up have enjoyed even larger gains. Chief executives of large American companies, for
example, earn more than 10 times what they did in 1980. In short, top earners are where the
money is. Universal health coverage cannot happen unless they pay higher taxes.
Trickle-down theorists are quick to object that higher taxes would cause top earners to work less
and take fewer risks, thereby stifling economic growth. In their familiar rhetorical flourish, they
insist that a more progressive tax system would kill the geese that lay the golden eggs. On close
examination, however, this claim is supported neither by economic theory nor by empirical
evidence.
The surface plausibility of trickle-down theory owes much to the fact that it appears to follow
from the time-honored belief that people respond to incentives. Because higher taxes on top
earners reduce the reward for effort, it seems reasonable that they would induce people to work
less, as trickle-down theorists claim. As every economics textbook makes clear, however, a
decline in after-tax wages also exerts a second, opposing effect. By making people feel poorer, it
provides them with an incentive to recoup their income loss by working harder than before.
Economic theory says nothing about which of these offsetting effects may dominate.
If economic theory is unkind to trickle-down proponents, the lessons of experience are downright
brutal. If lower real wages induce people to work shorter hours, then the opposite should be true
when real wages increase. According to trickle-down theory, then, the cumulative effect of the
last century’s sharp rise in real wages should have been a significant increase in hours worked. In
fact, however, the workweek is much shorter now than in 1900.
Trickle-down theory also predicts shorter workweeks in countries with lower real after-tax pay
rates. Yet here, too, the numbers tell a different story. For example, even though chief executives
in Japan earn less than one-fifth what their American counterparts do and face substantially
higher marginal tax rates, Japanese executives do not log shorter hours.
Trickle-down theory also predicts a positive correlation between inequality and economic
growth, the idea being that income disparities strengthen motivation to get ahead. Yet when
researchers track the data within individual countries over time, they find a negative correlation.
In the decades immediately after World War II, for example, income inequality was low by
historical standards, yet growth rates in most industrial countries were extremely high. In
contrast, growth rates have been only about half as large in the years since 1973, a period in
which inequality has been steadily rising.
The same pattern has been observed in cross-national data. For example, using data from the
World Bank and the Organization for Economic Co-operation and Development for a sample of
65 industrial nations, the economists Alberto Alesina and Dani Rodrick found lower growth rates
in countries where higher shares of national income went to the top 5 percent and the top 20
percent of earners. In contrast, larger shares for poor and middle-income groups were associated
with higher growth rates. Again and again, the observed pattern is the opposite of the one
predicted by trickle-down theory.
The trickle-down theorist’s view of the world is nicely captured by a Donald Reilly cartoon
depicting two well-fed executives nursing cocktails on a summer afternoon as they lounge on
flotation devices in a pool. Pointing to himself, one says angrily to the other, “If those soak-therich birds get their way, I can tell you here’s one coolie who’ll stop” working so hard.
This portrait bears little resemblance to reality. In the 1950s, American executives earned far
lower salaries and faced substantially higher marginal tax rates than they do today. Yet most of
them competed energetically for higher rungs on the corporate ladder. The claim that slightly
higher tax rates would cause today’s executives to abandon that quest is simply not credible.
In the United States, trickle-down theory’s insistence that a more progressive tax structure would
compromise economic growth has long blocked attempts to provide valued public services.
Thus, although every other industrial country provides universal health coverage, trickle-down
theorists insist that the wealthiest country on earth cannot afford to do so. Elizabeth Edwards
faces her battle with cancer with the full support of the world’s most advanced medical system,
yet millions of other Americans face similar battles without even minimal access to that system.
Low- and middle-income families are not the only ones who have been harmed by our inability
to provide valued public services. For example, rich and poor alike would benefit from an
expansion of the Energy Department’s program to secure stockpiles of nuclear materials that
remain poorly guarded in the former Soviet Union. Instead, the Bush administration has cut this
program, even as terrorists actively seek to acquire nuclear weaponry.
The rich are where the money is. Many top earners would willingly pay higher taxes for public
services that promise high value. Yet trickle-down theory, which is supported neither by theory
nor evidence, continues to stand in the way. This theory is ripe for abandonment.
Robert H. Frank, an economist at the Johnson School of Management at Cornell University, is
the author of “The Economic Naturalist,” which will be published next month. Contact:
www.robert-h-frank.com.
October 9, 2007
Op-Ed Contributor
4. Captives of the Supply Side
By JONATHAN CHAIT
Washington
REMEMBER the Republican presidential
debate a few months ago, when three
candidates raised their hands to indicate they
didn’t believe in evolution? Something just
as laughable is likely to happen today, at the
first Republican debate on the economy.
Every candidate will probably embrace the
myth that cutting taxes increases
government revenues. At the very least, no
one will denounce it as a falsehood.
It’s been said for years that the Republican
nominating process is controlled by social
conservatives, and that any aspiring nominee
must kowtow to their demands. But this
year’s Republican primary is making it
increasingly clear that a different tiny
minority — the economic far right — truly
calls the shots.
Last year, Senator John McCain earned
widespread ridicule for publicly embracing
Jerry Falwell, whom he had once described
as “evil.” But an equally breathtaking
turnabout occurred earlier in the year, when
Mr. McCain embraced the Bush tax cuts he
had once denounced as an unaffordable
giveaway to the rich. In an interview with
National Review, Mr. McCain justified his
reversal by saying, “Tax cuts, starting with
Kennedy, as we all know, increase
revenues.” It was the political equivalent of
Galileo conceding that the Sun does indeed
revolve around the Earth.
Mr. McCain is not alone. Every major
Republican contender — Rudy Giuliani,
Fred Thompson, Mitt Romney — has said
that the Bush tax cuts have caused
government revenues to rise. No prominent
Republican office-seeker dare challenge this
dogma for fear of offending the economic
far right.
Yet there is no more debate about this
question among economists than there is
debate about the existence of evolution
among biologists. Most economists believe
that it is theoretically possible for tax rates
to be high enough that a reduction in rates
could actually produce more revenues. But I
do not know of any tenured economist in the
United States who believes this is true of the
Bush tax cuts.
Granted, economic growth sometimes
causes revenues to rise faster than expected
after a tax cut, as has happened since the
2003 tax cut. But sometimes revenues fall
faster than expected after a tax cut, as they
did after the 2001 tax cut. And sometimes
revenues rise faster than expected after a tax
increase, as they did after the 1993 Clinton
tax increase.
Even very conservative economists who
have worked for the Bush administration —
including Greg Mankiw, a former chairman
of the Council of Economic Advisers under
President Bush who is now an adviser to Mr.
Romney — have publicly stated that today’s
tax revenues would be even higher were it
not for the Bush tax cuts.
No Republican candidate can risk
committing heresy by acknowledging this
bipartisan consensus among economists. On
social issues, however, Republicans actually
tolerate diversity of thought. For example,
Mr. McCain, Mr. Giuliani and Mr.
Thompson all oppose, on federalist grounds,
a constitutional amendment to ban gay
marriage.
The Republican Party is organized around a
strategy of building political capital on
social issues while spending political capital
on economic issues. Republicans will
advance the social conservative agenda, but
they will rarely risk their popularity to do so.
As Trent Lott, the former Senate majority
leader, recently observed: “Republicans tend
to squabble, but when it’s fiscal issues,
when it’s economic issues, we tend to come
together. That’s what makes us
Republicans.” Mr. Lott is right if he’s
referring to the members of the Washington
establishment who run the Republican Party.
But when it comes to the party’s rank-andfile members, he has it exactly backward.
Grassroots Republicans agree on social
issues but disagree on economics.
The most recent Pew survey of the
electorate, which came out two years ago,
revealed that Republicans find common
ground on social issues like discouraging
homosexuality and teaching creationism
alongside evolution in the public schools.
They disagree on economic policy. In the
survey, most members of the Republican
coalition preferred deficit reduction to tax
cuts.
homosexuality with a curt “No sex talk,
please.”
Ardent anti-tax conservatives represent a
clear minority among Republican voters.
And yet the most extreme and counterfactual
subgroup among them — supply-siders —
remain firmly in control of the party.
Just last month President Bush insisted, yet
again, that “supply-side economics yields
additional tax revenues.” Hardly an eyebrow
was raised.
The party’s economic priorities are
reinforced at Grover Norquist’s weekly
“Wednesday Group” meetings, where
conservative activists, politicians, business
lobbyists and pundits meet to hash out a
common agenda. Mr. Norquist is known to
cut off any mention of issues like abortion or
A handful of fanatical ideologues, along
with a somewhat larger number of money
men who stand to gain a fortune from
supply-side policies, relentlessly enforce the
faith. They do so with far more success than
the religious right, and they receive far less
mockery for their efforts.
Jonathan Chait, a senior editor at The New
Republic, is the author of “The Big Con:
The True Story of How Washington Got
Hoodwinked and Hijacked by Crackpot
Economics.”