The Three Pronged Republican Economic Platform

The Republican economic platform can basically by summed up by three defining characteristics: 1) increase military spending, 2) cut taxes, primarily for high-income individuals, and 3) balance the budget. If you look at each of the Republican candidates' websites, you'll see pretty much all of the same policies (with the exception of Trump, who, instead of a balanced budget amendment, proposes what he calls 'revenue neutral' and everyone else calls 'budget busting' policies), with everything else pretty much secondary.

Perhaps the most interesting part of this nearly ubiquitous threefold policy is that each of these objectives are pretty much mutually inconsistent. Each candidate is effectively proposing massive spending increases (military buildup) as well as massive tax cuts (ranging in severity from 'insane' -- Cruz -- to 'I can't judge because there are no specifics' -- Kasich). Unless you buy into the idea that cutting income taxes incentivizes people to work so much more that the net effect on revenue is positive (relative to the higher-tax counterfactual, shut up Reaganites), you should realize that the three effects of each Republican's plan will be 1) massive deficits, 2) whatever supply-side effects (if any) the tax cuts have. and 3) no effect on the output gap, because the Fed, which reasonably thinks that the economy is already near potential, will offset the effects of any expansionary fiscal policy (the same can't be said for contractionary fiscal policy, shut up Market Monetarists).

So, when Rubio accuses Trump of having numbers that don't add up, he should really include himself in the same boat; balanced budgets do not go together with tax cuts and military buildups. Even George W. Bush knew this, at least he admitted that his plan would erase the surplus, even if Mr. NCLB accused Gore of "fuzzy math." Of course, everyone is now going to argue that the spending cuts that each administration will undertake will outweigh the military spending increases. My response: maybe, but have any recent Republican administrations done that? No? I thought so. Keep in mind that government spending has been more restrained as a percentage of GDP under Obama (and under Clinton) that it was under either Reagan or W.

What about the supply-side effects of tax cuts? Well, we do have one pretty good experiment of this from 2003, when Bush passed his tax cuts and, well, I'll let the subsequent lack of employment growth speak for itself:

Now, before everyone freaks out, I know I didn't adjust for demographics here, but I think it's fair to say (based on my own analysis linked above) that the demographic adjustment for Obama would be larger than for Bush, so I'm really being kinder to the Bush tax cuts that I should be. With that aside, it seems pretty clear that the 2003 tax cut did pretty much nothing in the way of speeding up the recovery, so what should make anyone think that more of the same thing will be all that different?

When it comes to monetary offset, as I wrote here, fiscal policy only has demand-side effects to the extend that the central bank doesn't act in the face of fiscal shocks. So, in the event of a massive fiscal expansion (assuming the candidates can't achieve the desired balanced budgets by gutting the government), we should simply expect the Fed to raise interest rates faster, which will mean that the only effect that fiscal policy will have is the supply-side one, which is probably minimal.

TL;DR: Republican fiscal plans = deficits + not much else

Timing and Composition

Family members are often confused by my simultaneous support for looser fiscal policy in the United States and disdain for Republican tax proposals during this election cycle on the ground that they would result in too much deficit spending. On the surface, my policy preferences seem contradictory; I neither support efforts to rein in the deficit nor the large tax cut proposals of the majority of Republicans. There are two primary reasons for this seemingly strange predilection: timing and composition.

The length of time each policy lasts is crucial to my support. As per the 'New Keynesian consensus,' loose fiscal policy should only be used until monetary policy can be reasonably declared unconstrained by the zero lower bound. This is why deliberate deficit cutting policies should not have been undertaken, and arguably should not be pursued further, until two criteria have been met: the federal funds rate must be above the zero lower bound and there must be little to no risk that the zero lower bound will be made to bind by either a tightening of fiscal policy or some other shock to the economy. At the time of writing this post, only the first criterion is fulfilled -- the Federal Reserve has decided to raise the target fed funds rate, but, since it stands somewhere between 0.25% and 0.5% (the Fed has adopted a target range instead of a strict target), it would be reasonable to suggest that a large negative fiscal shock could be more than the Fed can handle without being thrown back into a liquidity trap (in this sense, the US could still be considered to be in a liquidity trap, even though the zero lower bound no longer binds).

GOP tax cut proposals would undoubtedly achieve the temporary goal of looser fiscal policy, but they would be on a completely wrong timescale. Conventional analysis only suggests loose fiscal policy for the duration of the liquidity trap, and, since the tax cuts are permanent to the extent that they are not repealed by future administrations, they fail miserably in this regard. In other words, fiscal policy would be too loose for too long under large tax cuts -- especially if they are not accompanied by corresponding reductions in government spending. Additionally, spending cuts are arguably more damaging than tax cuts are stimulative in liquidity traps, so a fiscal adjustment fully in line with, e.g., Rand Paul's or Ted Cruz' preferences could completely fail to comply with the recommendations of mainstream economics, which scares me enough in its own right to warrant a revocation of support.

My second criticism of the GOP tax plans is more personal; I think that government spending and taxes in the United States should be higher, not lower. There are certainly arguments to be made that government spending in the United States does nothing to raise aggregate utility and should thus be cut, but I believe, and I think most other economists agree with me, that this is definitely not the case. This is especially true in infrastructure, or more generally government investment -- currently at its lowest level as a percentage of GDP since 1948 -- which sorely needs to be increased. Further, spending on Social Security and Medicare should increase over the next decade or two because of the changing demographics of the country. If we adopt the tax proposals of many if not all of the GOP candidates, spending cuts will have to come from somewhere and, given the Republican obsession with massive military spending, they will probably not be defense cuts. This pretty much leaves entitlements and investment -- both of which would cause significant pain going forward if they were cut significantly.

Ideally, fiscal policy makers would focus in the short term on simply not cutting spending too ferociously and in the long run on figuring out how to raise the revenue required for higher levels of government investment and entitlement spending. The GOP seems prepared to do neither of these and, as such, I am not prepared to endorse them for their fiscal policy.