May 16,2003




I got Rolling Stone and read the Krugman interview.  The Quarterly Journal of Economics it ain’t. (QJE is the oldest economics journal in English, edited at Harvard and published by MIT Press (Krugman used to be at MIT before he went to Princeton).)


Anyway, my comments on Krugman’s views are as follows:


“Quick rundown.”  I agree with Paul that we have a recession, whether anyone officially identifies it as such.  But, I would argue that one reason it is not officially seen as a recession is that our economy is in a major transition and the historical metrics are, as a result, less meaningful. 


As for the deficit, I think all talk of deficits and surpluses is meaningless.   To say that government has a deficit if it spends more than it takes in over a specific period of time is silly.  A dollar spent building a school (that will last for 40 years) is not the economic equivalent of paying a dollar in salary to a teacher.  In the absence of a capital budget, talk of deficits and surpluses is nonsense. 


In the unlikely event that Paul responds to the copy of this message that I will send him as a courtesy (he probably was not too pleased with my comments on his famous New York Times Magazine article on income disparity and never responded to those), I expect that he will say that a capital budget would be nice, but that it would be impossible to get agreement within government as to how particular expenses should be treated.  That is the argument other economists have made.  My view is that the dialog cannot get any more partisan.


Finally, as Paul’s colleague Joe Stiglitz at Columbia has pointed out, projections of future government budget results is a hopelessly inexact science.


“Is $500 billion significant?”  Paul is correct that $500 billion over time is insignificant as a percentage of the annual budget or the annual “economy” (by which I assume he means aggregate GDP).  That does not mean that $500 billion could not have a significantly favorable effect on the economy (nor does it mean that it will).


I suggest, however, that whatever portion of whatever number Paul or Bush wants to use as the “cost” of dividend tax reform is probably wrong.  The dividend tax issue is one on which I’ve written a lot (if you want to read it all, go to, and the more I think about it, the more I believe that, properly done, eliminating the tax inefficiency on dividend payments will increase, not decrease, Treasury receipts.


The Bush Administration proposal is not the way to do it, and there will be a cost if a plan based on that proposal is enacted.  Rather than taxing dividends at the enterprise level and then excluding them from individual taxable income, dividends should be deducted at the enterprise level and taxable to the recipient.  Also, there should be no incentives for retained earnings such as Bush has proposed.


OK, so assume it’s done my way.  And, assume that you class warriors are right and all dividend paying stock is held by rich people like me.  If I own stock in American Widget and AW earns $1000 this year, one of two things could happen: Either AW could dividend out the $1000, in which case the rich shareholders would pay 39.1% back to the government as tax on ordinary income, or AW could retain the earnings and the value of their AW stock would rise.  If and when they sold it – probably years in the future – they would pay tax at the capital gains rate on the increase in value over time.  The capital gains rate is (as I recall) 28%.  Now, which will make more money for the Treasury?  39.1% of $1000 today or 28% of some other number some years in the future?  [Now, to keep this short, I’ve simplified significantly, but the essence of the argument is the same.]


“Bush tax cut compared to Reagan.”  Since I do not accept the numbers, I can’t comment.  But, Paul is correct in saying that something has to be done about Social Security, Medicare and Medicaid.  Delving into that morass in this message would make it far too long.


“Time horizon.”  Paul is right in saying that it depends on the financial markets.  But, since the one thing – and probably the only thing – I agree with Stiglitz on is that future projections are essentially meaningless, I do not think we can predict when the world bond market starts to treat us like a banana republic.  It could come a lot quicker than 2010 depending on world economic events over which we have no control.  Right now interest rates are extremely low, inflation is essentially non-existent, and available risk-adjusted returns on alternative investments are not favorable.  Change any of these things and the cost of capital to the Treasury will increase.


“The next campaign.”  While there is always some element of political opportunism in government policy, I think Paul’s comment is grossly unfair.  And, whatever the politicians might want to do, their options are limited by the senior career staff, who are the people really running the government.  Carole Browner learned this the hard way when she went to her Senate confirmation hearing without consulting with her career staff.  They later explained to her, in no uncertain terms, that they were there before she got there and would be there long after she left, and that she needed them to get anything done.


“Mind set.”  Paul’s comments are unnecessarily partisan and irresponsible.  Undoubtedly some members of the Bush Administration are crass cynics, but most are people of good faith who want what is best for the country.  I would say the same of the opposition, even though I do not agree with them.


“Grow our way out”.  Every administration uses these silly projections and the date of doom has changed little.


“Bush people address.”  To be candid, I have to agree with Paul.  I think there are analyses to be made, but I don’t hear them.  I sent you a copy of my challenge to Hannity.  All I heard from both Hannity and Sperling that day I tuned in was an exchange of shopworn, “on message” sound bites.  I’ve provided by ideas on the dividend tax issue to folks on both sides and cannot get anyone to engage in a constructive debate. To both liberals and conservatives I say, “Tell me where I’m wrong.”  Bob Willens at Lehman has reviewed my analysis and found it sound, so I’m not totally off the reservation, but I hear no response from the liberals and mindless praise from the conservatives.  Steve Forbes responded with two words, “Good points!”  I wrote him back and said that if my points are so frikkin’ good, why are the not being made?  So, Paul’s right.  Bush has not adequately explained or defended his plan, but the Democrats have not done any better.


“Outcry.”  I suggest that people in glass houses shouldn’t throw stones.  Yes, the quality of debate is hopelessly poor and partisan, but Paul has been among the most strident critics, which is fine if that criticism is supported by sound analysis, but I have not seen that from him.  I wouldn’t expect it in Rolling Stone, but would expect it in his other work.


“Republican opponents.”  I’m shocked and appalled that there are kooks on the conservative side who would overreact to the views of Voinovich or Snowe.  The Democrats have no kooks, right?  This is politics where everything has to be dumbed down to sound bites and where there are a lot of fruits, nuts and flakes running around without enough to do.


“Media.”  Say what?  Current Social Security contributions are funding current retirees?  That’s just not true - yet.  The Social Security Trust Fund currently has a surplus and current payments to retirees are being paid out of current assets.  So, putting all other issues aside, now would be the time to phase in privatization.  The real problem, however, is that the government cannot privatize because it borrows all of the Social Security contributions to fund other programs.  If we privatize Social Security, the government will have to go directly to the bond markets to make up the difference.


“Media afraid.”  This comment suggests frank paranoia. 


“Iraq War Economic Consequences.”  What is going on in the international trade arena has nothing to do with the Iraq War.  So all of those comments are totally irrelevant.  I’m not as sanguine as Paul as to the economic consequences of the war.  First, there is a good chance that oil prices will collapse.  That is not a good thing other than for consumers.  It certainly is not good for the world economy.  Second, assuming Bush meant what he said when he promised to rebuild Iraq, I think we will spend much more that anyone is prepared to admit.  And, we must do this because otherwise I fear we will have fought the war in vain.  We do not want another Weimar Republic.


“Corporate governance.”  Paul’s right.  I’ve served as a senior legal executive at two public companies and have an understanding of the problem and its roots.  One of the most important reasons I want to see dividend tax reform is because of the dramatic improvement in corporate governance that I believe we will see.  [The explanation is too long to include here, but go to my web site and read my correspondence to Larry Klein at U Penn if you are interested.]  There are not many “bad guys” out there, but the equity market system is dysfunctional and there are many perverse incentives and prevailing practices that lead to absurd results. 


“Crystal ball.”  I cannot criticize what is essentially a personal future view.  I see the glass as more than half full, but I also believe that we face some very significant short-term challenges relating to globalization (which I support even though it has been very hard on me personally).  Our only chance for lasting peace and prosperity for our children and grandchildren is the evolution of a global economy that eliminates macroeconomic incentives for war and provides economic opportunity (and demand for goods and services) for the 60% of the world’s population that does not enjoy them now.