Krugman: Higher Taxes Are A Net Plus

As I have noted before, Paul Krugman told me during a Q&A in a session at the 2004 Southern Economic Association meetings (Dr. Joseph Salerno was sitting next to me and he can verify what I am writing) that the 70 percent tax rates that existed before 1981 were "insane." Given what Krugman has written in a recent blog post, my sense is that he has repudiated his 2004 statement.

He writes:

If we could wave away political reality, I’d let all the Bush tax cuts expire, and use the improvement in the budget outlook to justify a large, temporary increase in public spending.

However, he notes, so he goes to the next best thing: raising only the top marginal rates. His justification is pure Keynesian and it leads to asking the following question: If government spending always is better than private spending, then why not have a 100 percent tax rate on ALL income? Let me explain.

Krugman declares that wealthy people might not spend all of the income that accrues to them (they save it, and everyone knows that Keynesians believe that saving is bad, bad, bad), so government must confiscate as much as possible, since government always spends what it gets (and more). As for lower-income people, they are not so willing to save, so they spend their money, which is good for the economy:

It comes down to the dual fiscal problem the U.S. economy faces: short-term, the government needs to do all it can to prop up spending; long-term, it needs to reduce the deficit. The latter concern means that it would be a terrible idea to make the high-end tax cuts permanent; that would be a huge drain on the public finances, serving no good purpose. But why not a temporary extension? Because it would do very little to promote spending.

The basic framework we have for thinking about consumer spending goes back to none other than Milton Friedman, whose “permanent income” hypothesis says that people will save most of any income change they see as merely transitory. Telling rich people that we’ll keep their taxes low for a couple more years is, for them, a transitory income gain; they’ll save the bulk of it.

Isn’t the same true for lower-income people? Not to the same extent. Permanent-income reasoning doesn’t fully apply when some people are “liquidity-constrained” — they have depressed income, which would make them want to spend more than they earn right now, but they’re out of assets and unable to borrow, or unable to borrow except at relatively high interest rates. People in that situation will spend much or all of any temporary windfall.

So if we give money to people likely to be liquidity-constrained, they are likely to spend it. That’s why aid to the unemployed is an effective stimulus; it also suggests that tax cuts for lower-income workers will be relatively effective at raising demand. But the affluent, who typically have lots of assets and good access to borrowing, are much less likely to be in that situation. So tax cuts for the lower 60 or 80 percent of the population are an OK, not great but OK, form of stimulus; tax cuts for the top 2 percent, not at all.

Notice that Krugman says that letting lower-income people keep some of their money is "OK," but not "great." What is "great," obviously, is government spending.

So, I ask the question again: Given Krugman's logic, is it not better for government to confiscate ALL earnings from everyone and spend the money on what the Political Classes believe to be important? After all, Krugman clearly states in this post that government spending is better for the economy than private spending, so it seems to me that logic should prevail and all of us work for the government for free.