Krugman Endorses Insanity (His Own Words)

On the Sunday before Thanksgiving in 2004, I attended a session at the Southern Economics Association annual meeting, held in New Orleans, and the speaker was Paul Krugman. Joseph Salerno and I sat next to each other to hear the Great Wisdom from The Master. To be honest, I cannot remember anything he said, but I do remember his answer to my question during the Q&A.

My question dealt with tax rates. I asked that since he was critical of the current tax setup, would he endorse the 70 percent rates that existed before 1981? "Oh, no!" he exclaimed, "Those rates were insane!"

Since that time, Krugman seems to be doing everything he can to endorse insanity, and he does it again today in a column that totally misses the mark on the issue of economic growth. To be honest, the question he seems to be raising is a fair one -- Can we have both strong economic growth and high marginal tax rates? -- but his view of economic growth is so skewed that one hardly can answer it on his terms.

He writes:

The first thing you need to know is that America wasn’t always like this. When John F. Kennedy was elected president, the top 0.01 percent was only about a quarter as rich compared with the typical family as it is now — and members of that class paid much higher taxes than they do today. Yet somehow we managed to have a dynamic, innovative economy that was the envy of the world. The superrich may imagine that their wealth makes the world go round, but history says otherwise.

He is correct in that in the early 1960s, the U.S. economy was still the strongest in the world even though its highest marginal rate was about 90 percent. Thus, he reasons, tax rates really don't matter and we can raise rate much higher than they are today and still have lots of economic growth. In past columns, he has noted that a number of key sectors such as rail, truck, and air transportation all were organized into regulated cartels (though he does not use "cartels" even though that is what they were), and banking and finance were tightly organized into similar kinds of cartels. Things were so good back then, he argues, that any change in such legal arrangements could not have had any overall economic benefits and, in fact, the only reason things were changed was because people with the wrong ideology took power.

(Nowhere does Krugman acknowledge the Elephant In The Living Room. In 1961, the other economies of the world were recovering from that destruction of World War II. Japan's economy was in its infancy of productivity, Great Britain had moved to socialism and stagnation, Eastern Europe was walled off by the U.S.S.R., most of Asia was still in its ancient agricultural mode. The U.S. economy was in a position that would be changing, even if Krugman refuses to acknowledge that simple fact.)

Krugman seems to be saying that since this arrangement seemed to be successful in 1961, it ALWAYS would be successful, and he also seems to hint that the economy was successful BECAUSE of the tax and regulatory environment. For Krugman, it is post hoc, ergo propter hoc. Thus, if we were to return to such arrangements, we could then emulate the success of that era.

This brings me to the subject of his column, and that is his discussion of "the rich." If I read Krugman correctly, he is saying that Mitt Romney and his supporters are claiming that those who are wealthy really are the "engines" of a market economy, and that to raise taxes on them would stifle economic growth. Those supporters, Krugman, argues, are wrong because we had high marginal rates before along with economic growth.

Unfortunately, Krugman's entire analysis is based upon a very typical Keynesian "snapshot" view of the economy in which, to quote Robert Higgs, the individual factors of the economy are treated as just "goo" in which the only relevant analysis is to use pure aggregates. This has much political usefulness, as one can see, for Krugman does not have to deal with long-term trends or any underlying weaknesses within the economy. Furthermore, in his views, changes to the legal and regulatory structure have nothing to do with problems that  came about because of the structures of incentives and relationships created by tax laws and regulation. Instead, any changes to what had been a near-perfect system came about ONLY because of "conservative ideology."

Notice a word that never appears in any of Krugman's columns; never. It is "entrepreneurship." I have come to believe that Krugman thinks than an economy is totally administrative and very mechanistic: producers know the production function and then they produce things based upon their projections of how future spending patterns will go. The only things needed for a "successful" economy, then, are productions functions and spending.

The Krugman Economy is one in which economic growth would be due to changes in technology (and government researchers can "invent" anything that is necessary and innovative) and spending, lots of spending. Markets are useful only if they fit the pattern of "perfect competition" in which each firm is tiny and it faces a horizontal demand curve. Firms are simple production functions with given cost curves, with the sole decision by managers being where to set output.

Since entrepreneurship really is not necessary in the Krugman Economy, anyone who gains wealth via entrepreneurial activities is no different than a person who has inherited wealth, like the Kennedys. High marginal tax rates would have no effect upon production or wealth creation, since a government-run firm would be just as productive as a private one and probably more socially useful, since government agents and regulators -- at least if they are Democrats -- always govern with the best of intentions, and everyone know that intentions are all that matters. (Thus, if government agents intend to have high-quality "universal" medical care, then such a program is both morally superior to anything else and also will have the intended results.)

In the Krugman Economy, a Steven Jobs is no more useful than someone living in the Hamptons who lives off a huge trust fund, with the only real social use of either being the potential for government to take large portions of their incomes via taxation, which then can be converted into government spending, which is the REAL source of economic growth. There are no such things as incentives; corporations and entrepreneurs will not change their behavior or outlook a whit if the top rates go back up to 90 percent. Like the band in "Animal House," they will continue to march forward even if a wall blocks their way.

As I see it, Krugman argues that high tax rates will not hurt economic growth because entrepreneurs are both economically and socially unnecessary. He has not gone as far as John Kenneth Galbraith, who argued that entrepreneurs were parasites because they produced useless "private" goods that took away from "needed public investment," although is clearly is in Galbraith's neighborhood.

I would argue that Krugman is much closer to the views of his former professor, Paul Samuelson, who depended solely upon GDP models which permitted him to claim that the planned economy of the former Soviet Union was superior to that of a market economy because the U.S.S.R.'s aggregate numbers showed high growth. That the economy of the U.S.S.R. was primitive, blocked by massive shortages, poor quality of goods, and outright idiocy. Instead, people like Samuelson look at the overall production of goods, such as automobiles and then assumed that, for the purposes of economic analysis, a clunky, 1948-style East German Wartburg was no different than the superior cars made in the West and in Japan. All that mattered were aggregates.

Since entrepreneurship in the old communist bloc economies was illegal and those economies were growing rapidly, Samuelson and his followers reasoned that entrepreneurship at best was a dinosaur, historically interesting but unneeded in the modern, "sophisticated" economies in which wise planners armed with MIT doctorates could run via the creation and solving of simultaneous equations.

In a word, Krugman really does not understand the role of the entrepreneur, nor will he ever understand it. All he sees is someone with money who isn't spending enough of it at the present time. Furthermore, he cannot tell the difference between an entrepreneur and someone who lives on inherited wealth, nor can he tell the difference between market entrepreneurship and political entrepreneurship (i.e. Solyndra).

So, in the Wonderland of Krugman's economy, 90 percent tax rates make perfect sense. It might be "insanity," but in Wonderland, the insane is sane.