'Horrendous': Nobel economist George Akerlof criticizes Bush administration's economic stimulus package

By Bonnie Azab Powell | 12 February 2003

George Akerlof, winner of the 2001 Nobel Prize in Economic Sciences and a critic of the Bush Administration's economic stimulus package.

BERKELEY - "Ten Nobel Laureates Say the Bush Tax Cuts are the Wrong Approach" proclaimed a full-page advertisement in the Tuesday, February 11, edition of the New York Times. Paid for by the Economic Policy Institute, a nonprofit, nonpartisan think tank, the ad went on to say that "there is wide agreement that [the Bush plan's] purpose is a permanent change in the tax structure and not the creation of jobs and growth in the near-term. Passing these tax cuts will worsen the long-term budget outlook, adding to the nation's projected chronic deficits." (Download the ad as a PDF.)

The petition prominently displayed the names of 10 Nobel Laureates and four world-renowned economic experts, among them three current UC Berkeley faculty members: George Akerlof, co-winner of the 2001 Nobel Prize in Economic Sciences and the Goldman Professor of Economics at UC Berkeley; Daniel L. McFadden, also a Nobel laureate in economics and the director of UC Berkeley's Econometrics Laboratory; and Janet Yellen, a member of Berkeley's Haas Economic Analysis and Policy Group and an economics professor. More than 450 economists from U.S. universities and tax-policy institutes also signed the petition, including more than 10 from UC Berkeley.

The NewsCenter asked Akerlof to explain why such a petition was necessary and what flaws he sees in the current economic stimulus package.

Why do you feel it was important that you sign the petition about the economic stimulus package?

Akerlof: We shouldn't call it a stimulus package until there is evidence to show that in fact it is a stimulus package. Right now there is no such evidence. It's a horrendous bill. This must be well known by every single member of Congress, and I am sure that it is clear in the reports from the Congressional Budget Office, which has always done a good job. But the public does not seem to be aware of the extraordinarily serious consequences of this stimulus package.

'Because the tax cuts are long term and permanent, it's very likely that instead of being a stimulus, they will act as a damper on the economy.'

The deficits being contemplated are out of sight. Each and every measure in this package contemplates long-term cuts in revenues, which means that the government will not have the revenues it needs to pay its bills. These bills fund extremely necessary things like Social Security, Medicare, and an effective military. In addition there's a grab bag of fairly small government expenditures, surprisingly small but nevertheless important, which includes such items as support for science, the justice system, Medicaid to help the disadvantaged, and some federal aid to education.

The budget deficits being contemplated are so very large and extend so far into the future that one doesn't see how in fact these needs are going to be met. These needs are only going to escalate as the baby boomers retire; more important than the population bulge, however, is the fact that people will be living longer and requiring more healthcare. The revenue will not be there over the longer term.

But we've known about the population bulge and longer life spans for a while. Wouldn't we be facing a revenue shortfall regardless of which stimulus plan is implemented?

No. The revenue shortfall as of January 2001 was serious but not tremendously so. Then there were the first major tax cuts. And with them, the revenue shortfalls became very serious. Now, with these additional proposed tax cuts, the revenue shortfall isn't just serious, it's extraordinarily serious. That's why it was possible to get so many economists to sign this petition so very quickly. Given the short length of time involved, it's truly remarkable the number of people who signed it.

So this is a near-term crisis. You're not just looking 10 years down the road and foreseeing huge cuts in social Security and Medicare.

This is permanent. Most of these tax cuts are envisaged as being permanent. That means it's a shortfall of tax revenues as far as the eye can see into the future.

'The average tax dividend dollar will go to people who are already indeed quite rich. In terms of redistribution of income, this is probably one of the worst possible places to give money.'

There are four problems with the so-called stimulus package. The first is that it creates deficits so large that one cannot even contemplate how we are going to pay for our governmental needs but especially our promises to the elderly - Medicare and Social Security, programs that have been extraordinarily popular and for very good reason.

Second, because the tax cuts are long term and permanent, it's very likely that instead of being a stimulus, they will act as a damper on the economy. If the tax cuts are implemented, they will cause deficits, which in turn will raise long-term interest rates, which will actually cause an economic contraction. The net effect is likely to be negative rather than positive.

The third reason to vote against this package is that since it's going to result in higher long-term interest rates, that will increase the deficits even more. Higher long-term interest rates will increase the interest payments on the national debt. The additional debt repayment burden means that the current estimates of the government deficits are far too conservative. They have to be multiplied by a very large factor. Say the government has approximately $5 trillion worth of debt. Higher interest rates resulting from that very deficit will massively increase the repayment on that debt.

Lastly, the redistributive aspects of the package are extremely worrisome. It seeks to redistribute wealth in the wrong direction, in a very big way, to the very wealthiest end of the spectrum. The people who least need a tax cut in the U.S. economy are those whose major source of income is taxable dividends. The average tax dividend dollar will go to people who are already indeed quite rich. In terms of redistribution of income, this is probably one of the worst possible places to give money.

Some would argue that it is not a question of whether the wealthy need such tax cuts, but that the cuts will inspire them to increase their investment in the stock markets and in business, creating jobs and thereby goosing the economy.

That's a highly dubious argument. My answer is that the tax cuts will decrease revenues, resulting in deficits. Deficits of this magnitude are certain to raise long-term interest rates and that will greatly dampen private investment, which is private capital formation.

The petition in the New York Times singles out the dividend tax cut as "misdirected in that it targets individuals rather than corporations, is overly complex, and could be, but is not, part of a revenue-neutral tax reform effort." Why should a dividend tax cut target corporations rather than individuals?

It's corporations that tend to be making the decisions about investment, not individuals. An investment tax credit would better target investment directly. A dividend tax cut for individuals is a very, very diffuse incentive to invest. But the most important problem with the dividend tax cut is that it's not revenue neutral.

Explain what "revenue neutral" means for us non-economists.

It means that it does not change the budget's balance. The dividend tax cut is not revenue neutral because it is going to create very large increases in the budget deficits.

The other major change to the tax structure in the Bush plan is to create individual retirement savings accounts up to $15,000, the income of which would be non-taxable. What problems do you foresee with that?

It has two extremely bad features. Again, it's a redistribution of income to the wealthy: people who can save as much as $15,000 per year on average tend to be quite a bit richer than the general population.

Beyond that, it would have an extremely dangerous fiscal effect. Currently, people with IRAs and 401(k)s and other similar tax-deferred savings programs will eventually pay taxes on the income from them, giving us a future source of government revenue that will alleviate some of the problems with paying for the Social Security and Medicare of the future. But the proposed new savings program does the exact opposite. With the proposed program, savers in these accounts will pay taxes on the funds when they first open the account, but the earnings - the dividend and interest earnings in those accounts - will be nontaxable.

As a result, tax revenues will be brought forward, in the sense that current contributions to savings will be taxed but there will be no future revenues from these taxes. That will make the deficit look small in the near term but simply balloon over the long term. We collect the tax revenues now, but we give up money for the future. And this is a matter of losing trillions of dollars.

What are some alternative spending and/or tax measures that you think would actually expand demand and stimulate investment?

Related stories From Feb. 11: UC Berkeley economists urge California legislature to accept tax increases and revisit Prop. 13 Background on Akerlof: Feature package commemorating Akerlof's winning the Nobel Prize

If I were going to put together a stimulus package, it would emphasize two things. First, I would rebate money to the states from the federal government. Most states have a balanced budget provision in their constitution, and therefore a dollar transferred from the federal government to the state will very likely result in an extra dollar of expenditure right off. So that would be a very effective stimulus that would benefit everybody. Will that be used for programs that are needed? You bet your life it will be. It would especially impact education - and if there's anything this country needs, it's better education.

Second, if one is going to give a short-term tax rebate as a fiscal stimulus, I would target a short-term, limited-time-only decrease in the payroll tax - what individuals pay for Social Security and Medicare. That's a regressive tax, so on average it would go to people at the lower end of the income scale. One should limit that payroll decrease in terms of time, say one or two years while the economy remains weak, which would avoid creating huge deficits. As I said before, a permanent reduction in the tax, such as these new savings programs entail, will result in extremely damaging deficits that stretch as far as the eye can see.