Prof. Boskin's Boo Boo 7/30/2003
Earlier this year, Professor Michael Boskin of Stanford University circulated a draft paper claiming that revenues would automatically increase as a share of the economy -- without painful tax hikes -- as baby boomers cashed in their 401k and IRA savings and paid income tax on the withdrawals. To some, Boskin's preliminary work implied that past predictions of massive budget problems when the baby boomers retired were exaggerated. However, Prof. Boskin has found an error in his original calculations, which overstated the possible increase in revenues.
Text of Prof. Boskin's message to the academic community noting that the earlier draft contained a significant error.
Needless to say, whenever an economist seems to find a free lunch, word gets around in Washington. Politicians love to raise spending and cut taxes without worrying about the consequences.
Indeed, several business magazines noted that Prof. Boskin's preliminary calculations meant that economists' longstanding predictions of a enormous budget crunch after 2010 (when the baby boomers start to retire) might be exaggerated. They implied that Congress could continue to cut taxes and raise spending without worrying so much about future budgets.
By contrast, Centrists.Org argued that even if Boskin's preliminary calculations had been accurate, there would still be a huge gap between our current spending trajectory and likely revenue collections throughout the next 3 decades. Even assuming a gradual 4 percentage point increase federal revenues as a share of GDP -- a generous proxy for Boskin's original calculations -- budget deficits would nonetheless grow to an economically hazardous size as the baby boomers retired.
Moreover, future politicians would be very unlikely to let revenues drift so high in the first place -- they would cut tax rates on 401k and IRA under pressure from those very baby boomers paying the extra taxes. In fact, Congress is considering proposals to do just that right now, by reducing the required withdrawals from IRA and 401k plans, and by converting regular IRAs (which are taxed at withdrawal) to Roth IRAs or the like (which taxed at deposit, so to speak, not at withdrawal).
Finally, other economists have noted methodological concerns with Boskin's preliminary work.
This academic discussion is all for the good. Scholars produce new theories, which are then checked and duplicated (or not) by others. Methodological assumptions are challenged and re-considered.
But it was premature to declare that longstanding predictions of future budget problems were exaggerated.
It's eerily reminiscent of the January 2001, when Federal Reserve Board chairman Alan Greenspan and many op-ed writers worried that based on official Congressional forecasts of huge budget surpluses, the entire national debt might be paid off too rapidly, with possible disruptions to financial markets.
What Greenspan and the pundits didn't say was that the official Congressional forecasts are wired to be overly optimistic. But Congress didn't see any caution flags. Congress saw a green light to do what it wanted: cut taxes and raise spending. Only this time, the economists said that it would be OK.
Now, we face large deficits even before the baby boomers retire. And the debt is increasing, not falling toward zero.
If there's a lesson here, it's this: When economists offer free lunches, policymakers should be appropriately skeptical.
Text of Prof. Boskin's Message:
July 17, 2003
Friends and Colleagues:
I recently sent out for comment a preliminary draft of a paper, “Deferred Taxes in Public Finance and Macroeconomics”. Much of what is in that paper - the asset of about $3 trillion of taxes on future withdrawals from retirement accounts that the federal government has accrued; the fact that accrual accounting for deferred taxes would offset roughly half the increase in the national debt from 1981 to 1992 and a multiple thereafter; the addition of a third side to the future political economy of deferred taxes with pressure to lower taxes coming from the larger number of voters withdrawing funds; the understatement of historical estimates of real returns to stock and bonds as current BLS methods would substantially lower historical CPI inflation used to deflate nominal values, to name a few - remains valid. However, the part of the paper projecting the future contained a programming error that in turn resulted from a word-processing error which I should have but did not catch. The term for the share of after-tax withdrawals consumed was inadvertently dropped from the investment equation. While the qualitative discussion remains valid, this did lead to a considerable overstatement of future deferred taxes. I am in the process of correcting this problem, but as the preliminary draft, circulated for comment, has gotten into the public domain (given the Internet age, people have been citing and writing about it before I have had a chance to correct it), I especially want to alert you well before the revised draft is ready for Working Paper status. Please do not cite or quote anything from the original paper without explicit permission. I apologize for any inconvenience this may have caused you. The fault is entirely my own, not that of anyone who may have quoted the preliminary draft.
Best,
Michael Boskin
Links:
Professor Boskin's retraction (July 17, 2003)
Centrists.Org Measuring the Cost of Unfunded Federal Spending Promises (July 14, 2003)
Centrists.Org What if Prof. Boskin is Right? (June 30, 2003)
Congressional Budget Office A 125-Year Picture of the Federal Government's Share of the Economy: 1950-2075 (Revised July 3, 2002)
Alan Auerbach, William Gale, and Peter Orszag Reassessing the Fiscal Gap: Why Tax-Deferred Saving Will Not Solve the Problem Brookings (July 14, 2003)
Jagadeesh Gokhale and Kent Smetters Fiscal and Generational Imbalances: New Budget Measures for New Budget Priorities AEI Pamphlet (12th draft, revised April 26, 2003)
Michael Boskin Deferred Taxes in the Public Finances (Original working paper, now retracted January 2003)
Centrists.Org No-BS Up-To-Date Budget Baseline Homepage
BusinessWeek "A Hidden Stash?" (June 30, 2003)
