Krugman Contradicts Krugman on California
Earlier this week Paul Krugman’s NYT column discussed the sorry state of California finances. According to Krugman, the reason the Golden State is in such a hole these last few years, is because of a tax revolt in 1978:
The seeds of California’s current crisis were planted more than 30 years ago, when voters overwhelmingly passed Proposition 13, a ballot measure that placed the state’s budget in a straitjacket. Property tax rates were capped, and homeowners were shielded from increases in their tax assessments even as the value of their homes rose.
The result was a tax system that is both inequitable and unstable. It’s inequitable because older homeowners often pay far less property tax than their younger neighbors. It’s unstable because limits on property taxation have forced California to rely more heavily than other states on income taxes, which fall steeply during recessions.
For those who don’t know about it, Prop. 13 was awesome. (I am well aware of its details because of my time spent working for Arthur Laffer, who at the time was one of its biggest proponents.) By limiting real estate taxes to 1 percent of the assessed value, it overnight cut property taxes by more than half. (!) The ballot initiative’s authors were also smart to add in a provision that the assessed value could rise at most by 2 percent per year, unless there were a transfer of ownership. So for people who stayed in their homes, the most their property taxes could rise was 2 percent a year.
In addition, Prop. 13 required that both houses of the state legislature had to get a two-thirds vote in order to pass any further tax hikes. You wouldn’t expect something like this to come out of California, now would you? (But then again Ronald Reagan came out of there during the same period.)
OK so now you can see what Krugman is talking about in the block quotation above. But still, what does that have to do with the current crisis? How does California’s 11-percent unemployment rate (cited by Krugman early in the article) relate to Prop. 13?
Even more important, however, Proposition 13 made it extremely hard to raise taxes, even in emergencies: no state tax rate may be increased without a two-thirds majority in both houses of the State Legislature. And this provision has interacted disastrously with state political trends.
Isn’t that funny? California’s economy is in the toilet because its taxes are too low? For what it’s worth, the Tax Foundation says that in 2008, California’s state and local “burden of taxation” was 6th highest in the nation. (That’s somewhat near California’s 5th highest unemployment rate; an interesting coincidence.)
But don’t worry, the rest of us are safe from California’s irrational aversion to taxes:
Will the same thing happen to the nation as a whole?
Last week Bill Gross of Pimco, the giant bond fund, warned that the U.S. government may lose its AAA debt rating in a few years, thanks to the trillions it’s spending to rescue the economy and the banks. Is that a real possibility?
Well, in a rational world Mr. Gross’s warning would make no sense. America’s projected deficits may sound large, yet it would take only a modest tax increase to cover the expected rise in interest payments — and right now American taxes are well below those in most other wealthy countries. The fiscal consequences of the current crisis, in other words, should be manageable.
But that presumes that we’ll be able, as a political matter, to act responsibly. The example of California shows that this is by no means guaranteed….
So will America follow California into ungovernability? Well, California has some special weaknesses that aren’t shared by the federal government. In particular, tax increases at the federal level don’t require a two-thirds majority, and can in some cases bypass the filibuster. So acting responsibly should be easier in Washington than in Sacramento.
Now wait just a second. It sure sounds like Krugman is saying California should raise taxes now, in order to reduce its budget deficit. (Doesn’t that sound like what he’s saying?)
But in his December 2008 NYT article, Krugman warned the state governors not to worry about reducing their deficits, since that’s what Herbert Hoover foolishly did in 1932.
OK OK, maybe Krugman would clarify and say that California is in danger of scaring away potential bondholders, and so it needs to raise taxes not to entirely close the deficit, but just to keep people willing to lend to it.
But no, that doesn’t really work either, because in this blog post earlier this month, Krugman explained that if the Chinese decided to stop buying so much Treasury debt (thereby driving up interest rates), that would actually boost the American economy. So if people who lived outside California stopped lending them money (even though the Golden State–heh heh–has a constitutional requirement for a balanced budget), that should boost gross state product, right? (The specific mechanism in the China example was that it would weaken the dollar and thus boost exports. Can anyone translate that into a case where different regions use the same currency? I mean, the choice of currency shouldn’t affect the trade flows, right? But then again I am constantly mystified by the results of a Keynesian model.)
The more I try to reconcile these three writings by Krugman, the more I think that he just grabs whatever argument he needs at the time, in order to justify bigger government and redistributionism. I know that sounds petty to say, but really, that’s the one common link in just about everything Krugman writes. As Scott Sumner put it recently:
Over the last few months I have had a chance to closely examine many of Krugman’s recent and past writings on fiscal and monetary policy. One thing that I notice is that Krugman is very skilled at making an argument. He can use the same basic model to make either monetary or fiscal policy seem like the only reasonable option. All that is required is that one tweak the assumptions in such a way that the less favored policy seems either undesirable or infeasible.
