Suppose Uncle Sam hires only American workers and buys only American-owned resources to raze the Rockies. Suppose further that Uncle Sam finances this program exclusively by raising taxes. An extra $10 trillion in taxes is raised, and every cent is spent successfully leveling the Rockies.
According to Krugman, because “we” received every cent that “we” paid to level the Rockies, the net burden to “us” as a group of leveling the Rockies is zero! The program is costless! But clearly that conclusion is incorrect.
Massive quantities of valuable, real resources are used up to raze the Rockies. The workers and resource owners didn’t pay for these resources to be used in this way (as these workers and owners voluntarily contributed, for pay, to the effort). Taxpayers paid; and the cost can be reckoned in the foregone value of whatever it is those workers and resources would have produced had they not instead been used to raze the Rockies. The net cost to Americans of razing the Rockies clearly is $10 [trillion] – a cost that doesn’t disappear simply because the tax payments by some Americans of $10 [trillion] were received fully as income payments by other Americans.
Here are some other readings on the topic. Krugman 1, 2, 3. Mankiw (pdf with some macroeconomics). Boudreaux 1, 2
To the point of why I decided to come out of hiding to write this post, Boudreaux's choice of policy in his analogy (leveling the Rockies) is scarily wealth-reducing. If you haven't done so in your lifetime, take a road trip through the Rockies and you'll experience abundant consumer surplus from the beautiful scenery.