Mankiw: Trade Pigovian Taxes for Permanent Income, Dividend, and Estate Tax Cuts

Greg Mankiw has an idea to solve the political impasse on the budget deficit:

Greg Mankiw's Blog: A Comeback for Pigou?: In the past few days, I have run across a couple of articles (here and here), admittedly in relatively minor places, arguing for higher Pigovian taxes, such as a tax on gasoline or a tax on carbon. ... Pigovian taxes both produce government revenue and correct a market failure arising from an externality like pollution. I have long thought that Pigovian taxes are underused.

How about this for a political compromise?

The Democrats say they want more environmental protection. The Republicans say they want to make permanent the recent cuts in income, dividend, and estate taxes. Everyone says they want a smaller budget deficit. We can achieve all of these objectives by agreeing to higher Pigovian taxes, such as taxes on gasoline or carbon. The Republicans concede that government revenue will be higher than it is under the President's proposed budget, and the Democrats concede that the President's tax cuts on income, dividends, and estates will be permanent.

Please don't post a comment saying how politically naive this is. I know it is. But I bet I could convince a majority of the American Economic Association to sign on!

It depends. These taxes are a good idea in isolation since they solve market failure problems, so if we get to ignore political realities there is no need to trade one tax for another, Pigovian taxes can be imposed on their own merits. So yes, I will sign on to correct market failures through the imposition of Pigovian taxes.

But if I am forced to trade these taxes for other policy changes that I do not agree with on both efficiency and equity grounds, then the details of the tradeoff become important. What size changes are we talking about? Would it be better to use the revenues to, say, offset the negative consequence of pollution rather than to reduce other taxes? In addition, the difficulty for me comes with being asked to trade a Pigovian tax that both Republicans and Democrats can agree, or ought to agree is needed on efficiency grounds for policies that Democrats disagree with. In such a trade, it's hard to see what Republicans have given up. Are Republicans opposed to efficient markets?

Comments

[Winslow R.]

I see Greg as an enabler of the predator class.

"For in a predatory regime, nothing is done for public reasons. Indeed, the men in charge do not recognize that “public purposes” exist. They have friends, and enemies, and as for the rest—we’re the prey. Hurricane Katrina illustrated this perfectly, as Halliburton scooped up contracts and Bush hamstrung Kathleen Blanco, the Democratic governor of Louisiana. The population of New Orleans was, at best, an afterthought; once dispersed, it was quickly forgotten.

The predator-prey model explains some things that other models cannot: in particular, cycles of prosperity and depression. Growth among the prey stimulates predation. The two populations grow together at first, but when the balance of power shifts toward the predators (through rising interest rates, utility rates, oil prices, or embezzlement), both can crash abruptly. When they do, it takes a long time for either to recover.

The predatory model can also help us understand why many rich people have come to hate the Bush administration. For predation is the enemy of honest business. In a world where the winners are all connected, it’s not only the prey who lose out. It’s everyone who hasn’t licked the appropriate boots. Predatory regimes are like protection rackets: powerful and feared, but neither loved nor respected. They do not enjoy a broad political base."

James K. Galbraith

[CalculatedRisk]

Mankiw has no credibility on the budget. I'm not sure he understands the difference between a cyclical budget deficit and structural budget deficit. And, from his writings, Mankiw seems to think the SS payroll tax is really just another General Fund tax.

I'd listen to Mankiw on the budget as much as Cheney on WMD in Iran. Not at all.

[eightnine2718281828mu5]

Carbon taxes? But carbon is the 2006 Official Element of the Republican Party!

[CalculatedRisk]

Another comment: Why does Mankiw think this is Republicans vs. Democrats issue? Shouldn't everyone be concerned about the environment? I know I am, and I'm still a registered Republican (and embarrassed to admit - a former delegate to the RNC).

The budget debate (like Global Warming) is really between reality based people (GOP or DEM) and fantasy / faith based people.

Remember the Bush tax cuts were supposed to return the surpluses to the people.

"... our budget will run a deficit that will be small and short-term" George W. Bush, SOTU Address, Jan 29, 2002

"The U.S. budget deficit is falling, and it is falling fast." Joshua Bolten, July 14, 2005

Mankiw is part of that fantasy world.

Best Wishes.

[PoDad]

I don't understand why Mankiw fails to consider the taxation of excessive income or wealth as a pigovian tax. It would seem to fit well within his own definition.

[hj]

Before anything else we need to use taxes to diminish income inequality in the US. Unreasonable rewards such as CEO salaries in the multi-million dollar range, multi-million dollar contracts to athletes, etc., etc. could all be eliminated by subjecting income over one million to a 70% tax and income over 2 million to a 90% tax. Income over $500,000 could well be taxed at, say, 45%. After those changes are in place we could consider Mankiw's taxes.

[Jeffrey Miller]

One shouldn't disregard the message because one doesn't like the messenger. I don't have a high opinion of Mankiw, but a tax on pollution - more specifically a tax on carbon and other greenhouse gases - is the right way to go.

A tax on carbon is a more direct and certain way to reduce carbon than using revenue from other sources. If you start with a small tax, with a built in provision for regular and significant increases over many years, the effect will be enormous. It's very important to do something like this now because a lot of utilities are gearing up (I was just reading the Pinnacle West Annual Report yesterday) to build new coal plants, and environmental nightmare unless the carbon is captured and sequestered.

The standard concern is that the poor would suffer more from a carbon tax. So why not make this deal, in which everyone wins: provide free health insurance and eliminate income taxes for the poor; keep taxes on dividends and capital gains low for investors; and impose significant and ever increasing taxes on carbon for the benefit of everyone? That would be rational, and so probably impossible ...

(Oh, and keep the estate tax high while we're at it)

[anne]

Republicans whether in political office or as academics, whether complaining of the President's supposed failure to be properly conservative in failing to slash more social benefit programs, Republicans never mention the terrible lunatic economic drain of $10 billion a month for the war and occupation or "colonizing" of Iraq. Phooey.

[bakho]

The immediate objection is that Mankiw is proposing a further tax shift from the wealthy to the poorest workers. If anything, estate taxes should be increasing, not decreasing.

The environmental problems will not be fixed by "taxing pollution". The gasoline crunch will not be solved by raising taxes either. Why?

20,000 miles / 20 mpg = 1000 gal
$3 / gal X 1000 gallons = $3,000 per year.
Doubling gas mileage would equal $1500 per year.
At $1500 per year, it is still better for the consumer to hang on to the old gas guzzler for a few more years than to buy a new more efficient model.

CAFE standards worked in the 1970s and they will work today.

I would support a gas tax that would keep the price of gas relatively constant and go to development of more efficient transportation and energy efficient/sustainable development. It makes more sense than letting energy companies collect windfall profits and continue to buy politicians that keep consumers at the mercy of Big Oil.

Long term, we need to change the way we fuel our transportation. But that is long term. It requires investment in new technology and/or infrastructure. CAFE standards would have an effect after just a few years and make sense as an incremental step in getting off the gasoline addiction.

[Robert]

I don't understand why Mankiw fails to consider the taxation of excessive income or wealth as a pigovian tax. It would seem to fit well within his own definition.

Indeed!! Progressive taxation of income & wealth taxes are inherently Pigovian.

[Bruce Webb]

"So why not make this deal, in which everyone wins: provide free health insurance and eliminate income taxes for the poor; keep taxes on dividends and capital gains low for investors; and impose significant and ever increasing taxes on carbon for the benefit of everyone?"

Jeff the poor have free health insurance. It's called Medicaid. Jeff the poor don't pay income taxes. Between the standard deduction, the child tax credit and EITC the working poor get money back. What Mankiw and you are suggesting is shifting the tax burden down from the wealthy to the middle class. (In line with the standard Social Security "reform" which calls for people making up to $90,000 to take cuts in benefits even though that system is fully funded while eliminating all taxation on returns from capital.)

We could just as well call this proposal the Punish the Middle Class Commuter/Reward the Fat Cat Tax Act of 2007.

[hj]

OT: Juan Cole has started a petition on his blog in defense of Mearsheimer and Walt and their paper against the smears made about them and it. I would encourge those who believe in freedom of expression to sign it.

[save_the_rustbelt]

Mankiw won't rest until the middle class is destroyed and the poor are put in their place.

How Bushie of him.

[Dirk van Dijk]

Carbon taxes are a good idea, but why use them to ofset Cap gains/Dividend/Estate taxes. Far fairer would be to use them to ofset Payroll taxes, or to say double the standard deduction. Of all the tax cuts, the estate tax cuts are far and away the worst. You can make fairly convincing cases on the dividend cut (the double taxation argument) and capital gains (raising the value of stocks, so that wealth is increased) although I think equity arguments swamp to pro cut arguments. The elimination of the estate tax will just mean that over time the reason for income inequality will not be due to meritocracy but from aristocracy. Meritocracy leads to a far more dynamic society.

[pcs]

Wow, Mankiw is my new hero. A true Robin Hood! How noble, stealing from the Poor to give it to the Rich… While we are at it, why not add the Pigovian tax on food as well. After all, I think everyone will agree that we eat too much in this country. Consequently, we (fill in the blanks) too often. By introducing this tax we will reduce costs of the sewage treatment plants and improve the quality of water in our rivers and oceans at the same time.

Keep up the good work Greg!

[rjw]

A couple of points on gas taxes.

They have an advantage over CAFE standards as standards only work for new vehicles, whereas taxes also provide an incentive to cut current use - for all vehicle users. Taxes operate over the whole vehicle stock.

Taxes provide an incentive to buy smaller vehicles by raising the gas price, whereas direct technical standards do not provide any such incentive, as they do not affect the gas price.

Indeed, if the standards across vehicle classes are not intelligent they may work perversely by raising costs for small cars more than for larger ones, thus encouraging a switch to larger vehicles.

In other words, taxes operate on more 'leverage points' - which is part of the reason economists believe they are likely to be more efficient than direct regulation.

Of course, politically feasible they are not. Perhaps the only way to ever sell them in the US is using the 'reduce energy dependency / security ' argument.

[Michael B]

I am a student at a local college here. This is my second book that I am reading from Mankiw and I have a wonderful teacher of Microeconomics that really knows her stuff. Anyway, i dont think that raising the Pigovian Tax on gasoline is a good idea. First of all, it is not fair to the average Joe and Jane. It will not effect the rich very much but the daily activities of the average people will be much more costly due to the higher gas prices. Second of all, i have read one of the chapters recently and i have found out that when the government raises the tax on something, the deadweight loss or the loss in money due to that tax will rise even faster than the tax. That means that if the tax is large enough, most of the tax will be deadweight loss. Another thing is that when the tax on gasoline would rise, first the consumers would do is to conserve their spending. That menas that companies have a smaller profit which means that companies would have to lay people off because of it which means that unemployment would rise which menas that the economy would fall. I dont think that Mr. Mankiw wants the U.S. economy to go down, does he? That is what it comes down to. Well, replacing one tax with another is a whole other story. I like that idea. Anyway, i don't think that Mr. Mankiw has thought of the tax in this manner. Everything in the business world is connected. Environment is more important to me than the economy but the real challange is to satisfy both sides somehow. The answer is ethanol. This is called elementary economics Mr. Mankiw.