Pro Growth Liberal: Tax “Cuts”: Fill My Mug and Pass the Popcorn

PGL at Angry Bear reminds Greg Mankiw that tax cuts don't pay for themselves:

Tax “Cuts”: Fill My Mug and Pass the Popcorn, by PGL: Greg Mankiw provides this parable about tax policy:

Suppose that every day, ten men go out for beer and the bill for all ten comes to $100. If they paid their bill the way we pay our taxes, it would go something like this:

The first four men (the poorest) would pay nothing. The fifth would pay $1. The sixth would pay $3. The seventh would pay $7. The eighth would pay $12. The ninth would pay $18. The tenth man (the richest) would pay $59. So, that's what they decided to do.

The ten men drank in the bar every day and seemed quite happy with the arrangement, until one day, the owner threw them a curve. "Since you are all such good customers," he said, "I'm going to reduce the cost of your daily beer by $20." Drinks for the ten now cost just $80.

Let me interject something here from Greg's post. The story goes on and after the price cut:

[T]he bar owner ... proceeded to work out the amounts each should pay [after the 20% reduction]. And so:

The fifth man, like the first four, now paid nothing (100% savings).
The sixth now paid $2 instead of $3 (33%savings).
The seventh now pay $5 instead of $7 (28%savings).
The eighth now paid $9 instead of $12 (25% savings).
The ninth now paid $14 instead of $18 (22% savings).
The tenth now paid $49 instead of $59 (16% savings).

Each of the six was better off than before. And the first four continued to drink for free. But once outside the restaurant, the men began to compare their savings. "I only got a dollar out of the $20," declared the sixth man. He pointed to the tenth man," but he got $10!" "Yeah, that's right," exclaimed the fifth man. "I only saved a dollar, too. It's unfair that he got ten times more than I!"

"That's true!" shouted the seventh man. "Why should he get $10 back when I got only two? The wealthy get all the breaks!" "Wait a minute," yelled the first four men in unison. "We didn't get anything at all. The system exploits the poor!"

The nine men surrounded the tenth and beat him up. ... And that, boys and girls, journalists and college professors, is how our tax system works. ...

Back to PGL:

Greg continues with this parable, which can also be found here, commenting on the distribution of this alleged tax cut. I guess this is supposed to be a comment on the 2001 tax cut but there’s something missing here. In the real world, we did not get a tax cut – only a tax shift. Yes, government spending did not decline so somebody will have to pay more in taxes someday.

So let’s finish his parable by assuming that the owner raised the price of the munchies such as popcorn and the beer nuts. One cannot talk about talk about the distribution of the change in tax policy without bringing in the total picture. Yet, we often see our conservative friends implicitly denying that either sales taxes or employment taxes (or both) will have to be increased. Of course, this is one of many myths that get created when one falls for the free lunch fallacy that permeates Republican discussions of fiscal policy.

Hey bartender – pour me another pint and give me some more popcorn. It’s all free – right?

I'll note too that the fact that the owner can cut 20% off the bill and still make a profit ought to raise some eyebrows among the patrons - that's no small amount of monopoly power. In a competitive market, the owner could not do this. In addition, this is not how we analyze the general equilibrium effects of change in the burden of taxes after a tax change. Even with partial equilibrium analysis, when taxes are increased the customers will not face 100% of the burden, the burden is shared between the owner and the customers. In the opposite direction, when taxes are cut, the reduced burden is shared as well. That's missing from this analysis.

As to Greg's the main point, questions about the equity of tax cuts, the other thing missing is what taxes pay for. Making the good in the story beer (i.e. something we could do without) and then allowing the same quantity to be purchased at a lower price is not a parable that relates to government spending. Unlike this made-up story with it's made-up resentments, taxes fund government services - something must be given up when taxes are cut, or taxes must be raised in the future as PGL notes. In the case where programs must be cut, if it's essential social programs, then I hope that people do raise questions of basic equity. Cutting estate taxes when we cannot afford pre-school programs for disadvantaged children would be a much better parable for Greg to tell. We could point fingers at the disadvantaged and call them whiners for asking if paying for estate tax-cuts by not fully funding programs such as these is fair - but I suspect we won't hear that story.

Comments

[Callahan]

Most of our Republican friends believe that tax cuts are the greatest thing since sliced bread. Good for the economy. So why don't they cut all taxes for the rich? Hell we would have the best damned economy ever.

It would trickle down on us, I betcha.

[dale]

"The modern conservative is engaged in one of man's oldest exercises in moral philosophy; that is, the search for a superior moral justification for selfishness." JK Galbraith

[RN]

dale -

Fantastic quote.

Greg Mankiw is purely devoid of morality.

[eightnine2718281828mu5]

And the right claims that economic mobility allows the poor guy to eventually become the rich guy and vice versa.

Which complicates the concept of winner vs loser somewhat.

[spencer]

this is the type of "story telling" you expect to hear in some bar late at night after everyone has had too much to drink.

You would think a top notch Harvard economist and former head of the council of economic advisors could do better then this.

Maybe it is like the explanation of why Alan Greenspan only visited the Clinton White House once a month but went to the Bush white House every few days. People worried that it was political bias, but it really was because he had to keep repeating the same thing over and over again before Bush would get it. So I guess Mankiw
got in the habit of using simple stories like this to explain policy when he was at the White House and can not break the bad habit.

[dogfacegeorge]

What's interesting about this silly story is how many different reactions it provokes. And that, I think, is its power - the power to confuse.

Here's the one and only true point: The beer still costs $100. The patrons paid $80 of that cost; thus, $20 will be paid in the future. We do not know who will pay that $20, but there is good reason to believe that it will be paid by the poorest 5 or 6 patrons and their children.

[David]

dogfacegeorge, the $20 will be paid in the future, but what makes you think the poorest 5 or 6 will pay? They are paying little/nothing now. More likely, the $20 will be paid by the richest few people in the future (who may be children of any of the 10). In any case, the problem is that the people paying the $20 weren't drinking beer that night.

I think the shots at Mankiw are unfair. I don't believe the parable is intended to make any bigger point than that the criticisms of tax cuts favoring the wealthy using absolute numbers or percentage reductions are silly. When the bottom 50% is paying little or no taxes, their tax cuts can't be that big.

[eightnine2718281828mu5]

---
They are paying little/nothing now.
---

What makes you think that the tax story ends at the prmary payer? The lower tiers could bear part of the ultimate cost by having their pay lowered at the behest of folks whose taxes are raised.

See the latest Circuit City news for more details.

OTOH, taxing the poor directly limits their income, so part of the cost of the tax will be borne by places like Walmart who do business with them.

Elasticities present in every interaction/exchange enter into the determination of who shares in the burden of the ultimate cost. The idea that anyone is completely isolated from the others is misguided.

Money is a fluid; it flows into every available crevice and after a time lag, eventually settles to its natural equilibrium.

[calmo]

I don't know spencer, I think the 'beer' is ready made for the freshman class that he teaches (and to his credit that he engages that roudy bunch in preference to the staid graduates) and that the time Greenspan spent with w (as well as the time mankiw spent?) says something about w's learning curve rather than mankiw's captivating story telling...which I hope would be different from this beer parable.
David, I think this might be fair but (hope robertdf is busy elsewhere) possibly inexperienced:I think the shots at Mankiw are unfair. Angry Bear's pgl bangs this one out of the park with 'tax shift', but this topic surfaced here earlier (that experience) on a thread that discussed Mankiw's remark about a bias in reporting the share that wealthy taxpayers shell out. Mankiw seemed genuine about this claim and I my measure of his intelligence and political allegiance shifted with that. If I had the memory to pick out the month last year? I would search the archives here.

[DRR]

This is really strange, as Mankiw is one of the only conservative economists to admit in his textbooks that tax cuts, don't in fact pay for themselves. That he would later go on ti dissemble is troubling.

[dogfacegeorge]

"the $20 will be paid in the future, but what makes you think the poorest 5 or 6 will pay? They are paying little/nothing now"

First, it's not true that the poorest are not paying taxes now. They are paying plenty of taxes - just not federal income taxes.

Second, the entire arc of the Bush Admin is one of shifting taxes off the shoulders of capital and onto the shoulders of labor. That was the main theme of the two tax cuts, and the theme of the SS privitization scheme. The constituency for this shift will continue to push for it forevermore.

[ilsm]

David,

I have become a fan of taxfoundation recent report on distribution of tax receipts and benefits.

The lowest income quintile actually gets more from government than their "comprehensive income". The gets include transfer payments, public goods and private goods delivered by goovernment. The top quintile gets a much lower percent of their "Comprehensive income" than the lowest.

Looking at it terms of dollars figure 12 pg 64 benefit the lowest quintile gets: $ 35,500 the highest household income quintile gets #33,500 (2004).

So, the question is how can 20% of the population live on an average of $34,000 a year while the top 20% gets almost that much from the government?

Do the top get too little or too much?

Do the bottom get too little or too much?

The lowest quintile are actually wealthy in Throeau's terms he defined wealth as proportional to the things one can live without.

The rich are poor they seem to be hard pressed to live without the mney taxed from them.

[anne]

Clever, Ilsm :)

[eightnine2718281828mu5]

You know how electronics retailers have those rebate programs? And rely on the fact that some people are too lazy to send in the rebates? (Which the retailers may then claim to 'lose' but that's another story.)

But they can still make a sale to people who absolutely wouldn't have purchased it without the rebate; sort of a tiered pricing in effect, which asks the buyer 'how badly do you want the rebate?'

Taxes on the well-off may have similar characteristics. If their taxes are too high, they can wiggle out of them through write-offs or pass part of the burden along to their employees (through lower wages), customers (through higher prices), etc. This is a much more difficult game for those of more limited means.

So it seems that taxing the rich could be less onerous than taxing the poor since the rich have various and sundry ways of passing the costs off on others if they are motivated enough to pursue the alternatives. Much like our rebate customer.

But folks further down the ladder have fewer options in this regard.

[reason]

It is also not true that the rich only get their one beer. It is the rule of law, protection of property rights thing and public infrastructure. The rich have more to gain. They are finding that out now with Health Insurance.

[reason]

With Health Insurance what I mean is the problems that firms are having in providing employee coverage (not that rich personally need public coverage). Social Infrastructure would mean big savings for employers - get it.

[Alex]

I thought Mankiw was just remarking on the perception of tax cuts themselves.