Category Archive for: Taxes [Return to Main]

Thursday, October 04, 2007

America is Not at War, America is at the Mall

A proposal to raise taxes to help to pay for the war:

The Iraq money pit, by James P. McGovern, Boston Globe: I recently came across a photo of a handwritten sign in a US military facility in Ramadi, Iraq. The sign read, "America is not at war. The Marine Corps is at war; America is at the mall."

The sign reflects a perception among many US soldiers and their families that the American people are not sharing in their sacrifice. It is a perception grounded in reality..., who is really sacrificing? Certainly not members of Congress. We will not wake up tomorrow in harm's way in Baghdad or Fallujah. ...

I propose we change this dynamic by raising taxes on nearly every American in order to pay for the war in Iraq. ...

It is reasonable to assume that the cost will approach $800 billion by the time Bush leaves office. I will soon introduce legislation to impose a "surtax" to begin paying for future war costs that have not been budgeted and paid for by existing federal revenues. This war surtax is modeled on similar surtaxes imposed during World War II and the Vietnam War to cover war costs. ...

My surtax proposal is not an additional tax on income; rather, it is a tax on tax liability.

For example, if a low-income taxpayer owes $100 in taxes, he would be subject to an additional 2 percent surtax of $2. Wealthy taxpayers would pay a higher percentage. Corporations, trusts, and estates would also be subject to the surtax.

Needless to say, this idea of a surtax makes my colleagues - Democrat and Republican - exceedingly nervous. No politician likes to talk about raising taxes. But somebody, someday, somewhere will pay the hundreds of billions we have borrowed so far for this war.

My conservative colleagues will argue that we should cut spending to cover the costs. That's nice rhetoric, but it's not real. Are we going to eliminate the entire departments of Labor, Education, and Health and Human Services? Or how about eliminating all funding for the departments of Agriculture, Commerce, Justice, Energy, Interior, Treasury, the EPA, and NASA combined? That's what it would take to fund just one year of the Iraq war.

Some of my fellow antiwar liberals believe that since the war in Iraq is wrong, they do not want to pay for it. But isn't it also wrong to force future generations to pay for it?

I voted against the war in Iraq. I have consistently fought to bring the war to an immediate end and to bring our troops home. I believe it is the worst political, military, and diplomatic tragedy in our history.

But to force our children to pay for that tragedy would only compound it. The war in Iraq has been this generation's mistake. It should not be the next generation's burden.

We have an opportunity to say to our soldiers and their families that we are in this together; that their fellow citizens are also sacrificing just a little bit.

That's a message worth sending.

While it's certainly true that someone will have to pay for the war at some point - somebody, someday, somewhere will have to give up something to pay the bills - raising taxes right now is not good short-run economic policy given the current weakness in the economy. Driving the economy into a recession would show sacrifice, but that's not the best way to show our support.

It's not good politics either. If a bill was passed raising taxes, and George Bush actually signed it only to have the economy then sink into a recession due to the housing slump or other causes, the political fallout would be large (The WSJ is already claiming that the belief that Democrats will raise taxes is making businesses hesitant to invest and contributing to the current weakness). Thus, while good long-run budget policy does require a plan to pay for expenditures, the political gain from raising taxes now seems small relative to the potential political and economic downside.

I am not objecting to implementing reality-based long-run budget policy, but the mistake was cutting taxes with a war on and the economy relatively strong. We shouldn't compound that error by now raising taxes just as the economy is showing signs of weakness. We will need to pay for this war, and I understand the underlying political point being made through a proposal which has no realistic chance of passage. But even if it did have a chance to pass, now is not the time to put the brakes on the economy.


And please drop this argument:

My surtax proposal is not an additional tax on income; rather, it is a tax on tax liability. For example, if a low-income taxpayer owes $100 in taxes, he would be subject to an additional 2 percent surtax of $2.

That's just an accounting gimmick that invites ridicule from the opposition. This raises taxes, so just say that directly. If the person earns $1,000 and the tax is 10% (=$100), then with the surcharge the tax on income is 10.2% or $102. The $2 comes out of income one way or the other and calling it a tax on a tax doesn't change that.

Wednesday, September 26, 2007

Alan Greenspan versus Naomi Klein

This is part of a longer interview of Alan Greenspan and Naomi Klein:

Alan Greenspan vs. Naomi Klein on the Iraq War, Bush's Tax Cuts, Economic Populism, Crony Capitalism and More, Democracy Now [Watch 128k stream, Watch 256k stream]: AMY GOODMAN: ...We welcome you both to Democracy Now! ... You worked with six presidents, with President Reagan, with both President Bushes. You worked with President Ford, and you worked with Bill Clinton, who you have called a Republican president; why?

ALAN GREENSPAN: That was supposed to be a quasi-joke. ... I’m a libertarian Republican, which means I believe in a series of issues, such as smaller government, constraint on budget deficits, free markets, globalization, and a whole series of other things, including welfare reform. And as you may remember, Bill Clinton was ... doing much that same agenda... [H]e is a centrist Democrat. And that's not all that far from libertarian Republicanism. ...

AMY GOODMAN: Alan Greenspan, let's talk about the war in Iraq. You said what for many in your circles is the unspeakable, that the war in Iraq was for oil. Can you explain?

Continue reading "Alan Greenspan versus Naomi Klein" »

Saturday, September 22, 2007

EconoSpeak

Pro-Growth Liberal (PGL), in a post at EconoSpeak, says "Greg Mankiw Asks the Democrats a Good Question on Fiscal Policy." PGL has a few questions of his own.

EconoSpeak is a new blog featuring Kevin Quinn, PGL, Peter Dorman, Michael Perelman, Econoclast, B. Rosser, Sandwichman, and others to whom I apologize for leaving off the list.

Thursday, September 20, 2007

"A Serious Middle-Class Tax Cut?"

National Review editor Ramesh Ponnuru wonders why Republicans are pushing tax cuts that don't benefit the Party's lower income supporters:

Taxing the Hand That Feeds Us, by Ramesh Ponnuru: Republican presidential candidates can’t get elected without owning the tax issue. So far, the current crop is giving it away. ...

Republican contenders for 2008 are promising to keep all of Mr. Bush’s tax cuts. But the Democrats are not threatening the child tax credit or Mr. Bush’s reductions in the lower-level income-tax rates. Those issues are off the table.

What Mitt Romney and Rudy Giuliani ... are really saying is that they will make sure that taxes on capital gains, dividends, estates and high earners will stay low. Not many middle-class taxpayers will benefit directly from any of those policies.

Mr. Romney adds that he will try to cut the corporate tax rate, which his adviser Glenn Hubbard calls “a drain on competitiveness.” ... Cutting corporate tax rates may or may not be a good idea, but we don’t need to make it a priority to preserve our competitiveness.

Both Mr. Romney and Mr. Giuliani speak vaguely about making sure the alternative minimum tax doesn’t affect any more middle-class families. That is a step in the right direction. But it isn’t a tax cut.

Mr. Romney has also proposed an initiative to make the return on middle-class savings tax-free. It may also be a step in the right direction, but it’s small change. The primary focus of the Romney and Giuliani tax plans remains high earners.

What would be a serious middle-class tax cut? One answer is to expand the tax credit for children. But none of the candidates is proposing to do so, or any other big tax relief for regular folks. You might think that Mr. Giuliani would want to do everything he can to appeal to social conservatives short of actually becoming one himself. But why should he offer a pro-family tax cut when even the hard-core social conservatives in the race aren’t interested? Mike Huckabee wants a national sales tax and Sam Brownback wants a flat tax. Either proposal would increase taxes on a lot of middle-class families.

The Republicans in Congress are no better. For much of the right, the great passion of the moment is to make sure that the carried interest at hedge funds is taxed at what look an awful lot like preferential rates. For years, liberals have said that Republicans talk about “family values” but won’t do anything to meet the economic needs of families. Right now, on taxes, that charge hits home. ...

Continue reading ""A Serious Middle-Class Tax Cut?"" »

Wednesday, September 19, 2007

Uh, No, Your Tax Cuts Didn't Pay for Themselves

Not too long ago, some people were arguing that supply-side ideas are no longer part of the Republican mainstream. This is President Bush responding to Alan Greenspan's criticism of his tax-cuts:

I would also argue that cutting taxes ... made a significant difference in dealing with the deficit because the growing economy yielded more tax revenues, which allowed us to shrink the deficit.

The tax cuts paid for themselves? I wish the President and others would quit misleading people about this because it's not true. His own economists don't even believe that. I know some of you are tired of hearing this over and over, but somebody has to try to call them on this or they'll just keep saying it, and the press seems unwilling to do so so. For example, the Wall Street Journal article the quote above is taken from doesn't even bother to mention that there's no evidence to support this claim, instead it's treated as a "he said-she said" story between Bush and Greenspan.

The tax cuts made the deficit worse. End of story.

Monday, September 17, 2007

Paul Krugman: Sad Alan's Lament

Paul Krugman takes issue with Alan Greenspan's contention that he didn't mean to endorse the Bush tax cuts:

Sad Alan’s Lament, by Paul Krugman, Commentary, NY Times: When President Bush first took office, it seemed unlikely that he would succeed in getting his proposed tax cuts enacted. The questionable nature of his installation in the White House seemed to leave him in a weak political position, while the Senate was evenly balanced between the parties. It was hard to see how a huge, controversial tax cut, which delivered most of its benefits to a wealthy elite, could get through Congress.

Then Alan Greenspan, the chairman of the Federal Reserve, testified before the Senate Budget Committee.

Until then Mr. Greenspan had presented himself as the voice of fiscal responsibility, warning the Clinton administration not to endanger its hard-won budget surpluses. But now Republicans held the White House, and ... Greenspan ... was a very different man.

Suddenly, his greatest concern ... was to avert the threat that the federal government might actually pay off all its debt. To avoid this awful outcome, he advocated tax cuts. And the floodgates were opened. ...

Mr. Greenspan now says that he didn’t mean to give the Bush tax cuts a green light, and that he was surprised at the political reaction to his remarks. ... But ... if Mr. Greenspan wasn’t intending to lend crucial support to the Bush tax cuts, he had ample opportunity to set the record straight...

His first big chance to clarify himself came a few weeks after that initial testimony, when he appeared before the Senate Committee on Banking, Housing and Urban Affairs.

Here’s what I wrote following that appearance: “Mr. Greenspan’s performance yesterday ... was a profile in cowardice. Again and again he was offered the opportunity to say something that would help rein in runaway tax-cutting; each time he evaded the question... He declared ... that he was speaking only for himself, thus granting himself leeway to pronounce on subjects far afield of his role as Federal Reserve chairman. But when pressed on the crucial question of whether the huge tax cuts that now seem inevitable are too large, he said it was inappropriate for him to comment on particular proposals.

“In short, Mr. Greenspan defined the rules of the game in a way that allows him to intervene as he likes in the political debate, but to retreat behind the veil of his office whenever anyone tries to hold him accountable for the results of those interventions.”...

I received an irate phone call from Mr. Greenspan ... in which he demanded to know what he had said that was wrong. In his book, he claims that Robert Rubin ... was stumped by that question. ... I certainly wasn’t: Mr. Greenspan’s argument for tax cuts was contorted and in places self-contradictory, not to mention based on budget projections that everyone knew, even then, were wildly overoptimistic.

[T]wo years later, when the administration proposed another round of tax cuts, even though the budget was now deep in deficit..., guess what? The former high priest of fiscal responsibility did not object.

And in 2004 he expressed support for making the Bush tax cuts permanent —... tax cuts he now says he didn’t endorse — and argued that the budget should be balanced with cuts in entitlement spending, including Social Security benefits, instead. ...

In retrospect, Mr. Greenspan’s moral collapse in 2001 was a portent. It foreshadowed the way many people in the foreign policy community would put their critical faculties on hold and support the invasion of Iraq, despite ample evidence that it was a really bad idea.

And like enthusiastic war supporters who have started describing themselves as war critics now that the Iraq venture has gone wrong, Mr. Greenspan has started portraying himself as a critic of administration fiscal irresponsibility now that President Bush has become deeply unpopular and Democrats control Congress.

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Previous (9/14) column: Paul Krugman: A Surge, and Then a Stab

Saturday, September 15, 2007

Mankiw: One Answer to Global Warming: A New Tax

Greg Mankiw proposes (surprise, surprise) a Pigouvian tax to solve the global warming problem. The focus here is on its political viability:

One Answer to Global Warming: A New Tax, by N. Gregory Mankiw, Economic View, NY Times: In the debate over global climate change, there is a yawning gap that needs to be bridged. The gap is not between environmentalists and industrialists, or between Democrats and Republicans. It is between policy wonks and political consultants.

Among policy wonks like me, there is a broad consensus. The scientists tell us that world temperatures are rising because humans are emitting carbon into the atmosphere. Basic economics tells us that when you tax something, you normally get less of it. So if we want to reduce global emissions of carbon, we need a global carbon tax. Q.E.D. ...

Those vying for elected office, however, are reluctant to sign on to this agenda. Their political consultants are no fans of taxes, Pigovian or otherwise. ... Yet this natural aversion to carbon taxes can be overcome if the revenue from the tax is used to reduce other taxes. By itself, a carbon tax would raise the tax burden on anyone who drives a car or uses electricity produced with fossil fuels, which means just about everybody. Some might fear this would be particularly hard on the poor and middle class.

But Gilbert Metcalf, a professor of economics at Tufts, has shown how revenue from a carbon tax could be used to reduce payroll taxes in a way that would leave the distribution of total tax burden approximately unchanged. He proposes a tax of $15 per metric ton of carbon dioxide, together with a rebate of the federal payroll tax on the first $3,660 of earnings for each worker.

The case for a carbon tax looks even stronger after an examination of the other options on the table. Lawmakers in both political parties want to require carmakers to increase the fuel efficiency of the cars they sell. Passing the buck to auto companies has a lot of popular appeal.

Increased fuel efficiency, however, is not free. Like a tax, the cost of complying with more stringent regulation will be passed on to consumers in the form of higher car prices. But the government will not raise any revenue that it can use to cut other taxes to compensate for these higher prices. ...

More important, enhancing fuel efficiency by itself is not the best way to reduce energy consumption. ...

A carbon tax would provide incentives for people to use less fuel in a multitude of ways. By contrast, merely having more efficient cars encourages more driving. Increased driving not only produces more carbon, but also exacerbates other problems, like accidents and road congestion.

Another popular proposal to limit carbon emissions is a cap-and-trade system, under which carbon emissions are limited and allowances are bought and sold in the marketplace. The effect of such a system depends on how the carbon allowances are allocated. If the government auctions them off, then the price of a carbon allowance is effectively a carbon tax.

But the history of cap-and-trade systems suggests that the allowances would probably be handed out to power companies and other carbon emitters, which would then be free to use them or sell them at market prices. In this case, the prices of energy products would rise as they would under a carbon tax, but the government would collect no revenue to reduce other taxes and compensate consumers.

The international dimension of the problem also suggests the superiority of a carbon tax over cap-and-trade. Any long-term approach to global climate change will have to deal with the emerging economies of China and India. ...

Agreement on a truly global cap-and-trade system, however, is hard to imagine. ... A global carbon tax would be easier to negotiate. All governments require revenue for public purposes. The world’s nations could agree to use a carbon tax as one instrument to raise some of that revenue. No money needs to change hands across national borders. Each government could keep the revenue from its tax and use it to finance spending or whatever form of tax relief it considered best.

Convincing China of the virtues of a carbon tax, however, may prove to be the easy part. The first and more difficult step is to convince American voters, and therefore political consultants, that “tax” is not a four-letter word.

Thursday, September 13, 2007

Tax Cut Message No Longer Resonates with Independent Voters

Looks like the magic of the "tax-cuts fix everything" message is wearing off:

GOP Forced to Pivot on Taxes, by Erin Billings, Roll Call: Senate Republicans are likely to engage in a more serious message makeover than they previously thought following a private strategy session ... where they reviewed new polling data showing tax cuts are no longer priority No. 1 with key independent voters.  The news, GOP Senators acknowledged..., served as an important wake-up call as the party undergoes its massive internal image overhaul. The theme of lower taxes has been a cornerstone of the Republican platform ...

The findings ... showed Senators that Americans are far more focused on key domestic reforms like health care reform and the level of government spending rather than on previously enacted GOP tax reductions. ... Republican Senate sources said the latest information ... shows Republicans relied too easily on tax cuts as the answer to every domestic problem... [E]xplained one senior GOP Senate aide. "We've worn out the message."...

Tuesday, September 11, 2007

Robert Reich: The Way to Prevent the Looming Recession

Robert Reich says tax cuts are the answer:

The Way to Prevent the Looming Recession, by Robert Reich: With the economy heading for recession, all eyes are on Ben Bernanke and the Fed... But a Fed rate cut won't stimulate the economy. That's because lending institutions, fearing their portfolios are far riskier than they assumed several months ago, won't lend lots more just because the Fed lowers interest rates.

Average consumers are already so deep in debt ... they can't borrow much more, anyway. With average home prices dropping... And given last Friday’s report showing the first employment drop in four years, people are not in the mood to keep spending.

So if a Fed rate cut can't prevent a recession, what can? Putting more money into American pockets by cutting their taxes. Yes, I know: Tax cuts have gone out of style ever since Democrats became born-again deficit hawks, and George Bush squandered the $5 trillion surplus he inherited in 2000 mainly by cutting taxes on the rich. ...

[T]ax cuts for the rich won't help because the rich don’t increase their spending when their taxes are cut. They already spend as much as they want to spend. That's what it means to be rich. It's middle and lower-income Americans who spend more when their taxes are cut. And because the biggest tax they face is the payroll tax, the payroll tax needs to be cut in order to keep them spending and avoid a recession.

I say exempt the first $15,000 of earnings from payroll taxes for a year, starting as soon as possible. Sure, this may cause the budget deficit to widen a bit. But if the economy goes into the tank, the deficit will be far bigger.

There are reasons that work both for and against the use of fiscal policy to stabilize the economy, and I'm not fully convinced it can work very well in the present political environment in any case. But as to worries about the deficit, in general that is much less of a concern in a recession, and in this particular instance I don't see why workers should risk unemployment now because tax cuts for the wealthy, and the deficit the tax cuts brought about, limit our ability to respond to negative shocks.

Monday, September 10, 2007

Paul Krugman: Where’s My Trickle?

Paul Krugman says the experience since the Bush tax cuts shows that trickle down theory does not work:

Where’s My Trickle?, by Paul Krugman, Commentary, NY Times: Four years ago the Bush administration, exploiting the political bounce it got from the illusion of success in Iraq, pushed a cut in capital-gains and dividend taxes through Congress. It was an extremely elitist tax cut even by Bush-era standards: the nonpartisan Tax Policy Center says that more than half of the tax breaks went to Americans with incomes of more than $1 million a year.

Needless to say, administration economists produced various misleading statistics designed to convey the opposite impression, that the tax cut mainly went to ordinary, middle-class Americans. But they also insisted that the benefits of the tax cut would trickle down — that lower tax rates on the rich would do great things for the economy, helping everyone.

Well, Friday’s dismal jobs report showed that ... working Americans have a right to ask, “Where’s my trickle?” ... What’s really remarkable ... is that four years of economic growth have produced essentially no gains for ordinary American workers.

Wages, adjusted for inflation, have stagnated..., benefits have deteriorated..., [a]nd one of the few seeming bright spots of the Bush-era economy, rising homeownership, is now revealed as the result of a bubble inflated in part by financial flim-flam...

Now you know why 66 percent of Americans rate economic conditions in this country as only fair or poor, and why Americans disapprove of President Bush’s handling of the economy almost as strongly as they disapprove of the job he is doing in general.

Yet the overall economy has grown at a reasonable pace over the past four years. Where did the economic growth go? The answer is that it went to the same economic elite that received the lion’s share of those tax cuts. ...

The absence of any gains for workers in the years since the 2003 tax cut is a pretty convincing refutation of trickle-down theory. So is the fact that the economy had a much more convincing boom after Bill Clinton raised taxes on top brackets. It turns out that when you cut taxes on the rich, the rich pay less taxes; when you raise taxes on the rich, they pay more taxes — end of story. ...

[T]he whole idea that a rising tide raises all boats, that growth in the economy necessarily translates into gains for the great majority of Americans, is belied by the Bush-era experience. As far as I can tell, America has never before experienced a disconnect between overall economic performance and the fortunes of workers as complete as that of the last four years.

America was a highly unequal society during the Gilded Age, but workers’ living standards nonetheless improved as the economy grew. Inequality rose rapidly during the Reagan years, but “Morning in America” was nonetheless bright enough to make most people cheerful, at least temporarily. Inequality continued to increase during the Clinton years, but wages rose, as did the availability of health insurance — and the great majority of Americans felt prosperous.

What we’ve had since 2003, however, is an economic expansion that looks good if not great by the usual measures, but which has passed most Americans by.

Guaranteed health insurance ... would eliminate one of the reasons for this disconnect. But it should be only the start of a broader range of policies — a new New Deal — designed to turn economic growth into something more than a spectator sport.

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Previous (9/7) column: Paul Krugman: Time to Take a Stand
Next (9/14) column: Paul Krugman: A Surge, and Then a Stab

Sunday, September 09, 2007

Henry Farrell: Gift Economies

What are the forces driving the shift from government funded charity that represents collective political choice to a system that relies more on private sector sources and individual choice, particularly the choices of the wealthy, to support worthy social causes?:

Gift economies, by Henry: [edited] Christopher Caldwell is a columnist whom I usually find quite annoying, but his attack today ... on Bill Clinton’s forthcoming book on charitable giving gets to the crux of the issue.

...Mr Clinton['s] ... book ... is evidence that he has cracked the code of an inchoate form of political power that is still illegible to most of his contemporaries. … Giving tells us something about a decisive shift that is just beginning – from helping people (soup, a bath) to helping humanity (rain forests, greenhouse gases); from local, self-abnegating charity (the Salvation Army) to glamorous, globalised philanthropy (Angelina Jolie). …

We have seen this shift before. In The Gospel of Wealth (1889), the steel magnate Andrew Carnegie urged the very rich to give away their money during their lifetimes. … When plutocrats are involved in philanthropy, to place philanthropy above criticism is to place money-making above criticism. … If there is a refreshing lack of dogmatism in Mr Clinton’s book, there is also an inattention to elementary questions of political legitimacy. ...

Mr Clinton praises the rock singer Bono’s campaign to obtain debt forgiveness for African countries. Whether this is a wise move or not, who elected Bono to do it? The answer is, capitalism did. Today’s celebrity philanthropists are empowered by a society that specialises in movies and songs in exactly the way the robber barons were empowered by one that specialised in railroads and steel. Philanthropy is a route through which celebrity can be laundered into political power. It is also one means by which the responsibility for important tasks is being reassigned from democratic structures to less democratic ones.

The politics of giving is becoming an important issue ... because of the increasing disparities in wealth between the very rich indeed and the rest of us. It serves at best as a weak and inefficient means of redistribution – the emphasis tends to be more on circuses than on bread, and in particular on the kinds of circuses (alumni associations, high-prestige arts) that have obvious social or personal payoffs for the giver. The increased emphasis on gift-giving reflects how collective political choice ... is increasingly giving way to individual choice (and most importantly the individual choices of a very small minority of people). Contrary to some of the more glib arguments out there, there is no reason to believe that this is an improvement on the previous situation, and some reason to believe that it is a substantial disimprovement. It’s nice to see someone like Caldwell, who is clearly on the right, getting that.

Many people start with the presumption that the private sector is more efficient than the public sector, then use this to argue that there is a net social benefit when tax incentives and other schemes are used to replace public spending with private sector charity. The presumption itself maybe false in many cases, but if the result is that spending is distorted in the sense that resources are directed to uses that are inconsistent with collective political preferences, then another kind of inefficiency arises and it's not at all clear there is a net social benefit. Doing things we don't much care about at low cost is not optimal if important social problems are left unattended as a consequence.

The fact that people help more when the government helps less doesn't relieve the government from its responsibility to broker collective political choice to solve social problems. The government should do what needs to be done and if people or organizations in the private sector want to top it off with more, so much the better. I don't want to criticize Bono, or anyone else, for stepping in and trying to help even if their motive is, ultimately, for personal gain. Operas, museums, soup kitchens, shelters, cash grants to people on the street, whatever, so long as the government is doing its job, it's all just icing on the cake.

Thursday, September 06, 2007

Is Rudy Out of the Mainstream of the GOP?

There's an argument being made (Tyler Cowen, Megan McArdle) that supply-side economics, the kind that says tax cuts pay for themselves, is no longer mainstream in the Republican party, i.e. it no longer has any influence and is no longer used as an argument for cutting taxes.

Is it true that supply-side economics no longer has influence in the Republican party? This is straight from Giuliani's web site:

Rudy is the real fiscal conservative in the race. He cut taxes 23 times in New York and turned a $2.3 billion budget deficit into a multi-billion dollar surplus, while balancing the city’s budget. Because he turned his conservative principles into action, New York City taxpayers saved more than $9 billion in taxes and enjoyed their lowest tax burden in decades, while the economy grew and city government saw its revenues increase from the lower tax rates. Rudy Giuliani believes in supply-side economics, because he did it and he saw it work.

Update: Free Exchange quotes last night's Republican debate (Brendan Nyhan too):

Laffer Riot, Free Exchange: ...Over at The Atlantic, Megan McArdle took issue with Mr Chait's assessment of supply-side tax policies (whereby lower tax rates increase revenues) as hugely influential...

Matthew Yglesias [cited] ... the embrace of supply side orthodoxy by much of the conservative establishment, including prominent columnists and intellectuals, along with GOP congressional leadership and the president himself.

Tyler Cowen now places himself firmly in Ms McArdle's corner, disavowing supply sider influence. ...[A]s a counterpoint, I would refer him to last night's Republican debate in New Hampshire. Looking over the transcript one finds Senator John McCain saying:

I stand on my record, and my record is 24 years of opposing tax increases, and I oppose them, and I’ll continue to oppose them. I think it’s very clear that the increase in revenue that we’ve experienced is directly related to the tax cuts that were enacted, and they need to be made permanent rather than the family budgets and businesses being uncertain about their future.

Moments later, Rudy Giuliani chimes in:

I have without any doubt of all the people running for president the strongest record of lowering taxes. I did it 23 times in a city that had never lowered a tax before well over $9 billion. I lowered the personal income tax 25 percent, and I was collecting 40 percent more in revenues from the lower tax than the higher tax. I made supply-side economics work in a city that didn’t understand it, and I ended up having a very positive impact on the economy of the city as a result of that.

It seems that at least as far as major candidates for the highest elected office in the land are concerned, supply side tax policies remain influential.

Jason Furman: The Effect of the 2001-06 Tax Cuts on After-Tax Incomes

With all the debate about tax cuts the last few days, this is timely. Here is Jason Furman testifying before the House Ways and Means Committee today about the impact of the 2001-06 tax cuts on the level and distribution of after-tax incomes. The extent to which the tax cuts helped to pay for themselves is also examined, and the dynamic impacts are almost imperceptible (and may even work in the wrong direction).

But the fact that these tax cuts did not pay for themselves or even offset the costs to any noticeable degree is old news. What's interesting about these estimates is that they imply that the tax-cuts leave nearly three quarters of households with lower after-tax incomes. Why does this occur? Most dynamic economic models that predict tax cuts will lead to higher GDP growth also generally assume that the tax cuts are paid for by reducing benefits or raising other taxes (e.g. replace labor/capital taxes with lump-sum taxes as in the Mankiw-Weinzerl model).

Thus, although tax cuts may result in efficiency gains, which is often one of the main arguments given for tax cuts (e.g. "tax cuts, by reducing deadweight loss ... will be good for the economy"), when you factor in the new taxes and who pays them (or equivalently reductions in benefits like Social Security, Medicare, or food stamps) and look at the resulting distribution of winners and losers, the outcome is one where three quarters of households come out behind. Jason terms this "dynamic distributional analysis":

The Effect of the 2001-06 Tax Cuts on After-Tax Incomes, by Jason Furman[1], Testimony Before the U.S. House Committee on Ways and Means, September 6, 2007 (summary): Mr. Chairman and other members of the Committee, thank you for the invitation to testify today at this hearing on fair and equitable tax policy for America’s working families. I would like to start with a confession: as an economist I have no special expertise in fairness or equity. The members of this committee were elected, in part, to make critical value judgments about these fundamental questions. But in order to make these value judgments you need the understand who is impacted by the tax changes and how they are impacted. And economists do have a special expertise that can help further this understanding and thus inform the debate on the bigger issues.

Evaluating a tax change requires understanding the impact it has on households through three different channels: (1) the direct impact of the tax changes on take-home pay; (2) the economic effects of the tax change on before-tax incomes; and (3) the impact that the associated budgetary changes have on future taxes or government spending on households. All three channels can be usefully summarized in a single variable: the change in the after-tax incomes of households.[2]

Policy analysts and official scorekeepers have made varying degrees of progress on each of these three channels but have seldom integrated them into one comprehensive assessment of tax proposals. My testimony today applies such an integrated approach, potentially termed “dynamic distributional analysis,” to examine the long-run impact of the tax cuts enacted from 2001 to 2006 on the after-tax income of American families.

Some of the key findings of this analysis are:

  • The direct effect of the tax cuts enacted from 2001-06 is to increase after-tax income inequality. Ignoring the effects on the economy and the budget, making the tax cuts permanent would result in a 0.7 percent increase in the after-tax income of the bottom quintile and a 6.7 percent increase in the after-tax income of the top 1 percent. As a result, the gap between these incomes would grow.
  • Economic models generally rule out the possibility of a large, positive impact of the tax cuts on the economy and incomes. In one favorable – but highly unrealistic – scenario the Treasury found that making the tax cuts permanent would be equivalent to raising the growth rate by 0.04 percentage points annually spread out over 20 years. In other words, the growth rate could rise from 3.00 percent to 3.04 percent – a change that would barely be perceptible in quarterly data on the economy. In more realistic scenarios the Treasury found the tax cuts would result in higher debt and lower savings – thus reducing long-run output.
  • Economic models show that the need to eventually finance the tax cuts could result in a large, negative impact on the disposable income of households, for example through reduced Social Security benefits, Medicare benefits, or higher future taxes. This occurs because no economic model finds that tax cuts pay for themselves. The results of dynamic macroeconomic feedback show that the tax cuts are only slightly more expensive or slightly less expensive than shown by the official estimates that ignore such feedback.
  • Taken together, illustrative estimates show that even in the unrealistic best case scenario – in which tax cuts boost incomes and pay for part of their long-run cost through higher economic output – the financing costs of the tax cuts would leave 74 percent of households with lower after-tax incomes. If the increased debt and reduced savings associated with the tax cuts leads to lower incomes, then 76 percent of households would end up with lower after-tax incomes.

Out of the Mainstream?

Megan McArdle says supply-siders -- the ones who say tax cuts pay for themselves -- are out of the mainstream of the Republican party:

I'm all for someone taking on the sillier kind of supply siders who fanny about claiming that tax cuts increase tax revenue, but they've been rather thin on the ground lately. ...

Yes, very thin on the ground. A quick search of this site turns up, with little effort, Bush, McCain, Romney, Giuliani, Hassett, Stossel, and the WSJ Editorial page all making the Laffer curve claim.

The second three may be a "motley collection of names" and have little influence over the party, but the first four? Are Bush, McCain, Romney, and Giuliani part of the "barking moonbats"? [yes...] I agree they are making a silly assertion, but don't they run counter to the claim that nobody of importance in the party tries to sell tax cuts by saying they pay for themselves?

And, right on cue, in today's Washington Times we have this piece of hackery:

Tax cut extension needed, by David Limbaugh, Commentary, Washington Times: ...Contrary to liberal propaganda, the Reagan tax cuts led to dramatic increases in federal revenues even after adjusting for inflation. ...

Since President Bush's tax cuts took effect, Democrats have been condemning them because of their alleged responsibility for soaring deficits. ... Recent reports definitively confirm ... federal revenues increasing; the deficits are decreasing, just as in the later Reagan years. ... It's past time to extend the Bush tax cuts.

The idea that tax cuts pay for themselves, wrong as it is, is still being actively promoted as part of the sales pitch to cut taxes. It may not be official party policy, but influential members of the Republican party are more than willing to play along and even help to promote this idea, and they do so even though they ought be aware by now that there's no evidence to support such claims.

Update: Brendan Nyhan extends the list of statements from the administration claiming that tax cuts pay for themselves.

Monday, September 03, 2007

How the Supply-Side Cult Hijacked American Politics

Jonathan Chait looks at the Laffer curve cult (there's quite a bit more in the article):

How a cult hijacked American politics: Flight of the Wingnuts, by Jonathan Chait, TNR: American politics has been hijacked by a tiny coterie of right-wing economic extremists, some of them ideological zealots, others merely greedy, a few of them possibly insane. ... Notions that would have been laughed at a generation ago ... are now so pervasive, they barely attract any notice. ...

It was not always this way. A generation ago, Republican economics was relentlessly sober. ... Over the last three decades, however, such Republicans have passed almost completely from the scene, at least in Washington, to be replaced by, essentially, a cult. ...

The cult in question generally traces its political origins to a meeting in Washington in late 1974 between Arthur Laffer, an economist; Jude Wanniski, an editorial page writer for The Wall Street Journal; and Dick Cheney, then deputy assistant to President Ford. ... Wanniski and Laffer believed it was possible to simultaneously expand the economy and tamp down inflation by cutting taxes, especially the high tax rates faced by upper-income earners. ...

Wanniski and Laffer were laboring with little success to explain the new theory to Cheney. Laffer pulled out a cocktail napkin and drew a parabola-shaped curve on it..., the Laffer Curve... Cheney apparently found the Laffer Curve a revelation, for it presented in a simple, easily digestible form the messianic power of tax cuts.

The significance of the evening was not the conversion of Cheney but the creation of a powerful symbol that could spread the word of supply-side economics..., ... the Curve explained it all. ...

With astonishing speed, the message of the Laffer Curve spread through the ranks of conservatives and Republicans. Wanniski evangelized tirelessly ..., both on the Journal's editorial pages and in person. ...

Today, ... the core beliefs of the supply-siders are not even subject to question among Republicans. Every major conservative opinion outlet promotes supply-side economics..., deviation from the supply-side creed has become unthinkable for any Republican with national aspirations. ...

Like most crank doctrines, supply- side economics has at its core a central insight that does have a ring of plausibility. The government can't simply raise tax rates as high as it wants without some adverse consequences. ... And there are justifiable conservative arguments to be made on behalf of reducing tax rates.. But what sets the supply-siders apart from sensible economists is their sheer monomania. ... They believe that economic history is a function of tax rates...

It doesn't take a great deal of expertise to see how implausible this sort of analysis is. ... All this is to say that the supply-siders have taken the germ of a decent point--that marginal tax rates matter--and stretched it, beyond all plausibility, into a monocausal explanation of the world.

Aside from popular articles in places like the Journal's editorial page, two classic tomes defined the tenets of supply-side economics: Wanniski's The Way the World Works and George Gilder's 1981 manifesto, Wealth and Poverty. Both have had enormous influence...

Here is what makes the rise of supply-side ideology even more baffling. One might expect that a radical ideology that successfully passed itself off as a sophisticated new doctrine would at least have the benefit of smooth, reassuring, intellectual front men... Yet, if you look at its two most eminent authors, good sense is not the impression you get. Let me put this delicately. No, on second thought, let me put it straightforwardly: They are deranged. ... [...continue reading...]

Sunday, September 02, 2007

Will the Housing Crash Cause Police to Give More Speeding Tickets?

Judith Chevalier examines the impact of changes in local government budgets on revenues from traffic enforcement:

Welcome, Stranger. Here’s a Speeding Ticket., by Judith Chevalier, Economic View, NY Times: Driving through a tiny Vermont town a few weeks ago..., I saw flashing yellow lights appear in my rearview mirror. My car had picked up speed coming down a hill, and a police officer pulled me over. As I waited for a ticket, I wondered: Does this town supplement its finances by giving tickets to visitors like me?

I never got to the bottom of the situation in that particular town, but the broader question — whether police officers in some towns are motivated by fund-raising as well as safety when writing traffic tickets — has been examined systematically by ... Michael D. Makowsky, a doctoral student in economics, and Thomas Stratmann, an economics professor, both at George Mason University, ... in a recent paper, “Political Economy at Any Speed: What Determines Traffic Citations?”

Continue reading "Will the Housing Crash Cause Police to Give More Speeding Tickets?" »

Saturday, August 25, 2007

The Deceptive Presentation of the FairTax Proposal

Bruce Bartlett says when you read the fine print and uncover the deceptions, the FairTax proposal is far less attractive then its supporters woudl have you believe:

FairTax, Flawed Tax, by Bruce Bartlett, Commentary, WSJ [Update: open link]: Former Arkansas Gov. Mike Huckabee's unexpectedly strong second-place showing in the recent Iowa Republican straw poll is widely attributed to his support for the FairTax.

For those who never heard about it, the FairTax is a national retail sales tax that would replace the entire current federal tax system. ...

Rep. John Linder (R., Ga.) and Sen. Saxby Chambliss (R., Ga.) have introduced legislation ... to implement the FairTax. They assert that a rate of 23% would be sufficient to replace federal individual and corporate income taxes as well as payroll and estate taxes. Mr. Linder's Web site claims that U.S. gross domestic product will rise 10.5% the first year after enactment, exports will grow by 26%, and real investment spending will increase an astonishing 76%.

In reality, the FairTax rate is not 23%. Messrs. Linder and Chambliss get this figure by calculating the tax as if it were already incorporated into the price of goods and services. ...[T]hink of it this way. If a product costs $1 at retail, the FairTax adds 30%, for a total of $1.30. Since the 30-cent tax is 23% of $1.30, FairTax supporters say the rate is 23% rather than 30%.

This is only the beginning of the deceptions in the FairTax. Under the Linder-Chambliss bill, the federal government would have to pay taxes to itself on all of its purchases of goods and services. Thus if the Defense Department buys a tank that now costs $1 million, the manufacturer would have to add the FairTax.... The tank would then cost the federal government $300,000 more than it does today, but its tax collection will also be $300,000 higher.

This legerdemain is done solely to make revenues under the FairTax seem larger than they really are, so that its supporters can claim that it is revenue-neutral. ...

Similarly, state and local governments would have to pay the FairTax on most of their purchases. This means that it is partly financed by higher state and local taxes. ...

State sales taxes have long exempted all but a few services because of the enormous difficulty in taxing intangibles. But the FairTax would apply to 100% of services, including medical care, thus increasing their cost by 30%. No state comes close to taxing services so broadly. Consumers would also find themselves taxed on newly constructed homes. Imagine paying 30% ... on top of the purchase price...

Since sales taxes are regressive ... some provision is needed to prevent a vast increase in taxation on the nonwealthy. The FairTax does this by sending monthly checks to every household based on income. Aside from the incredible complexity and intrusiveness of tracking every American's monthly income ... the FairTax does not include the cost of this rebate in the tax rate. ...

Rejecting all the tricks of FairTax supporters and calculating the tax rate honestly ... professional revenue estimators have always concluded that a national retail sales tax would have to be much, much higher than 23%.

A 2000 estimate by Congress's Joint Committee on Taxation found the ... rate would be 57%. In 2005, the U.S. Treasury Department calculated that a ... rate of 34% would be needed just to replace the income tax, leaving the payroll tax in place. ...

Perhaps the biggest deception in the FairTax, however, is its promise to relieve individuals from having to file income tax returns, keep extensive financial records and potentially suffer audits. Judging by the emphasis FairTax supporters place on the idea of making April 15 just another day, this seems to be a major selling point for their proposal.

Yet all but six states now have state income taxes. So unless one lives in one of those states, this promise is an empty one indeed. In short, the FairTax is too good to be true, and voters should not take seriously any candidate who supports it.

Thursday, August 16, 2007

Alan Auerbach: How to Tax Capital Gains

Alan Auerbach explains how to tax capital gains:

How to Tax Capital Gains, by Alan Auerbach, Commentary, WSJ: The recent controversy over the taxation of "carried interest" ... demonstrates the problems that can arise from taxing capital gains differently from other types of income. While it's relatively simple to change the way we treat carried interest, it would be far better to undertake an overall reconsideration of the way we tax capital gains.

As President Reagan and others who crafted the Tax Reform Act of 1986 understood, different tax rates on different types of income-producing activities often distort economic decisions and increase the tax system's complexity. Their solution was a broad-based tax with low and uniform marginal tax rates. The identical rate was applied to capital gains and to wage and salary income. But the reform survived only a few years, and we now confront the old problems magnified by two decades of financial innovation.

We can do better, and here are some guidelines:

Increase the capital gains tax rate, but not the "lock-in" effect. ...[T]axing capital gains has a big impact on investors' decisions about when to sell capital assets. Higher tax rates delay sales, causing investors to be "locked in" to their current holdings...

By itself, an increase in the capital gains tax rate worsens the lock-in effect. But this impact can be offset by other desirable changes, such as indexing capital gains for inflation ... and taxing capital gains at death. (Currently, we do not collect capital gains taxes when someone dies; this makes people want to hold onto appreciated assets throughout their lifetimes.) So-called "constructive realization" (i.e., taxation of capital gains at death) could help solve our current estate tax impasse by substituting capital gains revenues for some of the lost estate taxes. ...

Reconsider how best to encourage innovation and risk-taking. Some argue that low capital gains tax rates can spur the formation and development of new enterprises, for the payoffs from successful start-ups flow to their owners largely in the form of capital gains. But ... only a miniscule fraction of the economy's capital gains are associated with new ventures. A low capital gains tax rate is a very poor way to encourage entrepreneurial activity. It would be far better to carefully tailor tax provisions to spur innovation...

Don't raise the cost of capital. ...Lowering capital income taxes reduces the cost of capital and spurs investment; raising these taxes increases the cost of capital and discourages investment.

But not all capital income taxes equally influence the cost of capital. Capital gains taxes have a relatively weak impact on the cost of capital because a large share of the tax revenues is associated with income not generated by new investment. Thus only a small portion of the capital gains realized over the next several years will result from today's investment, so changing the tax rate on the gains won't influence today's investment much. By contrast, tax provisions targeted toward new investment, such as the bonus depreciation scheme introduced in 2002, tie tax reductions to new investment and thereby produce a bigger bang for each buck of tax reduction. Offsetting an increase in the capital gains tax rate with a revenue-neutral tax reduction that targets new investment is likely to reduce the cost of capital. ...

There are, of course, more sweeping tax reform alternatives available. Some proposals would move us from taxing income toward taxing consumption, or toward taxing capital gains as they accrue, rather than only when assets are sold. There are coherent and attractive proposals available to implement either of these approaches. But we need not wait for the next grand tax reform to improve on our current method of taxing capital gains.

Thursday, August 09, 2007

PGL: Bush on Bridge Safety: Spend Smarter Not More

PGL at Angry Bear is driven to shrillness by the latest from the president:

President Bush on Bridge Safety: Spend Smarter Not More, by PGL: AP reports that President Bush is opposed to raising gasoline taxes so we can have more bridge inspections:

A week after a deadly bridge collapse in Minneapolis, President Bush on Thursday dismissed raising the federal gasoline tax to repair bridges at least until Congress changes how it spends highway money. "The way it seems to have worked is that each member on that (Transportation) committee gets to set his or her own priorities first," Bush said. "That's not the right way to prioritize the people's money. Before we raise taxes, which could affect economic growth, I would strongly urge the Congress to examine how they set priorities."

Alice Rivlin would be impressed. Her counsel to John Kerry during the 2004 Presidential race was spend smarter, not more. So President Bush is arguing that we should spend more transportation dollars on repairing bridges and less on bridges to nowhere. I would find this to be a credible argument from a President who had a track record of allocating our Federal dollars where most needed for public policy reasons. But when President Bush has discussed priorities in the past, it would seem his mantra for spending our Federal monies wisely was more driven by some Karl Rove calculus to maximize GOP votes than to maximize the General Welfare. But if President Bush has decided to finally adopt the fiscal wisdom of Alice Rivlin, I say: IT’S ABOUT TIME!

Joseph Stiglitz: Greenspan, Bush Errors Finally Come Home to Roost

Joseph Stiglitz says George Bush and Alan Greenspan have some explaining to do:

Greenspan, Bush errors finally home to roost, by Joseph Stiglitz, Project Syndicate: The pessimists who have long forecast that America's economy was in for trouble finally seem to be coming into their own. Of course, there is no glee in seeing stock prices tumble as a result of soaring mortgage defaults. But it was largely predictable, as are the likely consequences...

The story goes back to the recession of 2001. With the support of US Federal Reserve Chairman Alan Greenspan, US President George W. Bush pushed through a tax cut designed to benefit the richest Americans but not to lift the economy out of the recession that followed the collapse of the Internet bubble.

Given that mistake, the Fed had little choice if it was to fulfill its mandate to maintain growth and employment: it had to lower interest rates. ... But, given that overinvestment in the 1990s was part of the problem underpinning the recession, lower interest rates did not stimulate much investment.

The economy grew, but mainly because American families were persuaded to take on more debt, refinancing their mortgages and spending some of the proceeds. And, as long as housing prices rose as a result of lower interest rates, Americans could ignore their growing indebtedness.

In fact, even this did not stimulate the economy enough. To get more people to borrow more money, credit standards were lowered, fueling growth in so-called "subprime" mortgages. Moreover, new products were invented ... making it easier for individuals to take bigger mortgages. ...

Alan Greenspan egged them to pile on the risk by encouraging these variable-rate mortgages. But did Greenspan really expect interest rates to remain permanently at one percent - a negative real interest rate? Did he not think about what would happen to poor Americans with variable-rate mortgages if interest rates rose, as they almost surely would?  ...

Fortunately, most Americans did not follow Greenspan's advice to switch to variable-rate mortgages. Even as short-term interest rates began to rise, the day of reckoning was postponed... [But the] housing price bubble eventually broke, and, with prices declining, some have discovered that their mortgages are larger than the value of their house.

Too many Americans built no cushion into their budgets, and mortgage companies, focusing on the fees generated by new mortgages, did not encourage them to do so.

Just as the collapse of the real estate bubble was predictable, so are its consequences... By some reckonings, more than two-thirds of the increase in output and employment over the past six years has been real estate-related, reflecting both new housing and households borrowing against their homes to support a consumption binge.

The housing bubble induced Americans to live beyond their means - net savings has been negative for the past couple of years. With this engine of growth turned off, it is hard to see how the American economy will not suffer from a slowdown.

There is an old adage about how people's mistakes continue to live long after they are gone. That is certainly true of Greenspan.

In Bush's case, we are beginning to bear the consequences even before he has departed.

Monday, August 06, 2007

Not Laffing

Mathew Yglesias notes the press's failure to challenge false statements about tax-cuts made by Giuliani in the GOP debate:

Laffer Press Roundup, by Mathew Yglesias: Here's an interesting test case for the press. It seems that at yesterday's GOP debate, Rudy Giuliani derided the idea that higher taxes raise revenues as a "Democratic, liberal" assumption and put forward his alternative view that you generate revenue by lowering tax rates. This is a stunning confession of total ignorance of tax policy and economics by the GOP front runner. So how did the press cover it? Chris Cilizza at the Fix lives down to my expectations by totally ignoring the fact that Giuliani is incorrect:

"There is a liberal Democratic assumption that if you raise taxes, you raise more money," said Giuliani to huge applause from the crowd assembled at Drake University.

Michael Shear in The Washington Post's page A1 story also doesn't care about the merits of the issue:

Former New York mayor Rudolph W. Giuliani sparked loud applause when he declared that "the knee-jerk liberal Democratic reaction -- raise taxes to get money -- very often is a very big mistake."...

Nor does Stephen Braun of The Los Angeles Times care at all whether or not GOP tax policy makes sense:

Referring to last week's devastating bridge collapse in Minneapolis, the GOP rivals found common ground in insisting that increased private investment from cutting taxes would provide more money to repair the nation's failing infrastructure. ...

Mike Glover at the AP doesn't seem to mention the issue at all.

Adam Nagourney at The New York Times, by contrast, doesn't go nearly as far as I'd like, but does way better than his colleagues at the major papers. Here he is on the NYT political blog:

Mr. Giuliani proceeded to explain that when he was mayor of New York he had cut taxes, and that those tax cuts had produced revenues that allowed him to finance bridge reconstruction. (Actually, there’s a good argument that it was the stock market boom in New York that brought all that money into the city’s coffers, but we’ll let that pass for now).

And here he is teamed up with Michael Cooper in the print edition:

Mr. Giuliani said that as mayor of New York, he had increased revenues to pay for bridge and road repair by cutting taxes, thereby jolting the economy, and that he would do the same thing as president. The city’s treasury in that period was flush largely with revenues produced by the stock-market boom of the late 1990s.

It'd be nice to see reporters go further than Nagourney does here, but improvements at the margin deserve recognition and the Times is doing a much better job than the Post here.

Even Nagourney's "we’ll let that pass for now" is inadequate. Any reporter who thinks there's a debate about whether cutting taxes has increased tax revenues has not been paying attention and has no business covering economics. Let's take a cue from Paul Krugman and ask what the press should have asked, what does this say about Giuliani's character? First, I disagree with the characterization of his statements as ignorant. I don't believe he is ignorant about this topic, so that is no excuse (and if he were ignorant, i.e. if he has not bothered to find out about the consequences of tax cuts by now, that would tell us a lot too.)  He noted that he is aware of the evidence, but chooses to portray it as a "liberal Democratic assumption" even though it is nothing of the sort (see Andrew Samwick and Greg Mankiw's statements about this, both of whom served under Bush in the Council of Economic Advisers, or any reputable conservative economist for that matter, or this recent CBO report).

What this tells us is that just like George Bush in the run-up to the Iraq war, Giuliani is not an honest broker. He is willing to tell people what they want to hear in spite of compelling evidence to the contrary, and to surround himself with people who will not challenge him when he uses misleading statements to push a policy. He has no problem using dishonest statements to sell policy. There's a lot to be gleaned about his character from his willingness to engage in this type of dishonest salesmanship, a style of leadership that led us into our current predicament, and it's disappointing to see the press not even bother to make the connections.

Friday, August 03, 2007

Paul Krugman: A Test for Democrats

Paul Krugman on good Democrats, bad Democrats, and the ugly thing the bad Democrats are about to do:

A Test for Democrats, by Paul Krugman, Commentary, New York Times: It’s been a good Democrats, bad Democrats kind of week. The bill expanding children’s health insurance that just passed in the House makes you want to stand up and cheer. Reports that Senator Charles Schumer opposes plans to close the hedge fund tax loophole make you want to sit down and cry.

Let’s start with the good news: The House bill ... would provide coverage to five million children who would otherwise be uninsured.

The bill is so good that it has Republicans spluttering. “The bill uses children as pawns,” declared Representative Pete Sessions of Texas. Yes, the Democrats are exploiting children — by providing them with health care.

The horror, the horror!

What’s especially encouraging is the way House Democrats were willing to take on the insurance companies. The bill pays for children’s health care in part by cutting subsidies to Medicare Advantage, a privatization scheme that yields big profits for insurers...

All in all, the bill is both a fine piece of legislation and a demonstration that Democrats can stand up to special interests. Happy days are here again.

Or maybe not.

The hedge fund tax loophole is a crystal-clear example of unjustified privilege. ... For example, ... pension fund ... manag[ers] ... are taxed ... at rates up to 35 percent. But if that money is invested with a hedge fund ... the fees the ... manager receives ... are mainly taxed as capital gains, with a maximum rate of 15 percent. ...

We’re told that the tax rate on hedge fund managers has to be kept low to encourage risk-taking. But the managers aren’t risking their own money. The only risk ... is the uncertainty of their fees — and as any ... salesman who depends on commissions can tell you, most people with uncertain incomes don’t get any special tax breaks.

We’re also told that management fees would rise, reducing returns to investors... — as if someone with a $100-million-a-year hedge fund job would walk away if his take-home pay fell from $85 million to $65 million.

And we’re talking about a lot of lost revenue here. The Economic Policy Institute estimates ... $6.3 billion a year — the cost of providing health care to three million children. Of that total, almost $2 billion a year ... goes to just 25 individuals.

If being a Democrat means anything, it means opposing this kind of exorbitant privilege. Yet ... Mr. Schumer says that he opposes any increase in hedge fund taxes unless tax breaks for the energy and real estate industries are also eliminated, and pigs start flying. Seriously, his claim that he really would support closing the hedge fund loophole if other, deeply entrenched tax privileges were eliminated ... is a fig leaf that hides nothing.

Mr. Schumer ... insists that the large financial contributions that hedge funds make to his party aren’t influencing him. Well, I can’t read his mind, but from the outside his position looks remarkably like money-driven politics as usual. And that’s not acceptable.

Look, the worst thing that could happen to Democrats is for voters to conclude that there’s no real difference between the parties, that when you replace Republicans with Democrats, all you do is replace sweet deals for Halliburton with sweet deals for hedge funds. The hedge fund loophole is a test — and it’s one that Mr. Schumer is failing.

_________________________
Previous (7/30) column: Paul Krugman: An Immoral Philosophy
Next (8/6) column: Paul Krugman: The Substance Thing

Wednesday, August 01, 2007

The High-Tech Solution to Voter Irrationality?

I can't resist commenting on this post from Bryan Caplan (here's his co-blogger disagreeing with me today, but that's not what motivated this):

The High-Tech Solution to Voter Irrationality, by Bryan Caplan: This didn't make it into the book, but one of my favorite remedies for voter irrationality has long been to simply clone John Stossel. His column today just reinforces my support for the clone-Stossel solution:

More practically, [Caplan] thinks that "Everyone who knows some economics" should grab every opportunity to teach it. That's what I try to do with my "20/20" segments, television specials and the Stossel in the Classroom program, which brings economic ideas to high-school and college classrooms.

I wonder if Stossel realizes that when I was writing this section, I had him in mind?

Is it John Stossel's "The Tax-Cut Myth" that Bryan has in mind? John Stossel says it's a myth that tax cuts increase the deficit:

The Tax-Cut Myth, by John Stossel, RCP: ...[T]ax cuts stimulated the economy and increased tax revenues. It happens because, as the Laffer Curve illustrates, lower rates mean higher rewards for productive activities. ...

Bush boasted last year, "This economy is growing, federal taxes are rising, and we're cutting the federal deficit... Some in Washington say we had to choose between cutting taxes and cutting the deficit. Today's numbers show that that was a false choice. The economic growth fueled by tax relief has helped send our tax revenues soaring."

But I don't want tax revenues to soar. That's money you and I could be spending for things we want. I want revenue and spending and government overall to shrink. So I'm not celebrating with the president. ...

Bryan has argued that many voters are uninformed - he uses economics as his prime example - and that perhaps we should consider giving the uninformed less say in the political process. So I'm curious, should endorsing "myths," and what Stossel said is a myth, that's clear, should being uninformed about the effect of tax cuts disqualify him from voting?

Tuesday, July 31, 2007

In a Surprise, a Republican is Using Scare Tactics Based upon Misleading Claims

In a thoroughly misleading article designed to scare people about what might happen to the economy because the Republicans did not have the courage to make the tax cuts they enacted permanent, GOP Senator John Kyl says:

Failing to extend the tax relief we have passed would result in a de facto tax hike that could cripple our economy...

But according to a recent CBO report:

CBO director Peter Orszag said, “The short-term effects of [the 2001 and 2003 tax cuts] in stimulating aggregate demand in the economy have largely dissipated by now, and the supply-side effects of those policies are uncertain but are probably small.”

Some of the tax cuts’ provisions “increased incentives for people to work and save (which can increase growth), but other provisions had no effect on incentives. In addition, the two tax laws increased the budget deficit, and doing so tends to reduce economic growth over the medium and long term. At this point in time (several years after enactment), once those various factors have been taken into account, the overall impact of the tax legislation on the economy is likely to be modest”

Thus, despite the scare tactics claiming otherwise, it won't "cripple our economy" if we allow the Republican's tax policy to be enacted exactly as written. There's simply no evidence that these tax cuts had a substantial impact on saving, investment, and growth.

Kyl also uses careful wording to describe tax cuts and deficit reduction:

The tax relief has helped produce an economy that has generated higher than expected tax revenues for the federal government. Tax receipts have risen 37 percent over the last three years and are projected to increase another 7 percent this year. These rising tax receipts have, in turn, helped drive down the deficit...

Though it makes it sound like the tax cuts reduced the deficit without actually saying so, i.e. the standard Laffer curve nonsense, as I hope you know by now that didn't happen (as noted above, "the two tax laws increased the budget deficit"). In fact, the supply-side impact of the tax cuts is estimated to be very small, so small that it generated very little tax revenue. From the CBO report:

the tax cuts’ indirect impact on economic growth, investment and saving and could affect this year’s budget deficit anywhere from an increase of $3 billion to a reduction of $14 billion...

The CBO report also points out that "without the tax cuts, the budget would probably be in surplus this year".

Thus, while there is evidence that leaving the Republican tax legislation exactly as they wrote it and allowing the tax cuts to expire will improve the government's fiscal position, there is no evidence that keeping the Republican tax legislation in place will cripple the economy as claimed.

Sunday, July 29, 2007

Alan Blinder: Low Capital Gains Taxes Cause Distortions

Alan Blinder discusses distortions that are introduced into the economy when the tax rate on capital gains is lower than the tax rate on other types of income. He begins by explaining the current debate over whether income from private-equity and hedge fund management should be taxed as capital gains or as regular income, and comes down on the side of treating it like ordinary income (see the article for details), and then he asks why the rates should differ at all:

The Under-Taxed Kings of Private Equity, by Alan S. Blinder, Economic View, NY Times: An arcane debate is raging in Congress over the appropriate taxation of the bountiful incomes of people who manage private-equity and hedge funds — incomes that can range into the hundreds of millions a year. I don’t recommend trying to master the details unless you have either an accounting degree or insomnia. But one thing is easy to understand, though hard to swallow: Some people who are richer than Croesus are paying 15 cents in federal income taxes on the marginal dollar, while you may be paying 25 or 35 cents...

Why do we have a preference for capital gains in the first place? The main argument is that lower taxes on capital gains boost investment. But the evidence on that point is iffy at best, and there are better ways to spur investment, like, say, the investment tax credit. Besides, lower taxes on capital gains reduce the tax bills of the rich relative to the rest of us — after all, they own most of the capital. But in this age of hyper-inequality, shouldn’t we be making the tax code more progressive, not less?

A far more important objection is that the tax preference for capital gains undermines capitalism — a system in which capitalists, not the state, are supposed to make the investment decisions. When I discuss this issue with my Economics 101 students, I show them an example of a proposed investment that loses money before tax (and which, therefore, should be rejected) but which actually turns a profit after tax because of the preferentially low capital gains rate. ... The government thus induces people to make bad investments, which is a good way to run an economy into the ground. Come to think of it, that’s just what the old Soviet Union did. It invested copiously, but badly.

But would taxing capital gains like other types of income imperil our economy? No. The Tax Reform Act of 1986 did exactly that, and it did not end capitalism as we know it. In fact, the gross domestic product in 1987 and 1988 grew at about the same rate as in 1985 and 1986, and the investment share of G.D.P. barely budged.

As the tax debate unfolds, you may find it difficult to follow the mind-numbing complexities. Who doesn’t? So just remember one simple principle: If we tax Activity A at 15 percent and Activity B at 38 percent, a free-market economy will give us more A and less B. Some of this shifting will represent genuine movements of resources out of B and into A — including those bad investments I just mentioned. The rest will be paper manipulations devised to avoid taxes.

Which of these do you think our tax code should favor?

Thursday, July 26, 2007

David Wessel: Globalization Study Moves Past Rhetoric

While I've had issues with material on the Wall Street Journal's editorial page, and today is no exception, I want to be careful to separate what goes on there from what gets presented elsewhere in the WSJ.

David Wessel's Capital column is not on the editorial page, and it does not belong there. I don't always agree with everything he says, and I don't always disagree either, but I never get the impression that facts are twisted to sell a preconceived notion:

Globalization Study Moves Past Rhetoric, by David Wessel, WSJ: Most of the policy briefs, working papers and trade-association reports that cross a columnist's desk slide easily into the trash can or onto the read-someday pile.

But a recent study on globalization, commissioned by the Financial Services Forum, an association of the chief executives of 20 huge financial companies, ranging from American International Group and Citigroup to UBS and Wachovia, stands out.

The analysis, written by a former member of President Clinton's Council of Economic Advisers, a former member of President Bush's and a former Bush Commerce Department official, says:

(1) Globalization is good for the U.S. economy. (No surprise coming from a bunch of financial firms that make money doing business across borders.)

(2) Gains from globalization aren't evenly shared. (A little surprising, but in the past couple of years, there has been a willingness among business to publicly acknowledge that economic reality.)

(3) To avoid a backlash against globalization, governments and businesses must come up with new ways to spread its benefits more widely and assist those hurt by all sorts of economic change. (Very surprising, more like a Democratic candidate's talking points than a report issued and promoted by an outfit led by Citigroup Chief Executive Charles Prince and Don Evans, the former Bush commerce secretary.

What's Going On? Business interests with a strong stake in globalization ... see rising public anxiety about globalization as a threat. And they realize that preaching the gospel of comparative advantage isn't going to win the debate.

"The mounting opposition is in response to the other side of globalization -- outsourcing of jobs, economic dislocation, anxiety and fear," the forum said ... early this year. "Making the case for trade and globalization requires...a list of specific, meaningful, practical, cost-efficient, and effective public- and private-sector responses to the reality that while the aggregate benefits of free trade and globalization are tremendous, it can sometimes bring with it painful dislocations for individuals, families, towns, regions, even entire industries." ...

Some business executives, prodded by politicians such as House Ways and Means Chairman Charles Rangel, finally are realizing that trade-friendly Democrats will be overwhelmed by trade skeptics unless there is something tangible to offer workers worried about their livelihoods and their children's. A new Pew Global Attitudes survey finds Americans generally optimistic about the next five years, but only 31% expect their children's lives will be better than their own; Europeans are even more pessimistic. By contrast, 81% of the Chinese expect their children to do better.

The Financial Services Forum report is, in part, a response to that. The specifics are intriguing ... because they move beyond inadequate approaches such as making the failing Trade Adjustment Assistance program for dislocated workers a tad more generous.

Among the Proposals: Raise taxes on winners to share benefits of globalization more widely. Replace TAA and unemployment insurance with a big new program for displaced workers that offers wage insurance to ease the pain of taking a lower-paying job. Provide for portable health insurance and retraining. Create a way for communities to ensure their tax base against big factory closures. Eliminate tax hurdles for businesses that do what International Business Machines is proposing: Offer 50 cents for every $1 (up to $1,000 a year) that workers set aside to pay for training. ...

Grant Aldonas of the Center for Strategic and International Studies think tank, one of the report's three authors [said] "...We are renegotiating the social contract in America, but we're letting it be done by the United Auto Workers and Delphi, and leaving a lot of others out -- including the poor and the businesses on the leading edge."

Mr. Aldonas and his co-authors, Dartmouth's Matthew Slaughter and Harvard's Robert Lawrence, ... say the U.S. need not accept as inevitable the steady widening of the gap between economic winners and losers, an inequality that threatens to produce barriers to trade, investment and immigration that will hurt U.S. prosperity. ...

Now the question is whether business will go beyond talk. As C. Fred Bergsten ... puts it: "They haven't gone to the mat and talked to Charlie Rangel and Democrats who are wavering, if not worse, and said, 'We want to support a meaningful program of wage insurance, and we'll be willing to give up some of our beloved tax breaks to pay for it.' "

One troubling sign: Although forum chief executives issued statements blessing the new report, not one has been willing to talk to a Wall Street Journal reporter about it.

One thing that bothers me about the whole inequality debate is the presumption that the winners deserve their incomes because it reflects their contribution to the firm, i.e. it is the wage that would be earned in well-functioning competitive markets, with the reward is equal to the person's marginal contribution to the firm. Thus, the analysis often begins with the idea that any tax takes away someone's hard-earned income and redistributes it elsewhere.

But for the incomes where inequality is rising most - those at the very top of the income distribution - this is a questionable claim. The idea that the salary of a CEO or hedge fund manager is set by competitive markets, or even approximately so, seems unlikely, or at least open to serious question. It should not just be assumed in these debates.

If the incomes of the winners are higher than they would be in a competitive market, then many of the arguments against taxing their "hard-earned money" melt away. For example, if a person would earn $1,000,000 in a competitive market, but because of market imperfections earns $1,200,000 instead, is it unfair to tax away the extra $200,000?

At a 33% tax rate in a competitive market, after-tax income would be $667,000, i.e. the competitive income of $1,000,000 minus 33%. At the non-competitive income of $1,200,000, it would take a tax rate of around 44% to leave the person equally well off (i.e. $1,200,000 - 44% of $1,200,000 =  approx. $667,000).

For this reason, I would argue that tax rates such as the 44% rate in this example are not as high as they might seem. Part of the tax simply levels the playing field, i.e. taxes away the income in excess of the competitive level, and the tax rate is then 33%, not 44%, on the part of income that would be earned in a competitive market.

Update: Free Exchange at the Economist has a different take on this issue.

Sunday, July 22, 2007

Supply-Side Effects of 2001 and 2003 Tax Cuts "Small"

About that Laffer curve:

CBO: Tax Cuts’ Impact Has Faded, by Greg Ip, WSJ Washington Wire: The stimulative effect of Bush’s tax cuts has worn off and the supply-side benefits are “small,” the Congressional Budget Office says. At the request of House Budget Committee [chair] John Spratt (D., S.C.), the CBO analyzed the impact on the economy other than through the direct impact on tax revenues of the Economic Growth and Taxpayer Relief Act of 2001 (EGTRRA) and the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA).

In a letter to Spratt released Friday, CBO director Peter Orszag said, “The short-term effects of EGTRRA and JGTRRA in stimulating aggregate demand in the economy have largely dissipated by now, and the supply-side effects of those policies are uncertain but are probably small.”

Some of the tax cuts’ provisions “increased incentives for people to work and save (which can increase growth), but other provisions had no effect on incentives. In addition, the two tax laws increased the budget deficit, and doing so tends to reduce economic growth over the medium and long term. At this point in time (several years after enactment), once those various factors have been taken into account, the overall impact of the tax legislation on the economy is likely to be modest,” Orszag wrote.

Orszag concluded that the tax cuts’ indirect impact on economic growth, investment and saving and could affect this year’s budget deficit anywhere from an increase of $3 billion to a reduction of $14 billion, depending on the assumptions used. That is separate from the direct boost to the deficit through lost revenue and the added interest on borrowing to cover the gap of $211 billion.

It currently expects this year’s deficit to be between $150 billion and $200 billion, implying that without the tax cuts, the budget would probably be in surplus this year.

Saturday, July 21, 2007

"Economics is the Dope of the Religious People"

This is from Joan Robinson. It's about using economics as an ideological defense of wealth. Keep in mind as you read this that it was written in 1936, not today.

A lot of the discussion is about tax cuts, and I was amused at the end where she says that even though her opponent wasn't clever enough to think of it, to be fair, there is a way a tax cut can affect employment. She then goes on to foreshadow supply-side arguments, then dismisses them as unlikely to have much of an impact in alleviating short-run economic difficulties.

The introduction to this section of the book where this essay appears (the fourth volume of Collected Economic Papers by Joan Robinson) says that "Keynes read the drafts and I cut out anything that I could not persuade him was correct..." And, though it doesn't relate to the essay that follows, given the charges that the traditional Keynesian model ignores inflation, this is an interesting statement (it is in reference to an essay called "Full Employment" in the same section), "It is certainly absurd to suppose [Keynes] was not aware of the prospect of inflation setting in when near-full employment is maintained for a run of years." Here's her essay, "An Economist's Sermon":

An Economist's Sermon: Economics is the Dope of the Religious People, by Joan Robinson, 1936: Consider the case of a man to-day who has an honest intelligence, a strong social conscience and an independent income.

His intelligence tells him that he has no particular right to enjoy a privileged position. 'Right' is a vague phrase. A doctor has in a sense a right to a motor-car because it makes him do his work better than he could without it. And if he uses it to visit his friends as well as his patients, no harm is done to anyone. But our man is too honest to try to persuade himself that his own comfort really makes very much difference to the amount of benefit that he does to other people. His conscience tells him that he would be doing a good act if he endowed a hospital with his wealth and worked for his living. But his inde­pendent income is not easy to give up.

He cannot keep all three - integrity of mind, a quiet conscience, and the privileges of wealth. One must be sacrificed. If he is a saint he sacrifices the wealth - but we will suppose that he is not. If he is a man of no definite religious creed he can keep his mental honesty and his income by sacrificing his conscience. He can say "I am a selfish individual. I don't pretend to have any better right than anyone else to a comfortable life, but I propose to enjoy it if I can."

But if he belongs to a definite religion this line of escape is impossible for him. Conscience is more precious than anything else. Without its approval he can have no peace. He will have to sacrifice his honesty of mind instead, and make up arguments to show that it is right for him to be better off than the majority of his neighbours.

Now, it is here that the economist is a godsend to him. The economist is a self-appointed expert. It is his business to know about these things. A man may have an honest and independent mind and yet take on trust the opinion of experts on a subject that he has not time to master for himself. If the economist tells him it is all right, then he can keep his integrity, his income and his conscience all intact.

One of the main effects (I will not say purposes) of orthodox traditional economics was to fill this want. It was a plan for explaining to the privileged class that their position was morally right and was necessary for the welfare of society. Even the poor were better off under the existing system than they would be under any other. There is a significant passage in the reminiscences of Alfred Marshall. As a young man, a mathematician and philosopher, before he had embarked upon economics, he began to be troubled by social conscience:

Continue reading ""Economics is the Dope of the Religious People"" »

Tuesday, July 17, 2007

Keeping the Tax Rate Constant Can More Than Pay for Itself!

I've been a critic of the "tax cuts pay for themselves" school of thought since there's no evidence the economy is currently or has ever been in a position where that could happen, so let me discuss this a little further and allow for the possibility of a situation (even now) where a reduction in taxes could, in fact, pay for itself.

When taxes are cut, there are two separate things that happen that get confused in discussions of this topic. First, and obviously, there is a change in disposable income and this can generate economic effects. Second, there can be a reduction in the economic distortions induced by taxes, and reducing these distortions can generate higher economic growth. Thus, this second effect is the change in economic efficiency from the change in taxes.

The efficiency effect means that keeping taxes constant can increase tax revenue, and it's easy to see how. Suppose, as in the US, there is an income tax and without changing anyone's net tax burden at all (all things considered), it is replaced by a consumption tax. Since in general consumption taxes are more efficient than income taxes, output can increase without changing overall taxes one bit just by restructuring where they are levied (or choose your own favorite example of an efficiency enhancing shift in taxes, this is just an example).

This can easily generate Laffer curve type results. Suppose that in the example above, everything is the same except that after the consumption taxes are levied to replace the income taxes, overall taxes are reduced by one dollar. Because of the increase in efficiency, which could be large under the right conditions, it would look like this one dollar reduction in taxes causes amazing output effects. E.g. suppose output went up by a mere million dollars from the increase in efficiency, not much in the overall US economy. With a tax rate of 25%, the result would be a $250,000 increase in taxes from a $1 tax cut. This would appear to be quite amazing if it was attributed solely to the $1 change in after tax income rather than to the change in efficiency. Note, however, there is nothing special in this example about the tax reduction. Just as easily we could have overall taxes increase by $1 in the example and then it would look like increasing taxes increases economic activity. This means that even if a tax cut did pay for itself, which they don't, we need to be careful abut what the increase in revenue is attributed to.

An implication of this is that it is not necessary to reduce taxes on the wealthy, i.e. produce an increase in their take-home pay, to produce revenue enhancing effects from changes in tax policy. Simply changing where and how the taxes are levied can potentially produce much stronger effects. Since there is little evidence that tax cuts on the wealthy stimulate substantial additional effort or any additional economic activity, before we cut taxes to try to increase economic growth we ought to make sure that our taxes are levied and collected as efficiently as possible first, and that can involve restructuring how taxes are collected within income classes, i.e. trading one kind of tax for another, and other types of changes (I am setting aside equity considerations in this discussion, but there may be efficiency-equity tradeoffs to consider).

Continuing with this point, Stephen Gordon at Worthwhile Canadian Initiative has comments on a recent Romer and Romer paper looking at tax changes and economic growth. Given recent events around here, I am going to send you to his site instead of presenting his comments here:

Why doesn't the US have a consumption tax?, by Stephen Gordon

Update: I didn't mean to limit the discussion to consumption versus other types of taxes at all, restructuring taxes within income classes is more what I had in mind here, but I just noticed that Greg Mankiw discusses the question "If a government reduces a payroll tax and raises a consumption tax, how does the tax shift affect the economy?" and gives a "tentative" answer to the question. One issue that comes up is fraud under VAT taxes. If you are interested in that issue, see this five part series from Richard Baldwin at Vox EU on VAT fraud.

Kenneth Rogoff: US Will Learn Deficits Do Matter

Ken Rogoff says we will learn, soon enough, that budget deficits are not to be taken lightly:

Kenneth Rogoff: US will learn deficits do matter: The Bush administration was beside itself with glee ... when it announced that the fiscal year 2007 federal deficit was set to fall to just over $200bn, or 1.5 per cent of US gross domestic product ..., less than half what it was in 2004.

Publicly, some Democrats are still condemning Bush II profligacy and preaching a return to Clinton I fiscal conservatism. Privately, though, many are starting to question why a 2008 Democratic president should bother improving the government’s balance sheet if the end result is just a bigger pot for a future Republican president to lavish on his or her friends. Certainly the 2000s ... seem to have thrown cold water on the notion that sustained US budget deficits will automatically lead to high interest rates and low growth. Or have they?

First, the good news. Explosive financial globalisation has made US federal budget policy far less important as a determinant of global real interest rates. ...

And let us give credit where credit is due. The Bush administration’s decision to borrow massively, over a period where global long-term interest rates fell massively, was not a bad market call. ... One can question whether the Bush administration should have skewed tax cuts towards the wealthiest Americans... One can complain how money was thrown away on the catastrophic invasion of Iraq. But the Bush deficits have not been the short-term growth disaster that some predicted.

Of course, ...[the] Bush administration ... probably did not envision hitting up China, Saudi Arabia and Russia for money. Instead, the political types were seduced by the misguided belief that if the government cut marginal tax rates, the economy would grow so much that total tax revenues would actually rise.

Unfortunately, ... the ... “Laffer” curve ... effect was hardly big enough to keep this decade’s US federal budget from going deep into the red. Remember, too, that the $200bn figure ... incorporates the surplus on Social Security. Without this accounting gimmick (which the Bush administration did not invent) the projected 2007 deficit would be more than twice as large.

Both the Organisation for Economic Co-operation and Development and the International Monetary Fund have argued that US deficit policy is much more damaging than it seems. The US ought to be racking up big surpluses in preparation for impending old-age retirements and rising medical costs. ...

It is well understood that the Social Security pensions system can be fixed by indexing the retirement age to life expectancy and by modestly raising taxes. Medical care involves far trickier challenges...

[If] countries ... cannot resolve ... intergenerational frictions ...,[the] result will be paralysis, with huge potential implications for interest rates, inflation rates and growth. But this need not occur... Perhaps, [this] ... will simply bring forward the necessary conversations on pensions and medical spending. Of course, [it] might also bring forward a catastrophically divisive debate.

If there is a shorter-term Achilles heel to ... deficit policies, it is dependence on foreign financing. ... Incredibly, US borrowing accounts for roughly two-thirds of total net saving of all the world’s surplus countries. Although rebalancing of the world economy is likely to help ... somewhat this year, the global and US economies remain quite vulnerable to a scenario that forces faster rebalancing. ...

Here’s betting that the next US president, Democrat or Republican, is not going to end up going too far towards restoring fiscal prudence. Unfortunately, continuing this approach will eventually bring a shipwreck... The US government’s big shift into the red may have been fortuitously timed, but eventually, the deficits will matter.

Monday, July 16, 2007

Brendan Nyhan: Greg Mankiw and Tax Cut Rhetoric

Since Laffer curves have come up a lot recently, i.e. the idea that if we cut taxes it will pay for itself - a notion thoroughly discarded by recent research from the CBO and others - and since the political issue has been raised by Brad DeLong:

PGL and Mark Thoma on Greg Mankiw, by Brad DeLong:  ...Greg [Mankiw] is deciding whether he wants to be an economist or a politician. I fear he is making the wrong choice...

Let me pass along something I was made aware of by email that weighs in on the political question. This is Brendan Nyhan:

Greg Mankiw and tax cut rhetoric, by Brendan Nyhan: I'm quoted in a Harvard Crimson story on Greg Mankiw, the Harvard economics professor and former Bush administration economist:

N. Gregory Mankiw is not unfamiliar with the demands that come with being one of the foremost economists in the country.

After all, the Beren Professor of Economics survived a stint in the very public domain of Washington politics, serving as the Chairman of the Council of Economic Advisors from 2003 to 2005. But now, he's facing a new and perhaps even more public challenge - the wrath of online bloggers.

Several professors and economists have called on Mankiw to explain what they see as his changing views on tax cuts from before he began advising President George W. Bush to when he served as Bush's top economic advisor.

According to an online blog post by Jared Bernstein of the Economic Policy Institute, Mankiw had previously criticized certain supply-side arguments - namely, that lowering tax rates could actually generate more tax revenue - and then reversed his opinion while working in Washington.

But Mankiw said that he never made such a policy switch.

"[Bernstein] made a claim that I'd been inconsistent about the tax cuts and I don't think I had been," Mankiw said. "Being opposed to a tax cut as a policy and being critical of an argument for tax cuts are two different things." ...

Brendan J. Nyhan, a political science graduate student at Duke University and frequent blogger, points out that while Mankiw said he was "skeptical"of the claim that tax cuts could pay for themselves during his Senate confirmation hearing, Mankiw also denied that the administration had used "self-financing" arguments.

Nyhan then lists on his blog specific quotes from then-Press Secretary Ari Fleis[c]her, Vice President Dick Cheney, and President Bush, all of whom said in the early months of 2003 that the tax cuts would lead to more tax revenue.

"Mankiw failed to get the Bush administration to say things that were accurate about the effects of tax cuts on revenue and other economic issues," Nyhan said. "That Mankiw is unwilling to acknowledge that the Bush administration made these claims is exemplary of White House experts who are unwilling to publicly contradict their bosses in the administration."

J. Bradford Delong '82, a prominent economist at UC Berkeley, also weighed in on the debate on his blog, questioning whether it is "worth the sacrifice of the economics profession's outside credibility and the further confusion of the public that is entailed when good economists defend bad policies on the outside that they are working to change on the inside." ...

Mankiw announced in late 2006 that he had signed on as an advisor to the presidential campaign of former Massachusetts Gov. Mitt Romney, and the Republican candidate seems to be employing these very same supply-side arguments.

"If you lower taxes enough, you create more growth," Romney said in a video excerpt on his Web site from a closed-door presentation he made to the Club for Growth, a political organization that favors low taxes, in March 2007.

"And if you create growth, you get more jobs," Romney continued. "You get more jobs, more people are paying taxes. You get more taxes paid, the government has more money by charging lower tax rates"

It would appear that this is the very same argument for taxes that Mankiw has said he opposed.

Nyhan said that economists with ties to politicians need to be more honest with the public regarding their actual views, whether or not they clash with the prominent figures they're advising.

"We need to drive this idea out of the mainstream, because it is not accurate," Nyhan said.

Here are the links that are referenced in the piece:

-My Spinsanity piece on Mankiw's confirmation hearing claim
-The full timeline of Bush administration officials suggesting that tax cuts increase revenue
-The Romney video in which he states that tax cuts increase revenue (click on "On the Issues" then select "On Fighting for Lower Taxes")

It's especially sad to see that Romney -- who Mankiw advises -- is making these claims. After John McCain started saying that tax cuts increase revenue, Mankiw badmouthed McCain on his blog:

Senator McCain tells the National Review:

Tax cuts, starting with Kennedy, as we all know, increase revenues.

The interviewer, however, did not ask the natural follow-up questions:

1. If you think the 2001 and 2003 tax cuts increased revenue, why did you vote against them?

2. If you think tax cuts increase revenue, why advocate spending restraint? Can't we pay for new spending programs with more tax cuts?

I doubt that, in fact, Senator McCain believes we are on the wrong side of the Laffer curve. But unfortunately, fealty to the most extreme supply-side views is de rigeur in some segments of the Republican party.

It's a strange point for Mankiw to make. He has failed to acknowledge publicly that the Bush administration makes the same exact claims. In addition, I noted the apparent implication that Romney, whose [campaign] Mankiw had recently joined as an adviser, would not make similar claims. Judging by the quote above, however, the former Massachusetts governor is following McCain and Rudy Giuliani down the rabbit hole. Will Mankiw passively endorse this rhetoric again?

Sunday, July 15, 2007

Principles of Taxation: What is a Fair tax?

Greg Mankiw on fair taxes, with comments at the end:

Fair Taxes? Depends What You Mean by 'Fair', by Greg Mankiw, Economic View, NY Times: Do the rich pay their fair share in taxes? This is likely to become a defining question during the presidential campaign.

At a recent fund-raiser for Hillary Clinton, ... Warren E. Buffett said that rich guys like him weren’t paying enough. Mr. Buffett asserted that his taxes last year equaled only 17.7 percent of his taxable income, compared with about 30 percent for his receptionist. ... These claims are enough to get populist juices flowing. The problem with them is that they don’t hold up under close examination.

The best source for objective data on the distribution of the tax burden is the Congressional Budget Office. ... The C.B.O.’s most recent calculations of federal tax rates show a highly progressive system. ... The poorest fifth of the population, with average annual income of $15,400, pays only 4.5 percent of its income in federal taxes. The middle fifth, with income of $56,200, pays 13.9 percent. And the top fifth, with income of $207,200, pays 25.1 percent.

At the very top of the income distribution, the C.B.O. reports even higher tax rates. The richest 1 percent has average income of $1,259,700 and forks over 31.1 percent of its income to the federal government.

One might wonder how Mr. Buffett gets away with a tax rate of only 17.7 percent, while a typical millionaire is paying so much more. Most likely, part of the answer is that Mr. Buffett’s income is made up largely of dividends and capital gains, which are taxed at only 15 percent. By contrast, many other top earners pay the maximum ordinary income tax rate of 35 percent on their salaries, bonuses and business income.

The distinction is crucial for understanding how much the rich pay. Indeed, the share of top incomes coming from capital is much lower now than it has been historically. ... If your image of the typical rich person is someone who collects interest and dividend checks and spends long afternoons relaxing on his yacht, you are decades out of date. The leisure class has been replaced by the working rich. ...

None of these calculations, however, say whether the rich are paying their fair share. Fairness is not an economic concept. If you want to talk fairness, you have to leave the department of economics and head over to philosophy.

Continue reading "Principles of Taxation: What is a Fair tax?" »

Saturday, July 14, 2007

Church Attendance and Supply-Side Economics

When did supply-side economics come to mean breaking up monopolies to increase competition? I don't know whether increasing competition among churches increases membership or not, and the fact that religion is involved here is coincidental, but this is not supply-side economics as claimed in the article. This is nothing more than the standard result that increasing competition improves market outcomes:

In Europe, God Is (Not) Dead, by Andrew Higgins, WSJ (free): ...After decades of secularization, religion in Europe has slowed its slide toward what had seemed inevitable oblivion. There are even nascent signs of a modest comeback. Most church pews are still empty. But belief in heaven, hell and concepts such as the soul has risen in parts of Europe, especially among the young...

God's tentative return to Europe has scholars and theologians debating a hot question: Why? Part of the reason, pretty much everyone agrees, is an influx of devout immigrants. ... At the same time, anxiety over immigration, globalization and cutbacks to social-welfare systems has eroded people's contentment in the here-and-now, prodding some to seek firmer ground in the spiritual.

Some scholars and Christian activists, however, are pushing a more controversial explanation: the laws of economics. As centuries-old churches long favored by the state lose their monopoly grip, Europe's highly regulated market for religion is opening up to leaner, more-aggressive religious "firms." The result, they say, is a supply-side stimulus to faith.

"Monopoly churches get lazy," says Eva Hamberg, a professor at Lund University's Centre for Theology and Religious Studies and co-author of academic articles that, based on Swedish data, suggest a correlation between an increase in religious competition and a rise in church-going..."

Upstarts are now plugging new spiritual services across Europe, from U.S.-influenced evangelical churches to a Christian sect that uses a hallucinogenic herbal brew as a stand-in for sacramental wine. Niklas Piensoho, chief preacher at Stockholm's biggest Pentecostal church, says even sometimes oddball, quasi-religious fads "tell me you can sell spirituality." His own career suggests that a free market in faith is taking root. ...

The enemy of faith, say the supply-siders, is not modernity but state-regulated markets that shield big, established churches from competition. In America, where church and state stand apart, more than 50% of the population worships at least once a month. In Europe, where the state has often supported -- but also controlled -- the church with money and favors, the rate in many countries is 20% or less.

Continue reading "Church Attendance and Supply-Side Economics" »

Friday, July 13, 2007

Paul Krugman: An Unjustified Privilege

Paul Krugman urges Democrats to close the loophole that allows Warren Buffet to be taxed at 17.7 percent while his receptionist is taxed at around 30 percent:

An Unjustified Privilege, by Paul Krugman, Commentary, NY Times: During the 2000 presidential campaign, Ralph Nader mocked politicians of both parties as “Republicrats,” equally subservient to corporations and the wealthy. It was nonsense, of course: the modern G.O.P. is so devoted to the cause of making the rich richer that it makes even the most business-friendly Democrats look like F.D.R.

But right now, as I watch Senate Democrats waffle over what should be a clear issue of justice and sound tax policy..., I’m starting to feel that Mr. Nader wasn’t all wrong.

What’s at stake here is a proposal by House Democrats to tax “carried interest” as regular income. This would close a tax loophole that ... basically lets fund managers take a large part of the fees they earn ... and redefine those fees, for tax purposes, as capital gains.

The effect of this redefinition is that income that should be considered ... ordinary income taxed at a 35 percent rate is treated as capital gains, taxed at only 15 percent instead. So fund managers get to pay a low tax rate that is supposed to provide incentives to risk-taking investors, even though they aren’t investors and they aren’t taking risks.

For example, the typical hedge-fund manager ... gets a fee equal to 2 percent of the funds under management, plus 20 percent of whatever his fund earns. It’s not exactly straight salary, but none of this income comes from putting his own wealth at risk. Except for the fact that he might make a billion dollars a year, he resembles a waitress whose income depends on a mix of wages and tips, or a salesman who lives on a mix of salary and commissions, more than he resembles an entrepreneur who sinks his life savings into a new business. ...

There’s a larger question one could ask: should we even be giving preferential tax treatment to true capital gains? I’d say no, because there’s very little evidence that taxing capital gains as ordinary income would actually hurt the economy. ...

But even those who ... think the special treatment of capital gains is justified, should be able to agree that treating the income of fund managers differently from ... everyone else who works for a living makes no sense. And that’s why it’s very disheartening to read that prominent Democratic senators are taking seriously the claims of fund managers that making them pay taxes like regular people would discourage risk-taking.

The immediate response should be: what risk-taking? ...

Look, this isn’t about envy, about punishing success. ... [C]losing the carried interest loophole should be a simple question of fairness: other Americans also earn their pay, but they don’t get special tax breaks. Plus, we’re talking about a lot of lost revenue due to that loophole — revenue that could, for example, be paying for the health care of tens if not hundreds of thousands of children.

And since we’re living in the real world of politics, there’s also the Republicrat issue: the hesitation of the Senate Democrats is terrible for the party’s image. It conveys the impression that they’re as beholden to hedge funds, one of the few types of businesses whose campaign contributions strongly favor Democrats, as Republicans are to the oil and drug industries.

So here’s a plea to Democratic senators on the fence: do the right thing and close this unjustified tax loophole.

_________________________
Previous (7/9) column: Paul Krugman: Health Care Terror
Next (7/16) column: Paul Krugman: The Waiting Game

Yet Again, Tax Cuts Do Not Pay for Themselves

The Wall Street Journal says Kevin Hassett has discovered the Laffer curve, but I think these data might say something else. Here's the picture from the editorial where they are making their usual plea for more tax cuts:

Laff1

The blue line is supposed to be the Laffer curve, but this is far from compelling. Since it looks like all that's been done here is to draw a line through an outlier, Norway (an outlier that in other contexts we are told to ignore because it is an outlier, e.g. see below), and since this is clearly not the best fitting line to these data, here's another possibility:

Laff2

I haven't actually run the regression, but it looks clear to me that revenues rise with tax rates, and the fit also looks better than in the first graph. Toss out Norway, and the fit looks even better (and to quote The Economist blog on this point, "Throwing out Norway...").

I know how much supply-siders want to find a Laffer curve, they've become frustrated going this long without success. But if they really think one exists they'll need to keep looking because they haven't found it yet. [Update: Max has estimates.][Update: Response(s) to a post at The Economist's blog,  Free Exchange.]

Thursday, July 05, 2007

Winner-Take-All-Markets and Efficiency

Robert Frank says raising taxes paid by hedge fund managers can improve economic efficiency:

A Career in Hedge Funds and the Price of Overcrowding, by Robert Frank, Economic Scene, NY Times: ...I haven’t seen a formal survey, but a rapidly growing percentage of the best students I teach say they want to manage hedge funds or private equity firms. Little wonder. ... The combined income of the top 25 hedge fund managers exceeded $14 billion in 2006.

These managers also enjoy remarkably favorable tax treatment. For example, even though ... their 20 percent commission on portfolio gains ... has the look and feel of ordinary income, it is taxed at the 15 percent capital gains rate rather than the 35 percent top rate for ordinary income. ...

Congress is now considering a proposal to tax carried interest as ordinary income. To no one’s surprise, private equity lobbyists were quick to insist that doing so would cause grave economic damage. ... Yet..., economic analysis suggests that it would actually increase production in other sectors of the economy by reducing wasteful overcrowding in the market for aspiring portfolio managers.

Continue reading "Winner-Take-All-Markets and Efficiency" »

Wednesday, July 04, 2007

Taking a Higher Toll

When E-ZPass electronic toll systems are installed, tolls tend to rise:

Technology Eases the Ride to Higher Tolls, by David Leonhardt, NY Times: ...I spent a good part of my childhood summers at the Jersey Shore, and the tollbooths on the parkway always seemed to be a cruel final obstacle between me and the beach. Every 15 minutes or so, our car would have to stop yet again to drop a measly quarter in a bucket.

The ride is very different today, thanks mostly to the electronic toll system known as E-ZPass. At four of the tolls along the Garden State, the system is so sophisticated that cars barely have to slow down. A little box attached to the car’s windshield sends a message to a computer reader looming over the road, and money is then deducted from an electronic account. ...

As a result of E-ZPass and its ilk, ... many [drivers] don’t notice the cost of a toll. Which raises an interesting question: If you don’t know how much you’re paying for something, will you notice when the price goes up? Or has E-ZPass, for all its benefits, also made it easier for toll collectors to take your money?

A young economist named Amy Finkelstein started thinking about these issues a few years ago... So she collected decades of toll records from around the country and found a clear pattern.

After an electronic system is put in place, tolls start rising sharply. Take two tollbooths that charge the same fee and are in a similar setting... A decade after one of them gets electronic tolls, it will be about 30 percent more expensive on average than a similar tollbooth without it. ...

“You may be less aware you’re paying the toll,” said Ms. Finkelstein, now an associate professor at M.I.T., “but you’re paying a higher toll than you used to.”

The implications of this go well beyond highways. We increasingly live in an E-ZPass economy, in which bills are paid online, corporate cafeterias are going cashless and people take along their debit card, instead of cash, when they leave the house. Last year, 55 percent of consumer spending was done electronically..., while checks accounted for less than 25 percent and cash only 20 percent...

The E-ZPass economy is indisputably more convenient. It saves time and frustration. But the old frustrations that came with cash also brought a hidden benefit: they forced you to notice that you were spending money. With electronic money, it’s much easier to be carefree.

Marketers understand this dynamic well, which is a big reason they promote refillable gift cards and other forms of money that don’t feel like money. Part of what’s so intriguing about Ms. Finkelstein’s work is that it suggests that government officials may be coming to understand the dynamic, too. ...

Ms. Finkelstein obviously can’t prove that electronic tolls cause prices to rise by making drivers less aware of them. ... But she makes a spirited case for her conclusion. She has considered a number of alternate explanations for the increases and says the evidence doesn’t support them. At the very least, electronic systems do seem to make it easier for toll collectors to increase prices. ... Ms. Finkelstein discovered that tolls don’t usually rise as soon as an electronic system arrives. The increases tend to come a number of years later, once electronic payment becomes old hat. ...

Let me try an alternative to the agents don't notice price increases when the payments are electronic story (i.e. that agents are irrational). One thing to note is that after the E-ZPass system is installed, waiting times fall, frustration falls, and the inconvenience of not having correct (or any) change also falls. Thus, the economic cost is lower even if the dollar cost of the toll stays the same, and this would cause the quantity of trips demanded to increase. Over time, with inflation, the real cost of the toll falls further, the number of trips increases further, and eventually the increased congestion could require a return of the toll to its original value (in terms of the full economic cost, and assuming congestion is the reason for the toll), or even a higher value if demand for road trips grows due to economic or population growth.

[Another possibility, though I don't think it quite fits here, is that under the old system changing the price of a toll is costly in terms of transaction and collection costs. That is, a $1.00 toll is much more convenient than a $1.05 toll (more currency and coins are involved in the payment, and making change for, say, two dollars also involves more coins and hence more time), but with an electronic system it doesn't matter. Thus, under the old system, instead of changing tolls in small increments between, say, one dollar and two dollars as would occur with E-ZPass, changes will be larger and more infrequent (perhaps in quarter, fifty cent, or even dollar increments rather than nickel increments). The result will be that E-ZPass tolls that are more flexible and rise sooner than under the old system though with this story, in the long-run, the average toll would be the same (net of differences in transactions and collection costs).]

Thursday, June 28, 2007

Robert Reich: Fiscal Balance is a False Economy

Talk of rebuilding is a positive way to send a negative message. It says that things are not okay the way they are - they need to be rebuilt - but the message is one of hope rather than negativity. I think that was one of the keys to Bill Clinton's success. He didn't just tell us "It's the economy, stupid" and things aren't so good, people knew that. What made the difference is that he articulated a plan and a vision, efforts such as rebuilding infrastructure (which were, unfortunately in my opinion, largely abandoned later) that said things don't have to stay this way if you vote for me. As I hear the discussion of the economy, of Iraq, and of other things developing among Democratic presidential candidates, I wonder if there's a lesson here. Yes, we know things are bad, but can you give us any reason for hope? What will you do to change things?

Discussions within the Democratic party over the deficit are related. Economically, how important is deficit reduction now? While there are looming problems on the horizon, my view is: not very. By historical standards, the burden is not large and if we are making good investments that will pay dividends in the future, the benefits exceed the costs.

Politically, how important is deficit reduction right now? Again, I'd say not very. I think selling a positive message about how to improve infrastructure, health care - the usual list of worries - gains more votes than deficit reduction. If there were great economic gains from deficit reduction, I would want to try to let voters know why they should be more concerned. But as I said, I don't think there are big gains from deficit reduction and we can address more pressing needs by not insisting on giving up potentially valuable projects just to show an improvement in the deficit numbers.

Suppose, for example, that the war in Iraq were to end before the next president takes office (and how I wish this wasn't a supposition), or tax cuts are rolled back, or other measures are taken to make additional revenue available. Is our most pressing need to reduce the deficit? I'm not talking about increasing the deficit substantially, just what to do if additional funds becomes available. I think there is a discussion we need to have about whether our tax burden is equitably distributed, what are spending priorities are, and the level and progressivity of taxes needed to meet those priorities, but for now I think the politics keep us near existing revenue and spending boundaries.

Here's Robert Reich who not only thinks that we should maintain the 2% of GDP deficit we have now, he believes the deficit should be increased to 3% of GDP:

Fiscal balance is a false economy, by Robert Reich, Commentary, Financial Times: A quiet but important debate is breaking out inside the Democratic party. It will largely determine whether the Democrats, should they win ... in 2008 ..., will have enough revenue to do the things that need to be done in the nation. The debate is over the importance of reducing the budget deficit and the goal of a balanced budget.

In many ways it is a continuation of a debate that began at the start of the Clinton administration. The difference is that then the budget deficit hovered at about 5 per cent of US gross domestic product and there was broad consensus it had to be reduced. Now, the budget deficit represents only around 2 per cent of GDP, close to its historical norm. Yet it has become an article of faith among some Democrats that fiscal prudence is a necessary precondition for economic health. Indeed, ... Democrats’ proposed federal budget for the next fiscal year avows a commitment to reduce the budget deficit still further.

The Democrats’ presidential candidates are in a fiscal straitjacket. They are promising to address America’s sluggish wage growth and widening inequality by fixing the schools, providing affordable healthcare to all, repairing the nation’s infrastructure and leading the US towards new energy technologies, while also protecting Social Security..., being tough on national defence and homeland security. But they do not want to raise taxes, apart from rolling back President George W. Bush’s temporary tax cuts... How can they accomplish all this while still guaranteeing fiscal austerity?

When Bill Clinton was elected he promised to reduce America’s two deficits – the budget deficit and the growing deficit of public investment in schools, healthcare, infrastructure and environment. But the budget deficit was much larger than expected. Hence, he put the investment deficit on hold. It remained on hold for the next...well, it has now been 14 years.

In the late 1990s, when the budget deficit turned into a fat budget surplus, President Clinton again ignored his original investment agenda. ... [W]orried that Republicans would try to turn the surplus into tax cuts, Mr Clinton used the scare tactic of telling the nation to “save Social Security first”. By 2000, as budget surpluses mounted, candidate Al Gore proposed they be reserved for baby boomers’ Social Security. When the surpluses still overflowed, Mr Gore said they should be used to cut national debt.

The investment agenda had disappeared. Thus did Mr Clinton and Mr Gore tee up a $5,000bn 10-year surplus for Mr Bush to give away mostly to America’s very wealthy without the nation ever considering it might be used to finance what Mr Clinton and Mr Gore were elected to do in 1992.

Democrats had become the official party of fiscal austerity. Fast forward to now. The nation’s investment deficit is now much larger than it was in 1992. ...

Mr Bush has put rich people and big corporations first. Yet as a percentage of GDP the budget deficit is now far less than in the early 1990s. If we cut corporate welfare, raised taxes on the richest Americans, and allowed the deficit to move up to 3 per cent of GDP then there would be plenty of money to invest in the nation’s future.

Yet congressional Democrats have learnt the wrong lesson from the 1990s. They have concluded that cutting budget deficits and balancing budgets is a sure-fire formula for widespread prosperity. ... Their “pay-go” rules make it impossible for them to do much of anything without raising taxes, yet they have been unwilling to commit themselves to raising taxes on the rich. ...

Mr Clinton had it right in 1992. Inadequate public investment in the nation’s future will condemn us to slower growth and shrinking prosperity. It is already happening.

Wednesday, June 27, 2007

Our Progressive Tax System

Warren Buffet is only taxed at 17.7%?:

Buffett Slams Tax System Disparities, by Tomoeh Murakami Tse, Washington Post: Warren E. Buffett ... slammed a system that allows the very rich to pay taxes at a lower rate than the middle class.

Buffett cited himself, the third-richest person in the world, as an example. Last year, Buffett said, he was taxed at 17.7 percent on his taxable income of more than $46 million. His receptionist was taxed at about 30 percent.

Buffett said that was despite the fact that he was not trying to avoid paying higher taxes. "I don't have a tax shelter," he said. And he challenged Congress and his audience to see what the people who "clean our offices" are taxed...

Wednesday, June 20, 2007

Bruce Bartlett: Tax Cuts and the Not So Great Economy

Bruce Bartlett says if conservatives want to argue for lower taxes, fine, do so. But do it honestly and leave the exaggerated claims about tax cuts and tax increases out of the debate:

Greatest Economy?, by Bruce Bartlett: For an interview with a reporter about the state of the economy, I looked up a few numbers that are interesting. I compared the state of the economy today to where it was at the exact same point during the previous business cycle. Thus, according to the National Bureau of Economic Research, the most recent recession ended in November, 2001. If you count forward 21 quarters to the first quarter of 2001 [2007], we see the following:

Real gross domestic product: Up 16.4 percent Real gross private domestic investment: Up 10.2 percent Payroll employment: Up 5.3 percent Standard & Poor's 500 stock index: Up 34.2 percent

Viewed in isolation, these numbers don't seem too bad. For example, real GDP has risen at a 3.1 percent annual rate since the end of the recession. But in areas such as this, there are no objective criteria for saying what is a good performance from a bad one; only experience can guide us. Thus it is interesting to look at the same numbers above counted forward the same number of months from the end of the previous recession, which the NBER tells us ended in March, 1991:

Real GDP: Up 17.9 percent Real investment: Up 51.2 percent Payroll employment: Up 10.8 percent S&P 500: Up 82.2 percent

It is obvious that by every standard, the recovery and expansion after the 1990-91 recession was significantly better than that after the 2001-01 recession. Recognizing this fact is important for several reasons.

Continue reading "Bruce Bartlett: Tax Cuts and the Not So Great Economy" »

Thursday, June 14, 2007

"Paying Taxes Can Make Citizens Happy"

Colleagues find that paying taxes can make people happy:

Paying taxes, according to the brain, can bring satisfaction, EurekAlert: Want to light up the pleasure center in your brain? Just pay your taxes, and then give a little extra voluntarily to your local food bank. University of Oregon scientists have found that doing those deeds can give you the same sort of satisfaction you derive from feeding your own hunger pangs.

A three-member team – a cognitive psychologist and two economists – published its results in the June 15 issue of the journal Science. The scientists gave 19 women participants $100 and then scanned their brains with functional magnetic resonance imaging (fMRI) as they watched their money go to the food bank through mandatory taxation, and as they made choices about whether to give more money voluntarily or keep it for themselves.

The participants lay on their backs in the fMRI scanner for an hour-long session and viewed the financial transfers on a computer screen. The scanner used a super-cooled magnet, carefully tuned radio waves and powerful computers to calculate what parts of the brain were active as subjects saw their money go to the food bank and made yes or no decisions on additional giving.

Researchers found that two evolutionarily ancient regions deep in the brain – the caudate nucleus and the nucleus accumbens – fired when subjects saw the charity get the money. The activation was even larger when people gave the money voluntarily, instead of just paying it as taxes. These brain regions are the same ones that fire when basic needs such as food and pleasures (sweets or social contact) are satisfied.

“The surprising element for us was that in a situation in which your money is simply given to others – where you do not have a free choice – you still get reward-center activity,” said Ulrich Mayr, a professor of psychology. “I don’t think that most economists would have suspected that. It reinforces the idea that there is true altruism – where it’s all about how well the common good is doing. I’ve heard people claim that they don’t mind paying taxes, if it’s for a good cause – and here we showed that you can actually see this going on inside the brain, and even measure it.

The study gives economists a novel look inside the brain during taxation, said co-author William T. Harbaugh, a UO professor of economics and member of the National Bureau of Economic Research in Cambridge, Mass. “To economists, the surprising thing about this paper is that we actually see people getting rewards as they give up money,” he said. “Neural firing in this fundamental, primitive part of the brain is larger when your money goes to a non-profit charity to help other people.” “On top of that,” Harbaugh added, “people experience more brain activation when they give voluntarily – even though everything here is anonymous. That’s a very surprising result – and, to me, an optimistic one.”

However, this latter finding, which offers confirmation to the economic theory of “warm-glow” giving, doesn’t necessarily mean that taxes should be lowered and charity relied on more heavily, Harbaugh said. In a voluntary environment, he added, lots of people free-ride and donations fall.

The study, Mayr said, reflects the balancing act that every society must face. “What this shows to someone who designs tax policy is that taxes aren’t all bad,” he said. “Paying taxes can make citizens happy. People are, to varying degrees, pure altruists. On top of that they like that warm glow they get from charitable giving. Until now we couldn’t trace that in the brain.”

Neural activation from mandatory taxation, the researchers said, helps predict who will give. “We could call the people whose brains light up more when money goes to charity than to themselves altruists,” Mayr said. “The others are egoists. Based on what we saw in the experiments, we can use this classification to predict how much people are willing to give when the choice is theirs.”

There remain a lot of unanswered questions, Harbaugh said. “We show that people liked paying a tax that went to a food bank. But suppose the tax had been unfair. What then" Or suppose that people voted to make other people pay the tax, too" That would help other people even more, so would the voter get a bigger neural reward"”

Harbaugh, Mayr and co-author Dan Burghart, an economics graduate student, say they are not worried about the possibility that governments could use their method to monitor tax evasion, or charities could use it to figure out whom to ask for money. “To do this, we needed a $3 million scanner, some liquid helium and a few weeks of computer time,” Harbaugh said.

“If a participant moved her head,” Burghart added, “we had to start all over. It will be a while before this is built into cell phones.”

Progressive Taxation as a Political Shield for Globalization

David Wessel of the Wall Street Journal says there is increasing support for income redistribution policies to compensate the losers from globalization and prevent a backlash against trade liberalization:

The Case for Taxing Globalization's Big Winners, by David Wessel, Commentary, WSJ (free): A new argument is emerging among the pro-globalization crowd in the U.S...: Tax the rich more heavily to thwart an economically crippling political backlash against trade prompted by workers who see themselves -- with some justification -- as losers from globalization.

The sharpest articulation of this view comes not from one of the Democratic presidential campaigns, but from economist Matthew Slaughter, who recently left President Bush's Council of Economic Advisers to return to Dartmouth's Tuck School of Business.

"Policy has become more protectionist because the public is becoming more protectionist," Mr. Slaughter and ... Yale political scientist Kenneth Scheve, write in the new issue of Foreign Affairs magazine. "And the public is becoming more protectionist because incomes are stagnating or falling."

Globalization, the two academics argue with unswerving conviction, is good for the U.S. ... But the benefits ... have been distributed unevenly. ...

The conventional response from fans of globalization, including the Bush administration, is rhetorical support for more aid for workers hurt by imports ... and better education to equip the next generation of Americans with skills needed to command high wages in a global economy. Both are crucial. Progress on both is painfully inadequate.

But trade-adjustment assistance is traditionally targeted narrowly at workers hurt by imports. Today's angst about globalization is far more pervasive. ... And education takes generations to pay off.

What to do? ... "It is best not to address increasingly salient concerns about inequality by interfering with trade," Mr. Summers argued [recently]... His solution: use progressive taxation to offset some, but not all, of the increase in inequality. For starters, return tax rates for couples with incomes above $200,000 to the levels they were under President Clinton.

"Truly expanding the political support for open borders requires making a radical change in fiscal policy," Messrs. Slaughter and Scheve argue. Their particular proposal: eliminate the Social Security-Medicare payroll tax on the bottom half of workers -- roughly those earning less than $33,000 a year -- and make up the lost revenue by raising the payroll tax on others.

This, obviously, would be a sea change in fiscal policy. ... But all this talk is likely to influence any Democrat who takes the White House in 2008. He or she will almost surely move to raise taxes on the best-off Americans -- both to raise revenue to pay the bills and to resist the three-decade-old inequality trend.

There's a lot of argument about the extent and cause of widening inequality, and a lot about the damage higher tax rates can do to economic growth. That will go on. But the ... palpable resentment of the losers is producing growing resistance among politicians ... to further lowering barriers to trade and promoting globalization...

Expecting market forces to reverse the recent trend toward ever-bigger winnings for those at the top is unwise; the forces are too strong. Taxing winners isn't without risk; as Mr. Summers says, globalization makes it easier for them to "pick up their marbles and go somewhere else."

But using the tax code to slice the apple more evenly is far more palatable than trying to hold back globalization with policies that risk shrinking the economic apple.

Personally, I'm not much on redistribution simply to make outcomes more equal. But there are (at least) three reasons to depart from this. First, when there is change such that makes one group better off at the expense of another as has happened recently with globalization, and when redistribution can leave everyone better off, then redistribution is justified.

Second, I think everyone should have equal opportunity to be a CEO or a hedge fund manager, or whatever they want to be. However, the playing field is far from level and there is a lot more we could do on this side of the equation. Not everyone will be a CEO of course, or achieve their dream job whatever it might be, but everyone should have an equal chance to be one of the winners. In the meantime, until more has been done to level the playing field, progressive taxation is a means of making up for inequality in opportunity.

Third, for me at least, progressive taxation is justified by the equal marginal sacrifice principle (the last dollar paid should cause the same amount of disutility for everyone). Thus, even if opportunity is equal, and even if there were no winners and losers to worry about, justification for progressive taxation would remain. I think a more progressive tax structure than we currently have is needed to equalize the disutility of paying taxes.

We could list "preventing a political backlash" as a fourth reason for redistribution. But I'm not sure we need to invoke the political economy argument. If we use progressive taxation in accordance with the three principles above, then income will be more equally distributed and a backlash against globalization is less likely to occur.


Are the fears of a downward spiral of protectionism real? From China Daily, some evidence that congress has China's attention:

Continue reading "Progressive Taxation as a Political Shield for Globalization" »

Tuesday, June 12, 2007

The Hamilton Project: Reforms to The U.S. Tax System In Today’s Global Economy

Larry Summers, Robert Rubin, and others are proposing reforms to the U.S. tax system in an event today sponsored by the Brookings Institution, see Reforming Taxation in the Global Age [video] Here's part of the press release that came via email:

The Hamilton Project ... hosted a forum today entitled “Reforming Taxation in the Global Age”... During the forum, the Hamilton Project released a new strategy paper and three new discussion papers examining the need to modernize and reform the U.S. tax code to reduce inequality, expand opportunity and respond to the realities of a global economy. ...

Summers opened the forum by highlighting a new strategy paper he co-authored, along with Jason Furman and Hamilton Project Policy Director Jason Bordoff, on “Achieving Progressive Tax Reform in an Increasingly Global Economy.” The paper highlights the enormity of the increase in inequality: in total $664 billion has been shifted from the bottom 80 percent of households to the top one percent of households. At the same time, the tax system has become less progressive—since 1960 the average tax rate for the top 0.1 percent of households has been cut nearly in half while rising slightly for middle-income families

Summers noted that the erosion of progressivity in the tax code is the result of a combination of deliberate policy choices (like the 2001 and 2003 tax cuts) and the failure to reform the tax code to keep up with rapid changes associated with globalization and the increasingly sophisticated financial system. In particular, Summers highlighted the growing ease with which corporations have leveraged these factors to avoid paying taxes, thus contributing to the income gains for the wealthiest Americans.

“The increase in inequality has shifted $664 billion from middle-class families to the most fortunate – the equivalent of taking away $7,000 from each household in the bottom 80 percent. Rather than trying to offset part of this income shift, the tax code has become less progressive thus exacerbating these challenges,” noted Summers. “This inequality, in turn, undermines political support for a competitive market economy, which contributes to economic growth. By making our tax system more progressive, we can help everyone share in the tremendous benefits generated by the economy while creating the political and economic conditions for sustained growth.”

Continue reading "The Hamilton Project: Reforms to The U.S. Tax System In Today’s Global Economy" »

Friday, May 18, 2007

Robert Reich: Democrats and the Deficit

Robert Reich is not happy with the Democrat's commitment to deficit reduction. He has a point:

Democrats and the Deficit, by Robert Reich: House Dems have just unveiled their budget. It’s a gangly, wordy, and ambitious document that – no surprise – contains lots of things all Democrats can agree on, and whose numbers don’t quite add up. The most distressing aspect is its avowed commitment to reduce the budget deficit.

Here we go again.

Shortly after Bill Clinton was elected president he asked me to head up his economic transition team. He had promised during his campaign to “put people first” by reducing America’s two deficits – the yawning budget deficit, and the growing deficit of public investment in the nation’s schools, health care, infrastructure, and environment. ... But the ... budget deficit was so much larger than expected ..., Clinton ...[had] to put the investment deficit on hold. It remained on hold for the next ... well, it’s now been fourteen years.

In the late 1990s, when the budget deficit turned into a fat budget surplus, Clinton ignored his original investment agenda. ... Clinton was worried Republicans would try to turn the surplus into tax cuts, so he used the ever-reliable scare tactic of telling the nation to “save Social Security first.” By 2000, as budget surpluses continued to mount, candidate Al Gore demanded they be put in a “lock box.” When the surpluses overflowed even the lock box, Gore said they should be used to reduce America’s national debt.

Thus did Clinton and Gore tee up a $5 trillion surplus for George Bush to give away mostly to America’s very wealthy – without the nation ever considering it might be used to finance what Clinton and Gore were elected to do in 1992. While Republicans continued to spout the nonsense of supply-side economics, Democrats became the official party of fiscal austerity. The choice became either trickle-down economics or Calvin Coolidge economics.

Fast forward. The nation’s investment deficit is now much larger than it was in 1992. ... There’s less money for job training, and it’s harder for families of modest means to afford college for their kids. Millions more Americans lack health insurance than in the early 1990s. And according to a recent report from the American Society of Civil Engineers, America’s roads, bridges, transit and drinking water systems, and power grids are in worse shape than they were fifteen years ago. On top of all this, the nation will need to invest tens of billions to cope with global warming.

George Bush has put rich people and big corporations first – spending like mad on fat contracts for military contractors, price supports for big agriculture, bloated subsidies for oil companies, and subsidized research pharmaceutical companies. Yet measured as a percent of the gross domestic product the current budget deficit is still less than it was in the early 1990s. Cut the corporate welfare, raise taxes on the top, allow the deficit to move up to 3 percent of GNP, and there would be plenty of money to invest in the nation’s future.

Yet the Democrats don’t seem to know how to let go of Calvin Coolidge economics. Somehow, they got it in their heads that cutting budget deficits and balancing budgets ... is a sure-fire formula for prosperity. Flush from their mid-term victory, congressional Democrats have flung themselves headlong into the guillotine of fiscal austerity. They’ve promised to shrink the deficit, and enacted “pay-go” rules that make it impossible for them to do much of anything without raising taxes, yet they’ve been unwilling to commit themselves to raising taxes on the rich. Democratic presidential candidates, meanwhile, have been assiduously vague about how to finance their plans for affordable health care or anything else. ... All are careful to sound as if they believe that fiscal privation is the road to salvation.

Bill Clinton had it right in 1992. Inadequate public investment in the nation’s future will condemn us to slower growth and shrinking prosperity. It’s already happening.

The Sources and Underlying Causes of the Growth in Tax Revenues Since 2003

An email points me to this CBO report on the sources and causes of changes in tax revenue since 2003. The bottom line: the main source of the growth is corporate tax revenues, the bulk of which are from increased corporate profits. For personal income taxes, the report notes that the tax base for the personal income tax fell because "wages and salaries ... fell relative to GDP." Tax increases came from "higher realizations of capital gains (including any effects associated with legislated reductions in tax rates)," and "bracket creep":

Congressional Budget Office, Peter R. Orszag, , Director U.S. Congress, Washington, DC 20515: Dear Mr. Chairman [The Honorable Kent Conrad, Chairman of the Committee on the Budget]:

Continue reading "The Sources and Underlying Causes of the Growth in Tax Revenues Since 2003" »

Wednesday, May 16, 2007

"A Heavy Load: The Combined Housing and Transportation Burdens of Working Families"

As I was looking around the Richmond Fed website, I came across this research on the amount working families spend on housing and transportation. This is the the introduction to the study and a summary of the findings.

The main point is this. As we think about imposing tolls to drive into cities in order to control congestion, and with many people claiming that working families rely upon public transportation so the toll will have little impact on them, we need to keep this research in mind. It suggests that housing and congestion problems are related, and that there are others measures we can take besides or in addition to the imposition of tolls to help with congestion problems. But most of all it suggests that in areas where housing prices are high, families often locate far from their workplaces to reduce housing costs, and then rely upon private transportation to get to and from work:

A Heavy Load: The Combined Housing and Transportation Burdens of Working Families, by Housing Policy Chairman Kent W. Colton, Center for Housing Policy, October 2006:  Nationally, for every dollar a working family saves on housing, it spends 77 cents more on transportation. This was one of the dramatic findings from the Center’s earlier study, Something’s Gotta Give, which reflects the basic tradeoff many working families face between paying a greater share of their income for housing or enduring long commutes and high transportation costs. But how does this tradeoff play out at the local level? Are there metropolitan areas in which this tradeoff is more or less pronounced? Where do working families end up living within each area, and how does the availability of housing affect their choices? And how does the varying cost of housing and transportation within a region affect families’ combined  housing and transportation burdens?

Continue reading ""A Heavy Load: The Combined Housing and Transportation Burdens of Working Families"" »

John Stossel Should Do a Fraud Investigation on Himself

John Stossel makes a false claim about tax cuts. As we know, tax cuts do not pay for themselves. No credible analyst claims that. But John Stossel does:

The Tax-Cut Myth, by John Stossel, RCP: ...[T]ax cuts stimulated the economy and increased tax revenues. It happens because, as the Laffer Curve illustrates, lower rates mean higher rewards for productive activities. ...

Any decent reporter would know that isn't true. He can't even keep his story straight. After saying it was tax cuts that increased revenues, he then says:

President Bush brags that the deficit is coming down -- and it is. ... But that's largely because your FICA taxes currently exceed Social Security and Medicare payments. ...

He then goes back to the tax cuts increase revenues propaganda and quotes the president pushing the same myth:

Bush boasted last year, "This economy is growing, federal taxes are rising, and we're cutting the federal deficit... Some in Washington say we had to choose between cutting taxes and cutting the deficit. Today's numbers show that that was a false choice. The economic growth fueled by tax relief has helped send our tax revenues soaring."

Remember what Andrew Samwick, who was chief economist of the Council of Economic Advisers from 2003 to 2004, said about statements like this?

Next, Stossel gets himself all tied up in knots. Tax cuts are good. But if tax cuts increase government revenue, then tax cuts are bad because it means government takes more of our money. So tax cuts aren't good after all:

But I don't want tax revenues to soar. That's money you and I could be spending for things we want. I want revenue and spending and government overall to shrink. So I'm not celebrating with the president.

So a higher tax rate is bad, a lower tax rate is bad, and the tax rate we have is unacceptable. It's all the government's fault anyway. Because of politicians, we'll never, ever get to the promised land on the other side of the Laffer curve:

If revenues are pouring in, why don't the politicians return it to the taxpayers instead of spending it? Because politicians love to spend money. They get reelected not by how much they save but by how much they shower on interest groups.

He has a book called Myths, Lies, and Downright Stupidity. I haven't read it and don't plan to, but from the above, I assume it's autobiographical.

Sunday, May 13, 2007

Uncle Sam Needs You

Have you noticed how skinny and weak Uncle Sam looks lately? Ezra Klein says it's time to feed the poor guy so he can do his job:

Give bigger government a chance, by Ezra Klein, Commentary, LA Times: On April 2, this newspaper reported that the Los Angeles Police Department had asked Philip Morris USA for a $50,000 donation to help fund its investigation into counterfeit cigarettes...

[W]hy shouldn't ... police ... have corporate sponsors ... (you know, aside from the obvious reasons of favoritism, bias and perverse incentives)? For that matter, what's wrong with ... families ... holding constant fundraisers to pay for the unfunded needs of their local public schools — drama societies and marching bands and that sort of thing? Or with parents having to go out and purchase body armor ... so that their sons are protected in Iraq? What's so odd about the crown jewel of the University of California graduate system, Boalt Hall Law School, having to move toward "privatization" so that it can raise more money and better compete with its private counterparts in an era when state funding has dried up?

What's so wrong, in other words, with hollowing out the public sector and replacing it with a pay-as-you-go society? It is the natural endpoint, after all, of the privatization craze, of the gospel of tax cuts and of the smaller-government-is-better- government mentality that has been on the ascendancy in the U.S. for nearly 25 years. ...

How has this come to pass? ... Conservatives talk a lot about government failure, but over the last few years, it's really we who have failed government, depriving it of the revenue, the conscientious management and the attention needed for it to succeed. Undercapitalize a pizza joint and your customers will taste the poor ingredients, become frustrated by the long waits and grow repulsed by the grimy environs. Staff it with your unmotivated drinking buddies and the service will falter, as will the quality of the product. It's no way to run a pizza place, and it's certainly no way to run a government.

But that's exactly what we've done. With ... the ... tax revolt, and with presidents whose entire domestic programs amounted to mindless tax-cutting, and with Congresses that have been happy to pass cuts and stack deficits, we have systematically deprived the government of the revenues it needs to provide basic services, even as we've come to need it to do so much more. ...

All that money has to come from somewhere. And the "where" isn't the high-profile initiatives that the media is watching — the Medicares and Social Securities (although they may suffer too) — but from the smaller, less-noticed, but critically important programs and departments that millions rely on.

If ... states cannot pick up the slack, there will have to be cuts in funding for police and schools and jails and Pell Grants and the Food and Drug Administration and the National Institutes of Health and the Department of Veterans Affairs and the nation's infrastructure and all the rest. ... And that it's all happening even as the globalizing economy demands ever higher skills, as ill and traumatized Iraq war veterans are going without care, as roads and schools are crumbling and myriad other minor catastrophes are underway beneath the notice of the national media but well within the range where they harm ordinary Americans.

Such unhappy outcomes are not merely morally unsettling, they're often economically inefficient. Government spending can be ... necessary... It can step in, for instance, when the market fails to deliver public goods that society desires but private entities haven't figured out how to fund. (It's useful having a national military, right?) And it can use its regulatory power to ensure that competition works to increase well-being rather than to simply amp up industry profits.

UC Berkeley economist Brad DeLong once wrote that "sometimes government failures are greater than the market failures for which they purport to compensate. Sometimes they are not." The trick is knowing which is which. But if, like the Bush administration, you are blithely unconcerned with running an efficient, effective government, ..., you never need make those judgments as you have neither the resources nor the personnel to effectively deploy the central organizing structure of modern societies. And that's a shame.

Libertarian humorist P.J. O'Rourke likes to say that "Republicans are the party that says government doesn't work, and then they get elected and prove it." Over the last few years, that's been true. But government can work, and increasingly, Americans appear to be anticipating its return. A new Pew Research Center poll finds that public support for a societal safety net and for government protections is at its highest levels in more than a decade — which suggests that Americans don't think bake sales are the way to fund their schools or that Philip Morris is really who they want subsidizing law enforcement. ...

When asked what type of political system Americans would have, Ben Franklin famously responded, "A republic, if you can keep it." Well, he also bequeathed us a government, if we can run it. And somehow, I don't think the Philip Morris police department is quite what he had in mind.

Saturday, May 12, 2007

Did Tax Cuts Fuel Economic Growth?

Did the tax cuts in 2001 and 2003 stimulate economic growth?

Pop Quiz: Did the Tax Cuts Bolster Growth?, by Daniel Altman, NY Times: Politicians from the president on down have lately been saying that the tax cuts passed in 2001 and 2003 were responsible for the quick growth of the economy starting in mid-2003. That growth has since tapered, but ... it’s worth asking — are they right?

I decided to pose that question to a large group of mainstream economists through an informal survey. The answer, in a nutshell, was no.... But there was a lot more to the story. ...

Last week, I sent e-mail messages to the 177 members of the National Bureau of Economic Research’s program on economic fluctuations and growth. ... The e-mail message had just one question:

“Which factor was most important for the economy’s growth from mid-2003 through the end of 2006?” It offered the economists five possible responses:

a. The tax cuts signed by President George W. Bush.
b. Pent-up demand following the recession, the corporate scandals and the invasion of Iraq.
c. Both (a) and (b) were important.
d. Neither (a) nor (b) was important; it was the regular business cycle.
e. There’s no way to tell now.

...Forty-nine economists responded to my message, including many of the best-known names in the field. Of these, only five, about 10 percent, said that the tax cuts were the most important factor in the economy’s growth.

Two were Nobel laureates known for their conservative views — Robert E. Lucas Jr. of the University of Chicago and Edward C. Prescott of Arizona State University. Two other professors, Martin S. Feldstein of Harvard and Gary D. Hansen of the University of California, Los Angeles, qualified their answers by mentioning other factors. ...

But the majority, 30 economists, answered neither or supplied an answer not listed. Robert E. Hall of Stanford wrote that “the U.S. economy recovered from every single recession it ever had, so the growth in 2003-2006 was generally part of the normal cyclical recovery.”

Several economists volunteered other factors, among which monetary policy was the most popular. “I can’t believe you left off the list: superlow interest rates caused by the Federal Reserve,” wrote Alan S. Blinder, a Princeton professor... Paul M. Romer of Stanford echoed Professor Blinder’s sentiments.

Robert J. Gordon of Northwestern University added: “I hope others tell you that your question is absurd, because it leaves out ... an unprecedented period of negative short-run interest rates...”

Some professors were just as adamant in ... arguing that changes in productivity had been responsible for the economy’s growth. “Productivity growth and financial innovation are the big stories of the 2000s,” said Kenneth S. Rogoff of Harvard. ... Erik Hurst of the University of Chicago said that “aside from the inventory correction in 2001, the growth in 2003-2006 was not that different than 1996-2000 (which had nothing to do with tax cuts or pent-up demand).”

And one economist said that most of the factors named, with the exception of the tax cuts, were part of the usual behavior that followed recessions. “Pent-up demand following a recession sounds like the regular business cycle,” wrote Robert J. Shiller of Yale. “Also, part of the regular business cycle is the Fed and the behavior of speculative markets.” ...

[M]ost of the respondents were unconvinced by the politicians’ claims about the benefits of tax cuts. In fact, one actually argued that the tax cuts hurt the economy. “The tax cuts, by increasing uncertainty about how impending fiscal imbalances will be resolved, probably hurt growth, if anything,” said Christopher A. Sims of Princeton. ...

A similarly contrary argument was suggested by Lee E. Ohanian of U.C.L.A. concerning the war in Iraq. “Large increases in military expenditures are almost always associated with rapid growth ..., but the size of the Iraqi conflict spending is quite small as a fraction of total income.”

Economics is not an exact science, even in hindsight. Indeed, economists rarely say that they’ve proved an empirical hypothesis. Rather, they say that a hypothesis can’t be ruled out. In that spirit, several answered that there was no way to say for sure which factors had caused the economy to grow. ...

I'm not sure whether those who believe the evidence supports the tax cut story are more or less inclined to answer an email survey, so I don't know in what direction the proportions might be tilted. But this seems to me to be a fair representation of the opinion among macroeconomists about the causes of economic growth in recent years, and the quotes are from economists well worth listening to.

Friday, May 11, 2007

Market Failure in Everything: The Carbon Emissions Edition

What's the best approach to limiting carbon emissions, cap and trade or a carbon tax? Many economists will tell you a carbon tax is best. Political consultants, for the most part, will tell you something else:

Getting on a low-carbon diet, by Ronald Brownstein, Commentary, LA Times: ...Scientists, economists and political leaders who support action against global warming all construct their proposals on a simple foundation: attaching a cost to carbon emissions. Since the U.S. ... does not regulate greenhouse gas emissions, factories and power plants and cars can pump carbon into the atmosphere for free; to the polluter, carbon today has no cost. ...

Since none of those costs are internalized..., the effect is to artificially lower their price. That distortion encourages overuse of fossil fuels and discourages investment in clean energy alternatives... "The biggest market failure we have in the world is the fact that [carbon emissions], which are potentially threatening our ability even to survive on this planet, has no price," says environmental consultant Roger Ballentine, the chairman of the White House climate change task force under President Clinton. ...

To the extent American politicians in recent years have talked about controlling carbon emissions, they have almost entirely focused on a system known as "cap and trade"... But now a group of skeptics is questioning whether that approach by itself will achieve the reductions in emissions necessary... Their alternative has a sharper edge: a tax directly on the carbon emissions of fossil fuels. ...

Sen. Christopher Dodd (D-Conn.) is promoting a carbon tax in his campaign for the 2008 Democratic presidential race. ... But Dodd is the only prominent presidential candidate talking about a carbon tax. And he's not surprised to be ... alone. "Why I suspect the other candidates are not talking about this, is all their pollsters and handlers have said 'you are looking for trouble here,'" Dodd says. "I think…there is a larger constituency for [this] than people believe today."

Both a carbon tax and a cap-and-trade system are designed to place a cost on carbon emissions. A carbon tax does so directly: It would tax each fossil fuel based on the amount of carbon it emits when burned. Under that system, coal would be taxed the most, oil less and natural gas least. ...

A cap-and-trade system operates very differently. The cap part works like this: The government would set an overall limit on the amount of carbon the country will emit each year, and then allocate "credits" that establish emission limits for individual companies. At that point, the trade component would kick in. ...[F]irms that can reduce their emissions more efficiently could sell some of their credits to other companies ... that find it more expensive to control carbon. A trading system would develop that establishes a market price for carbon pollution.

There are some other fine points under debate, particularly whether the credits should be provided free to polluters or auctioned off (by all indications, a better option.) ... The cap-and-trade system Congress approved in 1990 to fight acid rain has produced greater reductions in sulfur dioxide pollution at less cost than initially expected and minimal economic disruption...

Skeptics, though, point to the troubles of the cap-and-trade system the European Union has used since 2005... Under pressure from industry, European governments gave away too many credits to polluters; the result was that the price of the credits collapsed, undermining the incentive to cut emissions or use cleaner fuels. ... A second round ... scheduled for next year could ameliorate the problem, but at the least, the European experience suggests that designing a successful cap and trade is an enormously complex undertaking which may require some trial and error before it works.

That prospect is at the heart of Dodd's argument for a carbon tax. A cap-and-trade system, he says, "is confusing, it's complicated and it takes forever." Enforcement could also be a challenge... By contrast, he argues, a carbon tax sends an instant, unambiguous signal discouraging the use of the fuels that contribute the most to global warming. ...

[T]he two policies have complementary strengths. ... Al Gore, in his Congressional testimony, ... testif[ied] that he believed "the most effective approach is to do both."

This discussion may seem wildly premature. ... At the moment there's no sign Congress is ready to approve even a cap-and-trade system... And a carbon tax proposal—because it includes that three letter word—is a much more incendiary proposition than a cap-and-trade proposal (which would also raise electricity and gasoline prices, though in a more muffled and indirect way).

But the political climate on these issues could change as abruptly... More leaders from different segments of American society—from utility and auto executives to the retired military officials who testified before the Senate this week—are endorsing meaningful, mandatory action...

When Washington is ready to act, the real lesson ... from this ... debate ... is that there is no best way. Progress against a challenge as vast as global warming will require us to use all the tools available to us: direct regulation (tougher fuel economy standards for cars, requirements on utilities to generate more of their electricity from renewable sources); economic carrots and sticks (a carbon tax that helps fund tax breaks for investment in greater energy efficiency and alternative energy sources); a cap-and-trade system that sets a hard limit on emissions; federal procurement that nurtures clean new technologies; and steps beyond all of these that we can't yet imagine. ...

Does anyone know any more about this? Is it generally accepted that "Australia's farmers have been responsible for virtually the entire share of the nation's greenhouse gas emissions reductions" due to "government laws banning land clearing"?:

There's little gold in them climate-saving trees, by Michael Duffy, Commentary, Sydney Morning Herald: This week's copy of The Land newspaper contains one of the more unusual items the state's august rural newspaper has published. It's a two-page ad presenting an invoice for $10.5 billion from some farmers to the governments of Australia. The farmers want to be paid for carbon dioxide their farms have absorbed because of state government laws banning land clearing. After all, the more trees left standing, the more carbon gets sucked out of the air.

The farmers argue that laws to protect native vegetation have enabled the Federal Government to claim it is meeting its Kyoto emissions target without penalising other industries. Therefore those industries, via the government, owe the farmers a lot of money. ...

The farmers say they will launch court action if their invoice is not paid. Their chances of success are probably zero, but the ad ... is also a useful reminder of how farmers have been shamelessly used by the Federal Government in relation to the Kyoto Protocol.

Not only have they suffered harshly from state native vegetation laws, which have effectively nationalised large parts of many farms without compensation, their suffering has been used as an excuse to allow other businesses to continue to belch out carbon and profit from it.

Australia managed to get a special clause inserted in the Kyoto deal allowing reductions in land clearing after 1990 to be part of the calculation of its net carbon emissions. Fortuitously, an unusually large amount of land had been cleared in 1990. As a result, the Federal Government has been able to claim that Australia was meeting its targets without any economic activity being penalised.

Apart, that is, from farming. Last October a think tank called The Climate Institute published a report claiming that, thanks to bans on land clearing, "Australia's farmers have been responsible for virtually the entire share of the nation's greenhouse gas emissions reductions … Over the same period, emissions from energy and transport have and continue to skyrocket..."

The climate institute also claimed that, because Australia refused to ratify the Kyoto Protocol, farmers have been unable to access those international emissions trading schemes that do exist. Our farmers "are unable to convert the emissions reductions they have achieved into financial value and benefit from the growing global carbon market". ...

Some farmers have seized on this with joy... My prediction is there will be lots of talk and no meaningful action.

The farmers' problem is that they are acting as though our leaders mean what they say on global warming. In truth they don't. Almost all government action on climate change is driven by the need to pretend to be doing something significant, while actually doing as little as possible. This is because any meaningful action would harm the economy. This is the situation in most countries, not just Australia. Most apparent action on climate change falls into four categories.

1. The commissioning of more research, including the setting up of high-profile study centres and inquiries. This allows leaders to say they're taking the problem seriously while postponing the need to do anything significant. ...

2. Commitments to action that would harm the economies of other nations while affecting one's own hardly at all. The Europeans are masters at this.

3. The portrayal of action that would have occurred anyway as part of a government's brave fight against climate change. Examples include steps to fight air pollution in developing nations, and land clearing bans in Australia.

4. Commitments to action that sound wonderful but never occur, or do occur but with little effect on carbon emissions. Perhaps the best example of this is the European Union's Emission Trading Scheme, whereby nations set caps on carbon emissions. Sounds splendid. But for 2005 the caps set by most nations were higher than actual emissions.

In light of the above, one might propose the following. To the extent that anyone will actually suffer from action to reduce carbon emissions, it will be the weak rather than the strong. ...