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Sunday, March 21, 2010

Is a Big Spender Surtax the Answer?

Robert Frank argues that a consumption surtax for wealthy households that kicks in during good times will cause the wealthy to spend more during the bad times, and the additional spending during bad times can help lift the economy out of recession:

Hey, Big Spender: You Need a Surtax, by Robert Frank, Commentary, NY Times: Last year’s stimulus spending is running out, yet unemployment stays stubbornly near 10 percent. And as state and local governments keep cutting their budgets, the economy desperately needs an additional spending boost. Concerned about growing federal deficits, however, many in Congress appear reluctant to act.
Their worries are misguided. Yes, deficits are bad, but protracted unemployment is far worse. ... But an effective remedy is at hand. ... What I have in mind is a surtax on extremely high levels of consumption. It would be enacted right away, but not take effect until unemployment again fell below 6 percent.
More than 99 percent of households would be exempt from this tax, which would be levied only on families earning more than $1 million who consume more than $500,000 annually. ... Once consumption topped $500,000, the families would be subject to the surtax. Rates would start low but rise as consumption grew. ...
A progressive consumption surtax would produce immediate, off-budget economic stimulus by giving wealthy families powerful incentives to accelerate future spending. For example, a family that had been planning to build a new wing onto its mansion, or buy a yacht, would want to make those purchases now rather than be taxed on them later.
Stimulating a new luxury spending spree may not seem an ideal way to stimulate the economy. Far better, perhaps, would be for the government to repair dilapidated bridges and build high-speed trains. But unless someone can persuade 60 senators to support a huge new stimulus bill, this second option is foreclosed. Given our choices, it would be much better to provoke an additional burst of luxury spending than to let high unemployment linger for years. ...
If the surtax were phased in gradually, it would shift spending from consumption toward additional savings and investment. In the long run, higher investment would increase economic growth and boost earnings across the income spectrum. ...
More than a decade ago,... I received a warm letter from Milton Friedman, the late Nobel laureate, who was the patron saint of small-government conservatism. Mr. Friedman began by disagreeing with my contention that additional public investment would yield high returns.
He quickly added, however, that if the government did need additional revenue, a progressive consumption tax would be the best way to raise it. ...
Such a tax would not cause painful sacrifices because, beyond a certain point, additional consumption serves needs that are almost completely socially determined. When all C.E.O.’s build bigger mansions, for example, they are simply raising the bar that defines how big of a mansion a C.E.O. needs. If a progressive consumption surtax induced all of them to postpone those additions, nothing important would be sacrificed.

Political battles make it very difficult to use discretionary fiscal policy to fight a recession, so more automatic stabilizers are needed. Along those lines, if something like this were to be implemented to stabilize the economy over the business cycle, I'd prefer to do this more generally, i.e. allow income taxes, payroll taxes, etc. to vary procyclically. That is, these taxes would be lower in bad times and higher when things improve, and implemented through an automatic moving average type of rule  that produces the same revenue as some target constant tax rate (e.g. existing rates).

The problem is that any rule can be waived by a future congress, and it is likely that whenever taxes are set to rise, a legislator would introduce a provision to suspend the increase (making an "it will kill job creation" or "it will lower economic growth" type of argument). But the fact that there is no way to bind Congress in the future does not mean we shouldn't try to do the right thing. It's also possible that the rule will be honored by Congress in the future, something that won't happen if we don't try to do something now, and it also changes the baseline upon which the actions of Congress will be evaluated.

In any case, it's hard to imagine anything like this will actually be enacted. But there is a need for automatic stabilizers that can overcome the political divisions that prevent effective fiscal policy responses to business cycle variation in the economy.

    Posted by on Sunday, March 21, 2010 at 09:18 AM in Economics, Fiscal Policy, Taxes | Permalink  Comments (46)


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