Economists are generally conservative, aren't they?

Great Debates
81

I never said anything about the Laffer curve. I said that some Democrats think every tax will result in increased revenues, and pointed to the luxury tax as an example when they did not. The 1990 luxury tax had the main effect of destroying 7,600 jobs in the yacht industry, and in the end the government paid out more than $7 million dollars in unemployment benefits resulting from the tax than it collected in increased revenue.

The luxury tax was a good example because the effects were rather dramatic and there were not a lot of confounding issues, so it was unusually easy to track the effect of the tax.

The problem with debating tax revenue vs tax rates is that the effects one way or the other take a long time to shake out, and by then there are so many confounding variables that demagogues on both sides can justify whatever claim they want to make. There is no doubt that revenue will go up immediately following a tax increase, or go down immediately following a tax decrease. But if the tax increase causes a decrease in productivity which manifests itself in slightly lower economic growth, then over a long period of time it might result in less overall revenue for the government. Likewise, a tax decrease might cost you revenue in the next fiscal year, but if it creates a more competitive and productive environment which leads to higher compounding growth, you can grow yourself out of the revenue hole and eventually show more revenue than was immediately lost through the cut.

Unfortunately, it’s nearly impossible to look at the state of the economy several years after a tax cut or tax hike and determine how much change in GDP growth was a result of that cut. So supply-siders can claim that all the growth came from the tax cut, or in the case of a tax increase the Democrats can claim that any reduction in economic output had nothing to do with the tax increase. And it’s hard to prove either side wrong.

IMO, the case for the Laffer curve was much stronger when Reagan first invoked it, as marginal rates were sky-high - over 70%. Today they’re down to less than half that, and it seems much less likely that tax cuts will directly lead to increased revenue.

82

Let’s slow down for a moment Sam. Additional unemployment benefits paid out are on the cost side, not the revenue side. So the rule that, “Every tax will result in increased revenues”, remains. It’s sort of like, “Demand curves slope downwards.” True, there’s the theoretical exception of Veblen goods, but such an oddity has never been observed.

Technicalities and presentation aside, the luxury tax example is an interesting one. I was not aware that this tax increase was or might be a deficit-enhancer (though I’d like to see a treatment of this policy issue).

On the alleged relevance of the Laffer curve: there are a couple of problems. Firstly for it to work, you generally have to assume labor supply elasticities that simply lack empirical support - they fail the laugh test. That’s why conservative tax cut advocates such as Mankiw refer to it as “Snake Oil”. I’m assuming tax rates are under 75% here: I don’t doubt that there are serious problems at, say, 95% rates. (And I’m not advocating >70% rates for the wealthy either.)

Secondly, I’m discussing pundits, not demagogues. Typically, they state that tax revenues rose after Reagan’s tax cuts, while ignoring the effects of inflation and population growth. Jeez, Sam: that simply is not a serious argument. And the problem with it has nothing to do with confounding factors.

Just to be clear:
------ “Unfortunately, it’s nearly impossible to look at the state of the economy several years after a tax cut or tax hike and determine how much change in GDP growth was a result of that cut.”

Yes, that methodology is a problematic one. But see my first point regarding elasticities.

Top marginal rates were really sky-high during the great expansion of the 1950s: 91%, I understand. And yet we has record economic growth.

And you mean “70%”, not “over 70%”, right?

Incidentally, Martin Feldstein emphasized the pronounced effects on savings during an era of high inflation. If inflation was, say 7% and interest rates were a hefty 11%, a tax rate of 50% would still result in substantially negative real rates of return (11/2 -7 = -2.5). That sounds… harmful. So I’m not saying there are not legitimate conservative arguments. I’m saying that modern Republican economic thinking is dominated by crankery.

Luckily, Paulson (Treasury) and Bernanke (Federal Reserve) both operate in the realm of reason and evidence. I disagree with aspects of Paulson’s latest plan, but my problems with it are of an entirely different kind.

83

I think we’re debating different things to some degree. I’m not defending the Laffer curve in this thread, and I happen to agree with you that far too many conservatives, including George Bush, have accepted the mantra that any tax cut is self-paying. That’s ridiculous on its face. If the Laffer curve has meaning at all, it just as readily shows that there is a region on the curve where tax cuts decrease revenue as it shows that in some regions tax cuts increase revenue.

I’m headed for bed, but here’s a quick cite on the effect of the luxury tax, with source cites included: http://www.ncpa.org/ea/eama92/eama92k.htm

84

If you are saying that the GOP embraces the notion that “tax cuts pay for themselves” as a way to sell tax increases that they would support even without this justification, then you and I are in agreement.

Since the rich pay most of the taxes in this country, it is indeed consistent that allowing people to keep more of what they earn will benefit the rich.

If you lower everyone’s income tax rate by, say, 10%, then the rich would disproportionately benefit. I find it difficult to see how that’s unfair.

True, but so does the huge increases in spending sought by the GOP and the even larger increases in spending sought by the Democrats.

Wanniski’s main theme is that cutting certain taxes will raise more revenue for the government in order to fund social programs. I was unaware that the GOP had campaigned on the notion that the government needs more revenue to spend on these programs.

85

Renob
---- Wanniski’s main theme is that cutting certain taxes will raise more revenue for the government in order to fund social programs.

Well, that’s certainly not the take-home message that Republicans seem to have absorbed. I stand by my position that the typical Republican stance is that tax cuts usually increase revenues, which is crankery. [When pressed, more sophisticated Republicans sometimes take Cheney’s formulation that, “Reagan proved that deficits don’t matter.” And indeed, the burden of budget deficits can be exaggerated at times. ]

---- True, but so does the huge increases in spending sought by the GOP and the even larger increases in spending sought by the Democrats.

When Democrats are in the Oval Office, deficits tend to be lower. Mechanism: the President puts forth a budget, and Congress typically returns a budget with different priorities – but very similar deficits.

Possible exception: Even if President Obama revokes Bush’s tax cuts on higher income groups, paying for semi-universal health care might reverse past historical experience, especially with the soft economy (2007-2010?).

----- If you lower everyone’s income tax rate by, say, 10%, then the rich would disproportionately benefit. I find it difficult to see how that’s unfair.

Tangent:

This, in a nutshell, is where liberals (me) and conservatives (you) talk past one another. My benchmark corresponds to equal revenue reductions across the population. Yours involves tax cuts where the revenue losses are tilted towards the wealthy. (True, but I finessed the percentage argument – equal percentage reductions imply greater revenue losses in higher income groups).

In both cases the starting point is the existing tax system (be it in 2000, 2008, whatever). That’s a little odd – who says that’s the appropriate standard of justice?

What I try to do is compare any tax proposal to my pre-existing ideal code, which has fewer loopholes (or ad hoc deductions), a low but positive corporate tax rate (surprise!), taxes on pollution (Mankiew pushes this as well, btw) and a top rate of around 50% (OMG: it’s TEOTWAWKI!).

I support progressive taxation (i.e. higher rates on higher income groups). In Taxing Ourselves, Slemrod points out though that there really isn’t a great orthodox justification [1] for this (though one could criticize a poll tax). So we wave our hands and invoke “values”.

Summary: I have no answer to that point.

Sam: Thanks for the link. I couldn’t find the original 1992 Congressional study (prepared for Olympia Snowe) online. It’s telling though that I don’t see a lot of center-left pushing for a luxury tax anymore, which suggests at the very least that the numbers were not completely cooked.
[1] That is, there isn’t a noncontroversial justification that follows from general principles such as ability-to-pay or the benefit principle. There is of course, plenty of rhetorical fodder for both sides, but no killer argument like Pareto optimality or whatever.

86

I am an economist, and I answer question such as the OP’s as follows:

Economics is fairly well equipped to determine what is efficient, but fairly poorly equipped to say what is “fair”.

As a simple example, rent control is a horribly inefficient idea, and I think most professional economists would agree. But is it fair? Can’t say. Same goes with minimum wage or protectionism.

As an aside, I cringe when someone mentions Cramer and his ilk in the same sentence as economists. Cramer has a law degree; he is as much an economist as I am a medical doctor. I might be a bit biased, because my school was very heavy on mathematical modeling. Around our department, the professors wouldn’t really call someone an economist unless they had a graduate degree and used mathematical models. I’ve worked with people who have masters degrees in “economics” where they took no calculus based courses and wrote there thesis on whether the president of Brazil was a good guy or not with nary an equation. In my book these people posers; they do not engage in economics.

87

Any economist worth his salt knows that GDP is merely a proxy for welfare. It’s popular because it’s easy to measure.

88

How do you figure?

If the only choices are “work – make no money” and “don’t work – make no money”, are you going to be the only schmuck out there accelerating your starvation by handing the government money? Communism is a total non-sequitor here; collective ownership implies that the benefits are collectively shared. It may correlate to a different tax rate for everyone, but even communists won’t work for absolutely nothing in return.

I’ll go ahead and defend (my understanding of) the Laffer curve: All you do is take two supposedly obvious minima, no revenue at 0% and 100% taxation, and posit that there is a maximum somewhere in between.

Personally, I don’t think “maximum government revenue” is the goal we need to be shooting for, but the Laffer curve doesn’t necessarily imply that. All it says is IF you wish to maximize revenue, there is a theoretical tax rate between 0% and 100% that maximizes it.

Why is that such a crackpot idea?

89

Here’s a thought experiment. The Chinese Emperor decrees that all income earned above $20,000 will passed over to the state, where it belongs. What do the peasants do?

Well, actually they have long experience with this sort of thing. They finagle: they simply declare less income than they earn.

Does the tax collector discover that everyone in the village is earning $20,000? Hardly. But he would note a drop in reported income, as the peasants seek to hide their earnings. Meaning that the headman might earn $50,000 and declare $30,000, sending off $10,000 to the state, which implies that the 100% tax doesn’t earn zero revenue.

The headman prefers that to prison.

It’s an economic truism that, yes, there is likely to be a peak somewhere there: after a certain point higher rates will probably reduce government revenue, if not exactly to zero.

But Laffer, Winninski et al were claiming that this relationship was empirically relevant in the 1970s and conventional wisdom among Washington Republicans is that it is empirically relevant today. This is pure crankery.

Permit me to quote a TV-economist (as opposed to a real one):

I

[quote Ben Stein]
(http://www.nytimes.com/2008/03/09/business/09every.html?_r=1&sq=stein%20that’s%20where%20the%20money%20is&st=nyt&adxnnl=1&scp=1&adxnnlx=1206925225-jEjkglUrnqIldOtzgfICAA&oref=slogin) merely to emphasize that Laffer-crankery is not limited to George Bush: it is conventional wisdom among Washington Republicans.

90

That’s not 100% taxation, though. Simply put, if you get to keep any money at all, the tax is not 100%. 100% means all of your money. I don’t know why you keep arguing otherwise.

I’ll agree, the idea that every tax cut increases revenue is a crackpot idea. However, it is pretty much self-evident that there are some imaginable situations where tax cuts increase revenue. Whether we are now or have ever been in one of those situations is something that we have to find out. How do you find out? Raise taxes or cut them (or study historical tax cuts and hikes), see which way the revenue goes.

I’m afraid that the maximum government revenue will come much closer to 100% tax than 0%. Personally, I think the goal should be maximum individual income. And no, that isn’t 0% tax. I think that police, infrastructure and education are all investments that cause citizens on average to earn more money that they would if there were no taxes at all.

91

Not only have there been " imaginable situations where tax cuts increase revenue" we know of some. They were common in international trade - Japan’s rice tariff and Australia’s sugar tariff for example raised zero revenue by design. A difficulty in modelling the effects of proposed WTO reforms is in assessing cuts to rates where the current tariff is beyond prohibitive (known as water in the tariff).

It’s known. There has been lots of study on the matter. And let’s be clear, the idea that the US income tax is above revenue maximising rates is not an open question.

And there are some pretty out-there open questions in economics. For example, there are serious people who believe that the Great Depression was caused by a forgetting of technology and that the appearance of unemployment at that time was really people sensibly deciding to take holidays as a response. I think that’s pretty wild, but it is an open question. Tax cuts in the US increase revenue is politically convenient crankery.

92

This is a narrower and less important point than Hawthorne’s but…

With all due respect, I think you’re missing something.

Laffer et al were discussing the top marginal tax rate on income. In the 1970s that was as high as 70%. They were not discussing the average tax on a rich person, that would have been lower.

As an example, today a single person earning $400,000 would face a top rate of 35% - for every dollar he owed above about $350,000. Between 160,000 and 350,000, he would pay a lower rate of 33%. And so on down the ladder. Faced with such a schedule, the taxes paid by this professional would be less than 35% of his total income.

If the mean 'ol government slapped a 100% tax on income above $500,000, Laffer would consider that a 100% marginal tax.

Recall that the point of Laffer’s drawing was to justify a cut in the top (marginal) tax rates. So my hypothetical evil Chinese Emperor was levying a 100% marginal tax rate, but not a 100% average tax rate.

93

But let me emphasize the positive. Joel Slemrod, from the Stephen M. Ross School of Business at the University of Michigan is the go-to guy on US tax policy. In this readable paper he outlines the sorts of responses that changes in tax rates might cause:

Timimg: Raise the capital gains tax rate for 2009, and taxpayers are likely to sell stock this year rather than the next, so as to lock in the low rates. Timing is perhaps the strongest effect.

Income Shifting: Raise the capital gains tax rate (holding others constant) and equity will become relatively less attractive than fixed income investments. A better example is the way multinational corporations will adjust their accounting to declare their profits in jurisdictions with lower tax rates.

Evasion: Illegal reporting of income. This amounts to perhaps 15% of the total tax take in the US.

Avoidance or “Tax Planning”. An old saying among tax professionals is, “The rich avoid and the poor evade.”

and finally:

Real Responses: Adjustments in savings or working, which is what supply side cranks tend to invoke. They do exist. But separating out these effects from the preceding is the topic of ongoing serious research.