« Freedom! | Main | Bridge »

February 05, 2005

Comments

Well, the only way out of this is the destruction of the value of the dollar, so that you can pay off those loans with much cheaper bucks.

But the Bush administration would never let that happen, would they?

The author of the article makes a very good point indeed, it's hard for me to believe that her extremely straightforward logic hasn't been adopted by more people. Tax cuts are really tax postponments, or tax deferrals. It could even be a bumper sticker -- or a campaign slogan. *sigh* Well, better late than never.

Thad Beier

On the other hand, I'm getting more of the money from my day's work. I'm saving a little more, not one of my strengths. I've improved my home, upgraded my wardrobe, enjoyed nice meals at the local restaurants and sipped a few beers. I've sent money to my kids, helped the folks and donated to United Way, Huntington’s Society and the American Red Cross. I've dropped a few bucks into the various collections at work for retirees and several who have suffered illnesses or family tragedies. Governments have lots of ways of getting our money. Income, property and sales taxes are only a few. In the last few years, my income tax has dropped and the property and sales taxes have creeped upwards a bit. I'm told the schools are getting a little more and the police and fire departments will be able to upgrade and hire more. In between, I've moved from one state to another, so most comparisons must remain anecdotal. You are right as rain, hilzoy; it's the spending, stupid! But unless my income taxes not only return to previous levels but are increased to some measure that eventually recovers what I've gained, in my proletariat little head, President Bush has helped me out a bit. And that's OK by me. And besides, it's not the President, it's the Congress, stupid (not you hilzoy - just turning a phrase) I remember enough from high school civics to remember that much. So knock of the minutiae of featuring a whole post on what something is named. I could have picked that up watching West Wing. If the world situation continues to improve, and the US economy continues to cycles toward strength, and folks feel good about proper spending and investing; AND Congress tends to their knitting, the debt will shrink. And frankly, some of the serious issues we're finally tackling should insure our childrens future on this planet. They might just as well help pay for it.

By all means we should cut Federal spending and reduce government regulation. The comment on foreign banks was overblown though.

The comment on foreign banks wasn't overblown. Foreigners hold almost 2 trillion dollars of US debt, and most of that is from Asian central banks.

Blogbudsman: On the other hand, I'm getting more of the money from my day's work. I'm saving a little more, not one of my strengths. I've improved my home, upgraded my wardrobe, enjoyed nice meals at the local restaurants and sipped a few beers.

But you've enjoyed all of those things at your children's expense. They'll have to pay back what Bush let you have. Nice for you. Not so beneficial for them.

Jes, I'm a bit more blunt. I call it bribery and theft.

They're stealing from the children, to buy the votes of the parents.

The sad thing is, I think the parents understand that it's going to be forced on to their kids. I just don't think they care. Can you tell that I'm a wee bit cynical?

Anderson's arguments seem to be based on the belief that tax rates are structurally too low. We should cut the rate of spending growth.

Timmy's got the right idea. Let's make a list. Mine starts modestly with the office of Faith Based Initiatives, taking care to snare its abstinence-only education grants (routed through HHS).

Cato outlines a much more ambitious program that targets corporate welfare.

And since we're now getting serious about fiscal responsibility, we probably ought to bring back the old "paygo" budget rules before we get to far ahead of ourselves. With their majorities in both houses, and strong across the aisle support, it's curious that the GOP let the rule lapse and hasn't reinstalled them since.

Makes one wonder about their motives.

Thad Beier,

The author of the article makes a very good point indeed, it's hard for me to believe that her extremely straightforward logic hasn't been adopted by more people.

She does make a good point. And, not to diminish the importance of her post, in fact this logic is very well understood by a great many people. The trouble is first of all that Bush is not and never has been concerned about whether his fiscal policies are logical, and second of all that the media either do not grasp the straightforward point Anderson makes, or are unwilling to cross the Administration.

Blogbuds: you may be enjoying things now, but (a) you or your children will have to pay, and (b) you'd be enjoying things a lot more if we hadn't made the very same choice you're applauding for the last few decades. Last time I checked, interest on the debt ate 17% of tax receipts. That's a lot to pay for the privilege of not paying for government spending when it happens.

Charles: no; she addresses that point later, but I didn't feel like quoting the whole post. Here's more, though:

It could also be argued that it's ok to call Bush's policies tax "cuts" if they will be paid for in the future with spending cuts, rather than future tax increases.  But Bush's own spending policies, notably including the new Medicare drug benefit, are plainly inconsistent with the kinds of spending cuts that would be needed to prevent future tax increases.  In fact, according to the Government Accounting Office's latest report, "today’s fiscal policy Is unsustainable" (p. 5).  Among the nuggets reported there:

"In fiscal year 2004 the federal government added $13 trillion in new liabilities, unfunded commitments, and other obligations, principally due to the new Medicare prescription drug program" (p. 7).

"The federal government’s net liabilities, unfunded commitments, and other obligations now amount to more than $43 trillion, or about $350,000 for every full-time worker, and these unfunded commitments are growing larger every day" (p. 7).

If Bush carries out his promise to make his tax "cuts" "permanent," and discretionary spending [only 1/3 of total federal spending] grows at the same rate as the GDP, "by 2040 the government would have only enough money to pay interest on the federal debt" (p. 8).

"Social Security is a relatively small part of the long-term fiscal challenge when compared to spending on health care. . . . [T]he estimated Social Security shortfall is about one-third the estimated cost of recent tax cuts if made permanent" (p. 12).

Timmy: The comment about foreign banks wasn't overblown at all. Here's an article from the Financial Times (I've linked to where Atrios quotes it since it's now behind a subscription wall, but I read the article at the time and vouch for the quote's accuracy):

During the past few years the US has become dependent, not so much on millions of investors around the globe but on a few individuals in a few of the world's central banks.


In 2003, the most recent year with full international statistics, central banks financed 83 per cent of the US current account deficit, with Asian central banks accounting for 86 per cent of flows.

A similar picture is emerging for 2004. Despite a good start to the year, when the private sector was a large net purchaser of dollar assets, central banks came to the rescue again. The People's Bank of China has let it be known that China increased dollar reserves by $207bn (€159bn) in 2004, financing nearly a third of the US current account deficit, estimated at $650bn.

Self-interest has supported much of this flow of cash. The US has lapped up cheap finance to fund its unquenchable appetite to spend. Asian governments have until now been keen to oblige, in order to keep their currencies from appreciating. But all investors have their limits and they may start worrying about their degree of exposure.

If new official flows to the US were to be curtailed, the dollar would plunge, creating a huge hole in the accounts of central banks holding dollars.

"The risk exposure for Asian central banks is already great," concluded Matthew Higgins and Thomas Klitgaard of the Federal Reserve Bank of New York in a recent paper."

it's not the President, it's the Congress

No, its the Republicans -- the party of fiscal madness.

Anderson's arguments seem to be based on the belief that tax rates are structurally too low.

They clearly are unless those in charge (i.e., Republicans) actually do something about spending. Since they clearly do not want to do so, then the tax rates clearly are too low. There is no logic in supporting the tax cuts while wringing your hands about spending too much, but continue the spending.

Also, I have yet to see anything logical from Republicans as to how they will cut spending to match the current tax structure. At best, we get vague promises to "halve the deficit in five years", but these projections are continually based on not extending the tax cuts. Then they advocate for extending the tax cuts.

If you did this in business or sold investments based on such a prospectus,,,; well, its called fraud, folks.

And two more things: First, cutting the rate of growth of discretionary spending will not do the trick. The numbers are too big. Second, even if we stopped running up debt tomorrow, the dependence on foreign banks would remain, since we need them to keep rolling over our debt. We have made the economic heath of our country hostage to the PRC, which I do not believe has our best interests at heart.

Actually Hilzoy, you're misstating the lessons of the Laffer curve. Of course misstatement on this are all too common on the right as well. That lower tax rates do lead to economic growth shouldn't be in dispute.

Does that mean tax cut lead to a long term increase is tax revenue? It depends. We don't understand the economy anywhere near precisely enough to say with any certainty. But the point is that there is probably one specific tax rate that maximizes revenue. Since it isn't zero, and upon reflection, can't be 100%, because there'd be no economic activity, it's got to be somewhere in between.

If raising tax rates doesn't work to close the deficit, it is reasonable to try cutting them - we don't know at any given time whether we're to the right or left of the maximum revenue generating tax rate. The added virtues of undershooting (lowering of rates) are that there is less of a tax burden on the economy and more economic growth, and less largesse for the government to squander. Seems like a reasonable chance to take because worst case, long term revenues don't rise and we adjust the tax rates back up.

Of course if you don't think greater government involvement in the economy (ie higher taxes) leads to inefficiency and retards economic growth, then the above is even more nonsensical than my typical early morning ramblings. But let me point out that if government participation in the economy were efficient, Kruschev would have buried us!

And if government participation in the economy is always inefficient, Eastern Somaliland will bury us!

I'm going to call city hall & the state courts tomorrow and demand that they stop stifling our can-do drive by salting the roads, running the subway, and enforcing the laws of property and contract and against theft. I expect productivity to soar like an eagle!

A regressive tax cut is also much worse when it's merely a postponement: Bush has proposed cutting taxes on the rich to be paid for out of my social security benefits. But of course the public would never support that, so it has to be done gradually and under layers and layers of deception. Very nice.

But the point is that there is probably one specific tax rate that maximizes revenue....

If raising tax rates doesn't work to close the deficit, it is reasonable to try cutting them - we don't know at any given time whether we're to the right or left of the maximum revenue generating tax rate.

But raising them does cut the deficit. See Bush Sr. and Clinton.

The added virtues of undershooting (lowering of rates) are that there is less of a tax burden on the economy and more economic growth

Not so. As Anderson points out, the burden is merely postponed. And again, we had better growth under Clinton than under Bush Jr.

Seems like a reasonable chance to take because worst case, long term revenues don't rise and we adjust the tax rates back up.

Actually, worst case is that revenues don't rise and we don't raise the rates back up.

Why do proponents of tax cuts keep saying that raising taxes doesn't close the deficit when that is demonstrably untrue?

Why do proponents of tax cuts keep extolling 'ecomonic growth' when the number of people living in poverty has increased by 5 million and real income has stagnated since Bush took office?

Why do proponents of tax cuts keep saying that raising taxes doesn't close the deficit when that is demonstrably untrue?

Because it's what they want to believe.

Why do proponents of tax cuts keep extolling 'ecomonic growth' when the number of people living in poverty has increased by 5 million and real income has stagnated since Bush took office?

Because it's a convenient excuse backing up what they want to believe.

(But I expect you knew that...)

hilzoy chides "(b) you'd be enjoying things a lot more if we hadn't made the very same choice you're applauding for the last few decades."

???? So, are you saying if we follow your advise, in a decade or so the world will be safe and my taxes will be lower? Tell me more!!

jesurgislc BOHA "But you've enjoyed all of those things at your children's expense."

All they have to do is have children who are taxed to death and we're home free.

blogbudsman: And besides, it's not the President, it's the Congress, stupid

Chas: We should cut the rate of spending growth.

Gosh, if only the President had the power to veto budgets and spending bills . . . .

Blogbuds: All they have to do is have children who are taxed to death and we're home free.

Ah, sorry: you're enjoying yourself at your grandchildren's expense...

Phil opines "Gosh, if only the President had the power to veto budgets and spending bills . ."

Which bill should have be vetoed?

Jesurgislac retorts "Ah, sorry: you're enjoying yourself at your grandchildren's expense..."

You're assuming a zero sum game, http://frodisman.com/2525.html>If man is still alive .

Actually Hilzoy, you're misstating the lessons of the Laffer curve.

There was a lesson from the Laffer curve beyond "If you like your computer, don't drink while studying it"?

She then addresses various responses: tax cuts will lead to economic growth (the data show they don't

Wait. That's incorrect. As a threshold matter, the data she cites does not measure the relationship between tax cuts and the GDP; it measures the relationship between tax cuts and tax revenues. It's a colossal error on her part to use tax revenues as a proxy for economic growth. I mean, we can almost end the discussion right there: her post, as a piece of economic analysis, is fundamentally flawed. (It's very close to a Donald-Luskan -- i.e., Brad DeLong's stupidest man alive -- level mistake.)

Second, the cited data actually demonstrates that tax revnues increased as a result of the Reagan-era tax cuts. The problem was that spending increased at a much faster rate. (Click through her post to the data link if you doubt any of the above.)

I'm no fan of the Bush tax cuts, for they're disingenuous on two levels: (1) Bush has no stomach for spending controls, and (2) there are legitimate large-ticket items that cannot be dealt with in a fiscally responsible way with the Bush tax cuts in place. But that doesn't make the Left2Right post correct. Simply put, two wrongs don't make a right.

By the way, the problem with the Laffer curve was that it was overly optimistic. Don't dismiss it en toto, however -- there were a couple grains of truth to it.

You're assuming a zero sum game, If man is still alive .

Ah: you're hoping that your grandchildren will all die off before they find out you squandered their future?

Hmmm... Actually, between discovering that my granddad had encumbered me with massive debts, and discovering that my granddad wanted me dead so I'd never find out about the debts, I'd really sooner the former. One should always choose the lesser of two weevils.

Now we get The Birth Tax

Last time I checked, interest on the debt ate 17% of tax receipts. That's a lot to pay for the privilege of not paying for government spending when it happens.

But more importantly it's a nice and efficient way of transfering wealth from the working and middle classes to the wealthy.

By the way, the problem with the Laffer curve was that it was overly optimistic.

No, the problem is that it was based on really, really shitty math and a stark, gibbering failure to appreciate the complexities of real-world modelling. It's perhaps the (mathematical) archetype of the statement that "A little knowledge is a dangerous thing."

[Disclaimer: I haven't read Laffer's papers on the matter, only discussions of it in econ textbooks and the like. I'm prepared to retract this statement if it turns out he had any appreciation for the complexities involved. Like, for instance, drawing the curve as a parabola; I've failed freshmen for less egregious errors than that.]

If all you mean is that Laffer noticed that it's possible to tax people too heavily and thereby reduce the total tax revenues... well hell, that observation's been around for centuries. Millenia, maybe. Doesn't seem like the kind of thing he (or it, depending on your preferred reference) should get points for.

"the cited data actually demonstrates that tax revnues increased as a result of the Reagan-era tax cuts"

1) "as a result of" or "after"? or even "despite"?
2) for God's sake remember the payroll tax hike.

(And Anderson cites the data in support of this statement: "supply siders promised that cuts in current tax rates will increase future tax revenues enough to close the deficit, by stimulating economic growth. But that didn't happen in the Reagan years, and it didn't happen with Bush's tax policies, either, as the data show.")

jesurgislac "...you're hoping that your grandchildren will all die..."

Wow!

Aha! Finally found Martin Gardner's "Neo-Laffer Curve" online; scroll about halfway down, looking for figures 3 (which is the classic Laffer Curve) and 4 (which is Gardner's "Neo-Laffer Curve"). I make no claims about the rest of the piece, btw, although it looked vaguely interesting.

Gardner's full discussion, and dissection, of the Laffer Curve is from "The Laffer curve and other laughs in current economics" which appeared in SciAm in 1981 and which was subsequently collected in Knotted Doughnuts and Other Mathematical Entertainments in 1986. I'm sure that understanding of the Laffer curve has progressed since then but, frankly, I'm not sure that what survived is worthy of designation.

(Reagan also raised excise taxes, and rolled back "about a third" of his 1981 corporate and income taxes in 1982. If you don't trust Krugman see Bruce Bartlett.)

OK, Katherine. I was reacting to Hilzoy's characterization of Anderson's statement; Anderson sufficiently limited her statement so that it was merely misleading, not Luskan-level foolish. Supply siders projected an increase in revenues from the tax cutsk, and, contrary to Anderson's suggestion, they occurred. By a significant margin. They just didn't keep up with spending increases.

By the way, the payroll tax increase you raise is a red herring -- it doesn't go into the general fund -- and the excise tax increase was insignificant on the macro level. But I suspect you know this.

As I wrote, the problem with Laffer was that he was overly-optimistic. The Laffer curve does indeed exist.

von: Sorry, I was being too quick when I wrote this. (The perils of trying to blog while at an unrelated conference.) What I should have said was, basically, what Anderson said: "Against this, supply-siders have, since Reagan, promised that cuts in current tax rates will increase future tax revenues enough to close the deficit, by stimulating economic growth.  But that didn't happen in the Reagan years, and it didn't happen with Bush's tax policies, either, as the data show."

Other things being equal, tax cuts do increase economic growth. Other things being equal, deficits impede economic growth. Other things being equal, investment (public or private) increases economic growth. So: if your tax cuts either (a) come at the expense of investment in e.g. infrastructure, or (b) come at the expense of deficits, you need to ask: does the increased economic growth gained by tax cuts outweigh the drag on the economy from deficits, and/or the foregone investment? What I take the data to show is: no, just the opposite.

The Laffer curve is a joke. Of course there are (at least) two points at which tax revenues are zero: if tax rates are zero and 100%. It follows that there are some tax rates (e.g., 100%), at which cutting taxes raises tax revenues. It also follows that there are points (e.g., zero) at which raising taxes raises tax revenues. Since we are now at neither of these two points, any further conclusions would depend on what the curve plotting tax revenues against tax rates actually looks like, and where we are on it. Absent such information, there's no reason at all to think that tax cuts will raise tax revenues.

And blogs: Yes, I am saying that if we raise taxes now, enough to cover whatever we think our expenses should be, taxes will not have to be as high later. This is for exactly the same reason that paying your credit card bill in full every month means that you will pay less over the long run: because if you don't pay it in full every month, you rack up all sorts of additional interest charges that you will have to pay eventually. All we are doing by not paying enough taxes to cover our expenses is delaying payment by taking on debt, and when you take on debt you have to pay not just the amount you initially decided not to pay just then, but also interest charges. Interest on the debt now eats 17% of federal tax receipts. If we hadn't racked up debt earlier, our taxes could be -- well, not 17% lower, since current tax revenues do not cover the cost of current government spending, but around 14% less. That's part of the price we pay for not paying our bills up front. (Other parts include lower economic growth and the need to actually repay the debt -- the 17%, recall, is just the interest.)

As I wrote, the problem with Laffer was that he was overly-optimistic. The Laffer curve does indeed exist.

Not in any sense of "existence" I'd be comfortable with. Could you expand?

Absent such information, there's no reason at all to think that tax cuts will raise tax revenues.

No. Not true. Quoting from pp. 658-59 of the closest (OK, only) undergrad Econ textbook on my shelf:

Some evidence suggests that past U.S. tax rates, at least for high-income individuals, have been above the critical level identified by the Laffer curve .... [discussing the results of the 1921-26 tax cuts] A similar pattern occurred for those in the highest tax brackets after the tax cut of 1983.

We must make two clarifications on this point. The first is that the above observations deal only with the highest tax rates. ....

The second .... is to point out that the increase in taxible income that results from a fall in tax rates reflects not only a potential increase in labor supply, but also a resduction in tax avoidance.

Barron/Lynch, "Economics" (3d Ed. 1993)

von: I think the textbook is citing some of the information I was supposing to be absent. I would also dispute the 1983 claim (don't know enough about 1921-6.) On the other hand, I would have thought that some of the extremely high rates during WW2 would have been in Laffer territory.

However, it seems to me very unlikely that our present tax rates are above that critical point (or points; there could, as Anarch's cite points out, be more than one.)

NO. Not "from the tax cuts". After. Come on von, this is basic "post hoc ergo procter hoc" stuff. Look at the numbers. From 1962 on, total tax revenues have risen during every presidency except George W. Bush's. They have risen every year except 1971, 1983, 2001, 2002, and 2003. You haven't shown that the revenue increases in the 1980s was caused by Reagan's tax cuts. Furthermore, you didn't address the point about Reagan rolling back part of his income tax cuts. Read Bartlett's article. Furthermore, you're simply wrong about what the data include. Look at Table 3--personal income taxes, social security taxes, and corporate taxes are all included. Surely you know that they use the social security surplus to calculate the budget deficit even though the money doesn't go into the general fund. Revenues from individual income taxes have risen every year since 1962 except 1971, 1983, 2001, 2002, and 2003. From 1981-1989, the Reagan presidency, they rose from 285.9 to 445.7. But from 1993-2001, the Clinton Presidency, they rose from 509.7 to 994.3. From 1964-1969, the Johnson presidency, they rose from 48.7 to 87.3. From 1974-1981, the Ford and Carter presidencies, they rose from 119.0 to 285.9. Furthermore, revenue from corporate income taxes fell from 61.1 in 1981 to 37.0 in 1983.

From 1981-1989, social insurance tax revenue nearly doubled, from 182.7 to 359.4. That's a higher dollar increase and a higher % increase than the increase in revenue from income taxes, and the only thing that kept total tax revenue from declining from 1981-3.

Here's the last four years, by the way. The first column is the year. The second is income tax receipts, the third is corporate tax receipts, and the fourth is social insurance tax receipts.

This is in billions of dollars, rounded off to the nearest billion:

2001 994 151 694
2002 858 148 701
2003 794 132 713
2004 809 189 733

It's amazing how regressive it is: the ratio of income tax revenue to payroll tax revenue has gone from 1.4:1 to 1.1:1. (During the Reagan years it had gone from 1.56:1 to 1.24:1). It hasn't all gone into the same fund, of course, but since Bush has made it pretty damn clear he intends to default on the general fund's debt to the social security fund....

The Democrats have to find a way to explain this clearly.

Katherine:

NO. Not "from the tax cuts". After. Come on von, this is basic "post hoc ergo procter hoc" stuff. Look at the numbers. From 1962 on, total tax revenues have risen during every presidency except George W. Bush's. They have risen every year except 1971, 1983, 2001, 2002, and 2003. You haven't shown that the revenue increases in the 1980s was caused by Reagan's tax cuts.

You're right the the table shows nothing more than correlation -- although the correlation in 1983 is consistent with my thesis. The causation data comes from other sources, summarized in the quote from the textbook above. (I'm not well-positioned to do a literature search, but I'll see what I can find later on.)

I would also dispute the 1983 claim (don't know enough about 1921-6.)

Well, as I understand it, the data is fairly well established for the highest tax rate of both eras.

By the way, don't discount the possibility of weak Ricardian equivalence with respect to debt increases. It's true that Ricardo himself disowned the notion of strong equivalency, but there is historical data that suggests households increase savings as a result of tax cuts, which results in a degree of de facto equivalency.

This issue has long been settled by actual experience. Anyone who still thinks cutting taxes will raise revenue is a certified idiot.

On the other hand, every time taxes have been raised, the deficit has gone down. Duh.

The comment on foreign banks wasn't overblown

Sure it was, simply reflecting, if the Asian Central Banks blow up the dollar their reserve currency is?

As for taxes, I'm all for taxing the rich, such as a 1 or 2% asset tax on the previous tax exempt trusts like the Ford Foundation. I would also would support a VAT if the govt cut the SS tax.

Sorta but not really OT: Currency Issues

Russia has announced it will stop pegging the ruble to the dollar and start pegging it to the euro. It might also denominate its oil sales in euros. Russia doesn't hold any significant amount of US debt, but it is a major player in the oil business. So my first question is, if Russia does switch to the euro for setting its oil prices, will that tend to skew all oil prices higher?

Also, the US delegation to the G-7 finance ministers meeting is pushing China to devalue the dollar against the yuan. I was surprised to hear this, as I have read in a number of places that, if China abandoned the dollar, the dollar would go into an uncontrolled devaluation.

Now, I understand why the Bush Admin might push for a weaker dollar (in order to make US goods cheaper overseas and imports in the US more expensive, thus helping with the trade deficit).

But my impression was that an uncontrolled devaluation is a Very Bad Thing, as our debtor countries (chiefly, China) - who are already very nervous about US economic policy - would stop buying US debt and dump the debt they currently hold ASAP. The dollar goes into freefall, nobody's loaning us money anymore, interest rates go zoom, and the economy collapses.

So my second question is, am I misreading something here? Why would the Bush Admin be pushing for international monetary policies that lead to a collapsing US economy?

Oh, and I suppose a correllary question would be:

If the Bush Admin is deliberately hoping to put the dollar into freefall, and if that means nobody outside the US will want to loan us anymore money, and if that means our deficit spending can no longer be financed.... is that another reason for the Bush Admin to be setting up a wholesale default on the SocSec trust fund? So they can either use the fund to offset the deficit or not have to pay back the IOU for the money they've already raided from the SocSec trust fund?

And, if the collapsing dollar leads to a collapsing US economy, what does that do to the value of those theoretical private/personal/whatever-the-WH-is-calling-it-these-days accounts they're selling as a replacement for SocSec?

if the collapsing dollar leads to a collapsing US economy

it is usually the other way around, a collapse of the US economy would lead to the demise of the dollar.

"The dollar goes into freefall, nobody's loaning us money anymore, interest rates go zoom, and the economy collapses."

Presuming that is true, that leads to a multi-year depression that Europe doesn't escape. At this very moment France and Germany are both closer to a recession than the US. It wouldn't take much to topple them over into a serious problem. Why are they so close to a recession? Their near-crippling pension programs.

von,

From Robert Barro's "Macroeconomics," 3rd edition, 1990.

"There is no evidence that the US has reached high enough tax rates for this result [lowered rates increasing revenues] to apply.....

Lawrence Lindsey estimated the effect of the Reagan tax cuts from 1982 to 1984 on the tax payments by taxpayers in various income groups. He found that the reductions in tax rates lowered tax collections overall and for taxpayers with middle and low incomes." (my bolding).

These are not left-wingers I'm citing.

We have made the economic heath of our country hostage to the PRC, which I do not believe has our best interests at heart.

The GDP of the PRC is? And if the PRC stopped trading with the US it would be?

Timmy: At moments like this you always ask what the GDP of the PRC is, and I never understand exactly why. (Is the idea that it is somehow too small to matter? It's not.) Despite not understanding what I take to be your rhetorical question, I have answered the question about the GDP of the PRC several times. So could you please just state your point this time, rather than relying on this question which I am too dense to understand? And look it up yourself? Thanks.

Hilzoy and the Wonder-Dog, tastelessly adapted from Brer Rabbit:

Hilzoy kept on asking him why he wouldn't talk and the Wonder Dog kept on saying nothing until hilzoy finally drew back her fist, she did, and blip--she hit the Wonder-Dog on the jaw. But her fist stuck and she couldn't pull it loose. The tar held her. But Wonder-Dog, he stayed still.

"If you don't let me loose, I'm going to hit you again," says hilzoy, says she, and with that she drew back her other fist and blap--she hit the Wonder-Dog with the other hand and that one stuck fast too.

"Turn me loose, before I kick the natural stuffing out of you," says hilzoy, says she, but the Wonder-Dog just sat there.


Best troll allegory/response I've seen. Almost as good as the habit of posting recipes that seems to have taken root over at dKos. :D

That elusive gd GDP.
here, and here and now at 11:07. If it's such a knock down argument, I'd have thought he would have looked the number up by now, but I guess that's me. How many more times y'all think he is good for? Of course, it depends on how many economic threads get posted, but I say at least 3 more times by the end of May.

Once again, TimmytheTuringMachine pops up with his tedious parrotry to annoy and deflect.

See, the thing is, I really would like an answer to my questions. I really do wonder about the consequences of things - things which we have been warned to watch out for, if they happened - now actually happening.

CaseyL: See, the thing is, I really would like an answer to my questions.

So would I. Good questions. Wouldn't it be cool if there was a kind of area-specific banning, so that Timmy could be confined to non-serious threads, and not disrupt interesting conversations?

Sebastian: Why are they so close to a recession? Their near-crippling pension programs.

Got a cite for this?

Nope, came across it 3 times in the past 2 years in three different news sources. I think the Economist, the Guardian, and somewhere else. But it is too late at night for me to rummage around looking for it. Besides, I playing bridge online right now. :)

Sebastian: Nope, came across it 3 times in the past 2 years in three different news sources.

I was wondering if it were the opinion of an expert economist, or just "something I read somewhere and am repeating here". So, it's the latter.

Besides, I playing bridge online right now. :)

Enjoy your game! Good luck. (I'm fighting vampires online...)

Actually it is likely to be both.

Actually it is likely to be both.

...depends how you define "expert economist", doesn't it? That was why I asked for a cite. (I did do a quick trawl on google, but didn't come up with anything substantive.)

http://www.cato.org/pubs/journal/cj24n1-2/cj24n1-2-6.pdf> Will the Pension Timebomb Sink the Euro
In fact if you just Google in Sebastian's words 'crippling pension programs' you get an eyefull and the challenges are not just European.

You evidently didn't come up with anything substantive either, Blogbuds, or you'd have cited it - instead of going for the opinion of someone whose economic credentials appear to consist of presiding over the disaster that was the Chilean privatised economy in the 1970s. (cite)

GDP of China at PPP: $6,500 bn, of which $436bn from exports of which 21% to US.
GDP of US: $10,990 bn.

(figures from the CIA World Factbook web pages)

So, China could stop trading with the US and not implode, but neither would the US. It would be interesting to know what proportion of the US debt is held by China - I suspect it's quite small. The real question is, does it matter whether the debt is owed to people in the US or people in China?

What a bunch of crap

Ken --

This issue has long been settled by actual experience. Anyone who still thinks cutting taxes will raise revenue is a certified idiot.

That's not my point. Read the damn thread.

Bernard --

Barro is citing the same data that Barron/Lynch are. Look at the qualification ("top tax rate").

Katherine --

You've thrown so many non sequitors at me (what about the fact Reagan rescinded some of his tax cuts? What of the payroll and excise tax increases? What of them?) My points were that the (1) Laffer curve exists and, (2) the cited data shows correlation between tax cuts and tax revenue increases. (It comes the year after, but that's when you'd expect it to show up b/c that's when the economy started turning around.) Now, this data, as I suggest -- though perhaps not clearly enough -- is not proof of the Laffer curve. The Reagan tax cuts did not increase receipts via movement along the curve (save (probably) for the highest income rates.) Rather, the 84-on tax receipt increases reflect growth in the GDP.

Before I spend my Sunday looking for data, I need to know what causation arguments are being disputed.

(1) All things equal, tax cuts increase labor payrolls (we can debate how much of this reflects less cheating by taxpayers).

(2) All things equal, tax cuts increase national investment/savings.

(3) All things equal, tax cuts increase economic growth.

I'd suggest that all three are correct, and have the folllowing effects:

(1) A cut in taxes leads to an increase in taxable revenue. Although this is almost always not enough to "pay" for the tax cut, it means that the tax cut "costs less" than its pure dollar amount.

(2) A tax cut leads to an increase in investment and savings over the long haul. Although actual Ricardian equivalence is actual bunk, the de facto effect is that taxpayers are wealthier than they otherwise would have been, which makes it easier for them to "pay off" future tax increases.

(3) A tax cut leads to longer-term economic growth, which leads to an eventual increase in taxable income outside of the more immediate payroll effects (1). We cannot, however, say that the Reagan boom was wholly "caused" by the Reagan tax cuts -- but they helped.

Note one further thing, because it's being confused by a few folks in the thead. The Laffer curve primarily relies on (1), not (2) or (3).

Now, this data, as I suggest -- though perhaps not clearly enough -- is not proof of the Laffer curve.

Let me rephrase that, because I've made it ambiguous. Regardless of whether the Laffer curve existed, we clearly were not at the predicted "spot" on the Laffer curve for all but the highest income earners (and, for them, only w/r/t their income taxable at the top rate).

CaseyL:

“So my first question is, if Russia does switch to the euro for setting its oil prices, will that tend to skew all oil prices higher?”

How sellers set the prices doesn’t matter all that much. If they invoice in euros, but convert their receipts into dollars, the end result is the same as if they had invoiced in dollars in the first place. What matters is whether US assets are attractive to the RoW.

“The dollar goes into freefall, nobody's loaning us money anymore, interest rates go zoom, and the economy collapses. So my second question is, am I misreading something here?”

If a freefall means the sort of thing that happened to the Reichsmark in Weimar Germany, that strikes me as a far-fetched scenario. If Greenspan is replaced by some lunatic who thinks Rapture is nigh, then of course it’s possible. More plausible would be this: the RoW decides that US treasury bonds are a lousy asset. Bond prices fall (hence US interest rates rise), property values fall, US equities fall, the dollar falls. At that point, even if the RoW still doesn’t fancy T-bonds, US equities and property start to look attractive. Crazy macroeconomic policies can mess up markets, but if I can have a chunk of Manhattan at a small fraction of its current price in euros, I will take it very gladly. The same goes for a slice of Microsoft or Oracle.

At the end of the day, if Americans are not bothered about the RoW owning a chunk of America then there is no reason for the dollar to become worthless.

Reassured?

I should add: if it is politically unacceptable to have a large increase in foreign ownership of American assets, capital controls can be imposed. Nixon did something along those lines, but I have forgotten the details.

I'm not quite sure what TtWD's getting at w/r/t China's GDP (it's large, and will soon exceed ours), unless he's making the point that a certain degree of interconnection is inevitable at this stage of the game.

von: I am not your target audience, since I do not dispute the existence of something like the Laffer curve (where 'something like' means: a curve plotting tax rates against tax receipts such that at least two tax rates -- 0 and 100% -- produce zero tax revenues, and one value -- the present one -- at which tax receipts are positive, and thus there must be at least one value at which, if you cut taxes, receipts will rise.) I dispute two different claims: (a) that we have anything like a justification for the claim that we know which values are which, for any values remotely relevant to present policy debates (i.e., we might be justified in asserting that a tax rate of 100% is one of those rates a cut in which would make revenues rise, but since we're nowhere near there, that's not remotely relevant) (and, I should add, since the shape of the curve might change over time: for any curve that we have any reason to think is the present one or something like it), and also (b) (a more specific variant of this) that we know that to what extent changes in tax returns after the Reagan tax cuts were caused by those tax cuts. -- But (a) is the important one, since it leads me to think that the Laffer curve has virtually no practical utility.

With that said: I am not sure, and have never been sure, about your first assertion above. ((1) All things equal, tax cuts increase labor payrolls (we can debate how much of this reflects less cheating by taxpayers).) Or, at any rate, sure that what effects it has aren't swamped by others, for the higher brackets, in a way that makes the claim true if absolutely everything else is held equal, but of no importance to public policy, unless the tax increases proposed are huge (e.g., from 35 to 90%, or something.)

If the lower brackets are cut, it might lead fewer people to cheat, and/or make declared, legal income look more attractive than either undeclared or legal income. So if 'labor payrolls' means legal, taxable labor payrolls, I agree.

But with respect to the higher brackets, we need to get more specific. First, when we talk about 'the tax rates', what are we talking about? The overall tax rate, or particular taxes (income, capital gains, etc.)? If it's the overall tax rate, then if we assume all the different taxes to be reduced proportionately, apply what I will go on to say about income tax to this case. If, on the other hand, the argument is: given ANY reduction in the overall tax rate, no matter how it's realized, then I would say: no, in this case, everything depends on how the change is realized, and what investment strategies by the wealthy this makes appropriate. (E.g.: suppose, to pick a deliberately extreme example, we abolished taxes on investment in unproductive assets, like works of art by people who have been dead for at least 300 years. The result of this would be to "cut taxes", but not to increase productive economic activity.)

Suppose we're just talking about the income tax, and in particular its highest bracket, and assuming other taxes remain at their present rates (which, Yahoo tells me, are 35% for single people and couples filing jointly making over $319,101/year.) Now: the income tax, per se, won't have effects on investment, except insofar as people who pay less taxes have more money to invest. You may or may not think that this is one of those things we should 'hold equal', on the grounds that a tax cut will give the government less to either invest or transfer to people who might consume stuff, leading to further economic activity, or use to pay down the deficit, reducing the drag on economic activity, etc. Its main effect will be on people's willingness to work.

Now, this might take several forms. (a) People deciding to enter or leave the labor foce. Hilzoy's Law of Large Groups (for all large groups of people, almost anything will be true of at least one of them) compels me to say that someone, somewhere might decide to enter the labor force at this level because of a cut in the highest tax bracket, but common sense leads me to add: not many. (b) people's willingness to go for a promotion that would get them into this tax bracket. Again, the Law of Large Groups is relevant, but in general, I think that at this level of income, the incentives provided by a cut of a few percent in the tax rate is normally swamped by other incentives, like prestige or the desire to succeed in one's chosen sphere. (How many lawyers' decisions to work their hearts out to make partner would be affected by a 2 or 3% cut in the highest tax bracket? How many corporate executives deciding whether or not to really go for a promotion?)

Some people decide to do this because they need more money. But unless the changes in tax rates are really huge, they will get 'more money' if they get a promotion, and while at the lower income levels the differences in question might really matter in a way that affected their decision, at these levels I think it often doesn't -- again, unless we're talking huge changes in the tax rates.

The people I think you'd be most likely to see this sort of effect with are people who work by the hour (and are paid according to the hours they work, not their hours together with everyone else in their company or firm's, suitably divided up.) -- people for whom the relevant decision is not, 'will I join or leave the labor force?', or 'will I go for this promotion?' but 'will I take this particular project on or not?' But that's a distinct minority in this tax bracket. And of those, the ones who'd let a 2 or 3% cut/hike in the tax rate affect this decision are a smaller group still.

Now: this group does of course exist. But the other group -- people who would be working hard at their jobs, going for promotions, etc., regardless of a non-huge change in the tax rates -- also exists. If their economic activity is unaffected by changes of a few percentage points in the tax rate, then any tax cut will take in less money from them without altering their level of activity. The amount of money that the tax cut generates by driving the group whose decisions are affected to work harder would have to outweigh this in order for the overall effect of a tax cut to be: more tax revenues. For non-huge cuts in the tax rates, I suspect this would not be the case. Thus my skepticism about the claim you made as applied to the higher tax brackets.

A very thoughtful response, Hilzoy (per usual). Three brief thoughts, because I'm about to busy myself with a day of home improving before the Super Bowl.

(1) I was thinking specifically about income taxes w/r/t the Laffer curve. (Although the curve can be, and was, specifically applied as an argument to cut capital gains taxes under Bush I. Not persuasively, though, IMHO.)

(2) A noncontroversial, and not insignificant, effect of a reduction in income rates is (as you note) that more earned income gets reported. In addition, people who have control over the amount of income they earn (e.g., small business owners) are more comfortable paying themselves a higher salary rather than taking an effectively higher salary in perks. It also may adjust the income/benefit ratio, because higher taxes encourage employers to seek to hire/retain employees by offering tax-free benefits rather than taxable salary increases -- company cell phones, cars, etc.

(3) With respect to upper-level tax rates, I think you dismiss the effect a cut can have on labor market entry -- particularly in two-income homes where one person is a relatively high earner. If one person earns 150,000 and his/her spouse has the potential to earn 30,000, there's a strong disincentive for the second person to enter the labor market because that 30,000 is taxed at a relatively tax rate. Why should I work, the thinking goes, since I'm going to pay almost half of it in taxes?

Kevin D, thanks! Your post was exactly the kind of response I was looking for.

And, no, I'm not terribly reassured. I was thinking not so much the Weimar Republic as the US in 1929, the last time buying-on-credit bit us in the butt big time. (The 1929 US economy bore some uncanny resemblance to today's, with a lot of people 'rich' on paper that turned out to be worthless. Once stock prices began falling, and panic selling set in, people defaulted on loans which were backed by their stock portfolios - except their stock portfolios had also been bought on credit.)

You did note in your post that interest rates would rise; that's precisely the trigger mechanism I worry about. The US economy is up to its collective neck in debt. A lot of people can only make the minimum payment on their credit card bills - and that minimum payment covers only the interest accrued in the current month. Rising interest rates would mean they won't even be able to do that much, probably triggering a massive default on consumer debt. The ripple effects from there are catastrophic, esp. if there's a second concussion wave triggered by massive defaults on home mortgages and a collapse of the housing market.

You don't address this issue directly, but you do say US assets would be cheap enough to interest RoW buyers - which to me sounds like a consequence of a massive debt default, caused by zooming interest rates. Did I read your post correctly?

My points were that the (1) Laffer curve exists...

I repeat, not in any sense I feel comfortable with. Specifically, I take issue with the following sentiment:

"The relationship between the rate of taxation and the revenues received by the government is a roughly time-independent unimodal function that's zero at the endpoints."

As near as I can tell, at least two, if not three, of those claims are unjustified if not outright incorrect:

  • It's not necessarily true that this relation will be zero at the endpoints. See, e.g., Hilzoy's Law Of Large Groups; there are people out there (and I'm probably one of them) who'd continue to work anyway because they believe their job is "morally" important.

    [This one probably doesn't turn out to matter -- it's "close enough to zero" for some notion of close enough -- but you know you're off to a rocky start when the basic premise is flawed.]

  • In order for the Laffer curve to make some kind of sense you have to posit the relationship between taxation and revenue is close to time- and history-independent. [Mathematically, this means we can think of this relationship as being something like a Markov chain.] This is, near as I can tell, crap.
  • In order for the Laffer curve to look the way everyone claims it does -- hence, in particular, for there to be the sweet spot that you keep talking about -- it has to be unimodal. There is, to the best of my knowledge, precisely zero meaningful evidence for this proposition. AFAICT the utility/meaningfulness/existence of the Laffer curve derives solely from this erroneous supposition -- which, incidentally, is an error that I have quite literally failed freshmen for.
  • Don't even get me started on the fact that the existence statement of the Laffer curve relies crucially on the given relationship being continuous. I know economists do it and somehow get away with it, but that doesn't make me any happier about it.

And then, of course, there's the central problem of the Laffer curve: everyone keeps talking about where this mythical sweet spot is while neglecting the somewhat important fact that nobody has any clue because we've (thankfully) never done the experimentation necessary to find it, which in turn is probably because, besides the potentially destructive nature of the such experimentation (anyone want to try jacking our tax rates up to 96%?), it's mathematically crap and thus would be quite difficult to locate.

This is what I take issue with: it's mathematical crap that's been rendered into economic demagoguery by years of complacency. IIRC, David Stockman finally acknowledged that there was no literal "curve" to speak of -- it was just a metaphor for the fact that decreasing taxes sometimes increases revenue, an observation that goes back centuries -- but the damage had already been done. I'd be interested to be proven wrong in this regard but, my respect for you notwithstanding, I'm not holding my breath.

Anarch: I agree with you on at least one point: that the claim about the results of the 100% bracket might not be true (although then again if I kept working, as I would, it's not clear that my employer would think it worthwhile to pay me a salary, since it and I would know that the money might just as well be transferred to the Federal government.) I was deliberately trying to phrase my claims in ways that didn't take a position on the rest, though. (In other words, I was trying to restrict myself to the old observation that you mentioned.)

If I had to speculate, I'd suspect that the shape of the curve (if there is one) changes over time, and in important ways. My evidence? None, as you would suspect. And since I also suspect that it's more likely that cuts in the bottom tax rate raise revenues than that cuts in the top rate do, I suspect that the curve has several local maxima. (If I'm using the words wrong, just let me know.) I have no view on whether it's continuous, other than, who knows?

But I completely agree with you any truth this might happen to have has next to no implications for policy, since we have no idea whether there is a curve, what its shape is, where its maxima are in relation to present tax rates, et. etc.

von: about spouses entering the work force: granted, but for this to produce a net gain in tax revenues, this (plus other gains in revenues produced by a tax cut) would still have to outweigh the losses from cutting rates on those people whose choices are not affected by a tax hike, which is what I'm skeptical of.

Enjoy the game; that will make one of us ;)

CaseyL,

Certainly the sequel to the 1929 crash is worth pointing out to anyone who takes a very sanguine view of the way the economy deals with a financial shock. The first thing to be said about it though, is that some lessons have been learned. John Maynard Keynes, Milton Friedman and quite a few others have left the mark. If something like that happens again, there is no way the Fed will just let a big bank go under, taking its depositors with it. Remember that the 1987 stock market crash looked pretty scary, but the Fed pumped money into the banking system just as orthodox economics says they should. No doubt there are pre-Keynesian crackpots who think the Fed should never do things like that, but I will only start worrying on that score when the Republican Party starts to argue that the Federal Deposit Insurance Corporation is a socialist monstrosity which must be “reformed” like Social Security.

So I wasn’t thinking of a massive debt default so much as the fact that a cheap dollar makes all sorts of US assets a bargain for the RoW. I probably wouldn’t touch T-bonds but a block of shares or an apartment, even though it too has its risks, is a real asset which is likely to perform well long-term, even (or especially) if the government inflates away the value of its debt.

But a sharp fall in the dollar checked by a substantial rise in interest rates would certainly hurt the real economy. The Fed ought not to be too kind in that situation because, like it or not, that is how markets are supposed to work. Right now Americans spend too much and save too little, because the RoW gives them goods in return for paper assets. When that stops, Americans will have to produce more internationally tradable goods and fewer non-tradables like services and housing. Adjustments like that are usually painful. Construction workers and waiters lose their jobs pretty quickly, but it can take quite a while for them to find even lower-paid jobs in manufacturing. So the process entails a recession.

The recession would certainly drag Europe, China and Japan down a bit also. That’s why I think of this as my problem too (I am Irish). Sorting out an American trade imbalance isn’t like sorting out an Argentinean one. The nightmare scenario is that recession creates protectionist pressures in both America and Europe, harming everyone and harming the developing world most of all.

My conclusion is that if Americans want lower taxes that is their right, but in fairness to themselves and everyone else they should start cutting spending as well. That may be painful but it is the only way to avoid an even more painful adjustment some years from now. As it is the Republicans are not “starving the beast”, they are just feeding it with borrowed resources.

von: one more point: you write: "If one person earns 150,000 and his/her spouse has the potential to earn 30,000, there's a strong disincentive for the second person to enter the labor market because that 30,000 is taxed at a relatively tax rate. Why should I work, the thinking goes, since I'm going to pay almost half of it in taxes?" -- My basic thought about tax cuts raising revenues in higher tax brackets is: You are probably right, but on the other hand, very few people in high tax brackets are going to say: I would have taken the job if I got to keep 68% of my income, but now that I only get to keep 65%, no way. I think that smallish differences of this kind are much more likely to have an effect on decisions by the poor, owing to our friend the declining marginal utility of the dollar; the richer you get, the more likely you are to be able to overlook a few hundred dollars here and there, and to make up your mind on the basis of other things, like whether you want to work or not. (And before someone points out that the 'small' difference between a 32% and a 35% top rate is a large difference in actual dollars for the rich, I will add: this doesn't affect my argument as long as the importance of each additional dollar paid in taxes goes down faster than the number of dollars goes up. Bill Gates' tax bills might vary hugely given even tiny changes in the tax rate, since his income is so huge, but for that very reason I think it's unlikely that he'd be deciding whether or not to go on working on that basis. This is, of course, armchair psychology, so I could be wrong.)

Anarch --

Rather than respond to your more theoretical objections -- because I think your conception of the Laffer curve is fundamentally flawed* -- I'll address your practical one.

everyone keeps talking about where this mythical sweet spot is while neglecting the somewhat important fact that nobody has any clue because we've (thankfully) never done the experimentation necessary to find it, which in turn is probably because, besides the potentially destructive nature of the such experimentation (anyone want to try jacking our tax rates up to 96%?), it's mathematically crap and thus would be quite difficult to locate.

Well, that's not correct. Assuming that you can get past your "Markov chain" objection (an objection that potentially dooms all social predictive models in all fields), there is evidence of a Laffer curve "sweet spot." See the following:

Sweden, somewhere under 70%. (It's "somewhere under" because the data shows that a drop from a 70% rate to a lesser rate increased tax receipts.) Charles E. Stuart, Journal of Political Economony, vol. 89, October 1981, pp. 1020-38.

U.S., 1921-26, somewhere under 73%. Yale Brozen.

1983, top bracket. Lawrence Lindsey, "Taxpayer Behavior in the Distribution of the 1982 Tax Cut," NBER Working Paper No. 1760 (1985). As Bernard noted above (citing Barro's textbook), Lindsey only found that the highest income bracket was above the Laffer "sweet spot."

You're also misapplying Hilzoy's "Law of Large Groups," and failing to distinguish between a model that tells us valuable things about reality and reality itself.

von,

What exactly are you calling "a bunch of crap?"

According to Barro, Lindsey's study did find that collections from high-income taxpayers (Adjusted Gross Income above $200,000, in the early 80's) increased. The key point though is that overall revenues decreased. This seems to dispute your point that

(1) A cut in taxes leads to an increase in taxable revenue. Although this is almost always not enough to "pay" for the tax cut, it means that the tax cut "costs less" than its pure dollar amount.

To be fair, you seem to be saying two different things here. The first sentence,and some of your previous comments, claim that there would be an increase in tax collections as a result of the cut. This study suggests that is incorrect. Your second point seem to be that a tax cut of X% may reduce revenues by something less than X%. Is that in dispute?

BTW, we can add to hilzoy's analysis a further group of people: those who work less because of the tax cut. There is a so-called "labor-leisure" effect which suggests that there are those who will use the tax cut to, in effect, buy themselves more leisure. There's a tradeoff. Leisure is more expensive, but your income is up, so it's not universal, but there will be some of this. So the effect on the labor force is ambiguous, but I do think the evidence is that it increases.

I don't think it's quite fair to dismiss Anarch's objections so blithely. At best, we really don't know the shape of the curve.

Hilzoy --

Only a moment left, but two notes. First, I'm no expert. I'm at best an educated layperson (meaning I have a BA in Econ). IOW, I have no idea if you're misusing words; I'm also fairly confident that I'm misapplying words.*

I think you're right that small changes in the tax code results in only small adjustments in tax receipts. I also agree that the idea really does break down for really wealthy people. For upper middle class/lower upper class folks (the hypothetical 150,000 earner), however, it can be a very big deal. A marginal rate drop from (say) 50% to 35% on income earned above 150,000 could very well convince a spouse to enter the labor market with a 30,000/year job, because s/he's getting a 3-4,000 pickup.

von

*My father, who is an expert, thinks the Laffer curve exists but it's impossible to get a predictive answer out of him -- one reason he remains in acedemia, I suppose. If DeLong shows up and wants to correct any of the above (or offer a contrary view), I'm willing to stand corrective.

Bernard, on Lindsey's study, we now seem to be saying the same thing. The confusion in the first of my sentences that you cite is a result of a poor choice of words on my part. IOW, I meant to write "taxable income" (income is, of course, revenue to someone but my usage of it is horribly unclear).

Thus revised, you'll see there's no disconnect in those two sentences:

"(1) A cut in taxes leads to an increase in taxable income [i.e., there's more income to be taxed]. Although this is almost always not enough to "pay" for the tax cut, it means that the tax cut "costs less" than its pure dollar amount."

Note that Hilzoy's and my debate regarding labor market entry is only one effect of a tax decrease. There's also less cheating, changes to the salary/benefit mix, etc. -- all of which I touch upon above.

Allright, I'm out -- gotta go watch a game.

I just want to mention that I wouldn't mind being the stay-at-home spouse who has to decide if he is going to work based on a $3-4,000 pickup. Ok, first I need to fly to NYC to get married. Well, actually I need to find someone who wants to marry me. Well, other than that woman over in Del Mar. I guess I need to find someone I want to marry. Other than that guy in LA. I mean someone I want to marry who ALSO wants to marry me! Oh, never mind. I'm obviously not very close to having this problem. :)

Rather than respond to your more theoretical objections -- because I think your conception of the Laffer curve is fundamentally flawed*...

Missing footnote? And you still haven't said what, exactly, you consider to be the Laffer curve and thus what's wrong with my conception of it.

Assuming that you can get past your "Markov chain" objection (an objection that potentially dooms all social predictive models in all fields)...

Yes, it does, which is one reason why I tend to be dismissive of claims that "social sciences" are indeed sciences. Not that they are unworthy of study, but that there are many historical factors that could conceivably be at play thereby spoiling reproducibility and obscuring the nature of the relationships.

See the following...

You're assuming that the presumed Laffer curve is time- and history- independent enough for those examples to be meaningful. You're also assuming the unimodality of the relationship -- which hasn't even been demonstrated to be functional in the tax rate -- so that these papers are identifying a global maximum (aka the "sweet spot") and not a local maximum.*

[And yes, hilzoy, you used the terminology correctly.]

In short: the evidence you provided is nice, and I thank you for it, but it's not even vaguely conclusive towards the end I think you're thinking of. That's premised on at least one layer of indirection, however, because you still haven't set forth what you believe the fundamental truths of the Laffer curve to be.

* Or, if you factor in time-dependence, a saddle point. Multivariable calculus sucks.

You're also misapplying Hilzoy's "Law of Large Groups,"...

How? All I'm saying is that even if the tax rate were put to 100% some people would still work. That's an almost exact application of her Law Of Large Groups... and even if it weren't, it'd still be true. I don't think it's relevant at a practical level, but it disturbs me when something is presented as axiomatically true that is, in fact, at best an approximation.

...and failing to distinguish between a model that tells us valuable things about reality and reality itself.

Huh? I'm saying that a) there isn't a model to speak of, and b) what there is doesn't usefully model reality anyway. At best, the Laffer curve is a heuristic overview of a fiendishly complicated relationship that wasn't original to Laffer; at worst, it's polemical gibberish premised on the kind of crappy mathematical reasoning I spend every day correcting in class.

I suspect that a large part of our disagreements here stem from the fact that it's Superbowl Sunday, so neither of us are really concentrating on accuracy here. Tell you what: I'll withhold further posting until you have time to set out exactly what it is you believe the lessons of the Laffer curve are, and where my misconceptions lie. Until then, let's enjoy the Ballet of the Bulldozers :)

Anarch: glad I got it right, since (von) I'm even more of a layperson than you, being largely self-educated in econ. -- I was spoiled, econ-wise, as a kid, since I got to talk econ with one of my relatives, who was a seriously good economist and loved to argue about it, even with children. (I think his view of kids was that they were a waste of time until they could argue economics. I didn't notice this until later, though, since I wanted to argue economics more or less from the get-go.) And he had unusually wide-ranging interests in econ., encompassing for instance the developing world, at a time when that was much less common among economists.

Because of this, when I got to college I intended to major in econ, but was completely put off by my first econ course (macro). For one thing, there was its incredibly restricted focus -- nothing but Keynes, unless you count the week of Milton Friedman thrown in for balance, and no mention of even the existence of economies outside Western Europe and N. America. I would ask why, and get these blank stares that seemed to convey amazement that anyone would think that the rest of the world might be worth thinking about. For another, there were all these (as it seemed to me) ludicrous assumptions about human behavior (e.g., economic rationality and motivation by self-interest.) I kept asking: if this is supposed to be a simplifying model, what is the point of these particular unlikely simplifications supposed to be? And the only answers I got were either: (a) Those aren't simplifying assumptions; they are true!, or (b) You have to learn them now so that we can explain why they are all wrong later, when you get to upper-level courses. Since I thought (a) was self-evidently false and (b) did not give me a reason to go through this (as it seemed to me) pointless exercise, I quit, though I did take a few courses later.

Still, I have tried to understand it, and normally try also to be more than usually careful when I write about it. This time, Anderson's point (tax 'cuts' without spending cuts are just tax postponements) seemed to me to be sufficiently obvious that I wrote carelessly, which you were right to call me on earlier. (Smacks head against computer.)

It's interesting to think about the 100% endpoint and try and figure out exactly what that means.

On the one hand, you could think of it as an impossible state, like travelling at the speed of light, that could never happen in reality. If the government takes 100% of all income, they'd have to provide all the food, housing, etc, giving us some sort of weird version of a communist-style command economy.

On the other hand, since we're discussing the Laffer curve for various tax brackets, if we consider a %100 tax-bracket over a certain amount, say $200,000, then it seems obvious that there would be at least some revenue from that bracket, although most people for whom it was an issue would certainly scheme to keep their incomes just under that level.

churchundra:

It's not clear to me what Laffer means by 100% in his premise. The one Laffer source I found http://www.heritage.org/Research/Taxes/bg1765.cfm>
here isn't explicit. I expect he is talking about 100% of income and not a marginal rate, by claiming revenues go to 0, but he may be looking at the slice of income above a marginal rate. He talks later of top marginal rate reductions as if that's what's important.

Even if he's talking about total income, I can imagine a collective where all proceeds goto to the group and are redistributed as goods and services that are not necessarily correlated to the individuals income. Individuals could be motivated by altruism, coercion or by the fact that if nobody produces they all will starve. The idea that 100% taxation would lead to 0 tax receipts seems as unlikely as a society that could function indefinitely with 100% taxation. Of course there would be incentives to find ways to accrue wealth without generating taxable income, but I expect that some level of income would exist to be taxed.

How do we reconcile the (unproven) idea that reductions in tax evasion are the cornerstone of the Laffer curve and thus of conservative economic theory with the way that the conservatives have gutted the IRS's ability to enforce tax law? _Perfectly Legal_ does a good job explaining how the IRS now has practically zero capability for prosecuting the kinds of cases that involve the biggest money but also require slogging through layers of partnerships and offshore accounts and ultra-obscure parts of the tax code. Whether it's causation or mere correlation, the fact is that the increasing adoption of conservative tax policies has been accompanied by a dramatic *increase* in tax evasion.

Anarch -- Let's try to simplify this, because you're shooting off in a dozen different directions, most of which are irrelevant. Economics uses math; it is not math. Nor is it physics. Nor is it chemistry. Nor can you look at an economic model and say, "for this to have validity as a predicting model, it must be exactly accurate." Rather, economic models tell us how large groups of people act on average -- and, on average, they tend to act in their economic self interest. (There's actually a lot of economic modeling that deals with situations where folks don't act in their self-interest -- it's part of why Vernon Smith won the Noble prize -- but you wouldn't have gotten to it if you stopped with the introductory courses.)

In other words, everyone acknowledges that Economics is an imperfect "science." Your noting as much is not particularly news. Nor is your complaint -- but I can come up with examples that must exist but don't fit the model -- a particularly valid one. Economic theory presumes that individual cases will not fit the model, and that -- even at the extremes -- there will be deviation.

The Laffer curve predicts that, at above a certain tax rate, further increases in taxes will not result on greater tax revenue because too many folks will "cheat." The cheating can occur in a myriad of creative ways. In the past, we have seen tax rates that, for a given society, are above the tipping point, which appears to be about 70%.

Now, will some folks still work at a 70% tax rate? Sure. At 80%? Sure. But will they report all their income as taxable income to the government? If there's a way to receive non-taxable income -- say, a company car -- will they be more inclined to accept it in lieu of taxable income? At a certain tax level, such "cheating" reduces the amount of actual taxed income enough that further tax increases actually lead to a decline in total tax revenue.

We've seen it happen in the past. We believe, based on that evidence, that there are tax rates at which it will happen in the future. You choose to disbelieve that: Fine. Of course, you haven't provided any evidence to back up your alternative model (whatever it is), save for a few critical suppositions and anecdotes. But I can't make you consider the evidence, any more than I can make a supporter of intelligent design come to grips with the fact that they, too, are proposing a "criticism" of evolution and not a "theory" of their own.

Finally, you seem to be confusing the Laffer curve with "supply side" economics. The two are related, but they're not the same thing. Maybe if you'd taken that next econ class....

von

P.s., Platypus -- The Laffer curve is "unproven" in the same sense that macroevolution is "unproven" -- neither case can be easily tested; rather, in both cases, we are looking at past data and surmising a theory that e explains it.

Platypus, tax complification is pretty much a bipartisan reality. (and yes I know complification isn't really a word.

Sebastian -- I thought complification was part of math, like uglification and distraction ;)

And von -- it was me that didn't get (much) past intro econ.

And von -- it was me that didn't get (much) past intro econ.

Ahh. I should've taken Anarch's advice, I suppose, I slowed my writing down to match my thinking. My apologies.

Daru Ibn Shamiq, The Lie Weaver
Tarsikus Ibn Meth'kultesh, The Book Binder
Severeth Na'Halastrian, The Wanderer
Harishek Apt Thul'Kesh, The Blind Clockmaker
Tellura Ibn Shartalan, The Dire Shepherd
Lazarius Ibn Shartalan, The Architect
Ghoresh Ibn Shartalan?


---

SH-M-Q (joyful)

MT-K-L-T-SH

TH-L-K-SH

SH-R-T-L-N

----

von:

Economics uses math; it is not math. Nor is it physics. Nor is it chemistry. Nor can you look at an economic model and say, "for this to have validity as a predicting model, it must be exactly accurate.

I agree with all of this. My point about approximations versus exactitude -- and perhaps it's a cultural thing -- is merely that one should distinguish between "no revenue will be received" (the 0% taxation endpoint) and "approximately no revenue will be received" (the 100% taxation endpoint) in one's exposition of the model; there's a marked qualitative difference between the two.

[I also agree with your general remarks about economics dealing with people in the aggregate and on average so I'll skip those paragraphs.]

The Laffer curve predicts that, at above a certain tax rate, further increases in taxes will not result on greater tax revenue because too many folks will "cheat."

And right here we run smack into the wall: that's not what the Laffer curve predicts in any exposition I've ever read; or, more precisely, it predicts a hell of a lot more than that. Specifically, it predicts that there is exactly one (local, hence global) maximum and that the function of tax revenue w.r.t. tax rate is uniformly concave down. This is what I object to about the Laffer curve: these bolded, qualitative features that have been claimed without, insofar as I have seen, adequate justification.

The horrible thing here is that I think we largely agree with one another. I, for example, agree with you that economics is the study of people in the aggregate/on average, that models need not be (and indeed, probably can't be) perfectly accurate in order to be useful, and that there are tax rates beyond which further increases in taxes will decrease the net revenue. Our disagreements seem to be largely semantic -- I find that, IMO, economics is not yet worthy of the designation of "science" and you apparently do, but BFD, we can argue that in another thread -- except for this one rub here. Pretty much everyone else in this thread agrees that part of the problem is that we "don't know the shape of the Laffer curve"... which is exactly what I'm complaining about.

Now, if all you've ever meant by the Laffer curve is that "above a certain tax rate, further increases in taxes will not result on greater tax revenue", then we've agreed with each other since the beginning of this thread -- as I've stated multiple times -- and this has been a colossal waste of time for all concerned. [I stand by my point that this observation is not exactly new but whatever.] The reason I've been involved in this discussion at all is that invocations of the Laffer curve invariably ascribe to it qualitative features which I have now cited three times and which you have yet to address, that are, insofar as I can tell, completely made up. We simply don't have the data to make the assumptions that they're making.

Maybe I'm wrong. Maybe there are studies that have controlled time-relations, that have controlled for historical progressions, that have controlled for society and which have studied the full spectrum of taxation levels in order to produce a time-independent, history-independent functional relationship with the qualitative features described by Larry Laffer. I don't know of any but I'd be delighted to see one if it exists. Absent that, I'm sorry, von, but the qualitative features of the Laffer curve are exactly the kind of intelligent design BS you've ascribed to me: "Well, we don't know what it looks like so it has to look like this!" That's argumentum ad ignorantiam and it has no place in anything called "science".

Of course, you haven't provided any evidence to back up your alternative model (whatever it is), save for a few critical suppositions and anecdotes.

I haven't provided an alternative model, period, nor would I dream of doing so. I'm saying that the extant evidence for this particular model is insufficient to consider it proven and that its predictive powers are lacking. I could be completely wrong in this regard -- you seem to think I am, fair enough -- but that's a markedly different observation than the one you seem to think I'm taking.

But I can't make you consider the evidence, any more than I can make a supporter of intelligent design come to grips with the fact that they, too, are proposing a "criticism" of evolution and not a "theory" of their own.

Yowch. Calling me an IDer is a fairly low blow, mon ami, and it's complete crap in this context as well. Were I a supporter of intelligent design I'd be putting forth a god-of-the-gaps argument that purported to explain the relationship between tax rate and tax revenue as a function of, I don't know, the harmonics of a dolphin's mating call. I'm not. I'm saying that, as a scientist and therefore a skeptic, the level of evidence does not meet the burden of proof. That's it. If I'm an IDer then you might as well start ladling out the incense and hosannas at every research facility on the planet.

Look, I know I'm treading on your home turf here von, but could you please answer the arguments I'm making and not the ones you seem to think I'm making? And could you please explain exactly what you believe is meant by "the Laffer curve exists"** and what you believe has been proven about it so that we can stop with the semantic run-arounds and start figuring out what our point of disagreement is?

** Sorry for the bold but this is now the fifth time I've asked and I'm getting a little cranky.

Blecch. Ignore the first few lines of my post; something completely different got caught in my Notepad. Actually, if a modly being were to crop those lines down to the beginning of my maintext, "von:", I'd be grateful....

Platypus, tax complification is pretty much a bipartisan reality. (and yes I know complification isn't really a word.

Yes, I would agree that the increase in the complexity of the tax code has been a bipartisan affair, but that's not really what I was talking about. The neutering of the IRS - cutting its budget, setting processing-time goals that preclude the necessary sorts of analysis and correlation, imposing rules and limits that hamper investigation - was almost entirely a conservative affair and a cornerstone of Gingrich-era Contract On America.

von,

I guess I don't understand the point you're making. On the on hand you seem to claim that the Reagan cuts increased tax revenues

"Supply siders projected an increase in revenues from the tax cutsk, and, contrary to Anderson's suggestion, they occurred. By a significant margin. They just didn't keep up with spending increases."

But your agreement with the Lindsey study cited in both our dusty textbooks suggests that's not what you think, just that the effect is restricted to high-income payers. Of course that was never the supply-siders' claim. They did claim, and have continued under Bush to claim, that the cuts are completely self-financing. Could you clarify? And if you are making the more modest claim, what are you suggesting as a consequence?

BTW, I find the spouse example highly unconvincing. This strikes me as exactly the sort of case where the tax cut is likely to reduce labor force participation. Isn't a big increase in one spouse's earnings often the trigger for the other to stop working? If the $150K (or more) earner gets a big increase in after-tax income, won't that encourage the other to stay at home. Note also that members of this group are likely to have substantial invetsment portfolios, so the cuts not only increase after-tax labor income substantially, they also increase investment income.

The comments to this entry are closed.

Blog powered by Typepad