Tuesday, January 22, 2008
Stimulating the economy
Economic activists of all stripes want to stimulate the economy and they want to do it now. The Democrats and their allies in the press think that this ought best be done by writing one-time checks to people rather than by cutting taxes. This ought not be surprising, because no reasonable person should expect them to give up on their dream of increasing federal taxes by allowing the Bush tax cuts to expire. The problem is that economic actors -- you, me, and all those other people wandering out there doing economic things -- cannot expunge from our brains the knowledge that the Democrats want to do this, so the looming massive tax increases after Bush are already affecting our behavior. That is why short-term stimuli are unlikely to do anything other than cause a few people to pay back more of their debt, which lenders will promptly use to do ... nothing. Other than rebuild their balance sheets, of course, which is important in and of itself.
That said, the market may be supplying its own "tax cut" in the form of a declining oil price. Crude oil prices have rapidly fallen more than 10% from their high a few weeks ago. Not only will that decline, if it sticks, have a counterinflationary impact on just about every good or service, but it will show up quickly as extra spending or saving money that otherwise would have been spent on gasoline. If you are a typical middle-American suburban family, you probably burn 2000 or more gallons of gasoline a year, which is now costing you $7000 or so. A 10% reduction from current prices saves you $700, or just about the one-time check that President Bush offered last week.
CWCID: Glenn Reynolds.
6 Comments:
By 
Christopher Chambers, at
Tue Jan 22, 01:35:00 PM:
You're right, forget the whole bloody structure/game you all have set up (yeah, I said "set up" Adam Smith was on opium when he saw an "invisible hand"). let the market correct things! Bleh Bleh Bleh. Tax cut Tax cut Taxy. Spend at wal Mart. Lay down at the altar of the hedge fund managers, Big Pharma, Insurance companies, etc. All will work out in the end. You're right. You're absolutely friggin' right.
Speaking of the market, the author of the textbook I'm using in a class I'm teaching this semester, Judge Richard Posner (are you clowns shocked? Unlike you, I try to find the good stuff on the "other" side) made some interesting comments on the market and fertility. I guess he'd seen "Idiocracy" on HBO and was horrified. He said that Big Health/Big Insurance should actually resist the call to cut costs and INCREASE coverage of IVF and other treatments, and even encourage drug companies to lower the cost of gonadotropins. This way, older/better educated couples can have more kids, thus off-setting the "natural" baby boomlet among illegal aliens, redneck/WalMart maven teens (and unfortunately that includes a goodly number of enlisted personnel in our vaunted armed forces), gangbangers/assorted Crips/Bloods/MS-13/La Eme/rapper baby-mamas. Hmmmmmmmm...now I call THAT a market correction. Hence we become Denmark, charge TH & Crew 60% income tax and have a happy, intelligent citizenry...
By 
, at
Tue Jan 22, 01:41:00 PM:
So far, the people most affected by the market downturn are traders in NYC and credit card executives. They're screaming about the onset of the next depression, but so far I think those guys are way overstating the problem, and I really don't worry if they lose bonus dollars. The people most affected by the liquidity crunch are much more widespread, both geographically and economically. The credit crunch is the real issue, and while the rate cut will free up a lot of reserves, there is no guarantee the banks whose costs just dropped will increase their lending in response as the Fed hopes, and there's no guarantee that even if banks loosen up their lending, housing values will stabilize. Allowing lenders to take a tax credit immediately for the fair market value difference of the old loan value versus the new value, while allowing a deduction over the life of the loan for financial reporting purposes would be a good way to give lenders and incentive to restructure loans to borrowers who might otherwise be foreclosed upon.
That’s a better use of tax dollars than anything proposed, in my opinion.
By Andrew Hofer, at
Tue Jan 22, 02:27:00 PM:
Wow. That was quite a brain-fart, Chris. Too much bourbon?
By , at
Tue Jan 22, 08:14:00 PM:
Alright, I continue to note the subtext on tax policy of “Lower taxes = better taxes, period” on certain conservative blogs that I read, and I am going to request the thinking that backs a slightly more nuanced position up. I realize that most major political figures, no matter their party affiliation, spend little time discussing the justifications of their policy and instead prefer to harp on the need, but I am going to outline my request in the following form: I'll outline the basic argument that I hear with some regularity from my more conservative friends, list my problems with it, list my more general objections to a more charitable position, and then close.
The basic argument I wish to address is what I shall lazily and shorthandedly dub “Laffer Curve Economics,” (LCE,) a school of thought often touted by candidates like Giuliani. The gist: we can lower taxes right now and thereby increase revenues, because the tax/revenues function is basically a negation and transformation away from the common parabola.
Short derivation: the government collects no taxes at 0% (fine,) and no taxes at 100%. (Questionable; wikipedia has counterexamples, but the basic one could be a state which takes all of the income and spends it on the requisite social goods, food, housing, and the like. People might not opt out of this state if it is well run and allocates goods to productive members, therefore the common objection is invalid.) We know the state collects revenues somewhere in the middle given numerous examples of this circumstance, and the simplest function which describes this behavior is the one described.
Numerous objections follow immediately from a more detailed derivation than the one just given. The first one I make will be technical and in this paragraph, made only because I like it, while the more substantive objections will be made in the next paragraph. Mathematically speaking, this function isn't going to be continuous; I choose an epsilon-ball of radius .00008 cents, for those that know the strict definition. The obvious response is that economists and sensible (non-mathematician) people generally have no problem with the two-decimal discontinuity, but I object on face as unproven the notion that all discontinuities will be of the two-decimal form. In circumstances where a very small change in tax rate leads to the death or birth of a significant sector, such as a class of industry with many actors all spontaneously losing solvency from their presumed state of perfect economic competition, we now have discontinuities. But let's say we set aside the nuances of what it means for a function to be continuous.
Why would it necessarily be true that this function is unimodal? Why could it not be the case that lowering a tax rate diminishes revenue, then repeated lowering causes a spike in revenue as high personal income leads to increased scientific research and a booming economy, or other such things? Perhaps the most substantive and important point is the one about which there is the most disagreement: how do we even know where the hell the mode of this function is? With all of the presumed simplicity of the proper derivation, it seems that the most simple mode would be 50%. However, most of the Republican candidates for president that I have seen (and many commentators on the current economic crisis, including TH in this post) seem to believe that the mode is below even the current top tax bracket of 35%. I have yet to hear a good argument that demonstrates this is the case, while I have heard several counterexamples (important ones being listed on wikipedia, for the curious) and several hilariously bad studies that attempt to prove this point, the failings of which in my mind undermine the argument. Perhaps the best example of this came from the opinion pages of the Wall Street Journal, in an article titled “We're Number 1, Alas.” http://online.wsj.com/article_email/SB118428874152665452-lMyQjAxMDE3ODE0MzIxODM4Wj.html. Printed based on materials produced by the American Enterprise Institute, the author repeatedly fell into error in an across-country comparison. Many of these have been pointed out, at great length, and have been listed here: http://theoldmole.blogspot.com/2007/07/deeply-dumb.html. Blatantly false analysis (presumably vetted by not-unintelligent people at the WSJ, the source least inclined to that confounded liberal bias,) only serves to undermine my concept of LCE as valid. Further, I find the simplicity of the model off-putting, as I imagine the state of the economy and ensuing tax revenues to be a multivariate function of taxes, the usage of tax dollars in scientific research or stimulus, the actual/nominal tax distinction and the number of loopholes available, etc. All of these objections are, in my mind, sufficient to sink the concept of LCE as a recommendation for cutting taxes, and the accumulation of them demands examination if I am to take the position seriously.
However, I imagine there is some kind of response to the objections that I am raising, as a not insignificant fraction of the American polity seems to believe that further tax cuts can still increase revenue. I am just curious as to what those justifications could be.
By Georg Felis, at
Wed Jan 23, 10:18:00 AM:
LC econ is my weak point, but there are a couple of things that argue in its favor.
Whenever the US has implemented tax cuts (and not just shuffling taxes around from one group to another), the economy has surged in a way advantageous to everybody.
The economic surge has the effect of raising certain government obligations (roads because people buy more cars, utilities as they buy houses…) and cutting certain government payments (welfare, unemployment…). Most of the obligations are tax-offset (gas tax, utility payments…) and the payments are negative tax-offset (more people working = lots of free cash in the unemployment fund). This is a *side* effect. The main effect is if you take $20 of each $100 in the economy, and you cut that to $18, your economy needs to grow to $112 to be supposedly revenue neutral.
So if the economy grows %12 after the cut:
Zero sum economists say the Government is losing $2.
Smart economists say the Government is breaking even, and the people are doing much better.
Bureaucrats say “Gosh we have a lot more money in the treasury than expected. We should spend it quickly on anything we see.”
Now both my post and yours should agree on one point. Tax cuts cause economic growth. If that economic growth is larger than a particular number, the Government makes money. If less, they lose money.
I believe it is larger.
By , at
Wed Jan 23, 01:31:00 PM:
My first response to the analysis you posited was a visceral reaction: what is the optimal tax level, then, and how do we know? I rarely hear people mention numbers for the positions they hold, and I would like to know where you think the growth/percent tradeoff evens out. This is something in which I take an interest, and I have only seen laughably bad analysis (as in the WSJ editorial I linked) to support cutting various types of taxes; I'd like to see where the strong analysis is coming from.
Even so, I suppose we can disagree on whether or not it the economic growth you mention is larger than a particular number, and we can both raise points and note studies that argue for our position. I would like to instead make a metapoint concerning the nature of government expenditure, and ignore the argument concerning the efficacy of LCE in favor of a policy discussion of what is maximally effective. It may be the case that, all the objections I raised aside, LCE produces a benefit; this isn't necessarily an argument in favor of LCE, simply because there may be a more effective solution that produces more benefit. In particular I'll extend the analysis I alluded to at the end of my previous post, concerning the multivariate nature of the economy. I can easily imagine a circumstance where a 40% top tax bracket rate with 2/3 of revenues plowed into scientific research results in more benefit to the individual because research tends to produce amazing things, like the computer, modern medicine, and energy technologies. Further, I speculate that many of these benefits wouldn't be accrued in a society where the government wasn't the one funding the research because of the nature of scientific revolution.
Historically speaking, there are many examples of innovations which came about due to primarily unmotivated research; the transistor in bell labs, penicillin, and the theory behind the computer all arose not because of the promise of profit but for the will toward learning. Individual businesses oftentimes have little reason to pursue this groundbreaking research because A) it is hard to know where it might come from, and B) the oftentimes collaborative nature of such an undertaking minimizes the personal stake that would justify control. Additionally, I think there is a perverse incentive structure when it comes to revolutionary research. No modern state would allow a truly revolutionary innovation to be policed by patent so rigorously as to allow significant personal benefit due to the monopoly analysis we all know and love; things such as deadweight loss and the like. This mitigates any incentive for individuals in an economy to be the actors that discover, and further places an incentive to be the person that didn't sink the time and money into the enterprise because the discovery will probably be rendered public anyway. This looks like a classic collective action problem to me, which is at least philosophically the province of government.
Before I close on the implications of this premise, I would like to deal with the quick counterexample that might be thrown back at me: Bell labs produced the transistor and gave it to the world, demonstrating that such a selfless act can happen. This may be true, but the fact that something can happen doesn't mean that it should be relied on to. I think the far more intuitive side of the equation is that few people will take a position of wealth, spend lots of money, and then render the fruits of their labor to everyone else. Even so, the collective action problem analysis I provided still applies.
So what does this mean for tax policy? At the very least it verifies a position that I feel is exceptionally intuitive: that it is beyond naïve to attempt to analyze taxes and revenues with so few variables. Until other such factors are incorporated into justifying analysis for tax cuts, I might remain skeptical that the simplifying assumptions of the model only apply to an unrealistically simplified world.
