Economic Policy Conservatives

In yesterday's Dallas Morning News, my former DC colleague Charles Blahous concludes his thoughtful op-ed on, Who will stop America's plunge into debt?, with the following:

One thing is for certain: Unless and until economic policy conservatives finally put the Trump years behind them, there will be no serious challenge to the left’s economic agenda, and the only debate will be over how rapidly to expand government. The contest over America’s economic future can only truly be joined if moderates and conservatives reunite to advocate for fiscal prudence and free economic activity, wielding the same energy and commitment that the left uses to pursue government’s expansion.

The first statement is true but it does not go far enough. It is a necessary but not sufficient condition.

Economic policy conservatives were on this road to ruin when Chuck and I both served on the Bush economic policy team. Not at our suggestion, the Bush administration passed a new Medicare Part D benefit that, at the time of its passing, had a larger projected unfunded liability than Social Security's projected unfunded liability, which was the fiscal threat that I went to Washington to help solve. My very first week on the job, I wrote a memo to try to get more means-testing onto that new entitlement. (Some of those ideas were later published here, alongside a similar analysis of the marketplace subsidies in Obamacare.) Prior to my arrival in DC, the Bush administration passed a series of so-called temporary tax cuts, almost all of which were eventually made permanent by the Bush and Obama administrations. When the latter did so in the face of the so-called "fiscal cliff" in early 2013, I referred to it as creating a fiscal grand canyon.

All of this happened before the Trump administration.What economic policy conservatives need to do to challenge the left's economic agenda is to acknowledge that:

1. Republicans have expanded our fiscal imbalances through entitlement spending when it suited their political interests.
   
2. Republicans have squandered resources in ill-conceived military operations in Iraq during the early part of this century.
3. Republicans have ignored fiscal balance over the last 20 years when passing tax cuts for the sake of passing tax cuts.
4. There are some valid reasons for the federal government to engage in deficit spending if needed, primarily when it benefits children who are born into challenging social and economic circumstances. (See this paper for an introduction.)
   

Economic policy conservatives, when they can acknowledge these things that implicate much more of the Republican Party's recent history than the Trump administration, might then be able to play a constructive role in countering the left's economic agenda. They are not credible elements of the economic policy process if they don't.

 

Stumbling Blocks Between Tax Cuts and Economic Growth

A few years ago, Bill Gale and I wrote a paper about the relationship between tax reform -- defined generally as lowering marginal tax rates and broadening the base on which those taxes are levied -- and economic growth, anticipating that there were likely to be claims in the near future that such tax changes would lead to economic growth. That future has arrived with the long-anticipated Republican tax plan unveiled last week.

The following quote from that paper appeared in the Christian Science Monitor last week:

Well-designed tax policies have the potential to raise economic growth. But there are many stumbling blocks along the way and certainly no guarantee that all tax changes will improve economic performance.

What are those stumbling blocks? The remainder of the paragraph from the paper gives some indication:

Given the various channels through which tax policy affects growth, a tax change will be more growth-inducing to the extent that it involves (i) large positive incentive (substitution) effects that encourage work, saving, and investment; (ii) small or negative income effects, including a careful targeting of tax cuts toward new economic activity, rather than providing windfall gains for previous activities; (iii) reductions in distortions across economic sectors and across different types of income and consumption; and (iv) minimal increases in, or reductions in, the budget deficit. 

The rationale for why there could be a link between tax reform and economic growth starts with the substitution effect, which in this case promotes economic activity because households get to keep more of the income they generate through that activity. Against this boost in economic activity are three countervailing forces:

1) The income effect, whereby the lower tax rate generates more after-tax income for a given amount of economic activity, encouraging higher consumption of all goods, including leisure. That reduces work. There is no guarantee that the substitution effect is greater than the income effect. As we note in the paper, this is more likely to happen when only the marginal tax rate changes. But if the whole schedule of tax rates is lower, then inframarginal tax rates are changing as well, and income effects are thus likely to be much larger.

2) The need to pay for the revenue loss associated with the tax cuts. This is the base broadening aspect of tax reform. In the Republican proposal, for example, the cap for the value of a mortgage on which interest can be deducted is lowered from $1 million to $500,000. This means lower deductions and thus some gain in tax revenues. Fine. But it also means less economic activity in housing, since we can expect fewer large homes or homes in pricey areas to be built. If lower marginal tax rates on work are thought to encourage work, then why would higher tax costs of housing not discourage housing? While discouraging further housing investment might be fine as public policy, the loss of economic activity in the housing sector is a drag on economic growth.

3) Alternatively, if the revenue loss is not made up contemporaneously through higher taxes elsewhere, then the horizon over which the economic growth is measured needs to include all of the time over which the higher debt due to the widening of the budget deficit is serviced. Servicing that incremental debt reduces economic activity elsewhere in the economy. If the tax revenue is not made up elsewhere, then what we have is not economic growth, but a shifting of economic activity to the present from the future.

So those are the stumbling blocks -- income effects, higher taxes due to base-broadening, and the costs of servicing incremental debt.

I expect to blog again soon about some other aspects of tax reform, focusing on income transfers.

Tax Cuts and Growth, or Not

In yesterday's New York Times, Neil Irwin asks, "Do Tax Cuts Really Spur Growth?" I am quoted as follows:

“The basic finding in the literature is that it’s very hard to detect a robust impact from changing taxes to growth,” said Andrew Samwick, a Dartmouth economist who co-wrote a review of the evidence. “If you look across countries, unless they’re actually out there confiscating assets through their tax system, you don’t find a strong relationship.”

In other words, there are countries with high or rising taxes that have strong growth, and countries with low or falling rates that don’t.

The review in question is this paper with Bill Gale of the Brookings Institution, which has recently been published in a conference volume on The Economics of Tax Policy, edited by Alan Auerbach and Kent Smetters.

What I had in mind in the quote is this recent article by Nir Jaimovich and Sergio Rebelo, "Nonlinear Effects of Taxation on Growth," from the February issue of the Journal of Political Economy. Consider their abstract:

We propose a model consistent with two observations. First, the tax rates adopted by different countries are generally uncorrelated with their growth performance. Second, countries that drastically reduce private incentives to invest severely hurt their growth performance. In our model, the effects of taxation on growth are highly nonlinear. Low tax rates have a very small impact on long-run growth rates. But as tax rates rise, their negative impact on growth rises dramatically. The median voter chooses tax rates that have a small impact on growth prospects, making the relation between tax rates and economic growth difficult to measure empirically.

The notion that it is very hard to find a systematic effect of tax rates on long-term economic growth is common knowledge in academic circles. My favorite quote on the matter is a 20-year-old remark that Bill Easterly made in discussing this paper by Joel Slemrod, "... the data mock attempts to discern the growth effects of taxes ..."

Note that this is a different question than whether a cut in tax rates can spur economic activity in the short run. Reducing tax rates, without reducing current spending, can shift economic activity from the future to the present, and this will be measured as growth in the economy financed by an increase in debt. But this is not long-term economic growth. Economic activity will be lower in the future when either tax rates are increased to retire the debt or the interest payments to service the debt crowd out other spending. Shifting economic activity forward within a multi-year period is not economic growth when measured over the whole period.

Income Tax Changes and Economic Growth

Policy makers and researchers have long been interested in how potential changes to the personal income tax system affect the size of the overall economy. Earlier this year, for example, Representative Dave Camp (R-MI) proposed a sweeping reform to the income tax system that would reduce rates, greatly pare back subsidies in the tax code, and maintain revenue- and distributional-neutrality.

In a recently released paper, Bill Gale and I examine how tax changes can affect economic growth. We analyze two types of tax changes — reductions in individual income tax rates without any offsetting tax increases or spending cuts — and income tax reform that broadens the income tax base and reduces statutory income tax rates, while maintaining overall revenue levels and the distribution of tax burdens. We do not consider reforms to the corporate income tax (see Eric Toder and Alan Viard’s recent paper) or reforms that would substitute consumption taxes for all or part of the income tax.

We examine impacts on the expansion of the supply side of the economy and of potential Gross Domestic Product (GDP). This expansion could come in the form of a permanent increase in the annual growth rate, a one-time increase in the size of the economy that does not affect the future growth but raises economic output permanently, or both. Our focus on the supply side of the economy and the long run is in contrast to the short-term phenomenon, also sometimes called “economic growth,” by which a boost in aggregate demand in a slack economy can close the gap between actual and potential GDP.

While there is no doubt that tax policy influences economic choices, it is by no means obvious on an ex ante basis that tax rate cuts will ultimately lead to a larger economy. While rate cuts would raise the after-tax return to additional work, saving, and investment, they would also raise the after-tax income people receive from their current level of activities, which lessens their need to work, save, and invest more. The first effect (the so-called “substitution effect”) normally raises economic activity, while the second effect (the “income effect”) normally reduces it. In addition, tax cuts that are not financed by spending cuts or offsetting tax increases raise federal debt, which reduces long-term growth. The historical evidence and simulation analysis are consistent with the idea that tax cuts that are not financed by immediate spending cuts will have little positive impact on growth. In contrast, tax rate cuts financed by immediate cuts in unproductive spending will raise long-term output, but so would cuts in unproductive spending that are not accompanied by tax cuts.

Tax reform is more complex, as it involves both tax rate cuts and base-broadening. In theory, such changes could raise the overall size of the economy in the long-term, although it is unclear how much. One fact that often escapes notice is that broadening the tax base by reducing or eliminating tax expenditures raises the effective tax rate that people and firms face on returns from additional work, saving, and investing, thereby offsetting some of the benefits of statutory tax rate cuts. But base-broadening has the additional benefit of reallocating resources from sectors that are currently tax-preferred to sectors that have higher economic (pre-tax) returns, which should raise the overall size of the economy.

Well designed tax policies may raise economic growth, but there are many stumbling blocks along the way and no guarantee that all tax changes will improve economic performance. Given the various channels through which tax policy affects growth, a growth-inducing tax policy would require (i) the presence of large positive incentive (substitution) effects that encourage work, saving, and investment; (ii) the presence of income effects that are not large enough to offset the substitution effects, (iii) a careful targeting of tax cuts toward new economic activity, rather than providing windfall gains for previous activities; (ivi) a reduction in distortions across economic sectors and across different types of income and types of consumption; and (v) little or no increase in the budget deficit.

Few if any tax real-world tax changes are likely to satisfy all of those conditions. Thus, the justification for sweeping income tax reform changes must rest primarily on objectives other than economic growth.

Cross-posted by Bill Gale at TaxVox. 
Tax Policy Center event video from September 9. 
 Media References:
"Tax Cuts Can Do More Harm than Good," David Cay Johnston, Aljazeera America, September 18.
"Can Income Tax Reform Spur Economic Growth," APPAM, September 15.
"Taxes and Growth," Dietz Vollrath, The Growth Economics Blog, September 12.
"Don't Count on Much Economic Growth from Individual Tax Reform ... Or From Rate Cuts," Howard Gleckman, Forbes, September 10.

The Unhelpful Way To Build Support for Raising the Minimum Wage

I find myself reacting quite negatively to two aspects of the way the White House and its allies are pushing the Raise the Wage agenda to build support for increasing the federal minimum wage from $7.25 to $10.10 per hour.

The first aspect is to compare the federal minimum wage to the poverty level without acknowledging that the Earned Income Credit provides income support for those with low incomes. The chart below gives an example from the White House webpage linked above:

The orange curve should be augmented by the appropriate EIC amount for the family type in question. In that case, we would see levels of income that are higher relative to the various poverty lines. That might or might not persuade you that the minimum wage is high enough, but it would give a fairer accounting of income relative to poverty and it would suggest another avenue for providing support.

The President's proposed FY15 budget includes provisions to expand the EIC and make more workers eligible. If income support is society's obligation, then it should be done through the tax code. There is no need to interfere with the workings of marketplaces, particularly in a way that discourages employers from creating the low-wage jobs that unskilled laborers depend on, to meet that obligation. Perhaps the Republicans will make that case and strike a deal -- adopt the higher EIC and the suggested mechanisms to pay for it and say no to the higher minimum wage.

The second negative aspect of this campaign is to produce narratives about single moms in which there is no discussion of the children's father's resources. Here's an example from an e-mail sent out today by Secretary of Labor Tom Perez:

Semethia's a 36-year-old single mom. Her son hopes to go to college one day. Her daughter wants to take gymnastics lessons. But with a service job that pays just $8.25 an hour, Semethia relies on food stamps and help from friends and family just to keep food on the table -- much less build the future she'd like for her kids.

That's all we learn about Semethia from the e-mail. You can find other vignettes in the popular press, like these two at the New York Times Motherlode blog. They are compelling stories. These moms are struggling, and they shouldn't have to go it alone.

What about the children's father?  Why are his earnings and resources not being applied to alleviate the financial burden on his children? If he is deceased, there should be survivor benefits from Social Security. If he is not deceased but they are divorced, then there should be divorce agreement stipulating child support, and courts should actively ensure that child support is being paid. If they were never married and his resources are not being offered voluntarily, then the appropriate policy is to enhance the ability for courts and others to obtain child support. All of these issues should find their way into the public discussion.

Let me be clear. I am not saying that Semethia should be married to the children's father or that he should even be a presence in their lives. What I react negatively to is that the policy in question -- raising the minimum wage -- would presume to take resources from Semethia's employer, the employer's customers, or other potential employees at this employer without first taking the resources from Semethia's children's father. The minimum wage is a tax on employers who provide employment for people like Semethia whose best opportunities in the labor force generate output that is valued at only $8.25. I do not see the wisdom in making it harder for an employer to do that.

Donating the Voucher

In honor of National School Choice Week, I'd like to highlight a paper I published last year that considers the federal government's tax treatment of private school enrollments. In brief, I'd like to see the federal tax code be as neutral as possible with respect to the funds that are used to meet the requirement that all students have access to primary and secondary education. Neutral with respect to financing helps to promote choice.

The starting point for the paper is the observation that most dollars spent by citizens to educate primary and secondary students are a tax deduction on their federal income taxes. For example, my property taxes and state income taxes are deductions when I file my federal income tax. My payment of these taxes has nothing to do with how much I use the public schools, only that I live in a jurisdiction subject to these taxes and that I have the right to send my children to these schools without additional payment. It also doesn't matter how much the public schools spend -- they could be spartan or lavish, efficient or inefficient. All of the tax payments can be claimed as deductions.

This arrangement contrasts with the funds that support private schools. Some of these funds are tax deductions -- for example, when a charitable donation is given to a private school, even if the donation is from a parent whose child attends the school. But the tuition payments paid by the parents are not tax deductible, and this is where my question arises. What should the federal government's tax treatment of private school tuition be? I think the answer starts with some recognition that enrolling children in a private school reduces the financial burden on the citizens of the state and locality of funding their attendance at the public school which their residence entitles them to attend. If there were no private schools, then public schools and the taxes that support them would have to be higher. Those higher state and local taxes could then be claimed as deductions on federal income tax returns.

We can approximate the amount of higher deductions by the per-pupil expenditures in the school districts of those students who attend private schools, modified to exclude those expenditures that would not follow the typical student and capped at the amount of private school tuition paid. This is what the paper noted above contributes -- an estimate of the tax cost to the federal and state governments for allowing these deductions by combining data from the American Community Survey, Public School Finance data, and the NBER Taxsim calculator. The result of the analysis is that the tax cost to federal and state governments is surprisingly small -- under $10 billion per year in 2010 dollars using the ACS from 2006 - 2010.

The title of the paper is "Donating the Voucher," based on the idea that if every student received a voucher equal to the per-pupil expenditures in his or her district, then 10% of the students are claiming no services with their vouchers and have essentially donated them back to the citizens who fund the public schools. I blogged about the politics of the idea several years ago, before I started work on the paper. The full abstract of the paper is:

Approximately 10 percent of school-age children in the United States are enrolled in private schools, relieving the financial burden on public school systems, and the taxpayers who support them, of the cost of their education. At present, the tax code does not allow families who provide this financial relief an income tax deduction, even though such relief is a gift to governments for exclusively public purposes and thus analogous to a charitable donation. Using the Public Use Microdata Sample of the American Community Survey and the NBER Internet Taxsim calculator, this paper estimates that granting families who enroll their children in private schools an income tax deduction equal to the per-pupil expenditures in their public school district would cost the federal government an average of $7.75 billion per year over the 2006 – 2010 period. This amount is less than one percent of federal income tax revenues. Because private school enrollment, public school expenditures, the likelihood of itemization, and marginal tax rates increase with taxpayer income, the dollar benefits of this change are positively related to income. At the margin, high-income taxpayers would receive about 35 cents in federal and state tax relief for each dollar of per-pupil expenditures foregone. 

Dead-ass Wrong and Morally Corrupt

So says Lee Saunders, president of the American Federation of State, County and Municipal Employees, of the federal bankruptcy judge's decision allow Detroit to reduce city employee pensions despite a state constitutional provision protecting them. The key article in the Michigan constitution seems to be this one.

That wouldn't be my exact choice of words, but I am with the unions on this one. Surprising, I know. I am no fan of the way unions and some municipal government regimes conspire to elevate compensation through deferred compensation. A better provision in the Michigan constitution would be to outlaw deferred compensation for public sector workers. They could take their pensions as defined contribution plans similar to 401(k) plans.

But those are not the rules under which the workers were employed. Other creditors to Detroit, whether they be bondholders or vendors or anyone else now at risk of not getting paid the full amount of what they are owed, could see the state constitutional protections for these benefits. They could have, and presumably did, demand higher interest rates or other payments from Detroit because workers and retirees had constitutionally protected claims. They have already been paid for the risk they took. They shouldn't get paid again.

If this bankruptcy process results in any of these other creditors being paid at all, while workers and retirees don't get paid in full, then this outcome is certainly wrong and corrupt. The same is true if there is any real estate equity left in the tax base of Detroit once this bankruptcy is resolved. These taxpayers paid lower taxes in the past because their city government chose not to adequately fund its operations. The bill has now come due.

Punch Drunk on Dumb Justifications for Stimulus

I am a Sheila Bair fan. I have been for the better part of the five years since the financial crisis hit. (Here's an example.) I wish the national Republican Party would line up behind (most of) the approach she lays out in her New York Times op-ed yesterday. Here's the meat of it:

I am a capitalist and a lifelong Republican. I believe that, in a meritocracy, some level of income inequality is both inevitable and desirable, as encouragement to those who contribute most to our economic prosperity. But I fear that government actions, not merit, have fueled these extremes in income distribution through taxpayer bailouts, central-bank-engineered financial asset bubbles and unjustified tax breaks that favor the rich. 

This is not a situation that any freethinking Republican should accept.

She's absolutely right. To varying degrees, almost everyone on the so-called Left would agree with her sentiments, I suspect.

I think she makes two errors in the rest of the op-ed that are typical of current discourse, even among smart folks.The first is the very next sentence:

Skewing income toward the upper, upper class hurts our economy because the rich tend to sit on their money — unlike lower- and middle-income people, who spend a large share of their paychecks, and hence stimulate economic activity. 

When the rich "sit on their money," they are lending it to people who want to use it for some economic activity. They drive down the cost of capital for people who want to borrow it to invest. That investment creates economic activity. There is nothing less virtuous about this than having low- and middle-income people spend most of their disposable income. But after five years of policy makers and pundits concocting justifications for the government to enact policies to promote spending, spending, spending, I suppose it is not a surprise to read this muddled thinking.

The second error is this notion that a first order issue, or any issue that Republicans should spend their time on, is major overhaul of the tax code. Fundamental tax reform would take years of bipartisan cooperation. We cannot even manage a week of it. And if we could muster the cooperation, we should use it to address the fact that we don't raise enough revenue to cover our expenditures rather than the various ways in which we don't raise it. But even is the political issues could be solved, there are problems with the economic elements of what she proposes.  Here's what she writes:

For instance, as part of renewed fiscal discussions over sequestration, Republicans should put fundamental tax reform on the table and make it our priority to end preferential treatment of investment income, which lets managers of hedge funds pay half the tax rate of managers of shoe stores.

[...]

If we eliminate this and other unjustified tax breaks, we can produce enough new revenues to lower marginal rates and reduce the deficit, according to both the Simpson-Bowles and Domenici-Rivlin debt-reduction plans.

In the first paragraph, she's writing about the carried interest loophole. I agree, wholeheartedly, that that loophole should be closed, along with any corporate tax loopholes we can find. But it is a far cry from closing those few obvious loopholes to the tax expenditures required to meaningfully reduce the deficit. The CBO is quite clear on this matter -- to make a real dent, you have to go after the big tax expenditures. They are, in order of foregone revenue, the exclusion of health insurance premiums from income and payroll taxes, the net exclusion of pension contributions and earnings from taxable income, and the deduction for mortgage interest on owner-occupied housing. None of these three are the exclusive playground of the rich. If she's serious about this idea, she needs to mention those tax policies by name.

In a future post, I will share some additional thoughts on what to make of proposals to curb the use of tax expenditures.

The Republicans Have Done Their Job?

My op-ed on the fiscal grand canyon in Sunday's New York Daily News topped the list of Must Reads on yesterday's broadcast of Morning Joe.


Listen carefully to what Scarborough says around 6:40 of the clip.  I think you are going to hear it a lot in the coming months.  He says, "Taxes were increased in the House of Representatives … The Republicans have done their job."  Earlier, he says, "Taxes have been raised ... That card has been taken off the table." You can bet the Republicans will use a similar talking point to fight any future tax increases.

The tendency for public discussion -- and future partisan talking points -- to not distinguish between a small, targeted tax increase that raises inadequate revenue and the broader tax increase back to Clinton-era tax rates that would have raised a lot of revenue is the reason why Obama should have held out for as much new revenue as going over the fiscal cliff would have produced.  He could then have negotiated with the Republicans on how much additional spending or tax relief to offer to mitigate the threat to short-term economic activity.

The Fiscal Grand Canyon

With the benefit of hindsight, I think the adoption of the "massive fiscal cliff" metaphor for our fiscal policy challenge was a bad idea.  I think Ben Bernanke introduced it to motivate action -- 10 months in advance -- to improve fiscal policy.  But what was meant to suggest urgency actually led to unnecessary panic.  A clear statement by a newly re-elected Obama in November that unless the Congress sent him a thoughtful bill to sign, the tax code would simply revert would have been a much better course of action.  The Republicans would then have to specifically introduce legislation to achieve their objectives.  The sad story of the last two years is that they have been able to get Obama to acquiesce to their demands without having to actively promote their agenda through legislation.  In this case, Obama really did hold all the cards, and yet almost all of the Bush tax cuts have been made permanent. 

Not to be outdone by Chairman Bernanke, I introduce the phrase "fiscal grand canyon" in an op-ed in the New York Daily News today.  We certainly jumped out of the frying pan and into the fire.  The key excerpt:

Unfortunately for Obama, he signed away the opportunity to pursue an ambitious second-term agenda when he signed this legislation.

In this era of partisan disagreement, we can expect congressional Republicans to oppose any new idea the White House may propose on the grounds that it costs more money and the budget is already projected to be in large deficit.

Enjoy!

So Who Won the Fiscal Cliff Fight?

Obviously, former President George W. Bush.  Despite how much he has been vilified in the years since his departure from office, the Congress and the President yesterday decided to ratify almost all of his tax policy agenda.  As Joe Wiesenthal of Business Insider noted, "The difference between the Obama Tax Cuts and the Bush Tax Cuts?  Obama's are permanent*."  Joe also pointed out, quite astutely, that even if top marginal tax rates are not lower than in the Clinton years, taxpayers with the highest incomes are still paying lower taxes because all the tax rates below the top are lower.  Who's laughing now?

Not me.  In over eight years of blogging, you won't find a single word of praise for the Bush-Obama tax cuts.  As a matter of revenue, we now permanently have a tax system that will not raise enough revenue to cover our expenditures.  As a matter of policy, we continued to constrain our choices based on whether some portion of legislation that wasn't popular enough to pass initially without explicit sunsets should be continued or not.  The proper course of action for President Obama was to allow all the sunsets to occur and then to force the Republicans to propose legislation to achieve their political objectives.  Instead, he surrendered his political advantages and handed it to them without a fight.  What an abject failure of leadership. I am reminded this year, as I was last, of a statement by Paul Tsongas in his Call to Economic Arms, "It takes toughness to lead a people toward their preservation no matter how disquieting the journey may be."

Maybe the next step is as Brad DeLong suggests -- they are now Obama's tax cuts, so he has to find a way to fund them.  A large carbon tax to recover much of the revenue would complete the "Green Tax Swap" that I have long wanted to see.  An economist can hope, can't he?

Happy Birthday, Great Recession

I've started contributing occasional posts to the Economic Intelligence blog at U.S. News and World report.  My first post takes note of the fact that the Great Recession began five years ago and revisits a number of themes about fiscal policy and dealing with downturns that I have been blogging about for almost as long.  Here's the motivation for the birthday wishes:

The mantra that guided both the small stimulus legislation signed by President George W. Bush in January 2008 and the much larger stimulus legislation signed by President Barack Obama a year later was that fiscal stimulus should be "timely, targeted, and temporary." The Brookings Institution went so far as to publish a primer on fiscal stimulus emphasizing this approach. One can only hope that with five years of hindsight and a continuing struggle to recover from the Great Recession, this approach has been discredited. 

I also spent some time discussing the fiscal cliff on a radio program last evening.  Listen here.

When You Come to a Fiscal Cliff, Take It

That's my main point in a Faculty Forum Q&A posted to the Dartmouth website last week.  Eight plus years of blogging, and you know what to expect:

What would you like to see happen?
Our biggest problem is that we’ve become accustomed to having a tax system that doesn’t raise enough revenue to cover our expenses. We’d be closer to it if we allowed all the policies in the fiscal cliff to actually revert. It’s not ideal to have them all revert at once, but that’s better than continuing to kick the can down the road. When you come to a fiscal cliff, take it.

Having the policies all revert is being portrayed in media coverage as the worst possible thing that could happen. 
No. Continuing what we’re doing is worse. Look, I’ll pay more in taxes, you’ll pay more in taxes—we’ll all pay more in taxes. The fact that we’re paying more taxes means that we’re covering more of our own bills.

If taxes go up, how do we avoid an economic slowdown?
We don’t have a problem that private consumption is too low. We have a problem that public investment is too low. If you were really worried about a decline in economic activity, you would let everything revert, and then you would commit to spending an extra $350 billion per year on public infrastructure, even if it had to be debt-financed. I would ramp up public investment in infrastructure and other critical national needs like roads, civilian defense, disaster infrastructure, smart grids, and basic research and development. All of these are needs that we’ve been neglecting.

Bill Gale of Brookings has been saying this for some time -- here is a recent interview with NPR -- though he and I offer different suggestions for how to spend the additional revenue to help promote economic growth in the short term.

Is This Journalism? I Say No

The title of the post refers to this article by Associated Press writer Andrew Taylor, "Huge Tax Increase Looms at Year-End 'Fiscal Cliff.'"  The purpose of the article seems to be to report on the findings of a study released yesterday by the Tax Policy Center, "Toppling Off the Fiscal Cliff: Whose Taxes Rise and How Much?"  The study is worth your time.  The article is not.

I am wondering whether it is standard practice in schools of journalism to encourage this style of writing (emphasis added):

Taxpayers across the income spectrum will get slammed with increases totaling more than $500 billion — a more than 20 percent increase — with nine out of 10 households being affected by the expiration of tax cuts enacted under both President Barack Obama and his predecessor, George W. Bush.

[...]

Monday's study, by the independent Tax Policy Center, deals with the immediate increases set to slap taxpayers in January under the existing framework of the tax code.

[...]

Few are talking of renewing Obama's payroll tax cut, even though that would mean a healthy tax increase for many working people. Working families with modest incomes would be hit hard as the child tax credit would shrink from a maximum of $1,000 per child to $500.

The world is complicated enough without reporters using violent language to describe non-violent events.  Running deficits in perpetuity is not a civil right.  The simple facts of the matter are that for over a decade, policy makers have been able to agree only on ways to lower tax revenues through the income and payroll tax systems, not on how to raise them.  They chose to do so by enacting temporary measures.  The failure of the anything-but-super committee to accomplish its objectives has brought this poor style of policy making to defense expenditures as well.   Many of these measures would not have passed if they had been described as permanent from the beginning.  In eight years of blogging, I have never defended this last decade of fiscal policy.

So what is looming is simply a reversion back to an older tax code.  We should let that reversion happen, as dictated by prior legislation.  Starting from that new baseline, we can ask the question of what productive uses of deficit spending we might have available.  The answer is the same now as it was nearly five years ago.

Taking Income

I think the choice of words in Annie Lowery's New York Times story about Emmanuel Saez and Thomas Piketty is unprofessional.  Here are the excerpts in which she describes the income of high-income or high-wealth households, with my emphasis added:

More than anything else, their work shows that the top earners in the United States have taken a bigger and bigger share of overall income over the last three decades,...

But both also express bewilderment over the current conversation about whether the wealthy, who have taken most of America’s income gains over the last 30 years, should be paying higher taxes. 

They figured out the benchmark for various income levels — the top 10 percent, top 1 percent and top 0.1 percent of earners, for instance — and calculated what share of income each group took each year.

But then inequality started increasing again, with the top 1 percent of earners drawing a bigger and bigger share of overall income.

Data that the two economists released in March showed that the top 1 percent of earners got nearly every dollar of the income gains eked out in the first full year of the recovery. In 2010, the top 10 percent of earners took about half of overall income. 

So, what is that -- 4 takes, 1 draw, and 1 got?  Income isn't taken by individuals away from some collective pile of "overall income."  It is produced by individuals working together under voluntary arrangements.  Absent coercion or government largesse, income is earned in ways that don't deserve to be derided in this way.


Her distorted language detracts from an important issue.  Tax rates need to go up primarily because we have a deficit problem, not a fairness problem.  They have to go up even though we have a weak economy, because we have a deficit problem.  In the process of raising tax rates, we should obviously consider ability to pay, which will generate larger tax increases on higher incomes.  The fine work of Piketty and Saez shows us just how much room there is in different parts of the income distribution, relative to historical distributions, to raise that revenue.

First, Let's Get the Prices Right

The Boston Globe ran a story on Friday about NStar's decision to "pay double the cost of conventional energy for Cape Wind power."  The quote is the headline, and the "cost" self-evidently does not include all of the externalities associated with burning fossil fuels.  I don't know if those external costs of transporting and burning natural gas would double the price, but that's the key piece of information required to make sense of the information presented. 

If you read the article, you will see that much of the public disagreement is about whether paying the extra amount for the cleaner energy is worth the environmental benefits.  If you want to make better policy, a wiser course of action would be to resolve what those benefits are and put a price on them.  With that price established, the decisions about whether a given project is worth the cost don't have to play out in public -- private companies can make those decisions and then come to market or not with power to sell.

The article also notes that this source of power would "add about $1 to customers' monthly bills in the first year" (presumably because this is only 2 percent of the load).  It seems like a sensible way to start off with renewable energy in the Northeast.

I Will Not Be Running a Benefit

For the ethanol producers (based on the first paragraph), but I'll stop short of declaring the Renewable Fuels Association a microeconomics-free zone (based on the second paragraph).  As Robert Pear reports in Sunday's edition of The New York Times:

“We may be the only industry in U.S. history that voluntarily let a subsidy expire,” said Matthew A. Hartwig, a spokesman for the Renewable Fuels Association, a trade group for ethanol producers. “The marketplace has evolved. The tax incentive is less necessary now than it was just two years ago. Ethanol is 10 percent of the nation’s gasoline supply.”

In response to a question about how the loss of the subsidy might affect prices and supply, Mr. Hartwig said: “We don’t expect the price of corn to fall or rise just because the tax incentive goes away. We will produce the same amount of ethanol in 2012 as in 2011, or more.”

Representative Jeff Flake, Republican of Arizona, said, “With record deficits and a ballooning national debt, it was ludicrous to expect taxpayers to pay billions to prop up a mature industry that should be able to fend for itself.”

I would still prefer a carbon tax on nonrenewable fuels, but this is a step in the right direction.  Let's hope the subsidy doesn't "unexpire" with election-year politics.

Bogus Art

The Los Angeles Times has a story this morning about the revenue loss to the Treasury from overvalued donations of works of art:

An alleged tax-fraud scheme involving donations of overvalued art to four local museums is part of a larger, unchecked problem with inflated art appraisals that has cost the federal government untold millions, a Times analysis has found.

Each year, the Internal Revenue Service audits donations claimed on only a handful of the 100,000 or more tax returns that allow art donors to reap nearly $1 billion in tax write-offs. Half of the donations checked over the last 20 years had been appraised at nearly double their actual value.

The crux of the public policy problem is the infrequency with which appraisals are checked. It makes all other remedies less effective:

A 2006 law tightened standards and increased penalties on bad appraisals. For donors, it lowered the threshold on what the law considers a bloated appraisal, from 200% overvalue to 150%. It also increased oversight of and fines for appraisers. But because the IRS checks so few appraisals, some believe that overvaluations will continue.

This is not a hard problem to solve. Every significant donation should have its appraisal checked by the IRS, and the donor should bear the cost of that process, not the government. There would be fewer small donations of art, but for major pieces, this cost of checking the appraisal would be small relative to the value of the tax deduction.

Workaholics Are Us

Here is the abstract from a new article by Dan Hamermesh and Joel Slemrod:

A large literature examines the addictive properties of such behaviors as smoking, drinking alcohol, gambling and eating. We argue that for some people addictive behavior may apply to a much more central aspect of economic life: working. Although workaholism raises some of the same health-related concerns as other addictions, compared to most of the more familiar addictions it is more likely to be a problem of higher-income individuals and is more likely to generate negative spillovers onto individuals around the workaholic. Using the Retirement History Survey and the Panel Study of Income Dynamics, we show that high-income, highly educated people exhibit behavior that is consistent with workaholism with regard to retiring–they are more likely to postpone earlier plans for retirement. The theory and evidence suggest that the presence of workaholism calls for a more progressive income tax system than otherwise, although other more targeted policies may be part of optimal policy.

The full paper is here. The reference to negative spillovers and a progressive income tax reminded me of this earlier discussion.

Your Pre-Super-Bowl Reading

From around the web:

• Via Brad DeLong, James Fallows follows the money in U.S./China trade, so you can, too.

• Greg Mankiw lets New Hampshire Senate candidate Jay Buckey into the Pigou Club for proposing a gas tax of roughly 7 cents per gallon at current prices. Read about the National Security Levy here. It's as good a place as any for an aspiring politician to start.

• Closer to home, Dartmouth's president, Jim Wright, will receive the Semper Fidelis Award from the Marine Corps Scholarship Foundation for his work on behalf of wounded veterans. Read more here.