November 18, 2010
Assessing Fantasy Scenarios
With the EGTRRA/JGTRRA extensions and proposals for tax reform and debt reduction flying left and right, I think it behooves us to review what the theoretical (well, actually undergraduate textbook) literature and the empirical assessments suggest will be the impact of tax rate changes. I want to devote special attention to the hypothesis that there will be large dis-incentive effects on high income households should their tax rates go up, with correspondingly large negative ramifications for overall economic activity.
Tax rate reductions can affect the macroeconomy in many different ways. In what is typically characterized as the Keynesian approach, the tax rate reduction increases disposable income, and hence consumption. In what is typically characterized as the supply side approach, the tax rate reduction induces an increase in labor supply.
The former effect induces an outward shift of the aggregate demand curve, while the latter shifts out the long run aggregate supply curve (since potential output depends upon the labor stock employed).
Figure 1: Shift in aggregate demand curve due to reduced tax rate, or shift in potential GDP.
Now, in typical macroeconomic modeling (in what is sometimes called the Neoclassical synthesis), both effects are included. Which effect dominates? This is an empirical issue (Interestingly, this was the topic of the first economics paper I wrote in college, during the era of Arthur Laffer and Jude Wanniski; I guess economic policy is like fashion -- some things, like platform shoes, keep on coming back).
To highlight the reason why this is an empirical issue, first consider the impact of a tax reduction on the after tax wage rate, and hence the labor-leisure tradeoff. Let IC1 be the original indifference curve, X the maximum number of hours of leisure, and Y income.
Figure 2: Impact of (after-tax) wage rate increase. Source http://www.knowledgerush.com/kr/encyclopedia/Labor_market/
The original equilibrium point is A, with XA hours of leisure, YA income. A tax rate decrease raises the after tax wage rate, making the relative price line steeper. The new equilibrium is at B. Now leisure falls to XB, as income rises to YB. Leisure is a normal good in this example. Notice that the income and substitution effects are then offsetting (XA to XC is the income effect, XC to XB is the substitution effect). Notice that the indifference curves could be drawn so that in fact leisure increased in response to the tax rate decrease. In such instances, the labor supply curve would be backward bending. Only if leisure is an inferior good (i.e., one prefers less leisure as income rises, which seems like an unappealing assumption) can one rule out the backward bending supply curve over the entire range of wage rates. (More undergrad-level notes here, and here).
Since theory does not provide guidance on the real-world effect, we have to appeal to data. There are numerous studies addressing this question (see a meta analysis here). I'm going to refer to the numbers the Congressional Budget Office uses in its microsimulation model, here; I show Table 2 from the paper below.
Source: CBO, "The Effect of Tax Changes on Labor Supply in CBO's Microsimulation Tax Model," Background Paper (April 2007).
The table can be read as follows:
Income elasticity measures the percentage change in total hours worked that would result from a 1 percent increase in after-tax income, holding the after-tax wage rate constant. Substitution elasticity measures the percentage change in hours worked from a 1 percent increase in the after-tax wage rate, holding the worker’s utility constant. The total wage elasticity is the sum of the two elasticities; it measures the percentage change in hours worked that would result from 1 percent increases in both after-tax income and the after-tax wage rate.
I think it's of interest that if one is worried about the incentive effects on the top four deciles (top two quintiles), these elasticities suggest that the anxiety is misplaced. The elasticity for these two quintiles is 0.028; that is a tax rate increase that decreases after tax wages by 1 percent would decrease labor supply by these individuals by 0.028 percent(!). Notice that the elasticity is much higher for secondary earners.
Overall, the CBO concluded in the 2007 report (Table 3) that only about 4% of the static revenue loss associated with extending the EGTRRA/JGTRRA and implementing an AMT fix would be offset by the increased tax revenue associated with people working longer hours due to supply side effects.
What this tells me is that in crafting tax increases, one should pay attention to incentives, but one shouldn’t overstress the importance of supply side effects. And in particular, those incentive effects seem particularly small for high income earners. There is a separate question of whether a higher tax rate would disproportionately impact the consumption of high income households, which account for a large share of overall US consumption (as opposed to raising taxes on lower-income liquidity constrained households, which arguably have a higher marginal propensity to consume). To me, that makes more sense, from an analytical perspective, than fixating on the supply side effect.
Postscript: These are static effects in the CBO study. For discussion of dynamic effects, see this post.
Posted by Menzie Chinn at November 18, 2010 06:20 AMdigg this | reddit
Any comments on the morality of cannibalism? Allowing some people to live off of the work of others?
Posted by: A.West at November 18, 2010 06:32 AM
The trouble is you are going to get the small marginal increases eventually, and they will be followed by decelerating economic activity EVEN THOUGH there is no causal connection. Then that will be cited as "proof" your analysis is wrong.
Bernanke’s biggest flaw is that he thinks this is only a credit contraction recession, so he can fix it with credit expansion tools. He doesn’t realize that he is up against (1) a generational shift to the Gen Xers who got buried in student loans, and view credit very differently from the Baby Boomers, (2) the retirement of said Boomers, the pig in the python with the largest cohort turning 48 ( the year of peak consumption per Harry Dent) in 2005 – did something change after that? And (3) technology, which slashes prices every year (OMG – deflation!).
SurviveTheGreatInflation.com the book launched yesterday – Bernanke isn’t going to change – given his history, he can’t – and Obama doesn’t have any idea how awful his appointments were. It's inflation coming, not deflation. Don't ever bet against the Fed.
Posted by: Michael Murphy CFA at November 18, 2010 06:47 AM
- The elasticity for these two quintiles is 0.028; that is a tax rate increase that decreases after tax wages by 1 percent would decrease labor supply by these individuals by 0.028 percent(!)
You don't mean 2.8 percent?
Posted by: q at November 18, 2010 07:08 AM
Hours worked is not the relevant issue in the top brackets. The relevant issue is investment and business formation and expansion.
Posted by: W.C. Varones at November 18, 2010 08:24 AM
Tax systems should be more progressive.
Tax cuts a more beneficial to long run growth than spending.
Tax cuts reduce revenue as a percentage of GDP. However, they increase the growth rate of GDP, therefor they will always result in higher revenue in the long run (it's just more likely decades than months).
Posted by: aaron at November 18, 2010 08:25 AM
Thanks for highlighting the CBO table, I like it a lot. However, you're focusing too much on primary earners. As you point out, the elasticity for secondary earners is much higher. I would argue that most households in the top income tax brackets are two-earner couples. The relevant labor supply elasticity for these households isn't .028 at all, but much closer to 0.4 times 1/2 (the response of the second earner times the fraction of second earners). This gives an elasticity of 0.2, almost ten times as high as the number you seem to be taking away from the table.
Posted by: Eric Swanson at November 18, 2010 08:41 AM
Within reason, I think that's right. A modest tax increase will, in general, not reduce the appetite to work much. Greg Mankiw will stay busy largely regardless of the tax rate.
However, it's still hard to find an example of a high tax country with dynamic growth. And that's because those high taxes go to fund, in large part, increased consumption of preferred political groups. And this tends to hollow out the economy over time. Thus, for example, Europe tends to have both higher taxes and higher unemployment than the US over time. And we see this in the US as well: population is moving from high tax states in the northeast to low tax states in the south and southwest, suggesting that low tax states are perceived to have more dynamic economies.
Posted by: Steven Kopits at November 18, 2010 08:43 AM
OK, there is a sort of intellectual absolutism at work in the comments that the post itself seemed aimed at avoiding.
aaron's claim that tax cuts "will always result in higher revenues in the long run" is based on his own claim that lower taxes will increase the rate of GDP growth. What is missing is evidence that A) lower taxes necessarily boost growth, and B) that the boost growth enough, even in the long run where aaron chooses to hide, to pay for the revenue lost to lower rates.
WCV claims that there is one and only one relevant measure of the response to tax changes at high tax rates. This is the "entrepreneurial hero" view of economics. Corporate execs, highly paid workers, hot shot engineers and creative types - none of them matter to the economy. Just the guy who goes out and creates a business. Nice story, told by the Randy types for ever so long. I don't know of any particular reason to believe it.
Posted by: kharris at November 18, 2010 08:52 AM
A good companion piece is in today's NYTimes:
It is, of course, impossible to derive any serious elasticity estimates from gross historical periods, but still worth noting.
Posted by: Mark Kuperberg at November 18, 2010 08:54 AM
Taxes were raised in 1993 and followed by one of the biggest bursts of economic growth in decades. Taxes were reduced in 2001 and followed by the most dismal economic growth since WWII.
It appears that the influence of marginal tax rates is either the inverse of many claims or of such little consequence in light of other factors as to be not worth arguing about.
Posted by: Joseph at November 18, 2010 10:11 AM
I scanned the CBO article and found that there were many caveats about uncertainties and lack of data on high income earners. Second, the CBO article applies to the labor supply, and thus does not take into account changes in the use of tax shelters as their value goes down with lower tax rates. Third, the numbers don't say anything at all about the effect of lower tax rates on the incentives to start new ventures. I also know that if my tax rates go down, I have additional money that can be used to make purchases or make investments - my own personal stimulus which I can use to purchase things which increase my well-being (and that of others).
I must admit that I am skeptical of macroeconomic models - is there any evidence they are useful in predicting the course of the economy?
Obviously you can't run alternative economies to evaluate the effects of different policies. I thought that I could compare forecasts, adjust for differences in assumptions and actual outcomes, and get some idea of the effect. I remember trying to evaluate the course of tax receipts before and after the Bush tax cuts, using the White House's annual reports and hit a snag because of changes of assumptions in the resports from year to year.
Posted by: Rich Berger at November 18, 2010 11:22 AM
This analysis generally seems to ring true for me, that incentives of the affluent are relatively less sensitive to increasing marginal tax rates. Money at the top tends to get hoarded and it slows down.
But it seems to me that it also matters on what the various deciles spend their money. What I am thinking about is that the impacts of fiscal policy (taxing and spending) depend on the leakage out of the economy, especially via purchases of foreign manufactured goods -- the flat screen TV leakage problem.
Does anyone know if some deciles leak less?
Posted by: MSM at November 18, 2010 11:44 AM
I agree with this assessment. The supply-siders were running amok, calculating huge efficiency losses from graduated income taxes from CGE models, until Mroz knocked the foundations out from under them with a close and rigorous review of the evidence on labor supply elasticities. I think his article should have made the lead in the Econometrica issue, but as I recall it was put second (after a nobel address?).
Posted by: don at November 18, 2010 12:46 PM
Not sure if anyone is interested, but here is a link to tax receipts (and as a percent of AGI) across the 2000-2006 time frame. The data seem to suggest that tax revenues fell inititally but recovered (and surpassed 2000 revenue recipts) while Tax as % of AGI fell over the course of that period. Obviously, this would need to be adjusted to account for population growth, but depending on that adjustment, the data seems to support the assumption that tax cuts DO lead to higher tax revenues IN THE LONG RUN.
Posted by: Gridlock at November 18, 2010 12:57 PM
Forgot the link!
Posted by: Gridlock at November 18, 2010 12:59 PM
Gridlock It's the long run that leads to higher tax receipts over the long run.
Menzie Your chart shows a uniformally vertical long run aggregate supply curve. My textbooks always show the AS-LR curve as being flat along most of the horizontal axis and then turning vertical to nearly perfectly vertical as you approach normal output levels. In normal times this distinction between your AS-LR curve and the ones in my old textbooks amounts to something of a distinction without a difference because in normal times we're operating near potential GDP. But these ain't normal times and my guess is that it would be more realistic to show the AD curves intersecting the AS curves at a point not quite vertical. Now why is this important? Because, as Krugman pointed out in his LSE lectures, when you're in a liquidity trap with interest rates at zero the Fisher effect is likely to overwhelm the Pigou effect, which means that there is nothing to guarantee that the AD curve will be monotonically downward sloping. Krugman argues that it will tend to be locally upward sloping at low output levels. So if you have a relatively flat AS curve and a steeply vertical but positively sloped AD curve, then any rightward shift of the AS curve will actually reduce output and generate deflation! So this is another response to why supply side economics is almost certainly not the answer to today's problem of weak aggregate demand. Supply side policies, to the extent that they would actually do what its advocates claim, would actually make things worse.
And drifting somewhat off topic for the moment, if you or JDH have a chance I would like to see a post on the new NBER paper by Saez, et. al. regarding optimal unemployment insurance conditioned on the business cycle. It's a bit of a long paper and I'm only part of the way through it, but I think the topic is important and right on target.
Posted by: 2slugbaits at November 18, 2010 01:55 PM
And no sooner do I point out Krugman's LSE argument about upward sloping demand curves then I see that he has just posted his NY Fed paper on exactly this same thing.
Posted by: 2slugbaits at November 18, 2010 02:02 PM
Taxes were raised in 1993 and followed by one of the biggest bursts of economic growth in decades. Taxes were reduced in 2001 and followed by the most dismal economic growth since WWII.
Yes, and I am perfectly fine with returning to Clinton-era tax levels if we ALSO return to Clinton-era spending levels. That would be a huge reduction from what it is now.
Deal? (sounds of crickets chirping).
Leftists somehow are so keen to return to Clinton-era taxes but not Clinton-era spending, showing their bankrupt ideology for what it is.
If the economy did well in the late 90s, it was due to low spending, and IN SPITE OF high taxes.
So let's match both taxes AND spending to the levels of the late 1990s.
Posted by: Heterosexual at November 18, 2010 04:46 PM
Steven Kopits is a credit to this site & speaks intelligently on this subject.
I would diffidently add that the effects of substantial tax changes are more complicated than the effect on measureable supply of labor or on spending by particular groups.
Further, the ultimate burden of gov't is not what it taxes but what is spends. Is there any here who would argue that increasing the burden of gov't inflicted on an economy is a benefit?
Posted by: Bryce at November 18, 2010 06:49 PM
The meta-analysis is helpful but doesn't seem to separate taxpayers by income level.
Saez and Gruber , and later Saez et al, claim that high-income taxpayers have a greater elasticity of income:
Those were the ones separating taxpayers by income level I know of. It's good to know of the CBO's results, and I will look through to see what they do differently- any ideas?
Posted by: celestus at November 19, 2010 05:24 AM
Notice that the indifference curves could be drawn so that in fact leisure increased in response to the tax rate decrease. In such instances, the labor supply curve would be backward bending. Only if leisure is an inferior good (i.e., one prefers less leisure as income rises, which seems like an unappealing assumption) can one rule out the backward bending supply curve over the entire range of wage rates.
This passage is very interesting and very revealing. It demonstrates an intresting understanding of the entrepreneurial spirit and illustrates why entrepreneurs are so neglected in modern economics. Notice that this passage could be described as "sloth is a higher good than industry."
When a person makes a life decision leisure is one part of the calculation. Most of the homeless I have encountered in my charitable work value leisure as either their highest good or one of their highest goods. When offered a job almost all either refuse the offer or are not willing to put in the effort.
But it is not just the homeless. Those who work for others fall into two categories. There are those who are failures at building their own businesses so must work for others and those who prefer to work for others. In both of these groups leisure is a higher valued good.
If a person is good at business and has a strong entrepreneurial spirit, any incentive, tax cuts, increased business, the challenge of the work, will inspire this person to greater achievement and harder work. Those with a weak entrepreneurial spirit and/or a preference for leisure will find the incentive that will inspire the entrepreneur to greater work pushing them in just the opposite direction.
Menzie is correct that indifference curves can be drawn to show that tax cuts do increase leisure and decrease industry, and most of us see it every day in our jobs. There are always those workers who are slackers, if they have a chance. But what Menzie misses is that America was not build on sloth but on opportunity. America is a place where those with the entrepreneurial spirit can provide places to work for those who prefer leisure.
But we must not miss the fact that it is the industrious that provide the jobs, not the slothful. Obviously tax cuts cut both ways. But are we better off by increasing taxes and forcing the disgruntled to work harder for less leisure? If we decrease taxes and stimulate the entrepreneur are we not also benefitting the slothful by allowing them to engage in more leisure?
Posted by: Ricardo at November 19, 2010 06:16 AM
In 1929 Henry Ford stressed three main factors needed for a recovery:
1 Prices Increase of the goods value or the price flattening to their existing level of equilibrium.
2 Increase of the salaries
3 obtain from the industrials the sacrifice of leisure for the hardship of work.
If 1 & 2 will appear to be controversial 3 found a natural answer,as markets values and prices going to their natural price equilibrium,entrepreneurs had no choice but to go back to work.
H Ford was calling on the industrial world.
Posted by: ppcm at November 19, 2010 07:09 AM
I could be wrong about this, and if I am I would appreciate hearing why, but there seems to be a foundational flaw in all of this.
Take Bernie Madoff for example, he may be an extreme example, but so long as we are clear on that, he will do. Now, if I understand the Marginal Utility Theory correctly (?), his contribution to the economy, before he was caught, was greater than that of all of those people who earned less money than crafty ol' Bernie did. Thereafter, once Bernie was caught though, his contribution to the economy may have actually increased; because now, his crimes have created extensive economic activity which involves lawyers, jailers, judges, accountants, and so on.
The point being, that unless I have misunderstood the Theory of Marginal Utility (?), most all of this, except that which Henry Ford made 'obvious', is just based on serving the rich and powerful and deciding what we are willing to let them take from us. More specifically, we come up against this consideration which is provided by Menzie: "I want to devote special attention to the hypothesis that there will be large dis-incentive effects on high income households should their tax rates go up, with correspondingly large negative ramifications for overall economic activity".
But, based on how we value the contributions of high income 'contributors' we don't actually even know, with any certainty, if these 'contributions' are in fact contributions or not. In other words, there are cases in which society may benefit from fewer of these 'skilled workers' but how would we know that?
Naturally, we could pretend that supply and demand factors are telling. Unemployment stats for example suggest that 'skilled workers' are well more in demand right now than what 'unskilled workers' are, but, trillions of dollars 'more' have been spent to keep 'skilled workers' from losing their jobs, than what has been spent on 'unskilled workers'.
Continuing along with supply and demand factors, we could also pretend that illegal and legal immigration has had little or no effect on the value of 'unskilled labor'. But of course how does one deny, that if there are 3 jobs and 2 workers, that labor values are the same as when there are only 2 jobs and 3 workers. Of course one doesn't, deny something so undeniable.
And so, ultimately, those who decide how the stimulus funds are spent, and what the laws are, and then, which of those laws are enforced, and how penal those laws are in relation to the harm done, are in fact those who need a Marginal Utility Theory to determine value.
That said, I think the title of the post is fitting:
'Assessing Fantasy Scenarios'
Posted by: rayllove at November 19, 2010 04:00 PM
The results from this paper cast doubt on the credibility of the conclusions you are trumpeting above.
Page 6, footnote 13.
However, some studies of the effect of taxes on taxable income, which consider a much broader array of behavioral responses, have found the largest response among high-income taxpayers. For a discussion of that research, see Seth H. Giertz, Recent Literature on Taxable-Income Elasticities, CBO Technical Paper 2004-16
From that paper's abstract:
In fact, the estimates suggest that the
ETI(elasticity of taxable income) could be as high as 1.2 for those at the very top of the income distribution. The major conclusion, however, is that isolating the true taxable income responses to tax changes is extremely complicated by a myriad of other factors and thus little confidence should be placed on any single estimate.
From the paper's conclusion:
The findings that very high-income filers respond more to tax changes than do those with
lower incomes and that estimates for the 1990s are generally smaller than comparable elasticities for the 1980s are consistent with the previous literature. However, the estimates are highly sensitive to an array of factors, including sample income cutoffs, the
methodological approach, and tweaks to each of the core methodologies. That sensitivity
warrants caution against placing too much emphasis on any particular estimate.
Posted by: tj at November 19, 2010 06:05 PM
tj You and a few others making a similar claim and citing other studies are not quite understanding the issue. You are confusing two different things. The CBO study only looks at how changes in the marginal tax rate effect the labor supply. The studies that you and others referenced are looking at something quite different; they are looking at how a marginal change in the tax law affects taxable income. The CBO footnote that you cited clearly says that the Giertz study looked at a broad array of behavioral responses beyond just the income and substitution effects on the labor supply curve that were the subject of the CBO study. For example, what the Giertz study shows is that high income folks are more likely to shift compensation from taxable income to nontaxable income (think goldplated healthcare) or reduced taxable income (think Wall St compensation as capital gains). The Giertz study is the kind of thing that can be very imporant for purposes of estimating lost tax revenue, and that's why CBO cited it in their study; but the Giertz study is not relevant for estimating effects on the labor supply curve. The CBO was trying to answer a fairly narrow question; viz., what will be the effect of a tax increase on the labor supply curve? The CBO paper was quite explicit in saying that they were not asking what the effect of a tax change would be on total tax revenues. That would have been a different question, of which the labor supply curve issue would have been only a part of the answer.
What you and others don't seem to recognize is that the Giertz and the Saez paper cited by celestus actually support the CBO's estimates. The point of the Giertz and Saez papers was that tax hikes don't cause rich people to quit working (and hence have very little effect on the labor supply curve), but those folks just get their compensation in ways other than ordinary taxable income. In other words, the Giertz and Saez papers agree with CBO that tax hikes have almost no effect on the amount of labor output from high income earners, but tax hikes can have a very large effect on how those high income workers are compensated.
Posted by: 2slugbaits at November 20, 2010 05:45 AM
My apologies. Thank you 2slugs, it is clear now. I got sidetracked between reading the post and looking at the paper and wandered off topic.
Posted by: tj at November 20, 2010 07:03 AM
To continue, at a certain point the 'dis-incentive' argument becomes ludicrous. As Menzie explained: "those incentive effects seem particularly small for high income earners" which, on the surface level of this argument, is a relevant point.
But on a deeper level there is something ludicrous about there being any need for the surface level argument at all. Not to suggest that Menzie should not be making his argument, but instead to say that those on the other side, the anti-tax-no-matter-what crowd, have become delusional.
To begin with, how do so many miss the fact that the very creative destruction process that they, conservatives etc., are so often quick to explain the value of... has been averted in the most extreme way in human history in relation to the FIRE sector? Yet now, with the actual value of contributions made by those who are supported by the FIRE sector, many of them lavishly, being spared the very creative destruction that is clearly necessary, to the point that nations all over the world are imposing capital controls to punctuate the inescapable message, a message that essentially says, that untold trillions are being misused, at least in part, to support a workforce that is severely imbalanced. Is this not the 'mother' of all 'distortions', and are not conservatives the very people who so often make the 'distortion' arguments?
But this workforce imbalance is more than that which is made fairly obvious by the FIRE sector. The US economy has also become dependent on crime and wars. For example, 25% of the global prison population is incarcerated in US prisons, and the US is of course only about 4% of the global population. The simple truth is, as the US economy became more reliant on its service sectors, the demand for these services increased as if by magic. And now, if crime could be eliminated by some other sort of magic, the US economy would collapse under the weight of severe unemployment. It is very possible also, without magic, if US incarceration rates were lowered to commensurable levels to those in other developed nations, by whatever means, this would still cause significant unemployment.
Same trend regarding the imbalance in our workforce can be seen in the advance of militarism as well. Without wars and conflicts, without 800 military bases around the world, without 17 intelligence agencies, and of course without the military industrial complex, where would our unemployment rate be now? Who knows, but it is increasingly clear that the configuration of the US workforce has become dependent on vast amounts of less than productive economic activity, some of which is purely destructive. But much of this destructive economic activity, according to the Theory of Marginal Utility, is applied to GDP as gainful.
Yet, there are those who argue that 'non-incentives' are a concern regarding efficiency. 'Delusional' may be too mild.
Posted by: rayllove at November 20, 2010 10:12 AM
It appears that the conclusions from the perspective of the leeches is: the more of us there are on the body, and the more blood we suck from our victim, the more blood he is willing to produce. That will work, until the man discovers this and pours salt on the leeches.
Posted by: A.West at November 21, 2010 05:49 AM
q: No, I have cited the figures correctly. Your response is representative of those who are not familiar with the empirical literature.
W.C. Varones: It is sometimes useful to recall some of key figures macro people walk around with; in particular, that labor income constitutes about 2/3 of total income. If output is characterized by a Cobb-Douglas production function, and marginal productivity of factor returns is approximately equal to factor returns, then increases in output due to say, increased rates of capital investment, will not typically be large. That's textbook, too.
Eric Swanson: Excellent point. Your observation on top four deciles mostly being in dual income households differs from what I've observed, but I've just returned from NYC, so perhaps my sample is biased. In any case, that's an empirical point -- we should appeal to a public finance person; I will update. In addition, shouldn't one earnings-weight, not person-weight, the two elasticities?
Steve Kopits: If memory serves, the US per capita growth rate under the "high tax rate era" of Bill Clinton.
Rich Berger: You are absolutely right; unlike many of the comments on the blog, the CBO report is hedged. Indeed, as in responsible analysis, they investigate the implications of a range of elasticities. I don't suppose you noticed that they undertook that measure?
2slugbaits: Haven't read the Saez paper -- thanks for the thumbnail sketch.
Regarding the AD-AS framework used, I'm willing to allow an upward sloping LRAS (see this post), as well as a non-monotonically sloped AD, but wanted to stick with a very conventional framework to be as clear as possible.
A.West: Do you have something more substantive to add than allusions to cannibalism or leeches?
Posted by: Menzie Chinn at November 21, 2010 09:10 AM
As long as anybody is "rich", there will be Leftists arguing that it is "fair" to increase taxes on the rich rather than cut gov't spending.
I feel that much of this unrealistic, overly simplistic macro modeling has one primary aim: increase taxes and increase gov't spending.
The increase in taxes, "on the rich", always seems to be bait & switched to be higher taxes on middle class, since bla bla bla (the rich & powerful never allow taxes to be really painful without loopholes).
Gov't spending, and gov't investment, is based on force. Win-lose. It's less productive in the long term than market oriented win-win deals ... unless one side fails to live up to their agreement.
Like all the Big Banks in the FIRE sector. Who should have gone bankrupt, with the Fed/ Treasury staving off economic problems (like not enough new factories getting loans to be built?), if necessary. Instead, the majority Dem Party voted in TARP bailouts, with Bush leading (& McCain cheering) despite the Reps being more against this corp. welfare for the super-rich that the Dems voted for. And again with more bailouts after the election.
One of the gorillas in the room is the reality that American workers are, globally, overpaid. So post-Cold War growth like under Rep Congress/ Clinton is unlikely to happen again in the USA, because the rest of the world's is busy catching up.
Posted by: Tom Grey at November 22, 2010 06:13 AM
It is a central planner's fantasy that those who get rich in the free market "win life's lottery" while those who get rich in government are totally selfless servants of mankind. Sloth and bacchanalia are part of a politician's DNA. I do not know of any entrepreneur, especially rich ones, who do not work 10-14 hour days and are constantly striving to expand their production which creates jobs.
Do not forget that taxes do not go to the citizens. Taxes go to the politicians. Capital in any form that goes to government is expended on the whims of politicians not the demands of the people. The demands of the people are satisfied by the market. Polticians only get involved when there is not sufficient demand to fund their pet projects because if there is sufficient demand entrepreneurs will be there in a heartbeat.
And never lose sight of the fact that it is the successful entrepreneur who provides the filthy lucre on which government "workers" feast. Government does not produce; it consumes the production of others (Keynesianism anyone!).
Posted by: Ricardo at November 22, 2010 08:29 AM
Ricardo: Could'a sworn the government had something to do with the a-bomb...
Oh, and the interstate highway system. Oh, and the genesis of the internet. Oh, and...
Posted by: Menzie Chinn at November 27, 2010 10:14 AM