November 02, 2010
Detachment from Reality and Innumeracy as Impediments to Rational Discourse
Tax cut version
On several occasions, I have observed that it is difficult to debate policy when facts are in dispute, and some individuals are impervious to the revelation of data. I was recently reminded of this by reader tim kemper's repeated assertions that the "the 2001 act and 2003 act actually increased revenues" (3/1/10). Most recently, he repeated that assertion (on 10/31) and linked to this source as proof of his assertion that tax cuts raise revenues, without realizing that the series he was pointing to was total (not just income tax) revenues, and not seasonally adjusted. Below is the actual evolution of personal income tax receipts both before and after the EGTRRA (the 2001 Bush tax cut).
Figure 1: Personal income tax receipts, SAAR, in billions of dollars (blue, left scale) and as a ratio to GDP (red, right scale). Vertical line at 2001Q3 (EGTRRA provisions take place starting July 1, 2001; Jan 1, 2002, Jan 1, 2004, 2006). Source: BEA, GDP 2010Q3 advance release, Table 3.2, line 3 and author's calculations.
In other words, it is hard to discern actual evidence for the extreme supply side proposition that tax rate cuts increase tax revenues, when examining the data (and knowing which data are relevant). Now, we know that many things are going on at the same time, but as a matter of fact one cannot say that income tax revenues rose immediately after the beginning of implementation of EGTRRA.
There are more sophisticated ways of analyzing this issue -- in particular one could say income tax revenues would have been even lower had not EGTRRA been passed. But I do not know of any studies that make this particular assertion, and assesses it in an econometric fashion. In any case, this counterfactual-based argument is not the typical one made by extremist-supply-siders. And the fact that revenues had not returned to pre-tax-cut levels even by the time the economy had returned to potential in 2006  also counters the extreme supply-sider perspective.
Of course, this is a separate question from whether output will be higher with lower taxes; for an analysis, see this post discussing the 2006 (Bush) Treasury report on the issue, as well as CBO's assessment.
I know there are some who believe argument by mantra is the way to go, but I think constructive debate should be informed by appeal to data.
Update 11:44am Pacific 11/2/10
In response to reader Steve, who has just become my new poster-child for detachment and innumeracy by writing:
With all due respect, every time a tax cut has been passed, revenues to the treasury have risen.
I post a graph of total Federal tax revenues.
Figure 2: Federal tax receipts, SAAR, in billions of dollars (blue, left scale) and as a ratio to GDP (red, right scale). Vertical line at 2001Q3 (EGTRRA provisions take place starting July 1, 2001; Jan 1, 2002, Jan 1, 2004, 2006). Source: BEA, GDP 2010Q3 advance release, Table 3.2, line 2 and author’s calculations.
Posted by Menzie Chinn at November 2, 2010 06:21 AMdigg this | reddit
The Bush tax and the economy Congressional service Thomas L Hungerford
Interesting findings when reading the distribution curve (indifference curves) P14
At 25% threshold, the tax cut benefit is saturating at the 99% quintile and does not provide much further tax relief for the last 1% quintile.
At 33 % the marginal tax reduction does not improve the tax position of the 99% quintile but comes to be of added value for the last 1 % quintile.
Reading the column further, a time when capital gain tax were devised as to encourage capital gain.
This applies to a Gauss curve,how about trying a Poisson?
Posted by: ppcm at November 2, 2010 07:54 AM
A local former Minneapolis Fed economist and columnist, a man named Ed Lotterman, had what I thought was a very relevant take on this recently in a column titled "Reagan aides dismiss GOP tax strategy".
Of all the misunderstandings that plague public policy making in our country today, none is as important as the question of whether cutting tax rates raises tax revenues.
Having written about this frequently, including columns on March 14 and 21, I won't replow the ground of how broadly economists dismiss this idea and why economic data show it did not happen in the past.
But all who believe in self-financing tax cuts should consider the views of two prominent Reagan administration officials who helped initiate the "supply-side revolution" 30 years ago and who are campaigning against the tax cut fallacy today.
David Stockman was the Director of Management and Budget for Ronald Reagan's first administration. He believed deeply in the supply-side prescription for lower tax rates and smaller government.
But in a New York Times opinion piece July 31, he blasted Republican Senate Minority Leader Mitch McConnell for his insistence on sparing the wealthy from tax increases and said fiscal doctrine "as practiced by Republican policymakers for decades now, has amounted to little more than money printing and deficit finance." He went on to assert that, "This debt explosion has resulted not from big spending by the Democrats, but instead the Republican Party's embrace, about three decades ago, of the insidious doctrine that deficits don't matter if they result from tax cuts."
Bruce Bartlett had impeccable supply-side credentials, serving as an aide to Rep.
Ron Paul, R-Texas, and helping the late Rep. Jack Kemp, R-N.Y., draft the Kemp-Roth tax reform bill that was the framework for the 1981 Reagan tax changes. He held a variety of positions in the Reagan White House and with conservative think tanks and was a mid-level Treasury official under George H.W. Bush.
The borrow-and-spend policies of Bush's son horrified Bartlett, however, leading him to write a 2006 book: "Impostor: How George W. Bush Bankrupted America and Betrayed the Reagan Legacy," followed in 2009 by "The New American Economy: The Failure of Reaganomics and a New Way Forward" in which he blasts the fiscal stance of post-Bush Republicans.
Some will dismiss the two as RINOs (Republicans In Name Only) or even socialists. But thoughtful Republicans who care about their party's long-term future, as well as our nation's, need to weigh these men's concerns. Why are two Reagan veterans now so disgusted by the core fiscal positions of their own party and, by extension, of the "tea party"?
The answer is that true supply-side economics was much more nuanced than current doctrine. The movement defined itself in opposing then-prevailing Keynesian policies of micromanaging the economy by manipulating overall national demand. It generally favored lower taxes, less regulation and smaller government. But it never argued that all tax cuts pay for themselves or that taxes should never be raised.
The Laffer curve plotted tax revenues against tax rates from zero to 100 percent. This curve argued that if marginal tax rates were very high, cuts in those rates could increase revenues. And it specifically was high marginal rates on high-income people that were crucial, since high-income people were more likely to save and invest any tax cut, rather than consume it as lower-income households would.
This expected increase in savings was the key link that would funnel tax cuts into more factories and equipment fostering greater economic growth. It was of utmost importance that tax cuts funnel directly to a higher national savings rate. Seeing it flow to higher consumption would be Keynesianism.
But while the Laffer curve asserted that cutting high marginal rates could increase revenues, it demonstrated just as strongly that once tax rates dropped below some point, further rate reductions would cut revenues at an increasing rate. Laffer and other original supply-siders never argued that all tax cuts would pay for themselves, only those involving high marginal rates on high-income taxpayers.
In any event, the Reagan tax cuts did not foster greater savings and investment, even among the rich. For whatever reason, household and national savings rates began to fall from usual levels in the mid-1980s and fell to near zero within the last decade. But increased savings were the key variable to making the theory work.
Income taxes paid by the rich did rise because the wealthiest 20 percent of the population garnered nearly all the increase in national income in the past three decades. But it was consumption rather than savings that boomed among those who benefited most from the tax cuts.
What the original supply-siders also know is that while Reagan always promoted lower taxes, he was a pragmatic politician who would sign tax increases when necessary.
In an article written for National Review in 2003, Bartlett details how Reagan signed bills for major increases in payroll taxes for Social Security and unemployment together with those on motor fuels and cigarettes. And, in the face of burgeoning deficits and pressure from fiscal conservatives in his own party as well as Democrats, he reversed some of his own income tax cuts. All in all, according to the 1990 federal budget cited by Bartlett, tax increases signed by Reagan amounted to 2.6 percent of GDP, or more than $350 billion of annual revenue in 2010 dollars.
Whatever the outcome of Tuesday's elections, the reflections of these two men who invested so much of their careers creating conservative tax policy should give us pause as we move forward.
St. Paul economist and writer Edward Lotterman can be reached at email@example.com.
Posted by: --Andrew at November 2, 2010 09:24 AM
With all due respect, every time a tax cut has been passed, revenues to the treasury have risen. It is interesting, however, that with continued low tax rates the economy is still currently in the tank. People are sitting on their money because they are unsure of where taxes will be in the future. One thought to perhaps stimulate business development, short of confiscatory taxation to meet deficit spending is this. Keep the current tax structure, but add a caveat. If you have income above a certain level and wish to continue with favorable taxation, you need to invest the money saved by the lower tax rates in America instead of chasing foreign markets. The more viable business inestments made here, the more work for the working class and middle class. Tax revenues would rise, the rich can keep their favorable tax rates and the unemployment rate would decline once the job bucket began to overflow. It will take time, but it would improve within one year and come out of the water in 2-3 years. The political problem is that Obama and the Dems fiddled while we burned. There is no way to bring the jobs back to the levels of 2006-07 until 2013-14.
Posted by: Steve at November 2, 2010 09:40 AM
I'm sure tax-cutters will be happy to adopt the argument that income tax cuts yield greater total tax revenue (regardless of what happens to income tax revenue). Your limiting the gain in revenue - in your argument - to income tax receipts only doesn't seem compelling.
Posted by: Joe at November 2, 2010 09:50 AM
What seems frequently misunderstood, or overlooked or maybe avoided, is that cutting taxes during 2 wars was made affordable by foreign inflows. The trade surpluses and other dollar holdings that are recycled back through the US, in of course mostly T-bills, is a clever way of minimizing competition from foreign investment. This ‘recycling’ takes vast sums of dollars out of foreign hands and puts this capital in US hands at a very low cost. This allowed the US government to fund its obligations which in turn made the tax cuts doable and that allowed US investors increased capital formation. But it is the minimizing of foreign competition that is critical to consider, and, it is "exorbitant privileged", as deGaulle put it, that is most worthy of consideration.
What this also does is to keep dollars out of global circulation and thereby boosts the dollar’s value. Combine an artificially inflated dollar though with excessive foreign inflows and the result is too much liquidity flowing through the economy in relation to wages/incomes.
So, looking at the Bush tax cuts solely in terms of income tax receipts is myopic. Without considering the effects of dollar hegemony it is impossible to understand the world we live in, regardless of one's political or moral leanings. And it is this myopic type of analysis that feeds the seemingly endless confusion that makes our national discourse misleading, and dangerously so.
Posted by: rayllove at November 2, 2010 09:57 AM
Here's a bit of data for you. My wife has a strong 15 year career. Living in NJ, where there is a ~9% state tax, (amt phases out deductability), coupled with a 39% income tax to come, coupled with a social security tax, unemployment tax, etc., we do not get to keep 50% of her income, assuming that my income is enough to keep her income at our top marginal tax rate.
She works 50-55 hour weeks with lots of stress, mostly to donate money to strangers.
Given this, she will probably withdraw her production from the broader economy, and we will spit at economists who say that ideas like individual rights and justice have no role in economics.
Posted by: A.West at November 2, 2010 10:01 AM
Something I've been wondering about. Do revenue charts like these you're showing include the effect of the 2004 tax holiday?
That act allowed firms to repatriate their overseas earnings at a significantly lower tax rate, and the result was -- as I understand it -- a short-term boost in revenues of hundreds of billions of dollars.
I'm not sure when the holiday ended exactly, but I'm wondering if it actually results in an inflation of how much revenues recovered.
Posted by: ds at November 2, 2010 10:20 AM
The supply side seems to be an other circularity problem,a demand side that is a credit supply and the supply of goods.
One resultant for these vectors.
Assets at Banks whose ALLL exceeds their Nonperforming Loans (LLRNPT)
This graphic can be applied to the banking industry as a whole in Europe
Posted by: ppcm at November 2, 2010 10:29 AM
That is a nice graphic and your conclusion is irrefutable. After reading Andrew's post, I am wondering if you can see the flip side of the tax cut in an increase in consumption to GDP and an increase in private saving to GDP. As you point out, there are other factors at work, but with such a large drop in tax revenue/gdp it would be interesting to see if it shows up in consumption and saving. If so, then we can estimate the millions of jobs that the Bush tax cuts saved or created ;))
I am not a Bush fan. If you can find consumption effects from the tax cuts then it is more likely we find adverse effects of full employment tax cuts.
I find this quote from Andrew's article intresting:
Income taxes paid by the rich did rise because the wealthiest 20 percent of the population garnered nearly all the increase in national income in the past three decades. But it was consumption rather than savings that boomed among those who benefited most from the tax cuts.
That sounds like a sound arguement for not repealing the Bush tax cuts. If you want to raise taxes only on the rich ($250K +) then consider that in most states a family of 3 or 4 is already losing 40% to 60% of their income to taxes of one sort or another. Is it reasonable to increase taxes on a family that makes $250K, takes home $125K after tax, pays $80K to put the kids through college and pays $20k in mortgage?
I wouldn't want to be in their shoes and find out my taxes are going up while my family of 4 has about $25k a year after tax, college expense and mortgage payment. RICH? Hardly.
Posted by: tj at November 2, 2010 10:48 AM
tj: With respect to "jobs saved or created due to the 2003 tax cuts, Greg Mankiw performed a standard calculation of the sort you mention [a].
ds: The figure in the original post, Figure 1, did not include the effects of the corporate tax holiday on foreign earnings repatriated to the US. The newly added Figure 2 does.
A.West: Gee, I think individual rights and justice matter (I've read Rawls too!). But that's a separate matter from the factual issue of what is the response of tax receipts to tax rates. If we can't agree on the data, can we even get to the issue of values in public policy?
Just out of curiosity, why would it be your wife exiting the market, as opposed to you?
Posted by: Menzie Chinn at November 2, 2010 11:58 AM
His point is made rather selfishly -- but it is important to note that most of the people who are going to be hit by the 250K threshold are middle class people living in the high-cost suburbs of the major metro-plexes. There is no way anyone could call these folks "rich".
Posted by: alan at November 2, 2010 12:42 PM
Menzie, in apology for my previous long post one should not try to argue logic against emotion. I didn't expect it to give other folks ammunition *against* repeal of the tax cuts.
For cripes sake tj the Laffer curve guys in Lotterman's article state that it was a *marginal* thing where most of the effect, if any, was gotten by Reagan's initial re-arrangement of the tax rates. In other words, it only applied in that particular situation. It was done mainly to increase investment and savings rates in the particular high marginal tax rate/low investment economic conditions that were going on in the 80's, trying to tweak the economy and increase activity in a manner different than the standard Keynesian techniques then in use. Even they say it was not to "raise tax revenue by cutting taxes", that was just a side benefit they *hoped* for and used to sell it to Congress. Tax breaks and tax increases are just as valid means for the government to tweak activity as any other, as long as they are revenue neutral (gee, "pay-go" who'da thunk) and the government manages to get enough to pay its bills, even if that moment needs to be delayed a bit. If you want to argue over what should be funded and the moral value thereof, that's fine, but that's a different animal that where and how that revenue should come from. And, on that note, personally I like having good schools for my little girl to go to and paved roads to drive on. And I'm not real thrilled with the current level of income disparity in the US that has grown up since the Reagan era, that sort of crud is very destructive of a society.
The Laffer curve is *not* an accounting identity! Even the Gipper *raised* taxes to balance his budget.
Posted by: --Andrew at November 2, 2010 01:03 PM
In 2006, the Bush treasury department published the "revenue effects major tax bills" passed since JFK and every tax cut resulted in less revenue.
Economic Growth and Tax Relief Reconciliation Act of 2001 in Current dollars 4 years out:
Jobs and Growth Tax Relief Reconciliation Act of 2003 in current dollars
Posted by: Jerry at November 2, 2010 01:04 PM
Steve -- do you have an actual poll result or some other factual data to support your claim that People are sitting on their money because they are unsure of where taxes will be in the future.
This is a very interesting claim in light of the fact that business investment in equipment and software grew faster over the last two quarters than at any period during the Bush presidency.
Yes, the personal savings rate is rising. But that was forecast by almost every economic forecast made over the last few years and is very hard to tie to "uncertainty" over future taxes.
Moreover, payroll employment growth has actually been stronger since the official end of the recession than it was at the same point in the early 2000s and early 1990s cycles.
So again, what factual data to you have to support your claim?
Posted by: spencer at November 2, 2010 01:07 PM
A. West -- so go Gault on us and see if we miss you.
Actually, my suggestion to you is to get a good tax attorney. The way our tax code is set up it is theoretically possible for someone to pay the rates you claim, but anyone who actually does is a fool.
Posted by: spencer at November 2, 2010 01:14 PM
Facts are stubborn things. You are only talking about the pieces of the info that bolster your opinion. My statement is in FACT, true! You know that when you cut taxes economic growth, resulting in higher revenues takes place. The fact that at a later date, due to mismanagement of the additional revenue and lack of stability in laws governing both the future of taxes and trade, the economy turns down and with it current revenues. This does not void the increase in revenue that was had by the original reduction in taxes.
You seem to want to try to make the case that if revenues from sources other than personal income taxes rise, they do not count as a consequence of the tax cuts. That is disengenuous and I know you are brighter than that.
I am in agreement that the mismangement of the current tax laws in this country are hurting the economy of the U.S. I am interested, in your thoughts on the second part of my first comment, when I suggested making those who profited from the American economy in the early to mid decade of the 2000's reinvest in the American economy or face higher taxes.
Posted by: Steve at November 2, 2010 01:27 PM
Oh, and one last thing, Menzie. Exhibit one if you will. Mr. Obama has said he saved millions of jobs. By the same token, it could be argued that the tax cuts prevented trillions of additional losses of revenue to the economy and therefore Bush was a deficit hawk who ran a virtual surplus over what would have happened! LOL
Posted by: Steve at November 2, 2010 01:31 PM
A.West: ...she will probably withdraw her production from the broader economy, and we will spit at economists who say that ideas like individual rights and justice have no role in economics.
We thank your wife for her patriotic sacrifice in quitting her job. Many people are out of work and will be quite happy to fill your wife's job and we hope she enjoys her new leisure time.
Posted by: Joseph at November 2, 2010 01:35 PM
Menzie, you use tax receipts as a percentage of GDP as your yardstick. I don't think that the goal should be to maximize the size of government relative to output. Maybe forward GDP growth for x quarters after a tax cut would be a better measure? Using your yardstick, the best thing that could happen would be for GDP to plummet and tax receipts to hold constant. Yes, the Obama / Summers / Geithner triumvirate are working on that one.
Posted by: T-Dub at November 2, 2010 01:44 PM
Steve: You remain my poster-child for detachment for reality. You failed to note Figure 2, which addresses the concern you've just highlighted...
Posted by: Menzie Chinn at November 2, 2010 01:45 PM
T-Dub: Look...at...the...blue...line...in...Figure 1.
Posted by: Menzie Chinn at November 2, 2010 01:47 PM
Yes, tax receipts declined for a few years and were back to new highs after the ensuing GDP growth. Recall that Bush inherited a recession from Clinton, so naturally tax receipts were depressed. Keep in mind that there is also a significant lag effect on tax collections following an economic boom. My point is that GDP growth is a good thing irrespective of the government's take of national output.
Posted by: T-Dub at November 2, 2010 02:02 PM
You're arguing an extreme position, I think. But if you look, marginal tax rates were very high in the 1970s, and the take was about the same as the better years of the Bush administration.
Notwithstanding, you can finesse this entire optimal taxation debate if you slide values (liberty, equality, community), expressed as incompatible objective functions, to the top of your analysis.
If values drive politics, then incompatible value systems (ideologies) will result in residual principal-agent problems in governance for democracies. That is, the prospect of facing an election is not sufficient to provide voter control over a politician because you don't get a unique optimum if an agent (politician) can choose at will from conflicting and largely irreconcilable objective functions. For example, many countries, including the US, have spending well in excess of tax revenues--a deficit bias, which reflects unresolved, conflicting values. Indeed, this is one of the key critiques you make of the Bush administration. It also explains why the standing of Congress as a whole is so low.
One solution to the problem is to institute an incentive program based on the three values, call it 'single rule governance'. Thus, the agent (politician) would face only a single objective function, which itself is the result of political negotiations about the trade-offs in value sytems. For example, the Single Rule could have incentives related to GDP growth and progress in the Gini coefficient. Politicians would be paid for achieving these goals. That's how the principal (the voter) gets control over the agent (the politician).
The point of political stress thus shifts to the incentive program (in essence, to a strategy debate), rather than implementation (getting specific programs passed in Congress). Vision is separated from execution, and this should ease gridlock.
Let's apply that to tax rates. Assume, for example, that politicians were paid for maximizing long-term GDP growth subject to fiscal stability. In this world, the optimum level of taxation will become a largely technical issue. Politicians will pick whatever level of taxation provides the best bonus. At a minimum, as a fiscal conservative, I'd have some confidence that politicians are factoring GDP growth and fiscal stability into their decision-making. The chosen level of taxation may not be optimal for me personally, but at least I have some confidence it's good for the country as a whole.
Put another way, this approach would segregate the analytical from the ideological aspects of taxation policy. Thus, my political objections ("Democrats want to hurt taxpayers") would be separated from my analytical objections ("the policy will slow down GDP growth"). My political objections relate to questions of motivation and credibility: the Administration and Democratic leadership have created the impression that they are out to destroy the taxpayer as a matter of principle. This inhibits a neutral assessment of policy initiatives. However, were incentives aligned, I would be much more sympathetic to higher taxes and continued stimulus, because I would have confidence that politicians' income will fall substantially if policy fails to deliver balanced growth. They might get policy right or wrong, but I would know that my interests are weighed in the decision.
So, put values at the top, and many intractable problems become analytically trivial. Apply the approach to policy, and it would also make economic analysis a growth industry and restore the standing of the economics community.
Posted by: Steven Kopits at November 2, 2010 02:16 PM
My usual comment, Menzie, would be "you need to get out more," because this kind of illogical denialism is standard. But I often read the comments here open-jawed in amazement at the profundity of the irrationality.
For my arguing purpose, I divide into categories:
1. Twisting facts, "As in tax revenues went up under Reagan." Well, sure they did because there was economic growth and, oh by the way, the 1981 tax cuts were followed by the largest tax increase in history in 1982, followed by tax increases in 1983, 1984, 1985, 1986, 1987, etc. Remember, the verbiage of the day was to call tax increases "revenue enhancements."
2. Omitting facts, as "half the people don't pay taxes." Well, lots of people don't pay income taxes but they pay payroll taxes and those are nearly as much in total as the income tax. Tax credits like the Child Care one were GOP ideas to encourage people to work so the tax credit subsidy replaces the social subsidy in transfer payments for them as welfare. The omitted fact is used to hide to hide the idea that they're proposing taxing the poor, as though that would balance the budget. They don't exactly then look at the amount of income in total of the poor.
3. Completely idiotic denials, as in your highlighting the moronic belief that tax cuts raise revenues. It's sad and funny how people believe what they want to believe. On the internet scale, this is not a form of fallacy but of crackpotism, kind of like arguing that relativity is wrong.
4. Wrong theory application, as in bringing up the Laffer Curve without realizing that it posits a maximum tax rate for generating revenue and that seems to be somewhere well north of 50% and perhaps above 70% (depending on the brackets). Cutting rates that are in the 30-40% range would on the Laffer Curve generate less revenue, not more because you're starting below the theoretical maximum.
Posted by: jonathan at November 2, 2010 02:17 PM
Posted by: Menzie Chinn at November 2, 2010 02:18 PM
Sometimes ya know, I just think Americans (maybe people in general) are just stupid. People have the facts thrown right in front in a thorough way, like Menzie has here, complete with follow-ups and redundancies for the slow-witted, and what would they choose to believe??? They prefer to believe what they hear from non-college graduates on AM radio and Republican propaganda on FOX. I can tell you clearly that human beings are just a "curious lot". By "curious lot" I mean shuffling, shambled, at times nonsensical.
I spent considerable time overseas in a country with state controlled media. The fact of the matter is, if you point at the blue sky and say that "the blue sky is red", and you repeat it to someone over and over and over again ad nauseam, people will then insist that the sky is indeed red.
I was talking to a very close family relative the other day. Someone of above average intelligence, and generally a good intentioned human being. She was looking at her paycheck, just steaming mad angry. She says (I'm paraphrasing, but accurately) "Look at what these bastards are doing to me!!! They have taken out over 50% of my paycheck in taxes!!!" I said "Huh?? Let me see the paycheck" I looked at it about 6 seconds.... I said "You know part of that money they are taking out for that final number, a large part of that 'takeout' is for your 401k plan"........
Awkward silence in the room.
Posted by: Ted K at November 2, 2010 03:19 PM
Yes, tax receipts declined for a few years and were back to new highs after the ensuing GDP growth.
You're repeating the "tax cuts set a record" nonsense. Tax receipts "set a record" every year except when there is a tax cut [u]and[/u] a rise in unemployment. Under the Bush tax cuts, a "revenue record" wasn't set until 2006 and that was with the help of a housing bubble. In other words, it took 6 years to surpass the 2000 level of revenue.
Posted by: Jerry at November 2, 2010 04:06 PM
There are a couple of different arguments going on here. Let's deal with them one at a time, and one curve at a time. Let's start with the aggregate demand curve. And let's take a completely implausible set of basic Econ 101 multipliers...say the MPC = .9 and the initial tax rate is 90%, with zero import leakages. Now reduce the tax rate to 10%. Say GDP = Consumption = $10T. Initially taxes are $9T. After the tax cut GDP increases to $52.6T; however, even with a more than fivefold increase in GDP tax revenues are only $5.26T, which is less than tax revenues initially. Now granted, the example is completely ridiculous, but the point is that even in a "best case" scenario in which you can throw away reality, you still can't get the math to work the way many clueless folks claim. Sorry, but math is hard.
That's looking at things from the demand side. Now if you look at the effect of taxes on leisure/labor decisions, then it is possible that at some point high tax revenues can shrink the aggregate supply curve and they can (at least in theory) "pay for themselves." This idea was not original with Arthur Laffer; it goes back to Mirrlees' work on revenue maximizing tax rates. The contemporary guru on the subject is Emmanuel Saez, and his estimates put the revenue maximizing rate at around 60%-70% (depending on how you factor in John Rawls...hey, Rawls mentioned twice in one thread!).
Bottom line is that today we are nowhere near the revenue maximizing rate. Not even close. Even Laffer agrees that we're well to the left of the Laffer curve.
Posted by: 2slugbaits at November 2, 2010 04:48 PM
When Dick Cheney said that "deficits don't matter anymore", he was not trying to sell the MMT. What he meant, (in 'empire-building-code-speak'), was that the US could gain a 'strategic' economic advantage over its enemies(all foreigners) by running deficits. And, if seen from a militaristic viewpoint, he was right, deficits can be used to channel capital to US investors while tying-up capital from the enemy,(by a nation with reserve currency "privileges"). (Anyone having trouble with the dynamics here should read my comment above).
The point is, it doesn't matter if the US economy purrs at 90% rates or if domestic investment roars at 35%, or whatever. The objective is about global market-share and 'making the world safe for democracy' and 'who gets what' at the global level. So, trade-offs are made and these must be understood if anything is to make sense.
For example, if the progress that China has made on poverty over the past decade is removed from the global equation, global poverty, even with the questionable WB standards, is getting worse by percentage. Take Brazil's progress out of the equation, worse yet. And this is the type of thing that threatens the US and the other so called 'advanced nations'. It is the attrition of statistical evidence, the undeniable proof of hegemony etc., the unprecedented growth rates of nations like China and all of that which shows that the current institutional paradigm is detrimental to human progress, that, is what threatens those in power (the Dick Cheney types).
So what does matter is that progressive thinkers understand the 'why' of it all. At times the 'why' is simply that which undermines a perceived enemy. But the why has little to do with the inherent efficiency of one marginal tax rate as opposed to another, those days have passed. The US economy is now just a part of the global economy, and it is in a defensive mode on a statistical front. But without understanding that, it is impossible to understand the rest.
Posted by: rayllove at November 2, 2010 06:27 PM
To tj and folks like him-
Just a reality check from one of those people who make about $250,000. For 2007, 2008 and 2009 I paid about 17% in federal taxes (income tax, social security, and medicare) on a gross compensation of between $250,000 and $350,000 (including salary, non-taxed employer pension contributions, non-taxed health/dental/vision/flex spending contributions but NOT employer health insurance contributions) and minor investment income). This idea that "in most states a family of 3 or 4 is already losing 40% to 60% of their income to taxes of one sort or another" is just another example of how detached from reality folks like you are. There is a difference between marginal and average tax rates, as there is a difference between gross compensation and adjusted taxable income.
Besides, I view the 20% of my federal taxes that go to social security and medicare to be part of the social contract that presumably will be honored when it's time for me to be on the receiving end. Whether or not the social contract is fully honored depends on whether the US can get medical cost growth under control.
Even if you add in state and local taxes, that still only adds up to about 1/3 of my total compensation.
Posted by: Steve at November 2, 2010 10:47 PM
Are you looking at the graph standing on your head?
The first Bush tax cuts was not a tax cut. It was a Keynesian redistribution of wealth that virtually all supply side economists said would do nothing. The second Bush tax cut, designed by Rep. Thomas, was a supply side tax cuts. The revenue increases kicked in mid-2003-2004 and ran until the Democrats took over the Federal House and Senate.
But the most serious decline in tax revenues came after the totally stupid Paulson-Bush Keynesian stimulus plan that vitrually destroyed production. No tax cut can over-come such economic suicide.
I guess your are right about one thing, "some individuals are impervious to the revelation of data."
Posted by: Ricardo at November 3, 2010 05:38 AM
When people argue that tax cuts help balance the budget does it ever occur to them that they are arguing with people who also pay taxes and who would love to believe that a tax cut increases revenue? It would be wonderful if tax hikes were needless but not a single country struggling with a budget problem is cutting taxes to balance the budget.
Posted by: Jerry at November 3, 2010 05:44 AM
steve wrote, "Besides, I view the 20% of my federal taxes that go to social security and medicare..."
How do you get 20%? Even if you make standard assumptions about elasticities, which leads to the common claim that the employee bears most of the employer portion, it's about 15%. Unless you're including stuff going to Medicare that's included in non-payroll taxes.
Posted by: liberal at November 3, 2010 09:49 AM
Wow, how long has Menzie been calling out posters by name in his updates? Or is this just something that happens during seething rages following elections?
I swing through here once a month (or two), and I'm just amazed at how blinkered and angry Menzie and several of those regulars here have gotten. I find it hard to believe that Menzie is here lamenting the quality of discourse even as he personally and repeatedly insults a commenter, and reads as we're told, for the nth time, that everything is wrong because, magically, FOX controls the minds of Americans.
Posted by: Brad at November 3, 2010 02:31 PM
Ricardo "The first Bush tax cuts was not a tax cut. It was a Keynesian redistribution of wealth that virtually all supply side economists said would do nothing."
Well that's an audacious piece of revisionist history. I guess I missed that part where Grover Norquist and Arthur Laffer and Stephen Moore and the WSJ were all opposed to the "Keynesian redistribution of wealth." And I suspect you meant to say "income" rather than "wealth," but confusing the two is pretty common among conservatives. But given that so much of their income is unearned, I guess I can sort of understand the confusion.
As to the 2003 tax cut, way most of it was directed towards tax relief of unearned income. It's not exactly a surprise that there would be a pulling forward of captial gains taxes immediately after the law went into effect. That's a feature of capital gains tax cuts, not a bug. The problem is that even though there may be a transient surge in capital gains tax receipts due to people selling old stocks (that's supposed to be the source of the economic efficiencies), over the long run it is a tax revenue loser. Sort of like that idiot Gov. Mitch Daniels selling the Indiana toll roads at firesale prices in order to pump up current receipts.
Posted by: 2slugbaits at November 3, 2010 03:44 PM
Not an economist, so excuse me if I make a basic mistake.
Both charts show an increase in revenues following the second tax cut. And clearly the big drop caused by the recession.
My question is what would have been the revenue increase without tax cuts? Wouldn't that be the relevant comparison?
My suspicion is that reasonable tax tables really don't have much to do with investment activity. Even the supply siders worked off much higher marginal rates and estimated the impact of tax cuts from those higher rates.
I suspect dynamics other than fiddling with tax rates are likely to be much more influential. Common sense recommends tax rates should be sufficient to produce balanced budgets at minimum during stable economic times. I'd prefer some cushion myself, that could be applied to deficit spending during crisis.
Posted by: beezer at November 3, 2010 05:31 PM
brad: I thought we like "accountability". Do you think people should feel free to say whatever they like, even if they know it's wrong (that's what my parents told me was "a lie"), or if they are completely ignorant of the data (i.e., a "mistake"); or do you think they should bear the heavy consequences of being called out? In fact, it would seem to me that if people are held accountable for what they say, then they might be a bit more circumspect about what they say. In the ideal world, they will not lie as much, or they might (gasp!) check the data. I infer from your comments you're against such measures.
beezer: Indeed, there are many things going on at the same time, including recession. That's why multiple regression is useful. And indeed multi-equation regression if one suspects there's endogeneity. I didn't do any of these, but I did point out that even when the economy had returned to full employment, income tax revenues as a proportion of GDP had declined...
Posted by: Menzie Chinn at November 4, 2010 11:16 AM
You would do well to conduct your own research.
Tax Revenue (in billions)
First Bush Tax Cut (Keynesian) mid-year 2001
Second Bush Tax Cut mid-year 2003
2006 $2,037 Tax Revenue Passes Peak Year of 2000
For those unbiased notice that tax revenue increased every year after the second Bush tax cut until the Democrats took over the House and Senate. This is also reflected in Menzie's graph.
Here is a quote from 2005 by Jude Wanniski, who is credited with naming supply side economics and the Laffer curve (notice that it is Keynesians who claim that any reduction in taxes produces the result, not supply side economists):
Keynesian demand-siders will argue that any reduction in taxes will produce this result, including rebates on taxes already paid. In the supply-side model, only certain kinds of tax cuts will have positive supply effects. Tax rebates, of the kind passed in 2001 by the Bush administration, have no supply-side effects, and in fact were designed by the President’s chief economic counselor, a conservative Keynesian, Lawrence Lindsey.
[url]http://www.polyconomics.com/ssu/ssu-050211.htm[/url] You would do well to read the entire article. It is worth the read for those who don't understand supply side theory.
Note what is written in this article on Supply Side in WordIQ:
Similarly, supply-side economists blame the Federal Reserve for the collapse of the economic bubble, and have argued that since the early phases of the massive tax breaks of George W. Bush's first two years were based on credits and not cuts in marginal rates, they did not act to stimulate the economy.
There are other supply side economists who took the same view but for me to dig out their comments is a waste of time. These two should suffice to prove my point. The ball is in your court to produce a quote from a supply side economist who said the 2001 Bush cut was a supply side cut.
Posted by: Ricardo at November 5, 2010 05:51 AM
Ricardo I don't know where you got your numbers, but I suspect you are looking at total revenue, which isn't particularly relevant when the issue at hand is income tax cuts. That's sort of something you should have learned in an "Analysis 101" type of class. According to the BEA Table 3.2, here are the personal income tax receipts over the years (in billions):
I think you'll find that these numbers track with the blue line on Menzie's first chart. And note that these are all in nominal dollar values. And don't forget that we still had normal trend growth, so an even better measure would be to detrend the data and then cyclically adjust. That's sort of what Menzie's red line shows.
Yes, personal tax receipts did drop in 2008...but supporters of the 2008 tax cuts never claimed that they would increase revenues!!! The tax cuts were supposed to be stimulative. A deficit was predicted and welcomed. There was too much savings relative to private sector demand. Increasing the deficit in that context is entirely appropriate.
There were plenty of supply side economists who supported the 2001 tax cut. For example, the Heritage Foundation
said that the tax cuts "are the source of important economic incentives" Sounds pretty supply sidey to me. And in Feb 2001 the Cato Institute had an article by Stephen Moore and he argued strongly for the 2001 tax cut as a supply side tax cut fashioned along the lines of what many states had tried. And I'd be very surprised if you could produce a wSJ op-ed piece from early 2001 (when the bill was actually being debated) in which the WSJ argued against cutting the marginal rates. Good luck with that.
Regarding you quotes, note that they are all well after the fact. The Wanniski quote was from 2005 when it was plain to everyone that his 2001 predictions were wrong. It's called moving the goal posts. Making up excuses after the fact. Your quote from WordIQ is laughable and is pretty strong evidence that you'll believe any ex post facto rationalization to justify your faith in supply side economics. While there were tax credits in 2001, those were over by the end of summer 2001. And yet 2001 saw very little fall off in revenue despite the recession and 9/11. Your story still doesn't explain why tax rates in 2002,2003 & 2004 were still below the 2001 level despite the fact that the economy was well out of recession and there were no "Keynesian" tax credits in those years.
But since you now seem to believe that the 2001 tax cuts were just ineffective warmed over Keynesian stimulus, then I suppose we can assume that you would have no objection to seeing those tax cuts expire in a few months. Is that a fair assumption?
Look, despite your faith in supply side economics, I don't think you actually understand the argument in favor of supply side tax cuts. So let me help you out by making the case for you. The biggest component to GDP=GDI is labor, so that's where the most potential is for pushing out the potential aggregate supply curve. The idea behind supply side economics is that you use the tax code to expand the effective size of the labor force. A decrease in the marginal rate has two opposite effects. On the one hand it makes that marginal hour of work more attractive relative to some other alternative such as leisure. In other words, the opportunity cost of leisure goes up. On the other hand, a lower tax rate also makes folks richer, which increases demand for leisure, since it's a "normal" good. And going the other way, a tax increase makes leisure somewhat less attractive relative to putting food on the table, which explains why very poor people tend to have several jobs and end up working 80 hrs a week. I'm doing some handwaving here, but this is essentially what economists mean when they talk about income effects and substitution effects. The net effect of these two is what determines whether or not a tax cut increases or decreases the size of the effective labor force, which is the major component of potential GDP. It's the relative elasticities of the two effects that drives the net effect on tax receipts. It all gets down to an empirical question. Most of the empirical studies that I've seen conclude that the supply side predictions don't really kick in until you get up around a 60%-70% marginal tax rate. You could argue we were there under Carter. You can't argue that we were there in 2001.
Posted by: 2slugbaits at November 6, 2010 09:37 AM
Once we've agreed that tax cuts during the W years led to a decrease in revenues/GDP%, I propose that we come to agreement on a Wynne Godley observation:
By accounting identity, a net surplus or smaller deficit in the (sovereign, i.e., USG) public sector must be offset by a deficit or lower savings in the private sector (leaving the trade balance unchanged).
In other words, beyond dismantling some conservative myths, why do we care about falling tax revenues? Is it because we assume that they are always and everywhere a bad thing? That they must be "financed" with new debt, which 'piles debt onto the backs of our grandchildren' and similar nonsense?
The sooner people learn to disparage the Clinton surpluses and the idea of balanced federal budgets generally, the better.
See the 7 Deadly Innocent Frauds at www.moslereconomics.com.
Posted by: arturo at November 8, 2010 04:46 AM