Relevant and even prescient commentary on news, politics and the economy.

Top Marginal Tax Rates and Economic Growth

Top marginal taxation and economic growth by Santo Milasi and Robert Waldmann has (finally) been published
here in Applied Economics

ABSTRACT
The article explores the relationship between top marginal tax rates on personal income and economic growth. Using a data set of consistently measured top marginal tax rates for a panel of 18 OECD countries over the period 1965–2009, this article finds evidence in favour of a quadratic top tax–growth relationship. This represents the first reported evidence of a nonmonotonic significant relationship between top marginal income tax rates and economic growth. The point estimates of the regressions suggest that the marginal effect of higher top tax rates becomes negative above a growth-maximizing tax rate in the order of 60%. As top marginal tax rates observed after 1980 are below the estimated growth-maximizing level in most of the countries considered, a positive linear relationship between top marginal tax rates and GDP growth is found over the sub-period 1980–2009. Overall, results show that raising top marginal tax rates which are below their growth maximizing has the largest positive impact on growth when the related additional revenues are used to finance productive public expenditure, reduce budget deficits or reduce some other form of distortionary taxation.

Update: Also US States say Carl Davis and Nick Buffie at T€he Institute On Taxation and Public Policy. “States without personal income taxes lag behind states with the highest top tax rates”

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House Passes Senate Tax Reform Budget Resolution and Creates 2018 Budget

Everyone is reporting a 2018 Budget has been passed. Tucked away inside the 2018 Budget is a Tax Reform Resolution which allows the House to write the bill.

The House has passed the Senate Tax Reform Budget Resolution creating a $1.5 trillion deficit with a 216-212 vote. What this means in the Senate is a majority vote is only necessary to pass the Tax Reform bill which Trump has been campaigning and tweeting silly comments. Unless the House and Senate can provide the necessary revenue generation in the Tax Reform bill at 10 years out, it will be subject to a sunset the same as the Bush’s 2001-2003 tax breaks were. The key to this budget is the resolution for tax reform which will be looking at state income and property tax deductions on federal income tax returns, 401k tax exemptions, capping 401k contributions, Medicare and Medicaid cuts, and the old standby cuts to the ACA.

Tax reductions for the 1% of tax paying households making >$500,000 annually as funded by everyone else.

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Lower taxes generate growth to replace lost revenue?

(Dan here..lifted from 2010 Angry Bear postings and still centrally relevant.  More to be posted)

A Proposed Bet for Professors Bryan Caplan and David R. Henderson  

by Mike Kimel

A Proposed Bet for Professors Bryan Caplan and David R. Henderson (and Anyone Else Who Believes Lower Taxes Generate Faster Economic Growth)
Cross posted at the Presimetrics blog.

Professors Caplan and Henderson,

Both of you have had recent posts that indicate you have some enthusiasm for betting on economic outcomes. (Your co-blogger at Econlog, Arnold Kling seems less enthusiastic about bets, and thus I have not addressed him by name here.) I have a few criticisms of your approach to betting. The first is that, frankly, y’all are betting on some rather peripheral issues. Why not cut to the chase? Why not propose a bet on something vital to your way of thinking but with which many people disagree? For example, as libertarians you believe that lower marginal tax rates on the “producer class” result in faster economic growth in a well-functioning, more or less market based economy, and that this outcome can be observed in the US economy. (Forgive the wordiness, but I want to be precise so you don’t think I’m trying to trap you up in a technicality or some oddball example.) I believe you are generally wrong, at least about the US economy. Many people share your beliefs, and many people share mine, so this would be an ideal topic on which to bet if your goal is to prove a point.

Another criticism I have of the bets I’ve seen you propose is that your bets tend to be based on a small number of events, typically one or a handful of observations occurring over ten years or less. But that is too short a period to leave out the effect of random fluctuations, acts of God, or long running conditions. For example, though I haven’t verified the data myself, I understand that it has been pointed out that had the Julian Simon bet (a favorite of Professor Henderson’s) occurred a few years later results would have been different. A truly fair bet would look at more data. In fact, an ideal bet would look at many different overlapping long time periods. Results over ten year windows, twenty windows, thirty year windows, etc., would all combined to ensure that the results aren’t just an artifact of the data.

Another safeguard which helps get at a “true outcome” rather than some random fluctuation is to consider whether the effect you are looking at can have lags of different lengths. For example, it may be that the marginal tax rate in 2010 might affect growth rates from 2009 to 2010, or from 2010 to 2011, or from 2010 to some later year. After all, as any libertarian would say, if you pay less in taxes this year, it means more money in your pocket this year. Since you spend more efficiently than the government, that creates more growth this year, and that additional growth has positive effects next year too. Of course, at some point, the future effects of today’s tax rates dissipate. Not having a precise theory, it probably pays to consider several of these “effect periods” to (perhaps) coin a term.

The third problem I have with your bets is that, frankly, it takes too long to find out who won.

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Genetics as an Omitted Variable in Psychology and Social Science

Here’s the abstract of an article by Frank Schmidt in the Archives of Scientific Psychology:

Governments often base social intervention programs on studies done by psychologists and other social scientists.Often these studies fail to mention other research suggesting that such interventions may have a limited chance of actually working. The omitted research that is not mentioned often shows that the behaviors and performances targeted for improvement by the environmental intervention programs are mostly caused by genetic differences between people and for that reason may be more difficult to change than implied in these studies. This is particularly true when the goal is to greatly reduce or eliminate differences between people in such domains as school achievement, impulsive behaviors, or intelligence. This problem of omitted research creates two problems. It tends to call into question the credibility of all social science research, even the studies that do not omit relevant research.And from an applied point of view, it leads to the expenditure of taxpayer dollars on programs that are unlikely to produce the desired outcomes.

Here are a few paragraphs from early in the article:

The first area of problem research focuses on the ostensible effects of life experiences on life outcomes. This broad area includes many research areas and topics in different psychological specialties. The aspect of much of this research that is problematic is the common failure to acknowledge the relevant findings in the field of behavior genetics.

These findings show that virtually all tendencies, traits, behaviors, and life outcomes have a substantial genetic basis (cf.Bouchard, 1997a, 1997b, 2004; Colarelli & Arvey, 2015; Lee & McGue, 2016; McGue & Bouchard, 1998; Plomin, DeFries, Knopik,& Neiderhiser, 2013; Plomin, DeFries, Knopik, & Neiderhaise, 2016; Plomin, Owen, & McGuffin, 1994; Turkheimer, 2000). Even day-to-day variability in positive and negative affect has been shown to be substantially heritable (Zheng, Plomin, & von Stumm, 2016).Research has further shown that most supposedly purely environmental variables (such as the number of books and magazines in the home) that are often concluded to be environmental causes of later life outcomes are themselves genetically influenced (e.g., see Plomin & Bergman, 1991; Plomin et al., 2016). That is, they are substantially influenced by the genetic makeup of the parents in the home, whose genes are passed on to their offspring.

Research also indicates that people seek out and create their own environments based on their genetically influenced proclivities and interests (Scarr, 1996; Scarr,1989; Scarr & McCartney, 1983).The forgoing is a very brief overview but is believed to be sufficient to establish the main point. These behavior genetics findings do not mean that experiences of people do not have any effect on their later life outcomes. But they do mean that failure to even mention potential or likely genetic influences on these outcomes is a serious problem, one that reduces the credibility of the research. The following are some examples of studies that fail to acknowledge these well-established research findings.

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What is the Matter With the Iowa ACA?

The story as it is told is “Iowa’s Healthcare Market has imploded.” Companies have gone out of business, lost money, premiums increased, policies canceled, etc. “ With Obamacare’s fifth open-enrollment season kicking off on Nov. 1, the consequences are playing out across one of America’s most politically influential states as residents struggle to maintain coverage.” It has been difficult to implement the ACA with the issues in the healthcare exchanges, Republicans badmouthing the ACA, and its first attempt at a US healthcare policy. Just one insurer is willing to sell policies in 2018 in Iowa. Why did it end up this way and what caused it?

Gov. Kim Reynolds: “Obamacare is unaffordable, unsustainable and unworkable and Obamacare has driven out consumer choice and competition.”

Trump: “Obamacare is finished. It’s dead. It’s gone. There is no such thing as Obamacare anymore.”

Vanessa Beauregard a resident of Iowa: “I cannot believe our politicians and government have put us in this situation. It’s just not right when you’re not a deadbeat.”

Dave Anderson, a health insurance expert at Duke University. “It’s hard to build inexpensive networks when the only hospital within 30 miles has you over a barrel.”

Aaron Todd, chief strategy officer for the Iowa Primary Care Association.: “There wasn’t a political will to make hard decisions or move people. They basically saw [keeping the noncompliant plans] the ACA as a relief valve.”

Nick Gerhart, who authorized the noncompliant plans to remain in the market as the state’s insurance commissioner. : “Why would I stand in the way of people keeping their insurance? It was a viable option. What does it look like if they’re in? The [premium] increases still would have been significant.” Disagreeing with these being a destabilizing factor.

Here is the story as I know it, a half commitment to the ACA with a lot of resistance from Republicans, and negativism from pundits.

CoOportunity turned out to be the canary in the co-op coal mine.” In the three years previous, 19 of the 23 nonprofit coop startups across the country, seeded with $2 billion in loans, had collapsed after piling up huge financial losses. One Republican appointee, Gerhart blames the disastrous performance in part to a lack of effective oversight from federal officials at the Center for Medicare & Medicaid Services. However, this is not the complete story as told.

“Effectively you’re running a venture capital firm out of CMS with nobody who understands insurance.”

.

After three years of procrastinating, Wellmark entered Iowa’s exchange. It too did not go well for reasons I will explain. Its troubles were attributed to a single patient who was costing the company $1 million a month in claims, a 17-year-old boy with hemophilia.

One would think the designers and legislators of the ACA would have put in place some protections for experienced insurance companies just entering the new market and the new startup Coops which were sponsored to compete with for-profit insurance companies. Install something akin to the Risk Corridor and the Reissuance programs which exist in the Medicare Part D drug program to protect insurers for exactly these reasons. Ahhhh, but they did do so.

If one could look to one or two things which plagued the ACA in Iowa, one would look to the Risk Corridor Program and Reissuance Program. Both were put in place to:

– Compensate insurance companies for startup losses whether nonprofit or for-profit.

– Cover those instances when an insurance company would end up with one, two, or a few of the $1 million dollar or the high insured a company had to cover, could not deny because of pre-existing conditions, or cancel a policy or change a item coverage due to illness or disorder (which by-the-way exists in Advantage programs).

So what happened?

The Risk Corridor program in the PPACA protects insurance companies from losses during the first three years if they did not estimate premiums properly which can happen in new markets with new different characteristics. With the mandate to insure all with pre-existing conditions, keeping children on parents plans, the exchanges, etc.; the Risk Corridor program was put in place (besides two other safe guards) giving insurance companies and Co-ops a three year window to get it right. Besides looking at losses, the Risk Corridor also looked at the profits of companies who had estimated accurately, had excess profits as a result, and required them to pay a ratio of excess profits into the Risk Corridor fund to help underwrite the losses of other companies. Outside of a plus or minus 3% was the basis for whether you gave up a ratio of profits or received a ratio of funding from the Risk Corridor program. The Risk Corridor program is nothing new and was used successfully with Medicare Part D forcing the evil and low profit insurance companies to share profits with the government. It still is in place for Part D and “still” generates additional revenue for the government. I do not recall any Republicans complaining about funding for drug insurance companies then; but then too, Part D was Bush’s legislature while the PPACA legislation was Obama’s. Strictly politics and constituents have paid the price of it.

Depicting the Risk Corridor particulars rather than attempting to explain it in writing will give a better explanation. Click on the image to better read the chart. Please note the plus or minus 3% and then the different ratios of revenue sharing or funding from and to healthcare companies and Co-ops. Besides being extra cash for the government, this fund was used to cover losses experienced by the drug insurance companies for the same reasons depicted above which occurred in the ACA.

invisible hand Again, what happened? The Risk Corridor program worked well for Part D, brings in revenue for the government, and is still in place. February 2014 found Rubio testifying to the House Committee on Oversight and Government Reform on behalf of his bill. At the same time the CBO released their evaluation of the ACA Risk Corridor program. Instead of being detrimental to the economy and a fiscal drag, the CBO projected the federal government would collect $8 to 16 billion from ACA healthcare insurers. Premiums would outpace claims, $8 billion would be distributed to the plans losing money, and $8 billion in additional revenue would be left for the federal government. Another and a House probe suggested initially there would be a shortfall with claims exceeding premiums.

The Republicans were not sitting idle and were investigating ways to derail the PPACA. As the ranking member of the Senate Budget Committee, Senator Jeff Sessions and the chairman of the House Energy and Commerce Committee, Michigan Representative Fred Upton came up with a plan to attack the legality of the Risk Corridor payments. They joined forces with the Appropriations Panel Chairman Colorado Representative Jack Kingston whose panel funds the Department of Health and Human Services and the Labor Department. Kind of get the picture of where this is going so far?

Senator Jeff Sessions wrote a letter to the GAO questioning whether the Risk Corridor payments were being appropriated correctly. Eventually the Appropriations Panel forced the HHS to make changes in how they appropriated funds allowing Congress to stop all appropriations. The PPACA could no longer appropriate the funds as they were subject to the discretion of Congress. The GAO issued an opinion on the legality of what the HHS was doing with funds.

GAO Letter to Senator Jeff Sessions. September 30, 2014:

Discussion; “At issue here is whether appropriations are available to the Secretary of HHS to make the payments specified in section 1342(b)(1). Agencies may incur obligations and make expenditures only as permitted by an appropriation. U.S. Const., art. I, § 9, cl. 7; 31 U.S.C. § 1341(a)(1); B-300192, Nov. 13, 2002, at 5. Appropriations may be provided through annual appropriations acts as well as through permanent legislation. See, e.g., 63 Comp. Gen. 331 (1984). The making of an appropriation must be expressly stated in law. 31 U.S.C. § 1301(d). It is not enough for a statute to simply require an agency to make a payment. B-114808, Aug. 7, 1979. Section 1342, by its terms, did not enact an appropriation to make the payments specified in section 1342(b)(1). In such cases, we next determine whether there are other appropriations available to an agency for this purpose.”

Further down in the GAO letter, the GAO did leave the HHS an out of using other already available appropriations for the Risk Corridor payments to insurance companies. Classifying the payments as “user fees” was another way to retain the authority to spend other appropriations already made by Congress. Otherwise if revenue from the Risk Corridor program fell short, the administration would need approval for addition appropriations from Congress. As it was, the HHS could no longer appropriate funds to make Risk Corridor payments unless the funds were already appropriated by Congress or Congress approved new funds which was not going to happen with a Republican controlled House.

Appropriations Panel Chairman Rep. Jack Kingston put the final nail in the coffin by inserting one legislative sentence in Section 227 of the 2015 Appropriations Act (dated December 16, 2014) which escaped notice. In the 2015 Appropriations Act, the sentence inserted said no “other” funds in this bill could be used for Risk Corridor payments.

Sec. 227.

None of the funds made available by this Act from the Federal Hospital Insurance Trust Fund or the Federal Supplemental Medical Insurance Trust Fund, or transferred from other accounts funded by this Act to the “Centers for Medicare and Medicaid Services–Program Management” account, may be used for payments under section 1342(b)(1) of Public Law 111-148 (relating to risk corridors).

This action blocked the HHS from obtaining any of the necessary Risk Corridor funds from other Congressional appropriated program funds identified in the 2015 Appropriations Act.

Nothing was said by Senator Sessions, Representatives Upton or Kingston before passage on what they had managed to do. It was Senator Rubio who issued a news release saying the provision was appropriate even though he had little to do with it. In the end, Colorado Rep. Jack Kingston’s one sentence purposely created a $2.5 billion shortfall in the Risk-Corridor program in 2015 as the HHS had collected $362 million in fees. Insurers who had misjudged the market sought nearly $2.9 billion in payments. Gerhart’ canary in a coal mine played out with many nonprofit insurance Co-ops failing due to a lack of reimbursements for losses, for-profit healthcare insurance companies lost money, healthcare insurance companies began to raise premiums to compensate, and some healthcare insurance companies recognizing an untenable environment created by Republicans took their losses and left the healthcare exchange market.

If you wish to know why there are few insurance companies and no Coops issuing healthcare policies on the healthcare exchanges, why the policies are arbitrarily expensive by default, and why companies are leaving or going bankrupt, etc. Ask your Republican Senators and Representatives why they sabotaged the Risk Corridor and Reissuance Programs. It is all politics with little regard for constituents.

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Corporate Profit Tax Cuts and Wages: Silly Theory

I jump at a rare chance to disagree with Paul Krugman and as a bonus also with my very good friend Brad DeLong, because Krugman just tweeted that Brad is right

update: Krugman has a whole blog post about how Brad is right.

The discussion started with Republican efforts to argue that, this time, it really will trickle down and corporate income tax cuts will help workers more than they cost the Treasury. Trum CEA chairman Kevin “Dow 36,000” Hasset claims that the tax cut will cause average houshold labor income to increase by $4,000 to $9,000. This has become the new GOP slogan. Many people noted that this implies that more than 100% of the incidence of the tax is on labor.

Greg Mankiw argued that it is possible for a corporate income tax cut to cause labor income to increase more than tax revenues decline. His analysis definitely is odd. He used a very simple model with a stylized economy and a stylized tax code. He compared the ratio of long run increases in wages to short run loss of revenue. His logic is that he is being hard on his fellow Republicans, because the long run effect of the tax cut is to cause increased capital formation, GDP and tax revenues (that is he is using static scoring not dynamic scoring to be hard on tax cuts). Most oddly, he considers long run benefits without considering the public sectors long run budget constraint. He doesn’t consider the effect of reduced revenue on budget deficits, government spending or other taxes.

Unsurprisingly, Mankiw has been criticized a lot. Larry Summers is brilliant as usual here

I want to pick out two odd claims (it’s about history of thought or semantics)

“the impact of a corporate rate reduction on wages in a so called “Ramsey” model or equivalently in a small fully open economy, with perfect capital mobility.”

I don’t think they are equivalent at all. They have very different behavior in the short run.

Krugman seriously considered an open economy model with flexible prices and a flexible exchange rate. It is not at all like a standard small open economy model, because the standard model relies on the miracle of the immaculate transfer. Here is a only mildly wonkish version. It includes the key phrase ”

“there is a somewhat interesting discussion going on over the effects of corporate tax cuts in an open economy. This discussion is, however, made somewhat more confused – in my view – by putting it in the context of Ramsey models”

The insanely wonkish version is here. It really isn’t insane to read it.

Brad criticizes Mankiw quite harshly here. This is the post which Krugman’s tweet endorsed without reservation.

I agree with you DeLong and Krugman that Mankiw is writing as a partisan Republican. I agree with DeLong Krugman and Summers that Mankiw errs by not considering a complete model, that one must consider the public sector intertemporal budget constraint when discussing fiscal policy, and that there is no point in looking at the ratio of one long term effect to a short term effect.

But I think that Brad’s claim that there is a math error is based on an uncharitable guess about which model Mankiw didn’t spell out.

I can’t typeset equations here (& I hate to typeset them anywhere) so I screen capture Brad’s equations

Depending on the model which Mankiw didn’t write out, either Mankiw or DeLong could be right. One key issue is that Brad assumes that wages and prices adjust quickly while the capital stock adjusts slowly. The other is that the Ramsey model is not equivalent to a small open economy model.

I think Mankiw’s static cost calculation is reasonable for an small open economy with sticky wages and prices and is reasonable for a Ramsey model. It isn’t a flexible price small open economy calculation, but it is reasonable.

First I will assume a small open economy model (as Mankiw did) & try to justify his math, and, in particular, the fact that he doesn’t consider Brad’s term b.

Mankiw wrote
“An open economy has the production function y = f(k), where y is output per worker and k is capital per worker. The capital stock adjusts so that the after-tax marginal product of capital equals the exogenously given world interest rate r.

r = (1-t)f ‘(k).”

and

“We cut the tax rate t. Because f ‘(k)*k is the tax base, the static cost of the tax cut (per worker) is

dx = -f ‘(k)*k*dt.”

Brad objects that, if wages and prices are flexible, real wages will jump up even if additional capital has marginal product zero (he considered a Leontief production function). This will instantly reduce the pre-tax return on capital and the tax base.

Brad’s short term is a medium term in which the capital labor ratio hasn’t had time to adjust (in his example it never adjusts) but prices and wages have adjusted. That’s how the pre-tax rate of profit changes so that the post tax rate is constant. In Brad’s model, this happens instantly.

In the real world, wages and prices are sticky. We are all assuming that output doesn’t change in the short run (with sticky wages and prices this would be because, as Brad likes to write, the monetary authority makes Says law true in practice). If value added, employment, wages, prices and the capital stock are all the same, then the pre-tax rate of profit is the same. The new Keynesian short run is as discussed by Mankiw. He is a New Keynesian.

Mankiw’s calculation is also correct if one considers a flexible price closed economy model. He wrote “open economy” but I suspect that was just because he didn’t want to scare readers by writing “Ramsey”, “Euler”, or “phase diagram”

For the sake of argument, I will assume flexible wages and prices. I will normalize the price of the one and only good to 1. The economy is closed. That is, I am assuming a Ramsey-Cass-Koopmans model. What happens when the tax on capital income is cut ? the capital stock doesn’t jump, technlogy doesn’t jump, the real marginal product of labor doesn’t jump. Wages don’t jump. Output is full employment output. Pre tax returns on capital don’t jump. The capital stock doesn’t jump. The pre-tax return on capital doesn’t jump.

Tax revenues decline by (delta t)kf'(k) your term a. There is no term b.

WE have a puzzle here. I think the solution is that the Ramsey model is *not* like a small open economy model. In the long run, they will end at the same balanced growth path with the return on capital net of depreciation and taxes equal to the pre-reform return. But the short run is very different.

In both models the wage is equal to the marginal product of labor. But in the Ramsey model, the supply of capital to firms is not infinitely elastic. People have to be convinced to save. The real interest rate paid to investors (that is the marginal product of capital net of depreciation and taxes) is not constant. It jumps up when the tax is cut. So consumption (per unit of efficient labor) jumps down then moves up the new saddle path to the new higher steady state.

In a small open economy which is otherwise like the Ramsey model, there is no difference between the short term and the long term. K jumps (there is nothing that prevents this) so the economy jumps to the new balanced growth path. This means that, if Mankiw’s calculation is wrong because he ignores term b, it is also wrong because he ignores term c. He clearly wasn’t thinking of a small open economy model with flexible wages and prices and no adjustment costs.

I guess the remaining model which isn’t totally uninteresting is a small open economy with flexible wages and prices but slow adjustment of K. That means a model of investment with installation costs.

Now we have to decide about accounting. It depends on whether the installation costs appear as costs in corporate profit and loss statements — well really on corportate tax returns. If the cost is subtracted from net earnings taxed at rate t, then you and Krugman are right. There is a new term b — that cost which reduces tax revnues. If they don’t then Mankiw is right. They are usually assumed to be counted as part of investment (hence reinvested profits). So far, with the simple model, Mankiw would be right. But wait, another part of the reform is expensing investment, so whether they are counted as operating costs or investment, you would be right and Mankiw would be wrong. Also wronger as, with expensing of investment, the corporate income tax doesn’t discourage investment from retained earnings and encourages debt financed investment (as noted by Krugman and Summers).

OK I was wrong about one thing, the last model is totally uninteresting.

This whole comment shows how pointless it is to use flexible price models to study the short run –insane assumptions must be made and the conclusion depends on exactly which insane assumptions.

After the jump, I will present a critique of Brad’s hermaneutics of the semantics of “static” (note before the jump — damned if I have a clue what “hermaneutics” might mean).

update: also a comment on Krugman.

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Corporate Profit Tax Cuts and Wages: the UK Experience

Corporate Profit Tax Cuts and Wages: the UK Experience

Kimberly Clausing and Edward Kleinbard have each written some interesting papers on transfer pricing. Here they team up on a different topic:

The President’s Council of Economic Advisers claims that slashing the corporate tax rate to 20 percent would boost the average American’s wages by $4,000 per year (“very conservatively”) — and perhaps by as much as $9,000. If true, that would be a remarkable gain for working Americans. Unfortunately, it’s extraordinarily unlikely to be true. The two of us can think of dozens of objections to the CEA claim, presented in an official report, but perhaps the place to start is with the United Kingdom, which has already run this experiment. Over the past decade, the United Kingdom has slashed its corporate tax rate, in several steps, from 30 percent down to 19 percent. At the same time, the United States has kept its corporate tax rate constant at 35 percent. Like the United States, Britain has a large open economy, investors in British firms come from all over the world, and Britain provides a sound legal and regulatory environment.

They next document the decline in real median wages in the UK since the UK began its experiment with lower corporate tax rates. They then note:

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Remembering Black Monday

Remembering Black Monday

The largest single one day decline in percentage terms of the Dow-Jones average (22.6%) happened 30 years ago today, on October 19, 1987.  It was a Monday, hence “Black Monday.”  Although unlike after the second largest such one day decline in percentage terms (12.8%) on October 28, 1929, the US economy did not go into a decline, much less anything remotely resembling the Great Depression.  Indeed, the very next day, after starting to decline further in the morning, the market turned around and starting rising, led by the futures and options markets in Chicago.  Although the market would decline far more between August, 2007 and March, 2009 at the front end of the Great Recession, there was no single day during all that when the market fell nearly as much as on either of these two days listed above.

Robert Shiller has written an interesting column in the New York Times about Black Monday (linked to by Mark Thoma on Economists View).  He did a survey after it happened of participants and found that they were driven basically by pure panic.  The Brady Commission report said that it was about the trade deficit and a possible tax change, and also program trading via portfiolio insurance.  Yes, Shiller says that latter was some of it, but in fact he determined that fear of it was probably more important than the actual program trading.  There was very little going on with fundamentals, but vague rumors and reports set off a huge crash, the biggest one day one ever, even if in the end it did not really amount to much.  But Shiller says it can happen again (and, if he were alive, the late Hyman P. Minsky would probably agree).

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