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The Right Way To Reform Corporate Taxes

This post is largely a comment on a New York Times editorial “The Right Way To Cut Corporate Taxes”. I disagree with the Times’s editorial board. Key parts of the editorial are

“If Republicans worked with Democrats, they could reach a compromise to lower the top corporate tax rate to between 25 percent and 28 percent, eliminated loopholes and reduced the incentive businesses have to take on debt, rather than to use equity to expand.”

Grammar Nazi notes that the compound sentence is not correct. To use an infinitive then continued with a past participle is made an error.


“would do even worse. The proposals would close some loopholes but create new ones, like allowing the immediate expensing of new equipment. ”

The logic of the argument is that it is more efficient to have a broad base and low tax rates. It is asserted (or rather implicitly assumed) that taxes impose dead weight losses which are convex in tax rates. This reasoning is not accompanied by any sort of economic analysis or theory (the editorial board made me praise economic theory and I will never forgive them).

In standard theory expensing investment and increasing the rate to keep revenue the same makes perfect sense. It is narrowing the base and raising the rate. By standard pundit assumptions this reduces efficiency. The assumption makes no sense.

Consider a corporation deciding whether to invest. A problem with taxing profits at rate say tau is that it discourages investment as the firm gets only (1-tau) times the pre-tax return. If it is allowed to deduct investment before paying taxes it pays (1-tau) times the cost of the investment. The tax does not distort the decision at all if investment is expensed. Tau can be 99 %m it doesn’t matter.

The Center for Equitable Growth noted that this is a standard argument and conclusion

It is well understood that the effective marginal tax rate on new investment can differ substantially from the statutory tax rate on business income. For example, in the case of a business tax system that allows full expensing—a policy under which businesses may deduct the full cost of any investment in the year the expense is incurred—the business-level effective marginal tax rate is zero, regardless of the statutory rate.

Also cutting the tax rate reduces taxes on the product of old capital. That has no effect on investment decisions which have already been made. It is a windfall for shareholders. There is no reason to give them that money — no corresponding gain in efficiency — no effect on the past. Also cutting the tax rate reduces taxes on markups due to market power (monopoly rents)- This encourages efforts to reduce compentition which the Antitrust division of the Justice Department has only some ability to fight (even assuming Trump and his political appointees don’t interfere as they surely will).

I think a large part of the appeal (aside from pundit group think) is the love of bipartisanship the “If Republicans worked with Democrats”. The problem is that the Republican proposal is almost entirely aweful (except for the one good bit which I defend from the editorial board’s criticism). The Republicans are determined to go the wrong way, Democrats would achieve a better policy outcome by voting no and trying to convince 3 Republican senators than by compromising. Compromise is not good in and of itself and nothing useful can be achieved by trying to work with Republicans.

The mantra of broaden the base and reduce the rates is a declaration of faith. It has no empirical support. It doesn’t even have any theoretical justification. The argument has no merits whatsoever.

On the other hand, I generally agree with the editorial and this op-ed is excellent.

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Ricardian Equivalence

This is going to be a very long post with independent chapters (I won’t impose by making a series of posts)

I. What is “Ricardian Equivalence”

The basic idea is that the timing of taxes has no effect on anything, and especially not on consumption/saving choices, because rational economic agents know that the state has a budget constraint which is binding and anticipate their share of paying for the national debt.

This idea is clearly crazy. Even Ricardo (who generally lived in a world of theory detached from reality) wrote that it clearly had nothing to do with reality. Sadly, modern macroeconomists are more detached from reality even than Ricardo, and it is a standard feature of standard models.

Another way of putting it is that domestic government bonds owned by domestic agents are not part of national wealth — they are money we owe each other not an true asset like physical capital. Now it is clearly true that government bonds are not net wealth. The idea that they don’t influence consumption as net wealth does is clearly crazy. There is no evidence in US data for Ricardian equivalence. The most basic implication is that, if one looks at consumption as a function of disposable personal income (personal income net of taxes) then one should be surprised that it is so low when budget deficits are high. The equivalence claim is that the variable should be disposable income minus the deficit that is personal income minus government spending. But at the very least, deficits should crowd out some private consumption. There is no evidence of any such effect in US data (long pdf warning)

I shoud just quote Paul Krugman who writes better than I do

Ricardian equivalence says that what determines consumption is the lifetime present value of after-tax income, and hence that, say, a temporary tax cut won’t stimulate spending, because people will figure that whatever they gain now will be offset by higher taxes later. It is a dubious doctrine even done right; many people are liquidity constrained, and very few people have the knowledge or inclination to estimate the impact of current government budgets on their lifetime tax liability.

II Future tax increases will and won’t follow temporary tax cuts.

The point of this post (if any) is that advocates of tax cuts switch Ricardo on and off when he is or is not convenient.

I am going to assume no Keynesian stimulus effects. It is as if I assumed that there is no unemployment or spare capacity so GDP is determined by labor supply and technology. What I actually assume is that the Fed will set interest rates to make unemployment equal to their guess of the natural rate of unemployment. This means that vulgar Keynesianism (TM) is an error. As always I cite Krugman (who is right about vulgar Keynesians even if he regrets one word in “Greenspan … is not quite God”). I am also going to assume a closed economy. This is really silly, but it’s what I am going to do. The sensible reader is invited to stop reading.

Consider a proposal to stimulate investment by cutting the tax on profits.

An argument against cutting the tax on profits is that the lead to deficits and the national debt creates the illusion of wealth (as people act as if government bonds are net wealth). This causes higher than sensible consumption and forces the monetary authority to set high interest rates to prevent over heating and inflation and in the end this crowds out investment. The counterargument is that people know that taxes will be increased in the future (and not just back to the old level but higher in order to pay interest on the debt) so there won’t be distortion of consumption savings decisions. On the other hand, the good incentive effect of lower tax rates, which cause higher investment, aren’t affected because higher taxes in the future cause no bad incentive effects because taxes are terrible now but won’t matter then.

This makes no sense at all. Future tax increases are assumed when one discusses consumption, but the incentive effects of future taxes are ignored when discussing the desired level of investment for a given interest rate. I think there is no way to make a coherent argument. The actual belief of advocates of cutting taxes on profits is that taxes and government spending should be cut. But they don’t propose that, because government spending is popular. They then argue that, even without spending cuts, taxes should be cut. This makes no sense. Sometimes they argue that debt is good because it will force lower government spending & not tax increases. There is no support for this view — the evidence such as it is, is that when Congress discovered that they USA could run huge deficits, they increased spending. People claim to dislike deficits, but they really dislike taxes. To starve the beast, one would have to insist on a balanced budget (which is also advocated by the same Republicans who are eagerly adding what they claim will only be $1.5 Trillion to the national debt).

[rant bumped down after the jump]

III Ricardo Vs Laffer

The more extreme advocates of tax cuts argue that they will pay for themselves; That the effect on growth and tax receipts is large enough that no future spending cuts or tax increases will be needed to pay for increased debt. This claim, made by Arthur Laffer when he drew a graph on a napkin for Jack Kemp, isn’t taken seriously by any wonks. It is always made using another equivocation. Supply siders argue that tax cuts will be followed by growth which will cause increased revenues. This is obviously true, so will tax increases, the economy tends to grow. The trick is to equivocate post hoc and propter hoc — between after the tax cut, GDP will grow so revenues will be higher years after the tax cut than they were immediately after the tax cut and because of the tax cut GDP will grow more than it would have without the tax cut so revenues will be higher than they would have been. This ultra clumsy rhetorical trick seems to have worked for decades, but also seems not to be working anymore.

My point (if any) is that you can’t have both Laffer voodoo and Ricardian equivalence. If the tax cut now doesn’t imply any tax increases or spending cuts in the future, it will cause higher consumption. Laffer’s claim is that tax cuts will make us much richer. Those who claim to believe in Ricardian equivalence must argue that this will cause us to consume more (other things equal). It doesn’t really matter if the effect on consumption is due to bonds mistaken for net wealth or for authentic wealth. This means that Laffer must admit that growth enhancing tax cuts will cause consumption to increase if other things are equal. Laffer may have made even more extreme claims, but supply siders now argue that the benefits of their tax cuts aren’t a jump in GDP but a higher growth rate. This means that higher consumption implies lower national saving.

Demand will equal supply (recall I assumed above that it is fixed in the short run) because interest rates will increase causing lower investment. Any increase in investment could only occur if higher interest cause lower consumption. There is absolutely no evidence that they do (and even the simplest theory doesn’t unambiguously imply that they should — in elementary models higher interest rates could cause eithe higher or lower consumption depending on paramters with parameters fitting the data definitely implying that high intereste rates cause high consumption).

To avoid predicting increased consumption (which would crowd out investment in a closed economy) advocates of tax cuts have to argue both that they will and won’t make us richer.

OK so before posting, I have to note that advocates of tax cuts have basically conceded most of what I argue here. They, and in particular the Tax Foundation, now argue that cutting the tax on profits will make us richer by attracting foreign capital. They don’t seem to have considered the fact that the foreigners will collect interest on money they send to the USA. Nor that foreigners already own shares of US firms and so will get some of the direct automatic benefits of the tax cuts.

As usual, Krugman has explained this. Click here, here and here.

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Freedom of Speech for Fascists? (An op-ed)

Freedom of Speech for Fascists?

I just finished reading the Chronicle of Higher Ed’s profile of Mark Bray, author of Antifa: The Anti-Fascist Handbook.  I don’t know how accurate it is as a portrayal of Bray and his ideas, but it seems like a sober, fair-minded overview of the debate over anti-fascist tactics and freedom of speech.

What the article doesn’t say, however, is that there are two very different bases for opposing public appearances by white supremacist and similar groups.  One is dangerously wrong, the other, which Bray presents, makes much more sense.

First the wrong approach, that groups should not be permitted to express themselves in public if they cause emotional distress to me or other people I care about.  You hear this one a lot: speech that I find demeaning is a form of violence, and there can’t be freedom for it.  There’s no difference between saying something horrible to me and punching me in the face.  No freedom for one, no freedom for the other.

This argument has its roots in a mindset that has become popular in much of the left, that the ultimate political goal is equal well-being for all, that well-being is essentially having a positive emotional state (or not being in a state of stress/despair/fear/etc.), and that actions should therefore be judged by the emotional response they engender, especially among marginalized groups.  It’s a deeply subjectivist conception of life and politics, one that puts feelings above “objective” conditions like economic status, access to social or institutional networks, risk of physical harm, or other measurable outcomes.  In fact, the primacy of subjective feelings is often asserted by denying the very possibility of “objective” anything.  (Objectivity is said to be a tool of knowledge/power to silence the oppressed.)

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Two thoughts on the Virginia election: it’s the net strong disapproval,stupid! But is the primary driver education or age?

Two thoughts on the Virginia election: it’s the net strong disapproval,stupid! But is the primary driver education or age?

It’s a slow week for economic news, but we sure had some electoral fireworks on Tuesday! Since I am a data nerd, here are two metrics from Virginia that caught my attention, which I’ll discuss in reverse order.
I. Is it education or is it age?
Here are two graphs showing how the elections broke down:
First, by racial makeup of the legislative district (horizontal axis) vs. percent with college degree (vertical axis):
Republicans were completely shut out in districts with less than 50% white populations. With one exception, they were also shut out in majority white districts with more than 50% holding college degrees.  On the contrary, the GOP won all but two districts with more than about 55%-60% white population where *also* less than 40%-45% hold college degrees.

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England, Employment, Wages and Brexit

The Guardian newspaper has a story about wages in England:

A shortage of factory workers is starting to push up pay rates but wage rises in the services sector remain rooted at around 2%, according to the latest feedback from the Bank of England’s regional agents.

The central bank said its agents, which are based in offices across the country, found that shortages this month across the manufacturing sector were leading to a “slight increase in pay growth” that would take average rate of pay rises up by half a percent, from 2-3% this year to 2.5%-3.5% in 2018.

The report appeared to justify Threadneedle Street’s move last week to increase interest rates, which officials at the bank said was needed to dampen the inflationary effects of wage rises.

A survey of employers in October by the Recruitment and Employment Confederation chimed with the BoE report after it found firms were having to raise their pay offers to hire new staff.

The REC said the increase, the second quickest rise in wages since November 2015, followed a fall in unemployment to the lowest level in 40 years that had restricted the number of workers available to take up new positions. It warned that higher pay offers were also needed to counter a growing shortage of EU workers ahead of Brexit.

“We already know that EU workers are leaving because of the uncertainties they are facing right now,” said Kevin Green, REC’s chief executive. “We therefore need clarity around what future immigration systems will look like. Otherwise, the situation will get worse and employers will face even more staff shortages.”

Official data shows that in August net migration fell to its lowest level in three years, with more than half the drop caused by EU citizens leaving and fewer arriving since the Brexit vote.

I find it truly shocking that employment and wages are determined by the market forces, or that the supply of labor is affected by whether foreigners can freely enter and exit a market. Who could have imagined such absurd chains of events? Fortunately, we can rest assured that this is an aberration and can’t possibly apply in the US.

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President Trump Must Release His Tax Returns

President Trump Must Release His Tax Returns

I know, boring boring boring old news. But now that he has had his hind end kicked by the recent off-off election results, it is time to get real. He has managed to cover up massive amounts of crimes and violations of ethical norms because he has violated so many. Nobody could keep track of them. But now that he has his behind kicked, and Mueller is zeroing in on him, it is time for him to deal with his most important violations and ‘fess up.

So, in my view the biggest violation of them all has been his refusal to release his tax returns. Of all the humongously numerous violations of ethical norms and actual laws, this refusal on his part increasingly becomes clear to be the most important. Of all the mistakes the American people made in electing this worst president ever elected, this is the worst mistake of all, electing a person who refused to release their tax returns.

There are two clear reasons why he must release his tax returns, and I call on all media to begin demanding relentlessly and repeatedly, every day, even though the media views this as a dead and boring issue, that President Trump release his tax returns. The way I see it, every day that passes that he does not release his tax returns is another day piling up that he should not only be removed oa as president, but that he should be put in jail for a very long time.

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A Bit More on Inflation Expectations

I honestly surfed here just to see if anyone was still interested in inflation expectations now that The Fed has shifted from extraordinary efforts to stimulate to normal efforts to take away the punch bowl before workers get uppity.

I was pleased to find the post by Bonddad immediately below

However, I don’t agree entirely with Hale Stewart and agree less with Stephan Poloz.

The first point is that expected US inflation has been very stable and very close to the 2% target (also when the target was informal). This is shown by TIPS spreads (as noted by Bonddad) and also in survey’s of people considered expert (say the Livingston survey).

But I think that this doesn’t mean that expectations are anchored. 3.5 years ago I wrote (PDF warning) “in practice “anchored” seems often to be used as a synonym for “low,” but it should be a statement about the relationship between expected inflation and variables which influence expected inflation – an anchor keeps a boat from moving when it is pushed – not all boats which are moving slowly are anchored.” I think a null hypothesis which can be tested against the alternative that expected inflation is now anchored and didn’t used to be is that expected inflation is a constant plus a constant times lagged inflation (this is called the “static expectations hypothesis” but I don’t know in what way it is static).

In fact The median Livingston Survey CPI inflation forecast is very well fit using only one observation of lagged PCE core inflation with an R-squared over 85%. It seems hard for the sometimes anchored sometimes not alternative to outperform the static expectations null.

There is no sign that inflation expectations were more anchored after June 1989 than before. The coefficient on the product of lagged PCE inflation and an indicator that the realization of inflation occurred June 1990 or later is statistically insignificantly different from zero and actually positive.

This simple pattern in a well known data set makes the fact that inflation expectations were regularly described as “anchored” a bit puzzling. I think that the expectations augmented Phillips curve was so firmly accepted that economists used “anchored expectations” to imply that unit labor costs were not growing rapidly or perhaps that actual inflation was not accelerating. In the language of contemporary macroeconomics the word “expectations” may refer to what should be expected given the ex post observed behavior of time series, or to what expectations must have been for a standard model to fit the data, but in any case not to any forecast made by an actual human being.

Also when a central banker says expectations are important, he almost automatically asserts that his credibility is important. The argument is that firm resolute determination to fight inflation is unambiguously good as it makes it possible to reduce inflation without persistently high unemployment. The argument is that it is best to firmly grasp the nettle as, for example, Paul Volcker grabbed it. The problem is that there is no hint at all in the Livingston data set that Volcker had unusually high anti-inflation credibility. In fact, the survey data suggests that he was below average in this.

The notoriously weak inflation fighter Fed chairs were Arthur Burns and G William Miller who allowed double digit inflation. Volcker is alleged to have tamed the inflation expectations beast after replacing Miller. There is much less than no evidence for this in the Livingston data

After controlling for lagged annual CPI inflation, expected annual CPI inflation was over 2.7 % higher when Volcker was chairman than when Burns or Miller were. This evidence that Volcker had lower inflation fighting credibility is strongly statistically significant.

Finally, the argument that anchored expectations elimininate the relationship beteen monetary policy and real outcomes is based on the assumption that Lucas was right and the only unexpected shifts in monetary policy affect output. The hypothesis was that, once economic agents understood the policy rule, the changes in interest rates, monetary aggregates and inflation rates caused by the the policy would be uncorrelated with real variables. Somehow this changed from a hypothesis to a revealed truth. The simple fact that inflation and unemployment are still correlated even now that inflation is stable and can be predicted (which doesn’t mean that real world non rational agents predict it well) is not allowed to touch the faith that this must not be true. It is argued that the apparent phillips curve has vanished even though data just like those plotted by Phillips show a curve.

Here is the average wage inflation over the 15 countries which were in the European Union in 1997 compared to the average unemployment rate. I’d say the Phillips curve still exists now and here (I am in Rome).

In sum, I think the confidence that inflation expectations matter *and* can be managed by firm resolute monetary authorities is a sign of blind faith and refusal to look at the evidence.

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This is Why Inflation Expectations Are So Important

by Hale Stewart (originally published at Bonddad blog)

This is Why Inflation Expectations Are So Important

The underlying trend in inflation is driven by the laws of supply and demand, which are as applicable today as they ever were. Excess demand pushes inflation up; excess supply pushes inflation down. Central banks exploit this relationship, working to create excess demand or excess supply in the economy, to target the inflation rate.
A central role in this relationship between the economy and inflation is played by inflation expectations. The more anchored those expectations are, the more quickly the economy will find its way back to normal after an economic shock. This is known as the credibility dividend: a credible central bank will see inflation expectations well anchored at the target level and will have a relatively easy time restoring normality after a shock. What this means is that the underlying trend in inflation may become more stable as expectations become more anchored. In short, the more successful the inflation target is, the less obvious the relationship between economic shocks and inflation will become.

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Fox’s Shep Smith on Tax Bill

I found this segment of interest from Fox News…while I differ on the generic federal deficit thinking, I notice while Obamacare repeal was ‘do or die’, Smith noticed the eight years of Republicans calling doom from the federal deficit gets hardly a peep.

Student loan deductions and credits disappear, among a list. as well…his affect is telling.

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Small businesses, tax cuts, and reporting

(Dan here…lifted from AB 2012)

Small businesses, tax cuts, and reporting

 I sometimes get the ‘eyes rolling’ reaction from people in my social sphere when I insist that at least linking to  original documents is important, and that someone needs to follow up on what an author says someone else says (as a way to gain traction and authority status for their own writing, such as saying the non-partisan Tax Policy Centers says).  I won’t go into the idea of spin, which involves figuring out intent.  Mine is a caution for readers:

The post is lifted from a note from Daniel Becker in response to a query I sent to him…Dan is a small businessman in the way most of us think of as small business.  (The IRS has a different criterion  of ownership that allows a company like Bechtal at $31 billion to be considered a small business).

Dan Becker’s note:

The Washington Post article is   Obama calls for small business tax breaks.   The article uses the  Tax Policy Center original under the title Temporary Tax Relief to Create Jobs  as the source for the reporting.

The WP article notes:

“The last time the country had a similar proposal to the tax subsidy was during the Carter administration, according to the Tax Policy Center. Research by the Labor Department found that few firms knew about the tax policy, but those that did increased employment notably.”

But from their source it actually notes:

“The last experience the United States had with a credit for incremental employment was with the new jobs credit enacted at the beginning of the Carter Administration in 1977. Evaluations of that credit and how it came about found that most firms were either unaware of the credit or did not respond to it. Research based on a Department of Labor survey found that only 6 percent of firms who knew about the credit said that it prompted them to hire more workers. Firms that were aware of the credit, however, increased employment about 3 percent more than other firms. ”   (bolding is Dan B.’s)

WP had another smoothing over (under the fold):

“An incremental jobs credit could be a cost-effective way of raising employment in the short run, the nonpartisan center said in a report this year. The effectiveness of any jobs subsidy depends . . . on how employers perceive its potential benefits when making hiring decisions.”

The actual statement:

In summary, the effect of this proposal on employment is very uncertain. In theory, an incremental jobs credit could be a cost-effective way of raising employment in the short run and some research suggests that the 1977 credit did increase jobs, although the evidence on that is far from conclusive.
The effectiveness of any jobs subsidy depends greatly on both the details of the proposal, still to be finalized, and on how employers perceive its potential benefits when making hiring decisions.

Dan B

(Editorial comment at end of note from Dan Becker….Man! They still want to believe that cutting taxes is actually the same as if the 99% were now getting that $1 trillion of income that is now with the 1%. Just like they believe cutting taxes will increase revenues (sure if you convince the dictator to stop taking a full 90% of all that his people produce, but that’s not US).

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