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

Robert Mundell And Supply Side Economics

Robert Mundell And Supply Side Economics

 The death of Nobel Prize winner Robert A. Mundell at age 88 has brought forth much discussion about his work and legacy.  Most of this discussion, such as several columns by Paul Krugman, have commented favorably on the work for which he was officially given the prize, several papers he wrote in the late 1950s and early 1960s while he was at the IMF.  These papers, drawing on the experience of his native Canada at the time as a nation with a floating exchange rate and open to capital flows with the neighboring and domineering US at a time when most major economies had fixed exchange rates, laid the foundation for the now textbook Mundell-Fleming model of international open macroeconomics, A crucial insight now universally accepted was of the “impossible trinity” that a nation cannot simultaneously have a fixed exchange rate, and independent monetary policy, and open capital flows. This certainly drew on Canada’s experience and explained why it went against the rest of the world to have floating exchange rates.

The Bizarre and Manipulative Crusade by Centrist NYT Columnists to Persuade Clinton to Adopt the Republican Fiscal and Regulatory Agenda – [with update]

All the experts tell us not to pay too much attention to polls for another week or two. Still, it does look as if Hillary Clinton got a big bounce from her convention, swamping her opponent’s bounce a week earlier. Better still, from the Democrats’ point of view, the swing in the polls appears to be doing what some of us thought it might: sending Donald Trump into a derp spiral, in which his ugly nonsense gets even uglier and more nonsensical as his electoral prospects sink.

As a result, we’re finally seeing some prominent Republicans not just refusing to endorse Mr. Trump, but actually declaring their support for Mrs. Clinton. So how should she respond?

The obvious answer, you might think, is that she should keep doing what she is doing — emphasizing how unfit her rival is for office, letting her allies point out her own qualifications and continuing to advocate a moderately center-­left policy agenda that is largely a continuation of President Obama’s.

But at least some commentators are calling on her to do something very different — to make a right turn, moving the Democratic agenda toward the preferences of those fleeing the sinking Republican ship. The idea, I guess, is to offer to create an American version of a European-­style grand coalition of the center­-left and the center-­right.

I don’t think there’s much prospect that Mrs. Clinton will actually do that. But if by any chance she and those around her are tempted to take this recommendation seriously: Don’t.

No Right Turn, Paul Krugman, New York Times, Aug. 5*

Republican Policy Response to Increasing Income Inequality

“Labor Share is decreasing so lets cut tax on capital to zero”.

That is it. Literally. When you parse out Paul Ryan’s ‘Path to Prosperity’ or the net effects of Rubio’s tax plan that is what Republicans are pushing as the solution to everything. And pretty much always has been since “Rising Tide”.

Forget the rhetoric and labels about “Flat Tax” and “Fair Tax” and focus on the mechanism and it ALWAYS reduces to “Cut tax on capital”.

Period. End of story. (Unless of course someone wants to treat this as an Open Thread. Because Comments are Open.)

Nick and Joe are doing their best to beat back Milton Friedman et al

Nick Hanauer, Joseph Sitglitz videos.

This is the latest presentation Nick Hanauer has made regarding the upside downness of our economy and the backward, selfish thinking that has gotten us here. In this one he is talking to his “plutocrat” friends:

We plutocrats need to see that the United States of America made us not the other way around. That a thriving middle class is the source of prosperity in capitalist economies, not a consequence of it. And we should never forget, that even the best of us, in worst of circumstances are barefoot by the side of a dirt road selling fruit.

He takes on economics and how it is used today by plutocrats to reinforce their positions:

…for thousands of years, these stories were called divine right. Today, we have trickle down economics. How obviously, transparently self-serving all of this is.


Then comes Joseph Stiglitz talking about the cause and fix for income inequality.  This is based on his latest book.     He lays the cause to the “supply side” economics and thus the results of politics and policy.  It was a “disaster”.

The financial sector in recent years has been more active in taking money out of corporations than putting money into the corporations.  The flow is going the other way.

It is nice to hear someone talking about the solution in a comprehensive way.  A way that reflects understanding society and its economy in the same manor we have come to understand the environment.

Wouldn’t you just love to see them together on one of the Sunday morning shows around at table with say Senator Warren and Sanders and on the other side the Koch brothers and say Paul Ryan, McConnell and Boehner?  Maybe a Chicago School boy or girl?  Let’s throw in Jack Lew or who ever is the latest to hold that position.  How about someone from labor and the US Chamber to balance it out?  Better yet, how about simply a table of Nick, Joe, Warren, Sanders, Labor and Robert Reich maybe also Paul Krugman.  Forget the fair and balance act.

Supply-side Economics: Tea Party Style

Our colleague PGL offers this take at Econospeak on the new deal this week:

Supply-side Economics: Tea Party Style

Andrew Leonard covers the opposition to the Obama-McConnell tax deal coming from Tea Party star Michele Bachman. I’m tempted to say that her comments make me feel 30 years younger (with the hesitation that this is the 30-year anniversary of when some twit named Mark David Chapman murdered John Lennon). After all, 30 years ago we were mocking supply-siders and their Laugher Curve.

Andrew notes:

And as for what the country can afford? The total cost of the tax cut package unveiled yesterday, counting the extension of all the Bush tax cuts, the new payroll tax cut, the unemployment benefit extension and the reinstated (at a historically low level) estate tax comes to around $800 billion-$900 billion over the next two years. The cost of extending unemployment benefits for 13 months is about $60 billion. If your worry is “massive spending” then there are more appropriate places to direct your ire than unemployment benefits … we should looking very closely at which tax cuts or social welfare policies are most likely to give us the biggest bang for the buck, in terms of encouraging economic growth. And on that score, spending money on unemployment benefits gets a very high rating. Extending unemployment benefits is a sensible move for a government when it is stretched for funds when economic growth is slow and the goal is to increase demand.

In Michele Bachman’s world – is $60 billion much larger than $800 billion? Or does she really believe reducing taxes does not add to the deficit? The latter seems to be the world Art Laffer lives in. Of course, Laffer might argue that fiscal stimulus ala tax cuts will increase real GDP. The endorsement of the Obama-McConnell tax deal from the National Review certainly sounded very Keynesian:

But the deal is still worth taking: If it won’t do much good for the economy, it will avert a serious blow to it.

Of course, a temporary tax cut on the very well to do likely is not going to generate much in the way of additional consumption demand, which is why increase government spending has a bigger bang for the buck. While Tea Party types say they’d like to reduce unemployment, they oppose even modest increases in government spending. And while they say they abhor deficits, they want large tax cuts with little bang for the buck. Go figure!

The Pseudo-Psychology of Psupply Pside Economics

by Bruce Webb

In my view you can boil Supply Side down to a simple aphorism: “If you tax something, people will use less of it”. And all things being equal and depending on how you define ‘something’ this seems economically and psychologically plausible, higher prices drive down demand. Unfortunately in the real world all things are not equal and many different incentives bear on demand, meaning we need to take a deeper look.

In Supply Side theory income tax is a tax on work and so serves to have workers do less of it with the easy corollary of less tax, more work, Tax Cut = Increased Productivity. Well I’ll let Spencer and Cactus do the heavy lifting and correlation, I suggest instead that Supply Side is simply caught up in a simple conceptual confusion.

In reality America doesn’t tax work either in its scientific or more normal sense, we don’t tax people at X pennies/Joule, instead we tax consumption or income or property, none of which have any necessary connection to actual amounts of work or for that matter skill, a Trust Fund Baby gains income and consumes things based on income and capital accumulation done by other people. So if the income tax doesn’t tax work, what does it tax? And what are the logical consequences of that? For an impressionistic answer follow me below the fold.

Now the ‘well duh’ answer it clear, an income tax taxes income, and so reduces people’s use of it in favor of the state. But this model while reasonable enough to explain early medieval taxation where tax, tithes and rent were all largely composed of slices taken off the top of income/productivity. later medieval and then modern taxation started building in controls that set taxation levels based on how total income was used and so taxation began to break down into two more distinct categories. One category was a tax on property, which could include real or personal property, together or separate. This is a tax on past consumption. The second category is a tax on current consumption.

And this is what puts the pseudo in supply side psychology. Its governing assumption, which is buried so deep as to be invisible to those trapped by it, that the goal of work is accumulation rather than consumption. In this world-view the governing rule is ROI. But I suggest that historically this hasn’t been the rule at all, humans didn’t come down from the trees with ledger books under our arms, instead humans target levels of consumption and just as importantly the leisure with which to do it.

As I note time and again, I am not an economist and as such not bound by any particular theory, nor by any supposed ‘truth’ of a given ‘Law’, instead my training was in history which for this purpose can be defined as the study of what actually happened. And if you examine world history you see that past civilizations mostly valued the concepts of display and largesse, both mythically and practically the role of the King was to bring peace and abundance, which is to say the possibility for consumption and the leisure to enjoy it. And nobody liked a stingy and miserly King, King Midas was not a sympathetic character. Nor for that matter was simple accumulation valued, the peddler/tinker/money lender being largely restricted to people on the margins or even outside of society (Gypsies/Roma, Jews, Irish Travellers, in ancient times Greeks and Phoenicians).

The ascent of the merchant from its former position outside and/or below the social structure to be ultimately assmililated within that structure and largely between the farmer/artisan and the warrior/aristocrat happened at different paces in different places, for example in Rome you had a distinction between the Senatorial class, the Knights (Equites-originally a military class turned economic one) , and the People from early on while in England it was long understood that gentlemen did not engage in ‘Trade’. But the ultimate result of having the merchant class being elevated to the pinnacle of society and its chosen norms being established as natural ‘Laws of Economics’ to some degree flies in the face of the history of society, the notion that everyone is born with an abacus or calculator in his head busily calculating ROI in the face of all variations is I think rather foreign to human nature as we see that expressed over the last few millennia and longer.

So if we take this cursory historical model and apply it to income taxes what do we see? Interestingly we see a model flipped on its head, rather than being a burden on capitalism, an income tax ends up incentivizing it.

If we regard total income as being a measure of potential consumption, then an income tax is first and foremost a tax on that potential consumption, per our simple aphorism people will do less of it. But this takes us two different directions. If the primary goal of humans is to target a consumption level and not accumulation as such, then the result of taxing consumption would be an intensification of work to get productivity up to the point that it compensated for the additional taking. If we start from consumption the result of more taxation is more work rather than less, or the opposite of what Supply Side psychology suggests. (And for those who are interested in such things there were some classic works by the Russian Chayanov in the early 20th century . In his Theory of Peasant Economy he showed with detailed statistical data how Russian peasants worked outside a capitalist accumulation model and instead on a consumption model where the intensity of the labor input varied over the family life-cycle and so could not be explained with either branch of Liberal Economics, neither the Manchester or the Marxist versions of economic development really fitting the realities of pre-modern rural history.)

But beyond the concept that taxes on income means taxes on consumption means an incentive to boost income to maintain consumption, there are some further wrinkles to explain why higher rates on income promote more economic input. Under our modern tax system, certain types of consumption are privileged over others. For example progressive tax rates and standard deductions are an explicit recognition that everyone has a right to some level of basic subsistence, which equally explains why we generally don’t tax groceries. On the other hand with sufficient progressivity in rates buying that classic Bugatti is going to cost you, in fact in 1958 it would have cost you 10X its sale price if measured in pre-tax income. On the other hand the tax rates were set up in such a way that you could shelter much of that income from taxes if you spent (invested) it in forms that could plausibly be shown to boost productivity overall. Now some of this simply ended up with tax avoidance of various types as consumption simply got shifted to the company ledger (the infamous ‘Unlimited Expense Account’ ) but it did provide incentives for companies to reinvest gains rather than distribute them in the form of salaries which would then be exposed to high effective taxes when converted to consumption. In this model decreases in top rates meant increased pressure for management to expand compensation to take advantage of the reduced tax bite. On the flip side it meant that for any given employee maintaining the same level of consumption meant less work rather than more, or perhaps simply more consumption for the same amount of work.

A model that starts from the standpoint of consumption rather than accumulation as such is a much better fit for the actual social and economic history of the last half-century. As consumption taxes in the form of high marginal rates came down, the tendency of consumption and particularly conspicuous consumption went up. With the result that certain wealthy people couldn’t tell you off the top of their heads how many houses they owned, and Ken Lay thought it reasonable to have multiple mansions in the same ski resort. Both in the 80s and in the 00’s there was a huge boost in the size and extravagence of upper income spending where Supply Side insisted that the reaction should have been in the direction of greater investment. and increasing productivity.

This shouldn’t be a surprise to anyone, look around the world and ask yourself what has historically been the response of ultra-wealthy people who among other things are not exposed to tax: Buckingham Palace, Versailles, the Forbidden City, the Taj Majal, Nero’s Domus Aurea. The ultimate fallacy of Supply Side is first to imagine that everyone has the temperment of a 19th century British Factory owner or Dutch Burgher intent beyond all on boosting the asset line in the ledger (though neither held back from consumption as such) and second to confuse a tax on income for a tax on work.

In Psupply-pside psychology the most rational man in the world, the epitome of Humanity is Ebeneezer Scrooge, Esq, a man so desperate to keep every stray farthing in his Okun Bucket that he would cut himself away from the world of consumption and leisure. If England had had an income tax in Scrooge’s time you might well see him cut back on his business rather than paying an extra pound to the Crown in tax. But then most of us are not sociopaths.

Taxes raise the marginal cost of exposed consumption and so decrease it leaving more income for reinvestment. Psychologically a lot more plausible than the idea that returning to Clinton or Reagan area rates means all the billionaires to go Galt on us. They seem to like their consumption where it is and can be expected to work to maintain it.

Reversed Psychology: Tax Cuts and Work

by Bruce Webb

In comments to his last post A Response to Megan McArdle, Again Cactus put the following up as a summary of the Economic Right’s approach to tax cuts:
1. tax cuts mean people are encouraged to work harder
2. people work harder
3, growth

Another version of this was posted, without apparent irony, on a MY post on the soda tax. How to Think about Public Health Taxes (bolding mine but actually echoed when MY later quoted himself)

Think about the case for taxing income, via the income tax and FICA. Why do it? Well, to get the money. That’s how we finance Social Security, the Department of Defense, Medicare, interest payments on the national debt, Medicaid, federal aid to schools, veterans’ health care and benefits, the FBI, etc. Now what’s the case against taxing people’s income? Well, it’s that it discourages work and it discourages investment. And that’s bad for the economy. Now we go back and forth over whether any given expenditure has a value that outweighs the economic costs. Liberals, like me, tend to think that a relatively high level of expenditure is justified whereas folks on the right tend to disagree.

But that simply shows, and not for the first time that some of our progressive wunderkinden have simply internalized the central tenet of supply side voodoo, the idea that income taxes are a tax on work and capital gains taxes are a tax on investment, and that like proposed taxes on soda or existing taxes on liquor and gasoline the more you tax something the less people are inclined to expose themselves to that tax.

This I think is a profound misunderstanding of the psychology of work and investment. Those who care about why I would think that and those who are just dying to mock the whole idea can follow me below the fold.

Now there are some people who work just for the sake of work itself. In fact a lot of people will spend many hours on work that comes with no monetary compensation at all. We call these people ‘hobbyists’ and ‘unpaid volunteers’. And I suppose if you taxed these people directly on their time there would be some tendency to reduce that time, or at least the time reported to the tax man. But most people do not approach work as some sort of dispensable hobby, instead work is the means to some other desired end whether that end be subsistance, or fame, or fortune with its attendant material objects, or in some cases simple sociality (e.g. some people live to organize office birthday parties). Mostly though people are one way or another working for the paycheck.

But even the paycheck amount is not an end in itself, at least not for everybody, and particularly not for those people who work outside the hyper-competitive world of Wall Street, not every clerk dreams of being office supervisor, not every framer dreams of being site superintendent. some times what you have is good enough.

And when we examine history we can see that in most times and most places this is the norm, sure there are always strivers and always some measure of economic mobility but particularly in largely pre-industrialized societies people tend to end up at some equilibrium. And that equilibrium point is mostly established by a desired level of consumption.

I first came across a formalized version of this in Chayanov’s The Theory of Peasant Economy. I just now ran across a pretty good version of Chayanov’s overall thesis here Russian History Encyclopedia: Peasant Economy

Perhaps the greatest theorist of the peasant economy was a Russian economist named Alexander Chayanov, who lived from 1888 to 1939. Chayanov published a book entitled Peasant Farm Organization, which postulated a theory of peasant economy with application for peasant economies beyond Russia. He argued that the laws of classical economics do not fit the peasant economy; in other words, production in a household was not based upon the profit motive or the ownership of the means of production, but rather by calculations made by households as consumers and workers. In modern terminology, the family satisfied rather than maximized profit.

According to Chayanov, the basic principle for understanding the peasant economy was the balance between the household member as a laborer and as a consumer. Peasant households and their members could either increase the number of hours they worked, or work more intensively, or sometimes both. The calculation made by households whether to work more or not was subjective, based upon an estimate of how much production was needed for survival (consumption) and how much was desired for investment to increase the family’s productive potential. Those estimates were balanced against the unattractiveness of agricultural labor. Households sought to reach an equilibrium between production increases and the disutility of increased labor. In short, households increased their production as long as production gains outweighed the negative aspects of increased labor. This principle of labor production in the peasant economy led Chayanov to argue that the optimal size of the agricultural production unit varied according to the sector of production at a time the official policy of the Communist Party of the Soviet Union was pushing for large collective farms. As a result of this disagreement with Marxist economists and the Party line, Chayanov was arrested in 1930 and executed in 1939.

Chayanov came to his understanding not from a position of armchair theorist but by doing some serious data analysis of the surprisingly (to us) abundant documentation of peasant work life in Czarist Russia. And the result was that he found some very large divergences in work effort over the course of the standard peasant work-life with the peasant couple stepping up their work hours during some periods (for example while children are small and when setting up children with their own holdings) and then dialing it back.

Now even in the Peasant Economy there are strivers who undertake to raise their equilibrium point, your German ‘kleinbauer’ maybe wanting to rise to the status of ‘bauer’ and your ‘bauer’ to ‘grossbauer’, but equally the shift could go the other direction in any given generation, but the whole effort was not particularly driven by the profit motive but instead by the desired outcome.

Which is where supply siders get their psychology reversed. They see the income tax as a tax on work and as such a disincentive to work itself. Just as they see a tax on capital gains as a tax on capital and so a disincentive to invest. The historical reality generally shows the exact opposite, the higher the tax the more you have to work to achieve your desired consumption outcome, and similarly the same is true for investment, more tax means more intensification of investment activity. Now certainly there are limits to how far this process can go, if you tax labor output down to subsistence and sub-subsistence levels you risk your serfs and/or wage employees simply running away, and contrawise if you tax capital at rates up to 98% it is no wonder that the Beatles ran away from England as well. But there is no evidence that current levels of taxation are actually above the sweet spot where taxes mean more work and more capital investment rather than less.

Meaning we need to redraw that Laffer curve to include consumption equilbrium points for various income levels. If a person’s current income is above his own personal equilibrium point he might well react to a tax cut by reducing his hours of work. If instead a tax increase takes him from above equilibrium to below he might react by increasing hours. And the same is true for the investor. If as a group a society’s top 5% or top 1% are living large at current returns and rates, a tax cut might just lead to them commissioning artists or patronizing writers and scholars. Traditionally aristocracies have sought to reduce or eliminate their overall tax burdens, and it was not because they had a burning desire to spend every day working their fingers to the bone. Instead that tax exemption enabled them to maintain or even expand their consumption.

Supply side psychology treats ‘work’ and ‘investment’ as ends subject to direct incentives or disincentives from taxes. But historical reality shows they the are instead means to other ends that include such things as consumption and display. Calculating the impact on any given tax change on any given group requires some deeper understanding of the sociology involved among that group. History is full of instances where people scraped and scrapped behind the scenes simply to maintain appearances at Court or its socio-economic equivalent (think ‘Sunday Go to Meeting Clothes’ among the working classes).

How hard are you willing to work to keep that Bass Boat and the Lake Cabin even as the taxes on them are “killing you”? Are you really going to cut back your overtime in response to a tax increase if it means giving up your Season Ski Pass?