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Lump sum tax breaks are a gimmick. They are a way to buy votes or convince the public that the government is doing something to help them. If you are holding a lot of credit card debt (say at 20% interest) it makes a lot of sense to pay down that card and save the balance for a time when you are desperate. $800 with 20% compound interest prevents even more future consumption. The same amount of money spread out over 52, 24, or 12 paychecks (depending how you are paid) will not be as evident and does spur consumption in a slump. Chapter 13 – Fiscal policy
The payroll tax holiday was a modest economic stimulus that produced the desired effects – increased consumption. It was only a 2% reduction in taxes per paycheck, a few dollars really. The effect was over a long period of time and the money was more likely to be spent. Payroll tax holiday
All states are required to balance their budgets every year. States are not allowed to run a deficit like the federal government. The recession was severely hurt state revenues. With consumption decreasing sales tax revenues and revenues from user fees were in decline. Property taxes were also problematic. Declines in property values meant that property tax assessments were forced down. States did not budget poorly, many even had rainy day funds that proved to be insufficient for the worst economic crisis since the Great Depression. The problem with just letting the states deal with it themselves is that revenue generating tax systems in the states tend to be more regressive than the federal progressive income tax. For example, if Washington State simply raised the sales tax by 5% they would increase revenues, but they would also reduce consumption. Not because people would stop buying things (though they might think twice about it) but because their paycheck wouldn’t go as far. Increases in property taxes would push many over the edge into bankruptcy, and many state income taxes are flat rates from 5% to 10%. Leaving the states to come up with the money in a regressive way would have been much worse for the economy than government expenditures from a more progressive tax structure. Aid to the states
This is what we call in political science a “frame”. When you wish to evoke a negative emotional response from the public regarding a policy issue, you come up with a term that will become common usage until even those who advocated the policy no longer remember why they did. Progressive tax policy does change the distribution of wealth in a society, but the bulk of that change comes from the voluntary actions of individuals to share their gains with those who helped them achieve them. It also stimulates the economy by convincing firms to pay their workers, venders, and shareholders more, and gouge their customers less. WC or supply-side analysis tends to look at all taxes the same. BAD for the economy. Keynesians argue (and have the data to prove it) that a truly progressive tax structure, with a marginal tax rate sufficiently high to eliminate incentives to hoard, will lead to a more equitable system of distribution through voluntary changes in behavior based on changes in the incentives of the tax system. Tax and spend
Profits = Revenues – costs Revenues are the prices charged to consumers for goods and services. Often there is little or no relationship between production costs and the prices charged. Prices are set to maximize revenue and they will be what the firm believes the market will bear. Costs are all of the things that firms spend on production. It is all of the consumption that business does and is not figured into taxable income. It includes worker’s wages, payments to vendors, capital investment (tax free over time through depreciation, R&D (also providing tax breaks), and interest. Additional tax deductions are provided for charitable donations to universities and other charitable organizations that may influence public debate in their favor. Once all the costs are deducted, what remains are profits, or the difference between what corporations charge consumers and what it actually costs to make the product. This is then taxed at 35% if over $10 million. Yes, a small corporation that wants to expand is taxed at the same rate as a multi-billion dollar mega corporation. The Ryan budget plan would reduce this to 25% and Obama has endorsed 28%. Corporate taxes
After tax profits – consumption to influence courts, public opinion, government, and academia = 100% savings or leakages from the economy. Federal revenues = 100% consumption Corporate taxes
Rational choice vs empirical evidence • 25% tax - Goal is to increase profits • 75% tax - Goal is to reduce tax burden
Based on what we have learned regarding leakages and injections to the economy, saving and consumption, and net exports, and based on historical data, it would appear that no good could come of a 25% tax rate for corporations. Corporate taxes
Income taxes are another thing altogether. We discussed two individuals and the result of a tax break. The person making $20 million a year who receives a tax break of $1 million, does not increase consumption by $1 million a year. Such a tax break would not have much of an effect on consumption. The person making $15,000 a year who receives a tax break of $1,000 (assuming it is not all in one lump sum) is likely to consume 100% of that tax break throughout the year. A $1,000 tax break to 1,000 low income families would have a stimulative effect. The tax break to the one guy has no stimulative effect except in terms of asset markets and asset inflation. This was the dominant effect of the Bush tax cuts that benefited the 1% more than the 99%. Income taxes
Small businesses pay income taxes compared to corporate taxes. There are some very large businesses who opt to be considered small businesses to receive certain benefits, like small business preferences in government contracting or preferred interest rates for loans. Income taxes Humans, whether they are completely driven by material concerns or whether they predominantly think in altruistic terms, respond to incentives. Costs and benefits are weighed to determine courses of action. A more progressive tax structure significantly alters the costs and benefits of increasing incomes, ultimately changing behavior. High top marginal tax rates become prohibitive, rather than punitive as opponents suggest.
Rational choice vs empirical evidence • 35% marginal tax rate – unlimited accumulation of wealth • 91% marginal tax rates - Goal is to reduce tax burden
Other effects of income and corporate tax rates • Low marginal tax rates • High marginal tax rates
Ultimately, progressive fiscal policy is about who is taxed and how. It is not, as opponents declare, about tax and spend or punitive tax rates. It provides for a much more efficient system of distribution that provides for higher levels of economic growth. Workers with higher wages who are able to save for the future increases autonomous consumption. Lower tax rates for the lowest income levels increases consumption. Low levels of capital accumulation in savings accounts by millions of citizens encourages investment geared toward increased competition. Capital accumulation in the hands of the few leads to investments geared toward eliminating competition to increase profits and wealth. There is less unemployment as more individuals can afford to leave the workforce via retirement There is less stress on the government to provide a social safety net as individuals are able to earn (with a single 40 hour a week job) enough to live a middle class lifestyle and save for retirement. Fiscal policy
Supply-side theories are based on models whose assumptions include that the rational choice of accumulated capital will be to invest in increased production to grow the economy regardless of demand, as has frequently been depicted in this textbook. Demand-side, or Keynesian theory reconstructs rational choices based on observed data. IE Why did worker’s wages, after keeping pace with productivity, suddenly stagnate after 1981? Why did CEO pay skyrocket in the same period? Why has healthcare inflation significantly outpaced broader inflation over the same period? At the end of this presentation I have provided numerous charts and graphs that depict the changes discussed over the last few slides. They will not necessarily be discussed in class. They are provided for your own evaluation of the data. Why the difference?
The supply-side understanding of Keynesian fiscal policy tends to focus solely on government spending and/or redistribution. The effects of progressive taxation to pre-tax decision making is ignored. Progressive taxation is not about redistribution, it is about encouraging more equitable pre-tax distribution. Government revenues neither increase nor decrease under more progressive tax plans, but the necessity of transfer payments and a social safety net increases under flatter tax schemes. This is because firms and wealthy individuals have less of an incentive to withhold wage increases from workers. Example: A firm facing a 35% tax rate avoids any wage increase it is not forced to accept. The firm receives 65 cents in after tax income for every dollar denied to workers. The firm will make every effort to prevent paying workers higher wages including union-busting and outsourcing. The same firm facing a high marginal tax rate faces a different set of choices. If facing the highest level of 91%, the firm only realizes 9 cents in after tax income for every dollar denied to workers. In this case, the paying of higher wages is actually a part of the strategy to reduce tax liabilities. The result is that the government receives fewer revenues at the top of the tax code and more from the lower rates. The result is both the government receiving less money in revenues, but also needing less revenues for the social safety net. The higher wages allow individual families to consume more and save more(which is invested by banks). This increases autonomous consumption and consumption. Discretionary fiscal policy
The indication from the figure is that fiscal policy is limited to only increasing or decreasing aggregate demand by the amount the government spends. Other effects are not considered An increase in autonomous consumption, increased consumer demand, and an increase in the multiplier effect are all a significant part of progressive taxation, but these effects are not discussed here. Specific government expenditures will also shift the LRAS curve to the right as government investments that were undersupplied by the private sector increase productive capacity in the economy. Examples are too numerous to comprehensively cover but they take on two basic types. 1) Day to day expenditures: Infrastructure repairs, public education, fire departments, police departments, the highway system, DoD, etc. 2) Large projects: Infrastructure development, The Erie Canal, Westward expansion, The Hoover Dam, The TVA, The Federal Highway system, NASA, the Internet. Some future federal spending that should be able to shift the LRAS curve to the right: Investments in solar, geothermal, and wind-generated power. A smart grid. High speed rail. Yes, all of these are connected to energy because energy appears to be our greatest limitation to economic expansion Figure 13.1 fiscal policy
Nondiscretionary spending: Fails to mention that Social Security and Medicare are funded by payroll taxes. If wages had kept pace with worker productivity these programs would have no problems; now nor in the future. Why not?
From the text: “Individuals…look to their disposable (after-tax) income when determining their desired rates of consumption.” Keynesians would agree with this statement with the provision that this applies to low income and middle class households. Those households whose autonomous consumption is unaffected by income would not be included. Wealthy households take taxes into account in considering strategies of how to save. When capital gains are taxed less than dividend, rent, and interest income, speculation (leakage) is encouraged. “Firms look to their after-tax profits when deciding on the levels of investment per year.” Keynesians and most microeconomics textbooks would disagree with this. In fact, this book disagrees with this. In the previous chapter we learned how inventory shortfalls and surpluses served as signals for business to either increase or decrease production. Levels of investment are determined by demand, not the tax rate or the interest rate. Changes in taxes
In order to make models work, taxes are typically represented as lump sum, or flat taxes, two forms of taxation that are regressive and fail to reflect the distributive effects of a progressive tax. All taxes are treated the same. In the supply-side way of thinking, all tax increases will reduce consumption by exactly the same amount, reducing any effect from government spending. In Keynesian thinking, the nature of the tax increase is dependent on who is taxed and how. Suppose we had a 5% tax increase on all annual income in excess of $5 million a year. If you are making $ 5 million a year this tax is unlikely to change your consumption habits. 100% of the revenues taken in would be invested by the government, perhaps by providing milk for a hungry child whose parents can then spend money elsewhere in the economy. In this example, the entire amount of revenue would shift from a MPS of 1 to a MPC of 1. Limitations of models
For a few decades now, record deficits have coexisted with record low interest rates and record levels of debt. This indicates that fiscal policy is putting more after-tax income into the hands of net savers at the expense of the government balance sheet. Government deficits have not crowded out investments by driving up the interest rates, though we may have been better off if it had. Induced interest rate changes
Firm’s do consider the interest rate when making decisions regarding taking on more risk. If a business is considering an expansion that they predict will increase revenues by 8% (ceteris paribus) and the interest rate is 5%, the business may consider the investment as too risky to take on debt. If the anticipated return on investment is 20% and the risks appear to be minimal, the business may well make the investment even if the interest rate 12%. Low rates of interest make riskier investments look less risky. More risky investments make for more speculative investments. Such investments may make sense ceteris paribus but in the aggregate can become disastrous to the overall economy in the case of a downturn. High interest rates means fewer risky investments, low interest rates means more risky investments. More risky investments means reduced economic stability. Crowding out of investment
As discussed previously, the primary factor that influences the decisions of businesses to increase or decrease investment, is the location of where the AD curve intersects the the SRAS. If the AD curve intersects the SRAS to the right of the LRAS we are more likely to see investment. If it is to the left of LRAS, investment is less likely. In the Keynesian perspective, demand is more likely to determine these business decisions than interest rates. Where is aggregate demand?
Just spending money is not a strong policy argument for fiscal policy. How the government spends money makes a difference. Understanding the ideas of shifting the LRAS and marginal propensities to consume or save, we can then identify those government expenditures that neither crowd out consumption or may shift the LRAS to the right, making growth possible. To shift the LRAS to the right, the government may invest in those improvements to infrastructure and technology that are currently being underprovided by the private sector. Increased investments in alternative sources of energy, battery technology, a smart grid, high speed rail, or long overdue maintenance of the existing infrastructure do not crowd out private investments. The private sector has underprovided these goods. Government spending that does not crowd out private spending is spending that provides for those Americans who would spend more if their income would allow it. The milk provided for school children provides nutrition for those who would otherwise not receive it. If it does crowd out some parent’s spending on daily milk, as a means tested program it allows that family to spend their limited resources somewhere else. Tax breaks at the lower income levels would likewise increase consumption. Transfer payments like social security, welfare, unemployment benefits, and food stamps all allow lower income families to increase their consumption. Not all government spending is the same
Subsidies paid to businesses that are already quite profitable and sitting in cash. Tax breaks (tax expenditures) to individuals and firms whose MPC is approaching 0. Subsidies that encourage clinging to our obsolete carbon-based system of energy generation. Spending on weapons systems that our military doesn’t even want. Spending more on defense than the next 26 countries combined. Government spending that does not have the desired effect
Supply-side perspective: Deficit spending encourages increased savings to prepare for future tax increases. Ricardian: It makes no difference to consumers. Austrian: Deficit spending is unsustainable and should not be done. Keynesian: Deficit spending may be desirable in the short-term to prevent a recession or depression from becoming too severe. In the long-term it is unsustainable. Progressive tax policy is necessary to address issues preventing a return to full employment in the long-term. Ricardian equivalence theorem
The argument presented could be utilized as an explanation of why the Bush tax cuts failed to work. The Keynesian argument of why the Bush tax cuts didn’t work is that the benefits went primarily to those at the upper income levels. Ricardian equivalence theorem
Supply-side economists will argue that the government should not be involved in providing goods and services that the private sector is capable of providing. Keynesian: “If public operation of an enterprise will produce a greater net social utility, the services rendered by this enterprise should belong in the category of public goods.” Keynesians would argue that private sector provision of goods and services is preferable, but when these goods and services are underprovided by the market, the government should step in. Distinct comparative advantage
Post office: increased access to communication and reduced the cost Fire depts: Firms and individuals no longer had to hope there would be enough people around to fight fires on their property. Westward expansion: Greatest experiment in government largesse by giving away land. Education: Private education had been around for years but illiteracy remained high. Fannie Mae: Credit markets were frozen, Fannie Mae unfroze the markets and kept housing stable for 30 years prior to privatization. National Institutes of Health: The private sector had been providing the newest and greatest snake oils for years. This stood out as a concentrated effort to fight disease that did not find an equivalent in the private sector. Private sector is more interested in what they can sell as opposed to what they can cure. Federal highway system. Improved interstate commerce by reducing the cost of shipping and providing greater competition to the railroads. Pensions and unemployment insurance: This is a major factor in retaining high levels of autonomous consumption. Medicare: People beyond a certain age could not get health insurance at any price. Past examples of market failure
Investment in wind and solar power. With carbon-based technologies there is a product to sell. With wind and solar there is a large upfront cost, but then nobody is able to sell you wind or sun, less the upfront cost and maintenance the energy is free. There is no profit to be had, nor shortages to create to drive up the price. Healthcare provision: See next slide Current market failures
Does this seem to be effective or efficient health care policy? Single-payer vs private health care systems US as outlier - In statistics, an outlier is an observation that is numerically distant from the rest of the data.
Costs are way out of line with every other industrialized country. Monopsony power (single payer system) to negotiate with monopoly power of the drug companies. Price is what the market will bear. Market will bear what we are willing and able to pay, insurance makes us able to pay more, the willingness is assumed. Federal government outlays for health care is the same as all outlays for other governments yet they have 100% coverage where we do not. 75% of medical bankruptcies are declared by people who were insured when they got sick. Failures of private health care system
A disconcerting direct expenditure offset is one surrounding the minimum wage. By providing Medicaid, Medicare, and food stamps, businesses are able to get away with paying low wages. The government steps in to provide support to those families who have been failed by the market system. These companies are using the social safety net to subsidize their profits. A more efficient way to address this issue that provides more equitable distribution as opposed to redistribution would be to both raise the minimum wage and increase corporate taxes. http://www.youtube.com/watch?v=Jazb24Q2s94 Wal-Mart, the high cost of low prices documentary 90 minutes Direct expenditure offset
The textbook provides a hypothetical in a grocery store where the government gives you $100 in groceries then turns around and taxes you $100. This is the supply-side concept of food stamps. Not all taxes are alike, this scenario would only be accurate if we had the form of flat taxes as are often used in the supply-side models and that supply-siders tend to advocate. This actually explains the Keynesian progressive tax effectively and shows why the standard deduction should be higher than it currently is. No household should be taxed and then have to turn around and get government assistance…it is inefficient. Profits are realized when workers are paid less than their productivity warrants. If firms paid their workers a rate commensurate with worker productivity (as was the case during the Keynesian paradigm), there would be little need for food stamps. The extreme case
Goods and services that are purchased in the private sector are more expensive to consumers than if they were purchased or provided collectively through the government. Assuming the cost is the same whether developed publicly or privately, the private sector then adds a profit margin onto the cost to the consumer. The consumer must then pay this middleman cost. What would it look like if the US government started using its monopsony power to negotiate prices like other countries do? If, for example, Americans were suddenly paying 1/3 the price for Lipitor, the dollar value contributed to GDP by Lipitor would be reduced by 1/3. Individuals on the lower end of the income scale could then purchase other goods to make up for that value and real GDP would be increased. http://www.washingtonpost.com/blogs/wonkblog/wp/2013/03/26/21-graphs-that-show-americas-health-care-prices-are-ludicrous/ Offsets to government spending
Trickle-down economics was a term coined during the Great Depression to describe the discredited theory of accumulating capital in the hands of the few to stimulate the economy. The trickle never came. When Ronald Reagan was running in the primaries, George H W Bush referred to the supply-side theories as “voodoo economics”. “…work harder and longer, save more, and invest more”. The average American worker is definitely working harder and longer as median wages decline. The family of four that used to have a middle class income with only one wage earner now needs two incomes to get by. Individuals are less likely to retire, either because they have been unable to save or because they are making so much money it would be crazy to retire. Trickle-down never trickles down, it simply shifts capital from net consumers to net savers. Those net savers either hoard cash or let it ride in the asset markets. Supply-side effects of trickle down economics
Again, the argument here is that by allowing businesses to keep more of the profits that they will increase production to increase profits. Paying workers less increases profits, charging customers more increases profits. The only way that businesses increase production is if demand intersects the SRAS to the right of the LRAS, and that requires increased aggregate demand which is defeated by firms paying workers less and charging consumers more. This also provides the issue of the types of incentives it offers to individuals at different income levels. The CEO who writes his own check will continue extracting far more income than they could spend or invest productively over several life times. The minimum wage worker is forced to take multiple jobs to make ends meet. Both cases increase unemployment. The failure of the CEO to retire and leave the workforce and the low paid worker who is forced to take two jobs. Those two jobs should be able to support two individuals not one. The high income individual will not increase consumption due to the greater income, while the lower income individual is likely to consume less than they would if one job would suffice. Supply-side economic theory, by focusing on marginal tax rates seems to believe that the incentives of the very wealthy are all that matter. Supply-side economic theory
Once again, the policy example given fails to specify the studies it claims provides evidence that tax cuts are more stimulative than government spending. It is not necessarily one or the other. There are tax cuts that go mostly to low incomes and tax cuts that go mostly to the upper incomes. There is spending that is wasteful (useless defense projects and a bridge to nowhere) and spending that is stimulative(extending unemployment benefits). It is ideological to see one of these tools as useful and the other not as useful. Not all tax cuts are alike, and not all government spending is the same. It is, however, often necessary to pretend as much to make the models work. Which affects real GDP more?
Recognition time lag – due to chainweighting the GDP deflator, the recession that started in December of 2007 was not announced until 2008. Were we still using a base year formula the government might have been able to act quicker. Action time lag – Our current Congress is split in two between those who ascribe to demand-side economic policies and those who advocate supply-side policies. In recent days, supply-side advocates have refused to budge (IE only passing a farm bill that had subsidies and crop insurance only – no food stamps). When the Keynesian paradigm was dominant Congress was less polarized on issues of government intervention into the economy. Time lags
Effect time lag: It can take months or even years to feel the effects of a particular change in fiscal policy. This is because humans take time to adapt to the new economic environment. Example: Marginal tax rates were raised from 25% to 67% in June of 1932 after three years of near continuous economic decline. Industrial production increased briefly in August but declined again. The economy did not turn the corner into recovery until February and March of 1933. FDR inaugurated March of 1933. Time lags
The textbook states, “Clearly, fiscal policy is more guesswork than science.” If I advised policy positions that routinely have the opposite effect of what was declared, I might say that too. Fiscal policy as a science
Read first paragraph after “The Tax system as an automatic stabilizer” on page 286. This is ridiculous. Only the most doctrinal of adherents to supply-side economic theory would believe that unemployed individuals who are now not paying taxes might increase their aggregate demand as a result of not paying taxes. They either have no income or only a small portion of what they received after taxes. How can they possibly consume more? Automatic stabilizer
The process of changing the tax code is difficult at best. Frequent changes to the tax code make planning difficult. Truly progressive tax codes have that stabilizer functions built into it. When I say truly progressive, I mean one that has more than a handful of tax rates. Observe in the 1937 tax code that for each additional $100,000 earned by a household, that that amount is taxed at a higher rate. This affects the decision of whether to work more while accumulating capital or to seek more leisure time or even retire. In 2008, most households are in the 15% rate. In 1937, that rate is not hit until after $250,000 a year. As households are pushed up into higher brackets by inflation, it provides a dampening effect on the economy to prevent even greater inflation. In this scenario, a new budget can be hammered out every 4 or 5 years without being disruptive to the economy. Automatic stabilizer function
Although previously treating transfer payments as being harmful distortions to the economy, the textbook is now recognizing the stabilizing effects of those payments, though still not recognizing it as a part of autonomous consumption. Transfer payments
The effect of fiscal policy during normal times is it determines distribution of income and wealth. Flatter rates shift income to the top while more progressive rates distribute income more evenly throughout the economy. The only way that you would see fiscal policy as having little effect in normal times is if your understanding of fiscal policy is limited to government spending. Fiscal policy during normal times
The Great Depression – A very solid argument can be made that fiscal policy brought us out of the Great Depression, but not necessarily through government spending. Hoover had tried industrial loans and federal works projects with little success. We did not see progress until after the top rate was raised from 25% to 67%. Interesting that they would advocate for government spending then but not now. Note: WWII national debt went through the roof. Fiscal policy in a crisis
Supply-side: all taxes are contractionary and reduce the effectiveness of any government spending. Keynesian: Both the taxing and the spending aspects of fiscal policy can be either contractionary or expansionary, it depends on the income and the marginal propensities of those whom are affected. If we look at Orszag’s recommendations, we find it far from Keynesian, but heading in that direction. Those tax increases that are proposed are ones that will predominantly fall on those with an MPC approaching 0. In other words, it is targeting what would otherwise be saved in order to increase consumption. You are there
4.6% increase in tax rate for income over $373,650. This income puts you in the top 1%. Only 2% of businesses fall into this category. Treat corporate dividends as regular income. This is how CEOs pay themselves to reduce their tax burden. Should a billionaire who lives off dividends pay the same tax rate as someone barely over minimum wage? A 5% increase in capital gains taxes is minor considering this is the income generated from speculative ventures Not really sure on this one. Will need to research it. Vast majority of inherited wealth is a transfer from one rich person to another. Poor people die in debt. The Walton heirs possess more wealth than the poorest 40% of the country. Proposed tax changes
Either an honest misinterpretation of Keynesian theory or a metaphorical strawman. Appendix D
