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A tax shift not a tax cut
Several years ago in an op-ed I wrote:
I favor a much smaller government but I do not favor the Bush tax cut. Or, to be more precise, I would support a tax cut if one had been proposed. But so far President Bush has neither proposed nor implemented a tax cut—only a tax shift.
Brad DeLong nicely explains the difference:
I, full professor Brad DeLong, am having lunch with lecturer Dariush Zahedi today. After lunch, I presume Dariush will say we should split the bill--$10 each. Suppose I say: "That isn't fair. Berkeley pays you less (a lot less: what we do to our lecturers is shameful) than it pays me. I should lay out more cash for this lunch. How about this: I put down $5 cash, you put down $0, and we put the balance on your credit card. That would be fairer, wouldn't it?"
Dariush would then be an unhappy camper. He would think--correctly--that I was mocking him.
Back in 2000 the U.S. government was running a surplus of some $200 billion a year--a broadly appropriate fiscal policy, given the state of the business cycle and the looming health care costs dilemma. Today we're running a deficit of $300-$400 billion a year. Relative to what would be a sane, reality-based, and appropriate fiscal policy, the Bushies are putting $500-$600 billion this year on our collective national credit card. That bill will come due: somebody has to pay it. To pretend that it won't...well, that would be the equivalent of me telling Dariush that only cash matters: that when we talk about who paid for lunch, we should count only cash put down now, and we shouldn't count the fact that his credit card bill will show an extra $15 due next month.
Posted by Alex Tabarrok on May 8, 2006 at 01:23 PM in Economics | Permalink
Comments
I don't know that I'd go so far as to give zero weight to the growth argument, but yeah.
Posted by: Jason Ligon at May 8, 2006 1:42:56 PM
On the fallacy that Democrats show more concern about budget deficits, or more fiscal responsibility generally, one needs only two words:
Social Security.
Posted by: KipEsquire at May 8, 2006 1:55:22 PM
I'm surprised that you think DeLong's analogy puts it "quite nicely." To the contrary, it assumes that the credit card bill will be paid 100% by Zahedi, who represents low salary tax payers. In reality, the "credit card" is a joint account, and will be paid mostly by DeLong, who represents high salary tax payers, who bear most of the tax burden. So if the analogy were constructed properly, DeLong's "deal" would indeed be a bargain for Zahedi.
Posted by: Doug at May 8, 2006 2:00:19 PM
Well, Alex, Im sorry but your reasoning is competely flawed.
First, suppose they didnt give a tax cuts. If they didnt, whos to say the
deficit would be smaller. The Bushies act as if theres no budget constraint
If they didnt give us back the money, it could well have gone to lobbyists
etc. (Have you heard of public choice economics. And that guy, Milton
Friedman; he once said -rightly- the the gov will spend whatever it has
whatever else it can get away with). All else is not constant.
Second, you are conveniently ignoring the growth effects. Dynamic
scoring and all that. In most economic models (Ramsey, Romer etc) the
growth rate is decreasing in the rate of taxation. All else is not constant.
Third, given economic growth, MU of consumption today is higher than in
the future. Using the most standard model, I can made a compelling
argument that bestowing debt on the next generation is completely optimal.
In other words, the tax shifts you talk about, are likely welfare
improving.
Fourth. Deficits are a way to force restraint on spending. Clinton ran
surpluses in response to Reagan. Also, I believe almost all government
expenditure is harmful; hence, the less revenues the gov has, the better.
All else is not constant.
Posted by: gary at May 8, 2006 2:05:10 PM
The analogy I've used to describe the same phenomenon is that you don't lower your grocery bill by charging it to a credit card and only making the minimum payment.
Posted by: neil at May 8, 2006 2:15:31 PM
"Fourth. Deficits are a way to force restraint on spending."
I agree, it is important to behave as irresponibly as possible so that in the future people will have to behave responsibly. Becaue behaving responsponsibly is important.
Posted by: Michael Foody at May 8, 2006 2:18:19 PM
I agree with Doug. The missing part of the analogy is that both parties will be, eventually, paying back the credit card bill. So the one party will pay $7.50 and the other $2.50. On the surface everyone takes the deal. As people are doing today. People are voting for people that allow them to pay zero today and in theory half the bill later. Only if the externalities are explictly stated, which no politician will ever do, will people choose to not take the deal. The interest that needs to be paid, that government debts are everybody's debts and putting it on your children is immoral.
While I agree that smaller government is desired, just cutting the taxes does not lead to smaller government. Someone has to have the cohones to vote for lower services to themselves to pay for it. Simple to describle, almost impossible to execute.
Posted by: Murphy at May 8, 2006 2:44:04 PM
There is no evidence that deficits reduce spending. Indeed the standard public choice argument - which of course I know well and which I mention in my op-ed - is that due to fiscal illusion deficits cause people to think that government is cheaper than it actually is and so causes increased spending.
Indeed, why do you think retail firms push credit cards with all kinds of teaser promotions - sign up for a credit card and get 15% off today? It's because they know that credit increases spending.
DeLong doesn't assume that the poor will pay the bill - he says that you can't evaluate a tax shift by looking only at today's "tax cut" - he is correct.
Alex
Posted by: Alex Tabarrok at May 8, 2006 2:55:00 PM
Kip- The only implied mention of any Democrat in that piece is when DeLong states what the 2000 budget surplus was. Your comment that Democrats support Social Security (as indeed we tend to, though the Clinton administration would probably have mistakenly privatized if it hadn't been for impeachment) has no relevance to that point, or anything else in the post.
Doug - I don't read the part about Zahedi's salary as having anything to do with the analogy, that is, he is not being analogized to poor tax payers. Rather, DeLong just wants to make his problems with lecturers' salaries known. The analogy is between Zahedi, who will have to pay off his credit card in the future, and future taxpayers who will have to pay off deficit spending in the future.
Posted by: washerdreyer at May 8, 2006 3:47:04 PM
My "shift" from the Bush tax cut amounts to thousands of dollars a year.
Given that I'll likely be the one paying it back in the future (I have and expect to continue to have a good income), why not take the shift?
I can't get these rates on my own.
One thing that confuses me on the standard public choice point Alex mentions:
How does the majority have any idea what government costs? Most people don't pay.
Posted by: Thomas at May 8, 2006 4:46:32 PM
"DeLong doesn't assume that the poor will pay the bill"
Huh? But of COURSE he does, he says:
"How about this: I put down $5 cash, you put down $0, and we put the balance on your credit card."
"YOUR credit card" refers to the poor man's card--he's saying that the poor man will end up paying the entire remaining balance and the rich man none of it. (Which makes no sense whatsoever as an analogy to the U.S. tax code)
Posted by: Slocum at May 8, 2006 4:55:10 PM
Slocum: It makes sense if you consider who the result of incurring such debt hurts the most. The credit card debt in the analogy represents inflation (which is what will happen, since spending was not cut: creating more money would be the only way remaining to pay): the money that the poorer man could've paid that day ends up diluting in value such that he cannot take that same money and pay the bill with it.
Translating the analogy in full, despite the obvious progressive tax incurred up front, because of contradictory fiscal policy the effect of our debt works as a stealth tax on the ones least able to afford it.
Posted by: b-psycho at May 8, 2006 6:48:58 PM
I agree with Slocum. DeLong is a smart guy who for some reason finds it necessary to use cheap shots and shifty rhetoric. His otherwise nice analogy is ruined by the completely bogus implication that the future tax bill will fall entirely on the poor. That's why I always read Marginal Revolution and almost never read DeLong.
Posted by: ed at May 8, 2006 8:31:12 PM
And the thing is, DeLong must have fully realized his analogy was bogus as soon as he started writing it. But I guess he just wants to score cheap points (even though, on this issue, legitimate points are so easy to score).
Posted by: ed at May 8, 2006 8:32:55 PM
Prof. AT,
You make an interesting point.
However, what if Dariush will be better positioned to pay his bill (higher than it is today) in the future? Well, paying his fair share today ensures that he is able to maintain his dignity/social position. Tomorrow, Dariush may be promoted to full professor or the appreciation on his house may entice him to refinance and have his property absorb his debt; or, he may declare bankruptcy if he is planning to live overseas for a few years or use his spouse’s credit until the bankruptcy is cleared.
Let’s transfer this condition to the level of the state. Absurd as its policies may seem, the Bush admin. does have some decent economists working for it. What future event, planned or otherwise can the bush admin. bank on to absorb the current spending discrepancy?
Many lay folk insist that war contributes to this (i.e. new contracts for arms sales –both domestic and foreign-, construction contracts, high energy prices leading to higher corporate taxes, a show of might that in the long-run may reduce concerns of instability and lead to additional foreign investment in the country-important after 9-11 ).
If Dariush agrees to pay less than 50%, he will appear weak in the eyes of his colleague who may be on the voting committee choosing the next full professor. At a subconscious level, people disdain weakness. Perhaps it’s because it reminds them of their own shortcomings. This may lead to a no vote for Dariush.
Other non-war factors exist for states to act richer than they are. Pandemics reducing a redundant workforce, an overseas labor market that produces for us without health care/retirement/high-wage costs, the long-term effect of an open borders policy etc…may change tomorrow’s landscape entirely. Is today’s spending level necessary for marinating national security/national stability to take the country into tomorrow? America may not be as invincible as it seems.
Let’s assume that the Bush admin. spending is not pure insanity. If there is a motive, a safety, what would that be?
Posted by: Chairman Mao at May 8, 2006 8:39:16 PM
This is the lamest post I have ever read on this blog. There is no second place.
Posted by: Will Franklin at May 8, 2006 9:53:18 PM
Insightful rebuttal. 'Lamest'?
Posted by: Chairman Mao at May 8, 2006 10:09:21 PM
How about "strawman" or "selectivity?" As if we had decades of surplusses before Shrub turned a deficit?
We have higher tax revenues now than at any time in the history of the Republic. How to account for that, in the face of these horrid tax cuts? I suppose that an increase in G and a decrease in T could be modeled to satisfaction on the IS/LM theory, but an historical review would sustain the assertion that lower marginal rates increases economic activity, which increases receipts to the feds.
The post is a splendid example of demonizing the one who brought the leftards, though. After all, they ARE the ones who have been erstwhile advocates of free-wheeling spending on social causes. Take comfort in the fact that Bush's current low poll numbers reflect the disaffection of his core constituency...not the slobbering antipathy of the left. There are at least as many of us conservatives who abhor the current Congress' spending spree as liberals...so don't play the martyr.
Remeber, if Democrats had the helm, spending would be even more out-of-control, but DeLong is correct in that Democrats would have soaked working Americans even more. Shame on him and his devotees.
Posted by: skh at May 8, 2006 11:04:15 PM
If only there had been a Democratic President some time in the past 25 years. That way, we would be able to see if it was really possible for a Democratic President to run a budget surplus, or to keep spending under control.
As it is though, I guess we will never know.
Posted by: Barbar at May 8, 2006 11:14:17 PM
I second Will Franklin.
By far, this is the worst post Ive ever seen here. I just
hope it's not the start of something.
Once GMU professors start invoking DeLong as an unquestionable
authority on taxation, it bodes nothing but ill.
Well, guys, why can't we just have a 100% tax shift and be done
with it. We'll pay off the national debt in no time.
Or not.
Posted by: gary at May 9, 2006 12:41:11 AM
This is a bad analogy. The reason why is because everyone is paying the future tax bill, both rich, poor, and middle class. That bill is being paid right now in the devaluation of the dollar. The "bill" is the erosion of savings as well as a shift of wealth from the west to the east. The "bill" is the misallocation of capital much like what happened with the hyperinflation of the Weimar in Germany.
Posted by: Andrew at May 9, 2006 12:44:53 AM
You are ignoring many important factors. Here are some:
1. The lunch bill is a poor analogy. A business investment would be more appropriate.
2. The interest rate and growth rate are not considered. With interest rates around 3% and GDP around 7%, running surplus would be a bad decision.
3. Who's credit card is he using, not his.
There are more.
Posted by: aaron at May 9, 2006 1:51:56 AM
Alex, you are right that credit increases spending. This is a good argument against deficits. It is a tax shift in that all government spending eventually becomes tax(if not by paying off principle, then by interest payments). It seems to cause people to dissociate cost and consumption. But this point is entirely your own, DeLong doesn't make it.
I think this is part of why some people are overly averse to credit. They don't correctly evaluate the risk, which in this case is the likelyhood that interest rates will go up (and by how much) and that economic growth will go down (and how much).
Also, how people see this depends on how they view government spending. If you view it entirely as consumption, no level of defecit is appropriate. If you view it entirely as investment, interest vs GDP is a great way to determine a good deficit spending level. However, the reality is probably a mix. Government spending probably doesn't quite give the return of the GDP growth rate, so some of it becomes inflation. Figure out how to tell how much and you'll win a Nobel Prize.
Posted by: aaron at May 9, 2006 2:36:44 AM
While I don't think this effect is likely to come into play in the Government, the idea that deficits reduce spending is not entirely wrong. When interest goes up, those who are overly risk averse will put pressure on spending.
I went without steady work for quite some time and used credit for consumption. I was able to keep interest low (almost 0%) the entire course of going on 5 years. At times I did spend less than judiciously (occasionlly from wanting a break from living frugally, sometimes from not paying attention, and expecting my situation to improve soon). Now that I have secured a good paying job and that I expect interest rates to go up (and promotions to disappear), I have cut my spending to near 0, will be able to pay off all of my credit card debt in a few weeks, will continue to live this way to accumulate some savings to invest (in addtion to what I put into my TSP), and I will be more averse to credit spending in the future.
Posted by: aaron at May 9, 2006 3:05:05 AM
Everyone else has commented, I think correctly, on the shortcomings of Prof. DeLong's argument. But I wanted to look at another part:
Back in 2000 the U.S. government was running a surplus of some $200 billion a year--a broadly appropriate fiscal policy, given the state of the business cycle and the looming health care costs dilemma. Today we're running a deficit of $300-$400 billion a year. Relative to what would be a sane, reality-based, and appropriate fiscal policy, the Bushies are putting $500-$600 billion this year on our collective national credit card. That bill will come due: somebody has to pay it.
Isn't this exactly what Keynesians have been trying to tell us to do for decades? A month into Macro 1 they beat into my head that you should run deficits to stimulate the economy when it is in recession, then pay it off with surpluses in the expansion. Is DeLong not a Keynesian but a social democratic monetarist? Or something else?
- Josh
Posted by: Wild Pegasus at May 9, 2006 6:45:12 AM
