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The Demand Side Politics of Supply-Side Economics
Following Jon Chait, Matt Yglesias writes:
...the central element of the Republican Party's tax policy -- lower taxes rates will lead to higher tax revenues -- is a discredited crackpot notion.
Fine, but a more fruitful question which I'd like to see Yglesias, Chait and others grapple with is why discredited, crackpot ideas can become central elements of a winning political party in the world's most important democracy. Explain the demand side and give us your policy prescriptions.
Posted by Alex Tabarrok on September 6, 2007 at 04:16 PM in Economics | Permalink
Comments
why discredited, crackpot ideas can become central elements of a winning political party
because people like the idea of free money.
Posted by: Francis at Sep 6, 2007 4:25:16 PM
Probably because at one point this idea had some legitimacy. Did people really work harder when tax rates were cut from exorbitant amounts to lower amounts by JFK? Probably not, in fact, you could now theoretically work less to get the same take home. But people probably made better decisions that helped to spur the economy when the largest factor in selling stock or a business wasn't can I pay the taxes on the gain.
Telling a guy who happens to be a huge jerk that he'll meet more women if he's nicer to people is probably good advice. But a lot of people that are already nice guys have a hard time meeting women because they're too nice and they fall into the "friend zone" too easily. Be nicer is not good advice to them.
Unfortunately, people understand a lot more about relationships than they do about the economy or politics. Think of it this way, genetically speaking everyone alive today is a descendant of someone who was able to mate with the opposite sex. The same can't be said about having an understanding of economics or politics.
Posted by: Chris at Sep 6, 2007 4:38:24 PM
Am I the only one that finds the notion that lower taxes MAY lead to higher reveniue persuasive. I always thought of it this way-- If tax rates are 100 percent, an underground economy will develop and tax revenue will be low because no one will work at a job that is subject to the tax code. So, at some point, reducing the tax rate would reduce the incentive to be employed in the black market (which is illegal, dangerous, etc.) and increase the incentive to become employed at a job that is subject to the tax code-- which would increase tax revenue.
Now, if the specific issue is whether reducing it from 37% to 30% (or whatever it was) increase(d)(s) revenue--I dont know. But as a general theory, I dont think it is discredited.
I also think that the government wastes a lot of money and resources. By giving it back to individuals, economic activity is increased and this leads to higher revenue.
Posted by: rick at Sep 6, 2007 4:38:52 PM
Tax revenue is clearly a simple optimization problem. Operating under strict supply-side logic, setting tax rates at zero would create the greatest revenues for the government, an absurd conclusion.
When the right will stop masking greed ("I don't like to have to pay taxes at all" with perhaps "to a government I don't trust" added in) with political cant and when the left will fess up to the fact that social policy may be separated from tax policy without threatening the validity of the former, then perhaps we can have a real dialogue.
Until then, posture away..
Posted by: martin at Sep 6, 2007 4:54:45 PM
Even Yglesias and Chait concede there are some cases where lower taxes spur higher revenue. I'll bet anything that the capital gains tax cut five or so years ago did.
But what Yglesias, Chait and others on their side of the debate won't admit is that what's emerging as a central economic thesis of Dems is also utter nonsense -- i.e., hostility to free trade.
Posted by: chris at Sep 6, 2007 4:57:20 PM
Rick -
everyone acknowledges that the Laffer curve does exist. The question is, which side of the curve are we on? The GOP folks that Yglesias is talking about have a prior assumption that tax cuts (esp. the top marginal rates) are always a good end, but they recognize that this is a normative judgment which isn't universally persuasive. so, to gain support for their preferred policies, they engage in intellectual dishonesty by arguing that the U.S. economy is on the right side of the Laffer peak, when in fact we are on the left side of it.
Right-wing economists who are not intellectually dishonest -- like Greg Mankiw and Glenn Hubbard -- do not do this. They acknowledge that, given the economic realities in the U.S., further tax cuts will not pay for themselves; they are in favor of tax cuts despite what they will do to federal revenues, because they believe that tax cuts are good things in and of themselves. But their bosses don't think that this is a politically feasible argument, so they lie and deceive. This drives left-wing economists (e.g. "Rubinomics" folks) and left-wing literate politicos absolutely batty, and understandably so. They are prevented from having a debate on the merits, because the extreme supply-siders won't acknowledge reality before coming to the debate.
Yglesias (and Chait) are not arguing against Mankiw; they are arguing against the WSJ editorial page, the Heritage Foundation, Pres. Bush, V.P. Cheney, etc.
Alex -
I assume you've read Caplan's book? I think you'll find your answer there. Unfortunately, there is no workable "policy prescription" which will make voters rational alluvasudden. The work of the reality-based economists and politicos is to educate people to the *true* costs and benefits of policy, and punish those who knowingly lie about them.
Posted by: wkw at Sep 6, 2007 4:59:59 PM
"Operating under strict supply-side logic, setting tax rates at zero would create the greatest revenues for the government, an absurd conclusion."
Martin, the Laffer curve placed tax revenue at zero when the tax rate is zero, so you're a bit off-base there.
I've read all sorts of economists I respect that lower tax rates do not lead to higher revenue, but am I mistaken that (setting aside causality) the JFK/Reagan/W-era tax cuts were followed by higher revenue? The relationship may be tenuous, but "crackpot"?
Posted by: seven at Sep 6, 2007 5:00:15 PM
I suppose it is rude to point out to the two hosts of this site that they wouldn't have their present jobs if it wasn't for the largess of a man who believes these "crackpot" ideas. Without his funding of the economics department and allied efforts such as Cato, the ideas would get no exposure.
I know our hosts think they are independent thinkers, and perhaps they are, but they were also trained at GMU and the same largess was responsible for this as well.
The secret of getting ideas out is that one needs to have an infrastructure to do it. In our society that means money. Money for think tanks, money for academic departments and endowments, money to fund opinion journals, money to run training institutes and money to buy politicians.
The success of ideas is not necessarily related to their validity. I only have to point to the large number of religious dogmas that exist and have existed in the past. The discarded ones are now regarded as invalid, but the state once support Zeus with an apparatus similar to that being used to support Adam Smith now.
Is a kept woman not a kept woman if she thinks the man is only doing it because he loves her?
Posted by: robertdfeinman at Sep 6, 2007 5:02:17 PM
The idea wasn't crackpot when it meant lowering rates from 70 or 50% to the thirties or twenties. But then they tried to make it seem like a principle, just keep lowering taxes, as a way to starve government, not a rational assessment of cost-benefit.
Posted by: Neil B. at Sep 6, 2007 5:09:29 PM
The idea wasn't crackpot when it meant lowering rates from 70 or 50% to the thirties or twenties. But then they tried to make it seem like a principle, just keep lowering taxes, as a way to starve government, not a rational assessment of cost-benefit.
Posted by: Neil B. at Sep 6, 2007 5:10:26 PM
How hard is this to understand? The taxpayer doesn't care about maximizing government revenue.
Politician A: Mr. Joe Sixpack, we can maximize government revenue by raising taxes by 10%, because you see, we'll only lose 9% to slower growth, so our revenue actually increases! Then we can spend it in lots of ways to make you happy!
Joe Sixpack: So, you're raising taxes by 10% and you're going to slow the economy?
Poltician A: Don't look so glum! It's for the children!
Politician B: Me cut taxes. You keep money, economy grow fast. Ugh. Me like cookie.
Joe Sixpack: I pick B.
Posted by: 8 at Sep 6, 2007 5:10:39 PM
lol, Kudos to you 8. comment of the month so far.
Posted by: angus at Sep 6, 2007 5:15:37 PM
Lost in the shuffle of all this is the alternative to just cutting rates, which is serious
tax simplification. Cutting rates in combination with that can do wonders, as a lot of the
missing revenues at high rates and complicated systems comes from people simply hiding their
income and not wanting to mess with it. The whole "more effort" thing was mostly baloney,
although I do believe the tale of Ronald Reagan not feeling like making another movie when
facing 90+% marginal rates, which was what convinced him.
So, one place that did rate cutting plus simplification was Russia shortly after Putin came in.
A hodgepodge system that led to 90+% (and even over 100% in some cases officially, called, bribe
your tax collector), to a flat 20% led to a surge of revenues. Yes, Virginia, the Laffer curve
exists and it has a hump. Evidence is that revenues did rise from the top 2% of the US income
distribution when their marginal rates went from 70% to 50%, but declined for the rest of the
population.
Thus, for all his thumping for lower rates, Bush would have done better to imitate Reagan in his
second term and pursued serious tax simplification. He had a bipartisan commission that made
some recommendations. Instead, he went off on a stupid bender over social security, thereby
totally depleting what was left of his Iraq-damaged "political capital." Just plain stupid.
Posted by: Barkley Rosser at Sep 6, 2007 5:17:14 PM
"How hard is this to understand? The taxpayer doesn't care about maximizing government revenue."
8 is absolutely correct.
I was a temp. at a factory over the summer (non union). Most employees were financially strapped, but earned enough income to not qualify for government programs.
Posted by: thehova at Sep 6, 2007 5:17:35 PM
The far left hates the Laffer curve because it implies that the electorate knows where it wants to be taxed(point E), and not lectured by some politician that we need more taxes to do more stuff.
The far right hates the Laffer curve because at point E Gov revenues are maximized, and even Milton Friedman wanted to starve the Beast.
I have taught a class on the Laffer curve at a Community College for 8 years now, and the consensus of my students is that point E is 25%- Total tax, which means all taxes paid, state, Fed,local,sales, property et all.
Posted by: russ at Sep 6, 2007 5:27:43 PM
The most annoying characteristic of the left by far is intellectual laziness combined with smugness. Yglesias remark is an illustration in point.
1. Let’s start with the straw man: The claim is not that every tax cut will always increase revenue. Even with constant elasticity of supply you will have taxes hit the laffer curve at some point, the question is only at which tax level, and over what time horizon.
The response to taxes is not only hours worked, but also education investments, decision to become an entrepreneur, intensity, career choice, incentives to evade taxes.
2. Saying “0% tax gives you less than 1%, so we proved you wrong” is just pathetic. No one is discussing cutting a 0% tax rate, but the current marginal tax rate that is for many people above 50% (including local taxes and sales taxes).
Simple example. Let’s say we cut the highest marginal tax rate for someone from 55% to 54%. (federal used to be 40%, you have local rates plus sales tax adding another 10-15% in many large states).
Marginal taxes for many people earning 80 k are also this high, due to SS, medicare etc.
Even with a low estimate of supply elasticity of 0,4 from Saez the tax cut finances itself by half. You only need a 0,8 elasticity for the tax cut to be self-financing. Many economic estimates are above 1, and higher yet over time when you include investments etc. (Note that this is not hours worked but total margin of all decisions effected by taxes)
3. The criteria is *not* that a tax is fully self-financing, but that you take into account the distortion. Again example:
Say for the sake of argument that the tax elasticity is a moderate 0,6 and that were are going from 50% to 51% tax rate. Yes, as the brilliant leftists economist note tax revenues would go up, slightly. But at this rate you are destroying 9 dollars of household income for every dollar the government collects!
Does the “reality based” community really think every marginal dollar in government consumption is worth 5-10 dollars in private consumption?
No? Than why do these morons think tax cuts are justified as long as you don’t hit the revenue maximizing rate? Don’t they understand close to the laffer curve you are still doing massive economic damage?
Let’s do a last low-ball example: someone facing a 40% marginal tax rate (again including local, sales taxes and contributions, and looking at the total margin) and a low 0,4 assumption of elasticity.
The government is destroying 2 dollars in private income for every tax dollar collected.
Can our liberal friends please tell us which marginal government programs they think are worth twice as much as private spending? Magic Cuban health care? More farm subsidies? Spending more than the current 10.000 per pupil at K12 education?
Posted by: Shirkuh at Sep 6, 2007 5:44:05 PM
"a more fruitful question which I'd like to see Yglesias, Chait and others grapple with is why discredited, crackpot ideas can become central elements of a winning political party in the world's most important democracy. Explain the demand side and give us your policy prescriptions."
The demand side is everyones desire to "have all that and a pony too". The enablers are right wing economiists who put their hands in their pockets and whistle when their compatriots trot out these goofy ideas.
Posted by: RobbL at Sep 6, 2007 5:45:07 PM
Considering we live in a world where a majority of people believe some supernatural being is helping to decide sporting contests and wars, wingnut economics almost look sane.
Almost.
Posted by: alphie at Sep 6, 2007 5:56:39 PM
martin,
First, you bunged the math, hardcore. At a rate of zero, revenue is zero. No one will or indeed can dispute this, not even the most ardent supply-sider. This fact is represented in every Laffer curve ever drawn by anyone.
Second, why do you characterize wanting to keep more of YOUR OWN MONEY as "greed"? I must not understand what this word means.
Posted by: Noah Yetter at Sep 6, 2007 6:29:59 PM
The most annoying characteristic of the left by far is intellectual laziness combined with smugness.
why do these morons think
Can our liberal friends please tell us
Do you make a habit of calling your friends smug and intellectually lazy morons?
Posted by: Bernard Yomtov at Sep 6, 2007 6:35:12 PM
The thing that Ive never understood is why cutting tax rates in order to increase government revenues is such a good idea in the first place? If you think that government outlays distort market signals then why would you want the government to have more cash? Cutting taxes is a good thing merely because it increases the amount of money within the private sector.
Posted by: John Pertz at Sep 6, 2007 6:57:10 PM
Alex (the one who isn't me):
I would say -- and I think Matt Y and Jon C would say -- that crazy supply-side claims work as a political message because they sound good and because *the press lets Republicans get away with saying them*. The media reports these claims as he-said, she-said without actually making it clear what the economic consensus is. Cheney says tax cuts increase revenue, some Democratic politician disagrees, that's the story. Maybe it's true, maybe it's not, but it sure sounds good don't it? In other words, the incentive comes from the poor operation of the media.
As such, I think you should realize that Jon's book and Matt's blog posts aren't trying to educate the public about economics. Only knowledgable, politically oriented people read that stuff anyway, and they don't need the help. Matt and Jon are trying to educate the politically active class about how the Republicans work the media in the hopes of changing not the Republicans or the public, but in hopes of eventually changing the way the media covers this stuff.
Posted by: Alex F at Sep 6, 2007 7:20:36 PM
"...everyone acknowledges that the Laffer curve does exist."
Show me a nation-state whose sole source of government revenue is a single, universal "tax rate" (on what?) and I'll believe that a Laffer curve exists. Maybe.
As a previous commenter said, it's a optimization problem, and one with many many variables at that. It's not a curve, it's a landscape. And considering market incentives are part of it, a shimmering one at that.
When the majority of the population organizes their entire lives around the notion that when they die their ghost will forever in paradise (so long as they give 10% of their income to child molesters in pointy hats), how hard is it to conceive of them buying into crackpot economics.
What sells is a SIMPLE message, that they WANT to believe, whether or not its right.
Posted by: efp at Sep 6, 2007 8:21:04 PM
People are more willing to believe poor arguments for ideas they like than good arguments they don't like. That, in addition to the fact that no one actually says the idea is complete garbage, means that the idea will persist.
Also, tax cuts were one of the major glues that held together the neoconservative coalition, which we can see now since every Republican Presidential Candidate STILL supports the idea. Coalitions naturally spawn off their own institutions to support ideas, and the core ideas receive the most support; they therefore die the longest and hardest death.
Posted by: Robert Olson at Sep 6, 2007 8:43:22 PM
I hate to repeat myself, but its important.
Most People don't care how much revenue the government earns. most people do not benefit significantly from government programs designed to redistribute wealth.
most people would rather have the government lessen their tax burden (perhaps a negative income tax for the very poor).
Yglesias has a worthless slogan: You can't raise government revenue by lowering taxes.
Not to many people swell with pride when their government earns more money (especially in a federalized society.
Posted by: thehova at Sep 6, 2007 9:09:38 PM
