« What to do about climate change? | Main | Sentences of provocation »
A Real Stimulus Plan
As you know, I'm not enthusiastic about a fiscal stimulus plan. What we need is a stimulus plan that does not increasing the budget deficit or waste taxpayer funds but that does increase the incentive to produce output. So what would I do? Here's a new idea.
The IRS knows how much income that each taxpayer reported last year. So let's cut everyone's marginal tax rate based on last year's income. In other words, suppose that last year Joe earned $66,520 which puts him in a 25% tax bracket. Joe's tax schedule this year will be exactly the same as last year except for every dollar earned above $66,520 the tax rate drops to 15%. We do this for all taxpayers so that each taxpayer has their own schedule and for each taxpayer there is a decreasing marginal tax rate.
Note that this plan increases the incentive to work and it doesn't increase the deficit. In fact, the Tabarrok plan increases tax revenues! The key is a marginal tax cut with a different margin for every taxpayer based upon last year's return.
That's the basic idea but there are some obvious modifications that could solve various problems. For example, the new schedule could be based on an average of say the last three years of income or the average plus some roundup for growth etc. It's also possible to cap the base on which the lower marginal tax rate applies, for example, we could create a lower tax rate on every dollar of income above last year's income up to an increase of 20%.
It is true that a permanent system like this could be (partially) gamed but the system can work very well if used occasionally, say for the most serious recessions. We would also learn a lot by applying this system and looking at the taxpayer response.
Posted by Alex Tabarrok on February 7, 2008 at 07:40 AM in Economics | Permalink
Comments
I am absolutely the dumbest guy that reads MR - and choose to comment rarely for fear of ridicule, but:
With the new marginal tax, does Joe just talk to his boss and say "I know there's a recession, and I know I'm salaried, but I'd like to work more and get a raise, please." Is the incentive of a lower marginal tax rate enough to make Joe go get a second job if that fails?
Seems vaguely Laffer-esque to me...
Posted by: Mike McHugh at Feb 7, 2008 8:00:26 AM
Love the notion that this doesn't decrease tax revenue.
Posted by: es32 at Feb 7, 2008 8:10:09 AM
I like the idea but I am not sure that it won't decrease tax revenue? In a hypothetical world where the
total wage volume is given but its individual distribution fluctuates from one year to the other (ok,
that's not very realistic), the increase in taxes from the group of people who see their revenue
increase would be smaller than the decrease in taxes from the group of people who see their revenue fall.
Posted by: vic at Feb 7, 2008 8:34:30 AM
Mike - good point about full-time salaried people, although who knows how many might actually get second jobs? But what about part timers who could increase their hours, people not in the workforce who could re-enter, professionals who could work more hours (doctors, lawyers, accountants, etc.), and, maybe most important, entrepreneurs who could expand their businesses, generating incremental income for themselves and creating jobs for others.
Posted by: gator80 at Feb 7, 2008 8:37:27 AM
Yeah, but under the Tabarrok plan all those people who are paying no taxes will not get a check in the mail! And of course, you are just giving another hand out to the rich. And maybe YOU, in your ivory tower office, have the option of expanding work effort such as delivering more guest lectures and writing more books, but what about the "typical" worker? Incentives don't really matter, do they?
Posted by: wintercow20 at Feb 7, 2008 8:55:21 AM
This is a very cool idea! Just as information technology has made many types of personalized pricing possible (e.g. sending different credit card offers to different micro-demographics), we could offer a more fine-grained tax policy. The current systems (mostly) doesn't use information about a taxpayer's past income. But using such information should make a more effective system possible.
Interestingly, low income people already in the zero percent income tax bracket could even have a negative income tax on the margin, offsetting the 15% payroll tax or even going beyond that, which would help with the distributional aspects.
As Alex notes, such a system would run into problems if in place permanently due to gaming as people shift income back and forth between adjacent years, but might make sense as a one-shot anti-recession policy.
Another downside is that it strongly favors people with highly variable incomes, either due to reporting flexibility or actual circumstances. In fact, much (most?) of the action would probably come from people who's income fluctuated in ways they couldn't control or who didn't actually change their effort, just their reporting. This would, on average, lower tax revenues. That said, increasing the deficit in this narrow case, is not a bad thing. As Larry Summer pointed out, that's more or less the point of a fiscal stimulus plan.
Posted by: A student of economics at Feb 7, 2008 8:55:23 AM
Jeez, a half-second's thought gives you the way to game it.
Move the following year's payments into the previous year.
I think Bell Labs had a permanent oddity in payroll where there were two payments in December and none in January, or something like that, to take advantage of some minor one-time tax change or other in the 60s.
Posted by: Ron Hardin at Feb 7, 2008 9:01:47 AM
It's a novel idea, but it disregards what motivates the politics behind these things in the first place. Lowering taxes on people when they make more money (especially marginal rates) is very much counter to the current vogue in Congress.
The Senate just barely shot down an alternative proposal that, instead of just handing everyone a check or a tax cut, would have dumped extra money into heating subsidies for the poor (as if it weren't Spring in two months), unemployment benefits, and handouts to seniors and disabled veterans (probably some energy independence nonsense, too). This was a near run thing to transfer money into a whole slew of unproductive uses (from the standpoint of economic growth and averting recession.
We'll be fortunate enough if the fiscal stimulus doesn't actively distort the economy, making a possible recession worse. Hoping for a plan that actually encourages productivity is optimistic indeed.
It'd still be fun and interesting to play with the tax code, though. Sometimes I'm surprised things stay as stable in taxes as they are, with mostly just playing with deductions at the margins.
Posted by: Garrett Schmitt at Feb 7, 2008 9:07:39 AM
Aren’t taxes supposed to be progressive for good reason? You are turning the picture around. Give the one that have more. They know best what to do with it.
Posted by: FightInequalty at Feb 7, 2008 9:38:14 AM
Isn't the conventional view that recessions are a demand-side problem, e.g. in the Capitol Hill Baby-Sitting Co-op Crisis? If the market for goods is weak because the money supply is too low, how can supply-side incentives like your scheme be effective?
Posted by: Brock at Feb 7, 2008 9:38:15 AM
Good to see new ideas. However, I wonder if it's really the problem that people aren't working hard enough. Americans already work very long hours compared to the rest of the developed world. Is it sustainable for them to further boost their working hours and if not, won't there be a problem when they later cut back?
Brock's point also seems valid.
Posted by: Finnsense at Feb 7, 2008 9:55:54 AM
A bankrupt form of conservatism can be summarized in 8 words: "as long as I get my tax cut."
A little more rational, and moderate, conservatism gauges debt and deficit.
Posted by: odograph at Feb 7, 2008 10:02:28 AM
How would that apply to those currently in the 10% and 15% brackets? Just curious... doesn't seem like all that great of a deal to them.
Posted by: Michael Fisk at Feb 7, 2008 10:02:55 AM
A very clever idea. I think you could tweak it to address most of the critiques that are made in these comments. Economically, I think the main flaws are:
(1) People can "game the system" by shifting output into the present.
and
(2) The effect will be to shift aggregate supply outward, but my best guess is that the recession is caused by a combination of demand being too low and supply being maladjusted to changes in consumer preferences related to the weaker dollar and the contraction in the housing sector. I'm not sure I see how an increase in factor supply addresses these problems--but maybe Alex can explain the connection.
Posted by: steve at Feb 7, 2008 10:14:56 AM
Brock makes a good point, the problem with a recession is that there is less work than people are willing to do, leading to a decrease in spending which can potentially spiral the problem further down. So there is already underemployment, and all this plan is going to do is increase the amount of people looking for jobs that are not there for the moment.
However, there is a version of it for recessions: why not increase the tax rate for income higher than this years, and use the money for some form of stimulus? After all, people whose income increases during a recession are people apparently not hit by the recession, and they are the natural source to pay for a stimulus package.
Posted by: greatzamfir at Feb 7, 2008 10:15:56 AM
greatzamfir writes above:
However, there is a version of it for recessions: why not increase the tax rate for income higher than this years, and use the money for some form of stimulus? After all, people whose income increases during a recession are people apparently not hit by the recession, and they are the natural source to pay for a stimulus package.
My response: Are the people who determine whether or not "there is a recession" paid by some form of government funds? If so, my guess is THEIR wages don't go down. Why then would any ever document a recession :)
Unless of course they would lose their jobs if they didn't document a recession when it occurred (losing all of one's salary vs. some fraction of it is a pretty bad tradeoff). But then who "really" determines when we are in a recession?
Posted by: AZ at Feb 7, 2008 10:33:49 AM
I presume this is a common point with regressive taxes, but doesn't this plan increase the marginal cost of extra workers compared to making existing ones work harder? Making it a disincentive to creating extra employment.
And don't you think people in the US are working hard enough already and the social costs of encouraging them to work longer hours are worth considering? The US does already have longer working hours than most developed countries already doesn't it?
Posted by: Tim at Feb 7, 2008 10:37:00 AM
AZ, of course Alex's plan has exactly the same weakness in reverse
Posted by: greatzamfir at Feb 7, 2008 10:38:19 AM
Not a bad idea, but two problems....
1) the IRS cannot keep up with IT programming now
2) I don't see any miraculous incentives in this
The highest earners have any number of deferral and avoidance possibilities already.
Posted by: save_the_rustbelt at Feb 7, 2008 10:40:25 AM
I partly take back my previous comment - if someone didn't work the previous year, then presumably the reduced tax rate will apply to the whole of their earnings, making them quite lucrative. There's an incentive there to turn over your staff if you can, off course, as long as you can discriminate for people with low or zero earnings the previous year...
Posted by: Tim at Feb 7, 2008 11:00:21 AM
STR-
Many fail to recognize that tax deferral and avoidance are only second best strategies when a major chunk of earnings would be lost to taxes. When tax rates are reduced, the value of deferral and avoidance decline. I just finished Reynolds' Income & Wealth and I believe he cited studies showing an increase in taxable income of 40% when rates were cut just due to income leaving shelters. The taxes generated by the increase in declared income is the excess over what would be expected just assuming that taxes go down in proprotion to the reduction in rates. Also, that is before any increase in effort in response to higher after-tax income. Supply-side theories predict higher than expected revenues from two sources: reduction in the value of shelters and incentives to produce more. Disclaimer - I do not claim that tax cuts are cost free, at least in the short term.
I don't know how I feel about Alex's proposal, but I always love to see 'em complain about any suggestion that working people keep more of their income.
Posted by: Rich Berger at Feb 7, 2008 11:01:56 AM
How does this increase tax revenue?
Posted by: max at Feb 7, 2008 11:19:53 AM
The tax doesn't cost any revenue because the drop in revenue would occur with or without the tax cut. The cut is designed to spur extra work, which could result in higher than expected growth and thus higher than expected tax revenues.
Under the scheme, companies would accelerate expansion plans, especially if the wage incentive on workers was coupled with a depreciation incentive for companies. Workers would also have an incentive to work more, perhaps proposing to accelerate their own schedules, proposing new expansion plans, or starting new businesses. In fact, some businesses may be forced to increase production, because their most able and talented employees would demand extra work and pay or they would shirk at their current job to focus on other work.
Posted by: 8 at Feb 7, 2008 11:20:44 AM
I'm semi-retired and my income oscillates. For what it's worth, I worked a fraction of 2006 and all of 2007. For me it would certainly be a windfall if my 2007 increase was taxed lower.
Essentially everyone who got a raise in the n+1 year, would get a similar windfall.
Actually we could make the straightforward mathematical observation that this would reduce gov. income: In any given year individual incomes go up and down. They average out. Under this plan everyone who moves up reaps a tax benefit, and everyone who moves down does not.
This would effectively reduce the average tax rate for the workforce.
Posted by: odograph at Feb 7, 2008 11:26:11 AM
Many people are making the mistake of thinking that demand and supply side factors are completely distinct. A supply side incentive plan that encourages work also encourages more spending.
Also an incentive plan such as this must be compared with some alternative plan such as a fiscal stimulus.
Posted by: Alex Tabarrok at Feb 7, 2008 12:08:43 PM
