Sunday, June 24, 2012

Defending lower tax rates

This article in the Fiscal Times slams the Romney jobs plan as 
In a phrase: more tax breaks for business.
Putting aside the accuracy of that assessment, lower taxes on business can easily be defended on their own terms. The article goes on to say
1,100 non-financial companies... were sitting on cash hordes in excess of $1.24 trillion last December. Apple alone was sitting on nearly $100 billion. The entire corporate sector had over $2 trillion in cash. Alas, robust hiring has not followed in the wake of surging profits.
This might be true. The flaw in these numbers is that the 1,100 companies surveyed also tended to be large companies, which aren't the ones doing most hiring. 

Past studies have found that over 80% of new jobs have been created by companies with 100 or less employees. The specific numbers can be contested, but the general picture remains: small businesses are extremely important for growth and job creation. 

Small businesses benefit more from low tax rates; a big company like GE has an entire legal/accounting division aimed at reducing tax incidence, so the marginal rate doesn't matter that much to them. For a small company though, taxes can make the difference between being profitable or not -- or if taxes appear too high to make a profit, someone who might have decided to start a business decides it's not worth it after all (or more likely, venture capitalists are less excited about funding their idea).

Lower tax rates not only make existing businesses more profitable, but more importantly, expand the range of potential business ideas which could be profitable. That is where the real gains emerge from.

The next logical question is, if not through lower tax rates, how can the Federal Government help in private-sector job creation?

I haven't read into all the specifics of Romney's plan but I'm more optimistic about it than the current approach, which is higher taxes plus higher spending. Some economists predict that when government spending goes up, individual consumption goes down because people realize they'll be paying higher taxes in the future (the Ricardian Equivalence argument) so they need to save now to keep their consumption stable. Taken 100% seriously, this would imply that every dollar the government spends is offset by a reduction in private spending. It's probably unrealistic to think people are this foresighted, but even some people behaving in this way would offset the economic benefit of high spending.

Tyler Cowen argues that this is roughly what has happened regarding state/local spending, which has been cut recently. Keynesians like Paul Krugman blame this local austerity for stalling recovery, but maybe people just aren't feeling as rich as they used to, so they want government services reduced to "affordable" levels. More federal spending then leads to a tradeoff at the local level. The solution is to rebuild trust in government through less red tape and more balanced fiscal policy (although Cowen does not make this prescription explicit in his article).

Regarding taxation and fiscal policy, I'd say that sometimes less is more.

2 comments:

  1. "Regarding taxation and fiscal policy, I'd say that sometimes less is more."

    Sure, when you're taxing people with a high propensity to consume and spending public funds on largely useless investments, then cutting taxes and spending simultaneously is beneficial. Problem is, cutting business taxes ain't the same as cutting the self-employment tax and lowest income brackets. It also implies that we should tax undistributed corporate profits because Apple's surplus is a useless pool of capital that would be better spent as dividends or hired workers.

    "More federal spending then leads to a tradeoff at the local level. The solution is to rebuild trust in government through less red tape and more balanced fiscal policy (although Cowen does not make this prescription explicit in his article)."

    Inflation adjusted federal, state/local, and even military current expenditures per capita are currently dropping, so I don't see what you mean by this tradeoff. If Ricardian Equivalence were right, then the private sector should be expanding with every laid off teacher.

    http://research.stlouisfed.org/fred2/graph/?g=8eJ

    As for Cowen's trust argument, it's thin. First, state and local governments have all kinds of fiscal and debt constraints that the federal government does not, e.g. balanced budget requirements and property tax caps.

    Secondly, Cowen is pleading that we need to prostrate ourselves before voters' revealed preferences and no magic policy will change them (this is really a passive-aggressive confidence fairy argument). He can subtly criticize Keynesians all he wants for "condescending to voters," but Cowen knows full well that the GOP has fomented and thrived on citizens' ignorance and distrust of government. When he writes, "And for better or for worse, those voters have lost faith in the social returns of these jobs and our ability to afford them," he should know full well that it's for the worse, yet he chooses inertness over advocating for what's right.

    For instance, as you know there's a declining marginal benefit to government spending, so if citizens are right to distrust government, shouldn't Cowen be arguing for shifting spending from less productive programs to more productive ones? Shouldn't we prefer cutting spending on Afghan wedding party drone massacres to keep elementary school teachers employed? And there's tons of other savings to be had, like cutting out-of-control medical costs, closing some of the 700+ military bases we have on the planet, laying off some of the paper-pushing generals created during the War on Terror, making the State Dept. use U.S. army instead of mercenaries for protection, making soldiers sleep in regular tents instead of air conditioned ones, mothballing a few aircraft carrier fleets and nuclear silos, and shuttering a few of our intelligence agencies.

    I'm sure doing that could fund some useful state transportation and education departments while reducing government spending overall and satisfying our Ricardian Equivalence needs, yet Cowen throws up his hands saying we can do nothing but wait for people's assets to regain their lost value. If I didn't know any better I'd think he believes voters' lost faith in local employment is for the better, not the worse.

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    1. "If Ricardian Equivalence were right, then the private sector should be expanding with every laid off teacher."

      That would be an overly simplified reading. If consumers think about their future tax liability to update their consumption choices over time, a one-year dip in government spending is just noise. The overall picture is of continually increasing deficits which will require higher lifetime taxes. No one would argue that either consumers or businesses respond only to the most immediate events.

      I don't want to read excessively into what Cowen means in that NYT article for fear of over-interpreting. I don't think either he or I would disagree about shifting funding from war efforts to social spending. That's not really the choice that is on the table though, regardless of which candidate wins the election.

      The point I take it is that federal deficit spending is no free lunch, because consumers/voters are watching what goes on and not trusting the pattern they see from government. The national level is harder to influence so state and local government services get cut (and as an aside, I'm not sure all fear of government is "irrational.") Fiscal caps are part of it, but if they really wanted to the states could follow the federal government's lead, and vote themselves a higher budget... but they haven't. I'd say that's function of both political institutions and revealed preference from state voters.

      The benefits of local government employment would have to be argued on a case-by-case basis. Value added by another police officer is probably high; value from additional administrative staff for public school districts is probably low. I don't see why this should be an object of faith at all, because not all government employment is alike.

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