Monday, December 24, 2012

Fiscal cliff or fiscal molehill?

Four thoughts, reflecting my frustrations with the "fiscal cliff" debate. 

1. Recession

How terrible will it be if we go over the cliff?

Bad, but for all the wrong reasons. If you, like me, didn't think that "stimulus" from government spending raised GDP in the recession, you can't complain that less government spending will cause a new recession now. The CBO's projections of recession are entirely Keynesian. Pay them heed if you still think the key to prosperity is for the government to borrow money and blow it.

There are no "cuts" in sight anyway. "Cut" in Washington means "increase spending less than we previously said we would." At worst a few programs will have to spend the same amount this year as last before spending increases resume.

It's not even obvious that the "cuts" will happen. Will Congress really try to pay doctors 1/3 less? (Will doctors take any medicare patients if they do?) Or will they pass an "emergency" bill, exempting doctors just like Social Security? Sequestration has never actually been used.

To an economist, the main worry is that higher marginal tax rates mean more distortions, which are a drag on the economy.  But distortions take a while to kick in. It takes a while for people to change to easier jobs, not start businesses, move businesses offshore, not go to school, choose easier but less rewarding majors, find more tax shelters, and so on. So the danger is not so much a recession, which comes, and then ends, and we go back to growth. The danger is settling in to a decade of (even more) high-distortion, sclerotic growth.

The headline rate people are fighting about -- 35% vs. 39.5 % federal income tax rate -- is basically irrelevant to the larger issues. If we had a clear, functional, stable tax system, with a total (all taxes) 39.5% top marginal rate, the economy would heave a big sigh of relief and take off like a rocket.

We have instead a horrendously complex, nay corrupt, tax system. It's chaotic, with teams of lobbyists descending now to carve out everyone's exemption, deduction and subsidy. Tax reform is, in my judgment, more important than the headline marginal rate. More generally, I think the lessons of growth economics are pretty clear that over-regulation and the consequent politicization of economic decisions is a larger danger to growth than any stable clear and uniformly administered taxes with faintly reasonable marginal rates. If you can start a business and know for sure you'll keep half the profits, that's more enticing than never knowing what new holdup you will be subject to from 100 overlapping regulatory agencies.

Furthermore, economics cares about the total marginal tax rate -- everything between the extra dollar you earn and the additional goods you receive -- including Federal, state and local income taxes, deduction phaseouts, payroll taxes, taxes on rate of return between earning and spending, sales taxes, estate taxes if you leave it to your kids, property taxes if you buy property, excise taxes, and on and on. Some parts of Washington seems to finally have figured out that reducing deductions raises taxes with less distortionary effects on marginal tax rates.  They have not so successfully figured out that every phaseout or income test adds to marginal tax rates. In any case, it makes no sense at all to talk about the Federal income tax rate in isolation.  

Economics cares equally about taxes and benefits. Whether you send the government a check or they send you a check doesn't matter, what matters is how that check changes based on your behavior. Marginal tax rates are high for lower income people too (earlier post on the subject). Asset tests are just as bad as income tests: If you save, and then an asset test takes away a benefit such as college aid, you might as well not bother saving. It makes no sense to talk about taxes and not benefits at the same time.

Economics cares about the overall impact of the Government on decisions, not just on-budget taxing and spending. If the government says "employers shall provide $15,000 worth of health insurance to every employee," that does not show up on the budget -- but it has exactly the same effect on the economy as a tax and benefit. If the government says "all gasoline shall contain 10% ethanol," that has the same effect on the economy as a tax and subsidy.

2. Distribution

The same points apply even more to distributional questions -- are the "rich" paying "their fair share," should they "pay more," and so on.  The headline Federal income tax rate is the tip of the iceberg. Economics tells us to consider the overall effect of the government at all levels on the distribution of individual consumption. (Not household, not income, not wealth.)

Obviously, we have to talk about taxes and benefits in the same breath here. We also need to talk about who benefits from government spending and intervention. There's a lot of corporate welfare, which ends up in the pockets of some very rich people. If we remove a few hundred billion in green energy subsidies, and the Al Gores of the world can't make another $100 million bucks on it, that ought to count as reducing the transfers to the rich just as much as raising their taxes.

Economics cares about the burden of taxation, not who pays taxes. This is clearest for gas taxes. It's clear to everyone that the government is not socking it to those fat-cat gas station owners with gas taxes, they are simply passed on to you and me.

3. Politics (admittedly dangerous speculation for an economist)

What in the heck is going on? Why is our national discussion paralyzed over the tip of an iceberg?

Only one story makes sense to me. President Obama has been saying for four and a half years that he wants to raise taxes on "the rich," and he means to do it. He wants to raise tax rates on the rich, for symbolic, social, political reasons as much as for anything in an economics textbook. Nothing else explains the Administration's monomania on this point, especially given that it won't make a dent in the deficit, the fact that it makes zero economic sense as a central policy to address our economic problems, and given the Administration's refusal to talk about reform -- which would raise tax revenue and help economic growth -- instead.

"The rich," need to get with the program, like Warren Buffet. It remains open season for deductions, exclusions, special deals and loopholes. Notice Buffet never asks for removal of all the clever dodges he uses to pay less taxes, and nobody has mentioned that he might do so. Tax on unrealized capital gains anyone? Limit the exclusion of charitable donations, even to family foundations that employ family members to run them, from estate taxes? Boy, that would raise a lot of revenue from some truly "rich" people.

Quid pro quo here, though, rich people and the CEOs who recently visited the White House had better line up and support the Administration if they want their special deal, deduction, credit, Obamacare waiver, and no visits from the NLRB, EEOC, EPA, consumer financial protection bureau, and so on.

High statutory rates, a Swiss cheese of loopholes renegotiated in every annual crisis, and an army of regulators on the prowl, are a recipe for permanent Democratic government. The cliff is beautifully structured to make Republicans look bad. Things happen when they make sense. This path makes enormous political sense.

The amount of magical thinking on the economic left doesn't help.  They used to claim that that economies like the US in the 1950s can still grow (for a while) despite high marginal tax rates (which nobody paid because of huge deductions). They used to claim that high tax rates wanted for other reasons don't hurt too much. Now they've talked themselves into arguing that high marginal tax rates are actually good for growth.  Why not just say the obvious, this is a policy desired for political reasons, and the political outcome is more important than the economic damage?

4. The future (admittedly dangerous prognostication for one who says things are hard to predict)

The discussion around the cliff  sounds like we are finally settling some large issue. We are not. This is the fiscal molehill, not the fiscal cliff. This is Harpers Ferry, not Gettysburg. It's the Anschluss, not D-day. It's... Ok, I'm overdoing the military analogies, you get the point. This is the prelude to what looks to me like 10 years of constant crisis.

Here is the big issue. The US has already enacted European welfare and regulatory state with American characterstics -- the bloated inefficiency, legalism, and red tape that is our specialty. We have not enacted the taxes to pay for it. We will either dramatically cut back the former, or rather dramatically raise the latter. On the table now is at most $100 billion out of a $1 trillion deficit, and likely much less. The fiscal molehill.

US Federal, State and Local spending is 40% of GDP. Pay attention to state and local, that's a lot more than the 24% Federal we talk about a lot. Europe is more like 50% of GDP, so it sounds like we're behind. But our government is bigger than it looks.

We have about a trillion dollars of "tax expenditures," including the deduction for employer-provided health insurance, deduction for mortgage interest, and (small but annoying) credits for all sorts of things like checks to silicon valley CEOs too subsidize the electric cars they drive down t their private jets. These are no different than a trillion dollars of tax and another trillion dollars of spending, or another 6% of GDP. We're at 46% right here.

Our government likes mandates and rules, which affect behavior and soak up the economy's taxing capacity just as much as on-budget taxing and spending, but hide the fact. Europeans tax gas and energy, and people choose small cars and turn down the heat. We have mileage standards, energy efficiency standards, carpool lanes, electric-car sales mandates, and so on. Same real size of government. And so on.

Before the ACA, our government was paying for health care for about half the country, in our inimitably inefficient style, including medicare, medicaid, schip, and current and retired government employees. Under the ACA, we're basically all in a European style system, funded by explicit or implicit (mandates) taxes. With those uniquely American characteristics.

The fact that government overall is about half of GDP matters to our tax debate. Properly measured, the average American must then pay about half his or her income in taxes. For every dollar taxed at a lower rate, another dollar has to be taxed at a higher rate. When we tax the average dollar at 50%, any progressivity  has to shift a lot of marginal rates well into the territory that destroys incentives and reduces revenue.

Europe pays for this stuff, and its middle class pays for this stuff. 30- 40% payroll taxes, 20% value added tax, $9 a gallon gas, 50% income taxes extending down to what we would call lower-middle-incomes, property taxes, estate taxes, wealth taxes. Sorry, Europe can't quite pay for this stuff, even with those taxes.

But this is our choice. European taxes to pay for the regulatory and welfare state we've already enacted. With the European growth and eventually southern European corruption they entail. Or a sharp cutback in that state. We can decide before or after we experience the European debt crisis.

So, the fiscal cliff is just the beginning. This will be a long hard road, and my guess is that we will lurch from crisis to crisis, with patchwork last minute deals, for another decade. It doesn't have to be so -- the economic choices are clear. But given the size of the question at hand and how little anyone is talking about the real issues, it's hard to see another way.

I think the deck is stacked towards the large-state camp.  There were two theories: "Starve the beast" said, cut taxes and eventually the size of the state will have to shrink. "Vote the benefits" said, increase spending and regulation, and eventually taxes will have to be raised to try to pay for it all. The latter seems to be winning.

I guess it's appropriate that the Grumpy economist is playing the Grinch for Christmas!


  1. I don't think Obama is driven by ideology or fairness. I think he is driven solely by politics. He doesn’t care if the country goes over the cliff. What he wants is to humiliate the Republicans. He is offering them the following choice:

    1. Be my slaves.

    2. Accept all of the blame I will dump on you for every thing that goes wrong over the next four years, and my slaves in the Media will beat you to a bloody pulp.

    If the Republicans take door number 1, Obama will laugh as they all get primaried and lose control of the House in 2014. At least that’s what the Democrats believe, and I don’t think they are wrong.

    Door number 2 is correct. There will be a veritable storm of blame if the the Republicans do not fold. And the MSM will blame the Republicans for everything from earthquakes to halitosis.

    But, I ask so what. No matter what happens the MSM will attack the Republicans. That is what they do. Indeed, it is the only thing they know how to do.

  2. As far as the consequences of going over the cliff are, Here is what I wrote a month ago, and I am sticking with it:

    1. Changing tax rates will not affect tax collections.

    From one my favorite websites:

    How much does the top income tax rate affect how much money the government collects each year?

    * * *

    The chart below plots the ratio of total government Revenue Per Household (RPH) to the Median Household Income (MHI) for the U.S. for each year from 1967 through 2010. The chart also plots the maximum income tax rate that the topmost income earners in the United States have had to pay for each year from 1967 through 2010.

    [chart omitted]

    * * *

    What we do see indicates that the maximum tax rate has little to no bearing on how much money the federal government collects per household in any given year. Since 1967, the government's RPH to MHI ratio has risen steadily on average, indicating that the U.S. government is collecting more and more money per household over time, with the changing level of the topmost income tax rate having little to no effect on the rate of that change.

    With that being the case, there is no legitimate reason to set higher income tax rates today, as they are now demonstrated to have little to no effect on how much money the government collects in any given year.

    Check it out at the link.

    The correlation between MHI and RPH is very tight. R^2 = .996584

    2. No matter what Congress does with the tax code, go over the fiscal cliff or do what Prez wants, there will be a recession. At least three factors determine that:

    a. The implementation of Obamacare will cause employers to reduce hiring, lay employees off, make full time employees part timers. It will also cause insurance premiums to skyrocket and millions of people to drop existing coverage.

    b. The ongoing cluster**** in Europe will get worse not better.

    c. China will continue to struggle to maintain any semblance of growth, and fail.


    Lasciate ogne speranza, voi ch'intrate.

    1. Yes, thank you for that. You can't imagine I often I've referenced those links since you first posted them.

  3. A superb essay!

    One might say the old expression of ‘money is the root of all evil’ is off target and the correct expression is: ‘other people’s money is the root of all evil’.

  4. How about we get the economy back on track first and when we're blowing and going again with a strong economy then we start cutting the deficit?


    Sometimes I just crack myself up

  5. So... If we know what the real big issue is, the real question is how we can bring the this to the forefront of a national discussion. Unfortunately, we only seem to be able to focus on something painful if it is a crisis.

    However, we seem to be able to focus on global climate change and many other things that are not short term crises. Why? Because someone decided it was cool and trendy. (And maybe because there is really no pain to the average voter from talking about it). So what would it take for the MSM to really focus on a fundamental issue that we really can do something about?

    New York Times, what would it take for you to do a series of articles on the upcoming apocalypse when we can no longer borrow from the Chinese to provide benefits for ourselves? Think about Greece times 100. Seems pretty trendy and cool!

    1. I don't think the NYT has any interest in the bigger issues. Let the state entrench, then urging "commpromise," pass the VAT and wealth tax to satisfy the bond markets, is exactly what they want to happen.

  6. Why exactly is big government bad? Can you offer some quantitative measure showing the advantage of small government as opposed to big one? I can point to one country having small government and few regulations: Somalia. Anyone wants to live there? Europeans developed their welfare state because for centuries small groups of wealthy people ruled and controlled everybody else. If sequestration happens, many people will lose their jobs. They in turn will stop spending. I fail to see how that can possibly help the economy. The current fight over taxes is simply a fight over fair distribution of profits. Since the 80s capital holders have been taking bigger and bigger share of profits at the expense of the employees. So the employees are rising taxes on the employers and voting themselves benefits. Why is this bad? Which is more important: a live-saving surgery for a coal miner, or another BMW for a coal mine executive? Which would benefit a society more?

    1. Rafal, there were numerous attempts to build a socially just society where the decision of what's more important - a life-saving surgery for a worker, or a limousine for a boss - lied with government.

      They all failed. These attempts brought misery, death, tyranny and corruption on the scale not seen before.

      And the funny thing about these attempts? Parteigenossen - the executives of the just society - did have their limousines, but coal workers did not have their surgeries.

    2. There is probably an optimal set of size and regulatory parameters for any given system, but bigger isn't necessarily better, which is why there are no 100 pound spiders and elephants don't rule the world. The larger and more complex a system is the more fragile and the more energy it takes to maintain. If large hyper-regulatory systems are best then then the USSR should be the greatest country in the world instead of shattered fragments.

      Do you want more regulations? They've already done sodas in NYC. Maybe they should do hamburgers next. But first explain to me why a woman is deemed capable of making a profoundly serious decision like whether or not to terminate a fetus but she's too irresponsible to decide on what size soda to drink. In what way does that lead to "fair" (undefined so far) distribution of profits?

      Here's a fun regulation. My staff is currently going through hundreds of charts to ensure that every page has the patient's name and date of birth on it. Medicare will fine me $2,000 PER INCIDENT for any that are lacking those two items. Meanwhile, the penalty for possession of small amounts of marijuana in my state is $150 for the first offense.

      So instead of working on providing patient care and collecting my fees my staff is printing out and pasting labels in charts. Who benefits from that besides label makers?

      The coercive push into electronic health records has cost practices tens of thousands of dollars (hospitals - millions) and cut productivity. Ditto the conversion to the 5100 billing form for CMS. When ICD-10 comes all hell will break loose as everyone has to adapt to the new coding system (complete with 68,000 codes), update software, deal with the inevitable bugs in the system (like we had with the 5100 conversion and people didn't get paid for months), etc.

      Again, how does that profit anyone except those who manage to situate themselves between the regulators and the regulated by selling software and consultation services?

    3. It is a pretty basic introductory economics example that taxation causes a deadweight loss. Government is great for lots of things like correction market inefficiencies but to much government also leads to inefficiencies.

      It seems that you trying to make a moral argument to which economics has no answers for. Economcis only says what is the most efficient outcome...for better or for worse.

      Also Somalia is a pretty bad example. Comparing a small governemnt to a big government is one thing but comparing a big government to a country that has no actual government is looking to mislead people.

    4. On the contrary, Somalia is a perfect example of big government. Not as an absolute, but relative to GDP. In Somalia, 100% of the GDP belongs to the king, president, emperor or whatever it is called.
      There are no taxes or regulations because they are not necessary, the king can dispose of any propery or people at will.

    5. As the size of Government increases, the opportunity for rent-seeking increases.

  7. John,

    "Furthermore, economics cares about the total marginal tax rate -- everything between the extra dollar you earn and the additional goods you receive -- including Federal, state and local income taxes, deduction phaseouts, payroll taxes, taxes on rate of return between earning and spending, sales taxes, estate taxes if you leave it to your kids, property taxes if you buy property, excise taxes, and on and on."

    Only if you think everything is an aggregate demand problem like most Keynesians.

    An unslanted economist would look at tax policy as an extension of monetary policy - how does tax policy affect the time cost of money ( or monetary cost of time if you prefer )?

    1. A significant part of our tax policy consists of attempts to channel the flow of money - a set of rewards and punishments designed to influence individual financial behavior. If that weren't the case we'd all be filing 1040A's.

      That's not an aggregate demand issue. It's an attempt to steer demand in certain directions.

  8. I don't understand one thing:

    Sweden, Norway, Denmark, Germany, Netherlands, Switzerland, Finland are not in any sort of crisis, are able to maintain dramatically more generous welfare states than US and are nowhere near any sort of southern European style crisis.

    I agree with you, they pay for their welfare states through higher taxes on the middle class. In other words, they trade off middle class consumption on junk food, tvs, etc. for state driven investment into K through 12 education, college education and healthcare.

    so what's wrong with U.S. doing the same?

    Btw, most of these countries have MORE regulations that we do about hiring, firing, permits, etc. and yet they are fine. How does that square with what you are saying ?

    according to this article,

    Sweden has more per capita billionaires than U.S.

    1. >Sweden has more per capita billionaires than U.S.

      Sweden major enterprises are mostly old - evidently, more regulation and protection helps. U.S. major enterprises are mostly young - despite regulation and protection.

      Another curious example.

      Poland and Ukraine were economically similar 20-30 years ago. Now Ukraine has more billionaires than Poland - per capita, too - despite the fact that Poland is much richer. And yet, Ukraine is much more "equal" society than Poland.

    2. View with a grain of salt ... I'd love to see something more academic on good v bad liberal policy (i.e. sweden v italy).

    3. "Sweden, Norway, Denmark, Germany, Netherlands, Switzerland, Finland"

      Lots of Lutherans with some Calvinists, not so many Anglicans, Catholics or Baptists. :-)

    4. Let's dispense with non data-driven explanations. Sweden used to be very poor in the 19th century and was still Lutheran.

    5. "Let's dispense with non data-driven explanations."

      I assume that comment is directed at me. The distribution of value systems is a potential data driven explanation.

      In the 1800s Sweden and Denmark were hit hard economically by the rise of competing agricultural producers - principally North America. Sweden responded by industrializing and Denmark responded by upgrading its agricultural production through government funded agricultural research. Denmark also had some industrialization (for example, Burmeister & Wain). By the 1930s Sweden had the highest standard of living in the world.

    6. for state driven investment into K through 12 education, college education and healthcare....
      So you don't actually know what we spend, right? look here:
      The US spends 8% more per student in Elementary and Secondary Education, 68% more in Post-Secondary than the countries you mentioned. We have tripled per-student expenditures, in real terms, during my lifetime. That alone should tell you--the problem isn't the amount of "investment".
      In general, I love the "why can't we be Norway" argument...Yeah, why can't we be like a country of 5-6MM people, with a gusher of petrodollars, racially and culturally homogeneous (with significant cultural strengths), bordered entirely by first-world nations...when you ask the question in that manner, the answer presents itself.

    7. In what way is the USA not a socialist state? Is it true that we have less government spending per capita than those other nations?

      You ask why can't we be like them? Well maybe the answer is that because we are who we are; with a very poorly run and corrupt government which makes stupid decisions. And a very stupid electorate which responds to the empty promises of cynical politicians.

    8. So basically anonymous and kyle8 are back to throwing insults around and away from a data driven conversation:

      anonymous: Denmark, Sweden, Germany, Netherlands, Finland, Norway is close to 80 million people and they are pretty diverse culturally and otherwise. In any case, cultural diversity is an asset not a liability for a country

      Kyle8: that's your way of saying you don't know I guess.

      there is a simple answer, I think. The idea that large welfare state kills growth is not supported by data to the degree that John and other libertarians assert

    9. No, anonymous it is you who dodged the discussion, I asked you a straight forward question, in what way is the USA NOT a big welfare state? We have spend both on the federal and local level trillions of dollars on public welfare, If the results are not what you would like to see then we go back to what I said, maybe it is because our government is incapable of making good decisions.

      Statists always use the example of the Scandinavian nations to prove that socialism works. But they always leave off the fact that every one of those states have moved toward lower taxes and less spending in recent years. Why?, because they had to to compete in the world marketplace.

    10. No, anonymous. Club Sweden is only around 8 million people. Yes, diversity is a positive, but only in a dynamic society with a culture of innovation. And so is a large population in that case. In a zero-sum socialist society, a small homogenous group works much better. The Scandinavian countries, despite some real liberalism (in the classical sense), racism is the norm and youth unemployment in Sweden is over 24%.

      It's interesting how proponents of socialism gravitate toward Scandinavia, but I see little in common with Scandinavian countries and much more in common with their Southern neighbours.

      Finally there's the straw man of killing growth. No serious libertarian, no serious economist will say that all growth is killed by a socialist state. People are imaginative and we did not survive as a species by throwing our hands up and laying down to die because life became tougher. And people still have to eat. Where the welfare state grows, everything grows much more slowly and the standard of living is much lower. Yes, even in the beloved Scandinavian states. Houses and cars are smaller, the number of personal items lower. They are forced into smaller, less rich lives. They are limited. Except for the politically connected, of course. That the standard of living in large welfare states is much lower is well supported by empirical evidence.

  9. "Quid pro quo here, though, rich people and the CEOs who recently visited the White House had better line up and support the Administration if they want their special deal, deduction, credit, Obamacare waiver, and no visits from the NLRB, EEOC, EPA, consumer financial protection bureau, and so on.

    High statutory rates, a Swiss cheese of loopholes renegotiated in every annual crisis, and an army of regulators on the prowl, are a recipe for permanent Democratic government."

    This is a very important point. High marginal tax rates give politicians much more leverage in doling out favors (or denying them). If the general marginal tax rate is 10 percent, the ability to deny or create deductions against that rate is significant, but not necessarily economically determinative of business decisions. However, when the general (federal) marginal tax rate climbs to 43.4 percent then this power has increased exponentially. (I'm talking about the marginal rate including the ObamaCare surcharge on investment income takes effect next year---this does not include state or local tax or the double corporate/individual taxes on corporate earnings). The power of government to dole out or deny a tax deduction for preferred constituents and activities becomes much greater. Creating high marginal rates with the ability to create "exceptions" to generate much lower effective rates is a politician's dream, particularly a politician who believes that he should also be the central planner. Add the ability to regulate or to exclude from regulation, and the power is enormous. In a similar manner, any crooked cop knows that the ability to shake someone down grows in proportion to the penalty associated with the alleged offense.

    Many readers may have missed the fact that the capitalization of "Democratic" in the following phrase "a receipt for permanent Democratic government" was likely meant to refer to the party rather than the process. There is nothing inherently democratic about how favors are doled out via tax expenditures.

    Republicans have been known to hand out tax favors, too; however, in general, Romney's proposal to reduce marginal tax rates across the board *and* eliminate deductions in a progressive manner to pay for them would have had the result of reducing the ability of government to exercise this power through the tax code. Unfortunately, it appears that any serious discussion of true tax reform was obliterated at the same time the partisan assault on Romney's "math" succeeded.

    1. "Unfortunately, it appears that any serious discussion of true tax reform was obliterated at the same time the partisan assault on Romney's "math" succeeded."

      The "partisan assault" basically went like this:
      1) Romney: "I have a plan that will reduce current tax rates across the board and make up the lost revenue through base broadening."
      2) Liberal: "I can't find opportunities for base broadening that could balance your proposed cuts in rates. Please give us the details of your base broadening plan."
      3) Romney: "I refuse to give the details of my plan."
      4) Liberal: "Q.E.D."

      How could there be a serious discussion of tax reform when Romney (and Ryan) expressly refused to give details? All Romney had to do to crush the "assault" was to give details that actually added up.

    2. Not True!
      In one of the debates Romney said that his approach would have been to limit the amount of deductions for high earners, and let them decide which ones to use.

      With regards to the cliff, I think Obama is looking for someone to blame for all the problems that he knows that Obamacare could cause.

    3. I think the Wall Street Journal published the details of the plan after the debate. It was an interesting idea that never seemed to get any traction. As I recall, the plan specified the amount of deductions (e.g., $15,000) and let the taxpayers choose which deductions (e.g., mortgage interest) to use. Romney/Ryan could then avoid targeting a specific deduction to eliminate.

    4. I'm not sure why anyone would argue that the spirit of the Romney tax plan is bad ... though our president does.

      I think Romney made a poor decision to be very specific on the popular piece (20% reduction of all marginal rates) and not very specific on the unpopular piece (what deductions to eliminate). My belief, is that Mankiw, wanted to pay for the marginal rate reduction by removing certain deductions completely (mortgage interest, health insurance, muni bonds, state and local income tax). While this would not effect anyone who is poor (doesn't pay income tax), someone with a good salary but awesome health care could be adversely affected. (God forbid they'd respond and switch to the amount of health care they actually want ...). While this change would still be progressive, SOME high earners would benefit and SOME medium earners would suffer. Because of the stigma that is "raising taxes on the middle class", (good thing Obamacare is not a tax on the middle class, oh wait, sc ruling...) Romney changed his tune to limiting deductions for just high earners. Still better than nothing, but he should have put some numbers on paper, (the wsj post you mentioned was probably by Dr. Feldstein on potential Romney plan ideas) and said, we can float the marginal tax cut % from 20 to a smaller number to make the numbers work statically for the CBO (dumb idea, but at least it's a political non starter then).

      I also think he hurt himself by allowing this to be the central piece of his campaign and not getting us back to number 1 on the "ease of doing business list" (stable long term fiscal and monetary policies, rule of law not man, good energy, strong property rights, lower tx costs (see litigation), reducing labor market frictions ...). I think the campaign did a poor job of explaining to the American people reasons for why the recovery was so poor and how a president advised by Taylor (love me some first principles) could have done SOOO much better.

      Sorry to be slightly off topic but I agree with the user above. "It's not me being stubborn, it's not politics, it's just math" should tell us all we want to know about whether the President cares about the economy or winning political points.

    5. "High marginal tax rates give politicians much more leverage in doling out favors (or denying them)"

      Interesting concept, but I doubt they all sit down and conspire to raise taxes so they can grab more power. Raising taxes is almost suicidal in politics.

      Nevertheless, once taxes are raised or new ones imposed I would agree that the power inherent in the ability to grant favors does increase. Exhibit #1: the ObamaCare exemptions being handed out, and to whom.

    6. "Interesting concept, but I doubt they all sit down and conspire to raise taxes so they can grab more power."

      Not all of them, naturally, but quite a few of them do. I can imagine that it took quite a bit of sitting down and conspiring to come up with the additional 3.8 percent tax on investment income and 0.9 percent tax on other income over $250K needed to partially fund ObamaCare, as well as the additional taxes (aka penalties) on persons who don't sign on to the program and purchase insurance through the exchanges. And, the additional taxes on health insurance plans that are considered too generous. And on the new taxes on medical devices. And the new taxes on indoor tanning salons. And, the 15 or so other new taxes in that power-grab of a bill. All of that took a lot of sitting down and conspiring. The purpose of all that conspiring was not to reduce the deficit, either. It was to increase dramatically the scope of government and the power of those writing and enforcing the regulations that go along with it.

      It also took a lot of sitting down and conspiring to come up with increased taxes "on the rich" on top of what I've mentioned in the prior paragraph. The brilliant thing about that conspiracy was that it was intentionally planned to be in two stages, so that by the time the second round of tax hikes would be discussed, the first round, while not yet in force, would already be part of the "baseline" for calculating future increases. The idea was that the first round would then have been largely forgotten by the majority of voters. It worked! That sitting down produced a brilliant strategy that thus far has not been politically suicidal. Quite the contrary.

      The unfortunate thing is that the bulk of these new taxes has already been committed to additional spending (and then some). The purpose of raising these taxes has not been to pare down the deficit, much less the debt. That would not have been a power grab (except when designed to pay for stuff that those same conspirators bought and intentioally failed to previously pay for). The purpose of the taxes is to help pay for new government programs. If you've been following the current discussions on the cliff, you will have noted that in addition to the new taxes, there are a bunch of new proposed spending programs, too.

      Of course, these taxes will not be enough because these "conspirators" have no real plan or even intent to cut back on spending. So, there will be a lot more sitting down and conspiring to figure out how taxes can be raised even more in yet another round. A number of people are now sitting down dreaming of how much more government we could have if only we could add a VAT on top of (not instead of) everything else and conspiring as to how that might be made possible. I think the same group is discussing new taxes on financial transactions, among many other things. These folks have even conspired to "educate" the public that all these new taxes are not only not bad for the economy, they will help the economy grow.

      People sitting down and conspiring to raise taxes so that they can grab more power? I would not doubt that for one minute.

    7. I think the process happens in reverse, and alas is not so easily attributed to evil motives but to the natural operation of a system with terrible incentives that ensnare even well-meaning politicians, of which there are many.

      "Special interests" come to demand favors. And who can resist helping the company in your town, the corn farmer in your state, a little deduction here, a little credit there. Lots of it hides in policy goals; deduction for your windmill, credit for your snazzy electric car. Even the big ones, mortgage and charitable deductions, come from all sorts of well meaning people. Let's help the homewoner, and the construction industry. Let's help the universities.

      But then, the tax code being full of Swiss cheese, it's not raising any money. The crisis comes, and we raise rates to compensate for the swiss cheese, as part of "responsibility."

      And start all over again.

    8. “All Romney had to do to crush the "assault" was to give details that actually added up.”

      1. Added up to what? There was a successful myth created by the Tax Policy Center in that debate that they somehow have the ability, via “simple math” and their own magic micro simulation model (details of which are a carefully guarded secret), to add up a few numbers and thus “prove” that Romney’s plan did not “add up”. I’ve got some news for you—no such model or computer program exists that can do that. The last time I checked, the TPC had claimed, still based on a number of their own erroneous assumptions, that Romney’s “plan” came up about $37 billion short. In reality that $37 billion was an estimate that is subject to a huge margin of error in either direction. This is not math and it is not science. It is an imprecise exercise, subject to numerous assumptions, that at the end of the process comes up with a very, very rough estimate. A bit more humility on this general topic in the future would serve the TPC and everyone else quite well.

      Consider, for example, the following statement of Peter Orszag, then head of OMB and formerly head of the CBO when it turned out that Obama’s deficit numbers were going south from prior estimates:

      Here’s another source on the same general subject you may want to consider:,33

      The TPC claim that Romney’s numbers did not add up as a matter of “simple math” was a claim that should never be made in any revenue projection business. We simply don’t have the ability to predict with much accuracy (much less within $37 billion which is well, well within the range of error) what the revenue effect of a large tax reform package will be. The TPC overplayed their ability and their hand in this case in a very political way. That’s unfortunate because real tax reform is likely going to be one of the main casualties of that effort.

      2. The kind of “details” you are presumably looking for are the kind of things that tax writing committees, not presidential candidates, come up with. I frankly do not understand the logic under which someone thinks they have sufficient “details” to do some definitive simple math and yet in the same breath complain that the person putting forth that plan did not come up with enough details to do the job. As noted under 1) even with more “details” any projection of the effects would have been no better than a rough estimate anyway.

      3. If you want “simple math” then I suggest that you engage in an exercise that can result in a reasonably accurate number:

      Add up the total revenue over the past four years and subtract total outlays.

      Does that result “add up” for you?

    9. "(stable long term fiscal and monetary policies, rule of law not man, good energy, strong property rights, lower tx costs (see litigation), reducing labor market frictions ...)."

      What planet are you living on Parth ? I have not seen any government with those sorts of values for many many decades.

    10. Not in my lifetime. The Republican party / the Romney campaign were smart enough to hire economists such as Taylor, Mankiw and Cochrane, but will they ever be brave enough to listen to them?

      Romney made a calculated decision to NOT run on a "first principles" platform but instead chose two important but smaller pieces. 1) lower rates and cap rich people deductions as opposed to lower rates and remove all deductions and 2) repeal obamacare rather than a comprehensive health care (supply!!!) proposal such as suggested by Professor Cochrane in this blog. WRT fiscal cliff negotiations, I believe Republicans should accept higher rates in exchange for pro growth policies. A list could include: consolidate regulatory agencies, remove czars, increase legal immigration (please stop sending PhD students away after we educate them), reduce tort, repeal VC regulation, extend treasury maturities, replace Dodd Frank craziness with higher bank equity and money market fund equity tranches, create stricter SSDI standards to increase the labor force, reform medicaid / food stamps / section 8 housing to reduce the poverty trap, remove farm subsidies, reduce ethanol quotas, approve the TC pipeline ... (and i'm sure the readers of this blog can compile a better list).

      Higher rates are bad, but we could tolerate higher rates if we offset them with other pro growth policies. Our biggest fear should be the reduction in the expected long run real growth rate.

      I wish the Republican house put together a "take your rates, let's grow the economy" bill then Obama could claim his higher rates grew the economy. Both sides would rather everyone looks bad then risk the other side looking good. A year ago, Washington "burned their ships" and said unless we solve this issue we'll go over the cliff. The cliff hurt the American people, not Washington politicians. I'd have some respect for Washington if the cliff dropped every single elected official's compensation immediately to unemployment insurance and Cobra until the issue was resolved.

      Back to Tirole ...

    11. Well, I agree that tax rates are not as important right now as much as overwhelming regulatory excess. But you have to understand that the Party in power is devoted to just such regulatory excess. It gives them enormous leverage in dealing with big business and with industry in general. Since their regulations can make or break a company, they can get any sort of concessions, contributions, kickbacks out of them.

  10. "I think the process happens in reverse, and alas is not so easily attributed to evil motives but to the natural operation of a system with terrible incentives that ensnare even well-meaning politicians, of which there are many."

    No need to attribute this to "evil motives". I'm absolutely convinced that those "conspirators" honestly believe they have everyone's best interests at heart (including their own). They really do think that more taxes, bigger government (and more power to folks like themselves who know better and will steer us all to a better world) actually do believe this is the best course of action. Never believe any argument that is predicated on the assumption that one's opponent has subjectively "evil motives". That's a cop out.

    As far as which came first, that's a chicken and egg problem. It's a re-iterative operation, I think.

  11. Where is the money in the US economy that isn't the result of borrowing?

  12. The man is called Buffett, not Buffet.


Comments are welcome. Keep it short, polite, and on topic.

Thanks to a few abusers I am now moderating comments. I welcome thoughtful disagreement. I will block comments with insulting or abusive language. I'm also blocking totally inane comments. Try to make some sense. I am much more likely to allow critical comments if you have the honesty and courage to use your real name.