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Friday, January 25, 2008
Heritage Foundation Blog Responds to My Posts
Writing on the Heritage Foundation's blog, The Foundry, rbluey calls me out for my bashing (here and here) of Brian Riedl's paper Tax Rebates Will Not Stimulate The Economy and recent statements he made in a BNA article($).
The following is my response.
Coming back to tenth-grade economics, in which we learn that "economic growth" refers to the change in the value of all goods and services (gross domestic product, or GDP) produced over a given time period in a given set of product and service markets, we can make any number of assertions that activity X will result in an increased value of such production.
Riedl's paper relies on this definition economic growth ("By definition, an economy grows when it produces more goods and services than it did the year before."), but then claims that increased consumer expenditure, prompted by an increase in consumer income enabled by government transfers (i.e. tax rebates), do not, in fact cause the economy to produce more stuff in 2008 than it would have without such rebates. This is wrong (see e.g., CBO Director Peter Orszag, Federal Reserve Board Chairman Ben Bernanke, Harvard Economics professor and former Chairman of the Council of Economic Advisers and President Reagan's chief economic adviser Martin Feldstein, and former Clinton Treasury Secretary Lawrence Summers).
Enter rebuttal #1: Jennings confuses the Solow growth model of how wealth is initially created with the old Keynesian formula for how existing wealth is eventually spent...
Well, no, I don't. The Solow growth model says that over the long run the economy tends to revert back to some baseline level of growth. So, a tax rebate this year will not, in the long run, change the rate of economic growth. Reidl contends that only by seeking to improve the productive capacity of our existing stock of labor and capital can the economy be stimulated. And this is all correct, but Reidl's sin here is that of omission - he remains silent on mechanisms by which short term growth can be accelerated. If his paper had asserted that "tax rebates, however, don't stimulate the economy in the long run," then there would be no bone to pick here.
Bernanke, Orszag, Summers, Feldstein, Democratic and Republican Congressional leadership, and myriad economists who have a weighed in on fiscal stimulus are all concerned with the short term performance of the economy. And changing the course of economic growth in the short term is at the epicenter of the furious debate over what constitutes effective fiscal stimulus. In this context, the Keynesian formulation of GDP (GDP = consumption + investment + government + net exports) is certainly an appropriate model, and Riedl does not explain why it would not be. That Riedl ignores these facts so that he can argue that tax breaks for businesses and permanent income tax cuts is the correct fiscal policy is worthy of derision.
Rebuttal #2: Jennings never stops to ask where Congress gets the money it mails out. Every dollar that rebates "inject" into the economy must first be taxed or borrowed out of the economy.
Again with the short-term/long-term conflation. Riedl's paper insists that when the government injects money into the economy "[n]o new spending power is created. It is merely redistributed from one group of people to another." Indeed. However, the current policy debate is economic growth over the short term - the next four quarters, giver or take. This distinction is important because that distribution from one group to another can include a group of people living in the future to a group of people living in the present. So, over a year, new purchasing power is created, but over ten years that purchasing power is transferred back to the original owner.
Rebuttal #3: Jennings mocks Riedl's basic point that "reducing marginal income tax rates has been shown to motivate workers to work more." Although economists debate the size of the impact, Riedl's point that some link exists is widely accepted. Does Jennings believe the same people would work the same jobs at the same hours, regardless of whether their tax rate is 0, 50 or 100 percent?
To respond to rbluey's query: Debating the marginal effects of labor incentives for 0, 50, or 100 percent marginal personal income tax rates is the absolutely wrong discussion to have if one wishes to mitigate an impending economic slump. Although it would be an interesting discussion, perhaps over coffee or in a dorm room, back in the really real world where some 23 million tax filers earn less than $30,000 - many of whom work more than one job - it seems rather naive to say that families who are having difficulty putting food on the table or paying rent and heating bills would work less because they have pay more in taxes. In the short term, fewer people are working not because they don't want to, but because there are no jobs to be had (i.e. the unemployment rate is rising). Permanently reducing their tax rates won't help them find a job.
And while empirical studies may show that some people who have the luxury to decide to work less actually do so, it is clear that these incentives are overwhelmed by other factors. Otherwise we wouldn't end up with an economy that grows faster when tax rates are higher:
I see absolutely not evidence to support Riedl's assertion that current tax rates - rates that were lowered in 2001 and again in 2003 - are responsible for the recent deceleration in economic growth and uptick in unemployment. It is simply bizarre to conclude that all of a sudden masses of workers stopped working or businesses quit producing because they just now realized - five years after a tax cut - what their effective tax rates are.
Posted by Craig Jennings
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