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Why the Reagan Tax Cut Worked in 1981 and Why It Wouldn’t Work Today

13 Aug 2011
Posted by Bruce Bartlett

Thirty years ago today, Ronald Reagan signed into law the Economic Recovery Tax Act of 1981. It remains controversial, with Democrats blaming it for undermining the nation’s finances and contributing to the maldistribution of income, while Republicans assert that the Reagan tax cut was so stimulative it actually lost no revenue and that its reprise is just what the economy needs today.

 
The truth is that the Reagan tax cut never came close to paying for itself, but neither was it expected to lose as much revenue as it did. And while it was highly stimulative, that is only because the economic and financial circumstances of the time made it so. Reenacting some version of the Reagan tax cut under today’s economic conditions would not bring about similar results.
 
It’s important to remember that inflation was the central economic problem at the time Reagan endorsed the tax plan that had been developed in Congress by Congressman Jack Kemp of New York and Senator Bill Roth of Delaware, which proposed cutting the top income tax rate from 70 percent to 50 percent and the bottom rate from 14 percent to 10 percent.
 
The Consumer Price Index rose 4.9 percent in 1976, 6.7 percent in 1977, 9 percent in 1978 and 13.3 percent in 1979. At the same time, unemployment was stubbornly high, averaging 7 percent from 1975 to 1979.
 
One of the key problems that the Reagan-Kemp-Roth plan was designed to deal with was bracket-creep. Since the tax system was not indexed at that time, whenever workers got a cost-of-living pay raise they got pushed up into higher tax brackets even though their real income had not risen. Consequently, the average federal income tax rate on a four-person family with the median income had risen from 7 percent in 1965 to 11 percent in 1978, and the marginal tax rate – the tax on each additional dollar earned – rose from 17 percent to 25 percent.
 
The dominant theory at the time said that budget deficits were a key cause of inflation. Therefore, virtually all mainstream economists thought the Reagan tax cut would make inflation much worse. A Congressional Budget Office analysis of the Kemp-Roth bill in 1978 estimated that it would add 2.7 percentage points to the inflation rate by 1983.
 
Reagan’s economic advisers had a different view. Tax rate reductions were not inflationary because they would increase labor supply and economic output, which would reduce inflation, not increase it. Reducing inflation was primarily a function of monetary policy. If the Federal Reserve reduced the growth rate of the money supply then inflation would fall regardless of the deficit. Simultaneous tax cuts would cushion the economic cost, the economists argued.
 
In 1979, the Fed began targeting the money supply, which brought on a recession in 1980. But inflation only fell to 12.5 percent. Continued tight money led to another recession in 1981 and 1982, which brought inflation down to 8.9 percent in 1981 and 3.8 percent in both 1982 and 1983. Ironically, this much more rapid improvement in inflation contributed heavily to the budgetary cost of the Reagan tax cut. Since taxes are assessed on nominal incomes and tax indexing didn’t start until 1985, the sharp fall of inflation shrank the tax base and increased the tax cut’s revenue loss.
 
The collapse of inflation also meant that real interest rates were extremely high. In early 1982, the federal funds rate was more than 14 percent, leaving a great deal of room for easing monetary policy. By the end of 1982, the fed funds rate was down to 9 percent. Thus the economic expansion of the 1980s was powered by a combination of tax cuts, falling inflation and lower interest rates.
 
Today, by contrast, income tax rates are at a historical low – the top tax rate is just 35 percent and revenues are less than 15 percent gross domestic product versus 19.6 percent in 1981. The average federal income tax rate on a median family is less than 5 percent and its marginal rate is 15 percent. Inflation is nonexistent and the federal funds rate is close to zero.
 
Therefore, there is no possibility of replicating the experience of the early 1980s because economic and financial conditions now are virtually 180 degrees opposite from what they were then.
 
Making economic policy is not like making cookies and you can’t use a cookie-cutter approach. Policies need to be crafted to the circumstances. I believe Reagan’s policies were appropriate to the economic conditions of the early 1980s. Today’s economic problems require a very different set of policies.

This time is different

The other thing that is different this time is that in 1982, the ratio of federal debt to GDP was roughly 35 percent. It is now roughly 100 percent. As Reinhart and Rogoff would say, "this time is different". But, let's be fair Bartlett, this applies not only to a reduction in tax revenues, but also to increases in government spending. You simply cannot repeat either stimulative strategy over and over again without reaching a point of negative returns. We've already reached that inflection point.


Net debt ratio is around 67%

Net debt ratio is around 67% now.


Gross Debt versus Net Debt

I'm glad you brought this up. The figures that I used were "gross federal debt", but I used that measure intentionally and for good reason. First, the reference was to the Rogoff/Reinhart study and their study focused on gross debt and not net debt. Second, I used the numbers consistently---gross debt compared with gross debt in 1982 and currently.

"Net debt" is only an appropriate measure if you think that the amount owed by Treasury to the Social Security Trust Fund shouldn't be counted. That, of course, suggests that the amounts owed by the Social Security Trust Fund to future retirees under the implied promises made to them should not be counted, because we will renege on those implied promises. I would have a little more sympathy for that measure in the past when amounts paid currently into the Trust Fund were suffficient to pay current benefits. Alas, we've now reached another watershed moment in history where Treasury is forced to actually pay part of those IOU's back and those payments need to be financed through borrowing or higher taxes. The myth that this shouldn't count is now debunked.

In fact, if one were to include all the net debt on the federal, state and local levels as well as the unfunded liabilities for all levels of government, which would be appropriate to evaluate our fiscal position and our ability to incur yet more debt (gross or net), would be much worse. Those unfunded liabilities have to either be paid for in future taxes or borrowing or those promises need to be reneged on and those combined liabilities are what affect GDP and not just the federal bit. All of this is a serious drag on future (real) GDP.


Reagan benefited in the

Reagan benefited in the largest drop in interest rates in recorded history during his administration.


THANK YOU. While I agree

THANK YOU. While I agree with Bartlett, so many times people forget Volcker's critical role in the economic recovery.


The role of Paul Volcker

What people seem to forget is that real growth tracks real interest rates - higher real growth and higher real interest rates go hand in hand. Reagan should be thankful not for Paul Volcker lowering interest rates, but for raising them through the 1970's and early 1980's to encourage the productive use of debt - instead of what we have today.

The trick is to get people to borrow at high real interest rates and this is where effective tax policy comes into play. Tax policy that encourages productivity is not a series of handouts and giveaways arranged by a group of lobbyists. Instead tax policy needs to be constructed more like the capital markets. A tax break that is sold by the U. S. Treasury department with a rate of appreciation and a duration represents a permanent tax break that also reduces federal debt issuance.


"Today, by contrast, income

"Today, by contrast, income tax rates are at a historical low – the top tax rate is just 35 percent and revenues are less than 15 percent gross domestic product versus 19.6 percent in 1981. The average federal income tax rate on a median family is less than 5 percent and its marginal rate is 15 percent. Inflation is nonexistent and the federal funds rate is close to zero."

I know you are advocating for higher rates on upper income, and I cannot disagree, but we cannot survive with a 5% tax contribution from a median family. I believe the whole Bush tax cuts must be ended, not just on upper income. I have calculated my liability both ways and ending all cuts adds much more to my liability.


federal tax rates on median family income

Your claim that the median family pays only a 5% "tax contribution" is false because it ignores the payroll taxes they pay. In 1980, when Mr Barlett correctly notes that the median family paid 11% income tax, payroll taxes were 12.2%, for a total 23% "tax contribution" on those making less than $26,000 (there were no payroll taxes at all on income greater than $25,900).

Today, the same family pays 5% income tax and 15.3 payroll tax, for a combined "tax contribution" of 20.3%. So to return to 1980 rates would require increase the median "tax contribtion" from 5% to 8.3%. As a median family earner, I have no objection to that so long as we also return to 1980 marginal rates, i.e., 70% at the top bracket. As that is unlikely to pass, I agree we should just let all the Bush tax cuts expire but only so long as the increase, calculated as a percentage of income, is not greater on the working poor than on the non-working wealthy. And yes, this includes the estate tax cuts, too.


Payroll Tax

To be clear, the worker does not pay 15.3% in payroll tax. The worker pays 7.65% and the employer pays the same.


I'm confused (typical of me

I'm confused (typical of me these days !)...I look at this

http://research.stlouisfed.org/fred2/graph/fredgraph.png?&id=UNRATE&scal...

and I don't see the 1981 tax cuts "working." What do others see ?

Can it be I'm confused because I've fallen for the GOP con job that tax cuts create jobs and I can't get up ?


tax cuts ma create jobs where capital earns the highest return

Mr. Bartlett addresses an issue that is almost always missing from every debate about the Laffer Curve: quantifying the benefits of lower taxes vs. the benefits of other policy/market/economic changes that might occur at the same time. If we're already closer to the "O" tax rate than we are to the "100%" tax rate, even Laffer would admit that lowering taxes further is not going to produce as many jobs as one would expect when starting from a higher tax rates.

There is another issue that is almost never addressed, though, and that is where the jobs are created. Lowering taxes in the U.S. may well be creating jobs in countries with lower regulatory restrictions, lower wages and lower capital costs. But because both political parties are captured by financial interests who benefit from "free trade" (even with countries whose workers are not free), I do not expect this elephant in the room will be mentioned by any mainstream candidates.


The Laffer Curve

You have got to understand, the Laffer Curve and supply side economics are both advocations of lower taxes, but for different reasons.

The Laffer Curve is a revenue maximization curve. It basically stipulates that at a 0% tax rate the government will collect no revenue and at a 100% tax rate the government will collect no revenue. It then offers that at some rate the federal government will maximize the revenue that it collects.

Supply side economics is about cost inputs to production, and so it would say that the best tax rate is 0% without regard to the federal government.


Every word makes sense

that's why reading Mr. Bartlett's book The New American Economy persuaded me that my vote for Carter in 1980 was an error. By the same logic as above, a vote for conservative policy now would be an error.

Vivian Darkbloom, perhaps you're overlooking the 112% debt to GDP at the end of WWII that was brought down not by debt reduction but by growing the denominator, GDP? You merely assert that our current 100% ratio is an inflection point at which further government spending will incur negative effects, but you present no historical evidence, economic analysis, or logical argument to support it. You seem to ignore the $1.2 trillion current output gap; firms won't hire because the consumer demand isn't there. With interest rates at historic lows, additonal government spending would greatly help GDP growth without costing much in the short run. It's been pretty well analyzed and supported that we could do much more to stimulate growth through short-term spending provided we reduce spending in the intermediate to long term. Spend now while demand is weak; reduce spending and debt later when the economy is stronger. What's so hard to understand about that?


“Vivian Darkbloom, perhaps

“Vivian Darkbloom, perhaps you're overlooking the 112% debt to GDP at the end of WWII that was brought down not by debt reduction but by growing the denominator, GDP? You merely assert that our current 100% ratio is an inflection point at which further government spending will incur negative effects, but you present no historical evidence, economic analysis, or logical argument to support it.”

Here are the data regarding WWII years and the immediate aftermath:

Percent Deficit of GDP

1943 28.03%
1944 22.35%
1945 24.07%
1946 9.06%
1947 -1.32%
1948 -4.33%

Spending as Percent of GDP

1943 41.78%
1944 45.73%
1945 47.93%
1946 29.94%
1947 16.96%
1948 13.23%

Government Spending as Percent of GDP (2005 real dollars)

1943 $1,883
1944 $2,035
1945 $2012
1946 $1,792
1947 $1776
1948 $1854

Federal Revenue (nominal)

1943 $27.3
1944 $51.4
1945 $53.2
1946 $46.4
1947 $44.6
1948 $47.3

What does this data tell you? At the end of WWII when the federal debt to GDP hit that high, government spending was reduced dramatically not only in real terms but as a percent of GDP. The debt was brought down primarily because of reduced spending, not because of growing GDP. In fact, the US experienced a brief recession in 1945 and another in 1948 to 1949. The debt was brought down primarily by reduced spending.

As far as logic and economic analysis are concerned, perhaps you should read Reinhart and Rogoff “This Time is Different” the findings of which were summarized as follows:

“The main finding of that study is that the relationship between government debt and real GDP growth is weak for debt-to-GDP ratios below 90 percent of GDP. Above the threshold of 90 percent, however, median growth rates fall by 1 percent, and average growth falls considerably more. The threshold for public debt is similar in advanced and emerging economies and applies to both the post World War II period and as far back as the data permit (often well into the 1800s).”

http://www.iie.com/publications/testimony/testimony.cfm?ResearchID=1781

What, exactly, is your point other than parroting something you heard from Paul Krugman's gape, the size of which is in direct proportion to Okum's gap?


Information is better

wait a sec. Didn't real GDP roughly double from 1949 to about 1961 or so...?

Yes.

Wasn't that significant to reducing the debt/GDP ratio?

Yes. This chart says it helped quite a lot:

http://en.wikipedia.org/wiki/File:USDebt.png

Saying "The debt was brought down primarily by reduced spending" is an assertion. But it's like saying only sunshine matters for plants to grow (as if water didn't matter, etc.). Just an assertion. Not useful.

Start with facts, no bias, before you try to form a conclusion.


Carry it out past 1948. Look

Carry it out past 1948. Look at spending vs revenue. Look at total debt. It is growth that reduces debt as a percentage of GDP. (Even with your own carefully chosen data you should notice the increase in revenue that occurred in '44)

Steve


So, what is your point?

If you are the same person who wrote the earlier post, again, what is your point? Do you want me to carry the data to the present? My original comment was about 1982, not the years immediately after WWII, so that parallel comes a bit out of left field. The original rejoinder was about the years immediately after WWII, so give me a break, I'm not the one picking the data here. Even so, are you suggesting that the growth in GDP after WWII (even after 1948) was due to increased government spending and that that increased spending reduced the deficit as a percentage of GDP? Government spending did not increase after WWII; it actually declined, so I fail to see how this proves whatever point you are trying to make. Are you trying to refute the research of Reinhart and Rogoff that high debt to GDP levels (say 90 percent or more) has a negative effect on GDP growth? Are you trying to say that piling on more debt (through tax cuts or spending increases) when the debt level is already 100 percent of GDP has the same effect as incurring more debt when the debt-to-GDP ratio is only 35 percent? Please come back and explain in detail, Steve, because I'm very interested.


Gross Debt or Net Debt?

Are your 1940s debt figures net debt or gross debt? If they're net debt then we still have a long way to go before we approach 100%


Another Possibility

Another possibility has come to mind, but you will need to explain. Are you suggesting, as a recent Vice President reportedly did, that "deficits don't matter" (and by necessary implication, federal debt)?


Deficits and debt...

Let me be as clear as possible:

1. Deficits don't matter, deficits must be financed by selling a liability
2. The federal government can never default on its liabilities because its liabilities are denominated in its own currency
3. Debt is a guaranteed liability as far as the federal government is concerned (14th Amendment).
4. Debt does matter for reasons of productivity, trade balance, inflation, and a few others.
5. The federal government does not have to sell guaranteed liabilities (debt) any more than a corporation has to sell debt. The federal government could just as easily sell non-guaranteed liabilities.

If you understand all of that, then you have a deeper understanding of capitalism than Mr. Bartlett.


The Reagan years....

What worked:

1. The federal reserve raised real interest rates to encourage real economic growth.
2. The federal government removed housing prices from its stated consumer price index (1983). This effectively put an end to the wage price spiral at the expense of a housing boom / bust and an S&L crisis.

What the Reagan tax cuts did was compound the small deficits of the 1970's with larger ones. This primarily led to large amounts of federal debt, increased trade deficits, and declining manufacturing participation in growth. The Plaza accord tried to remedy that situation (currency adjustment) with disastrous results - 1987 stock and bond market crash.

What Reagan didn't understand was productivity = real gross domestic product / total debt outstanding. How does tax policy affect productivity? Effective tax policy lowers the after tax cost of debt service in the private sector while simultaneously reducing the federal debt. The reason is simple - the federal government does not use debt productively.

Conservative economics rests on two pillars - don't give money away (monetary policy) and don't give tax breaks away (fiscal policy).

Anyone who still believes that the federal reserve contracted the money supply in the late 1970's ought to have their head examined. Here is a link to show what actually happened:

http://research.stlouisfed.org/fred2/graph/?chart_type=line&s[1][id]=TCMDO&s[1][range]=10yrshttp://research.stlouisfed.org/fred2/graph/fredgraph.pdf?&chart_type=line&graph_id=&category_id=&recession_bars=On&width=630&height=378&bgcolor=%23b3cde7&graph_bgcolor=%23ffffff&txtcolor=%23000000&ts=8&preserve_ratio=true&fo=ve&id=TCMDO&transformation=pc1&scale=Left&range=Custom&cosd=1970-01-01&coed=1990-01-01&line_color=%230000ff&link_values=&mark_type=NONE&mw=4&line_style=Solid&lw=1&vintage_date=2011-08-14&revision_date=2011-08-14&mma=0&nd=&ost=&oet=&fml=a&fq=Quarterly%2C%20End%20of%20Period&fam=avg&fgst=lin

Total credit market debt growth in the late 1970's peaked at 14% annualized in 1979 and fell to about 9.5% annualized growth in 1981, rose some, and then fell again in 1983. What was significant about 1983? Housing prices were removed from the consumer price index.


It is I

V.D., I'm the one who challenged your point. The data you provided are interesting, but a bit off the mark. They simply show that federal spending (and deficits) fell sharply at the end of WWII, after soaring during the war (the stimulus)... hardly a surprise. Either intentionally or inadvertently, you omitted the most important data--the two data series I mentioned: Total debt, and GDP -- the numerator and denominator in debt/GDP. You therefore attacked a "straw man": I don't support growing government spending at all times, I simply support it during a liquidity trap that causes an enormous output gap. I suspect it was inadvertent since you admitted that you didn't really understand my point, so here it is again: the soaring deficits and spending during WWII stimulated the U.S., bringing us out of a liquidity trap. Once the economy was able to walk under its own power, reduced spending was appropriate, and that's what happened. The growing economy reduced debt/GDP, even though debt was not reduced. Here's the data:

Total U.S. Public Debt

1943 136,696,090,329
1944 201,003,387,221
1945 258,682,187,409
1946 269,422,099,173
1947 258,286,383,108
1948 252,292,246,512
1949 252,770,359,860
1950 257,357,352,351

You wrote " The debt was brought down primarily because of reduced spending, not because of growing GDP." Wrong! U.S. debt didn't decline at all; it was flat from 1945-1950. So what brought down the debt/GDP ratio? Growing GDP:

Total U.S. GDP (in millions)

1943 198,600
1944 219,800
1945 223,000
1946 222,200
1947 244,100
1948 269,100
1949 267,200
1950 293,700

That's a 30% increase in GDP from 1945-1950. With the numerator flat, and the denominator rising 30%, debt/GDP fell from 116% to 87%, and continued falling. 10-year Treasury yields were the same as they are now. So no, 100% is not a threshold, particularly since the economic distress leading up to WWII was so similar to today's. And if your threshold argument were right, do you think interest rates would be falling now? No, they would be rising, but they're low and falling. You failed to respond to my point that with historically low interest rates, we could add debt in the short run without much incremental cost, provided we significantly reduced our debt in the medium and long run. This is a refutation of Reinhart and Rogoff.

Regarding Reinhart and Rogoff, I have read their book. Ken Rogoff has explicitly said that stimulus was the correct reponse to the crisis, and in a panel discussion sitting next to Chief Economist of Nomura and Keynesian extraordinaire Richard Koo, Rogoff significantly moderated his conclusion, saying that stimulus and additonal debt in the short run is probably necessary but significant debt reduction must occurr thereafter. That position is identical to mine, Koos, and a very long list indeed of esteemed economists.

You should also be made aware that Keynesian thought is not solely Paul Krugman's concept. It is the status-quo, mainstream economic thinking taught in the vast majority of universities and followed by nearly all major policy makers central bankers globally. I listened to the past 2 1/2 years of interviews in "Bloomberg on the Economy" of chief economists and chief strategist at major banks and investment firms, and something like 95% of them supported the stimulus. It is you who is parroting minority opinions and left-field concepts from heterodox thinkers.

Whenever the issue of fiscal stimulus comes up, you can count on someone chiming in to say, “Only an idiot could believe that the answer to a problem created by too much debt is to create even more debt.” It sounds plausible — but it misses the key point: When everyone tries to pay off debt at the same time, the result is contraction and deflation, which ends up making the debt problem worse even if nominal debt falls.

From 1929 to 1933, everyone -- government, citizens, and corporations -- was trying to pay down debt — and the debt/GDP ratio skyrocketed thanks to contraction and deflation. During and immediately after WWII, there was massive borrowing — but GDP grew faster than debt, and the debt burden ended up falling.

Yes, it seems paradoxical — but that’s the kind of world we’re living in. And the refusal of so many people to face up to the fact that we’re in a world where conventional rules don’t apply makes it likely that we’ll stay in that world for a long time come.


The Paradox of Debt

Your narrative is getting very confusing and you are distancing yourself further and further from your original post (we (Bartlett and I) started with 1982 and the present; you shifted the discussion to post-WWI and now you are moving us into the depression era). The thesis you originally put forward was in response to my observation that deficit stimulus in 1982 (either through spending increases or tax cuts) does not have the same effect when the starting point was a ratio of gross debt to GDP of 35 percent versus the current ratio of more than 100 percent. You countered this by citing post-WWII data supposedly to show that stimulus spending during that time reduced the debt-to- GDP ratio. In fact, precisely the opposite happened: During the War deficit spending increased GDP, the federal debt and the debt to GDP ratio. After the war (when the debt ratio went down) spending was dramatically reduced (cut, even, in real terms) the US economy was initially stagnant, then grew, and the debt-to GDP ratio dropped and that that drop was due primarily to reduced government spending. If you are arguing that the drop as measured by debt-to-GDP was due to growth in GDP induced by deficit spending, that growth occurred when government spending dropped, not when it increased. US spending, both in real terms and as a percentage of GDP dropped dramatically in the post-WWII years. The growth in GDP was due to increased private sector activity and productivity growth—not government stimuli. Here's the data on real spending (2005 $):

1943 $786.81
1944 $930.75
1945 $964.47
1946 $536.64
1947 $301.25
1948 $245.24
1949 $277.51
1950 $305.99

Blind followers of Mr. Krugman politics disguised as economics seem to have latched on to the term “liquidity trap” as an explanation for everything and a justification for fiscal stimulus in the form of deficit government spending. Since when did the massive US spending during WWII have anything to do with a “liquidity trap”? I thought that spending was designed to defeat the Nazis and the Japanese, not failed monetary policy. And “liquidity trap” certainly had nothing to do with the post-WWII era: The prime rate moved from 1947 from 1.75 percent steadily and continuously upward to 4.5 percent in 1957.

Now, if Keynes were alive I suspect that he might very strongly agree with Rogoff and Reinhart. If I am not mistaken, to the extent Keynes believed in fiscal stimulus at all (as opposed to monetary stimulus) he would have proposed it only as a counter-cyclical policy, not a continuous one. In other words, he would have advocated reducing the debt-to-GDP ratio in good times so that there was sufficient fiscal “ammunition” to spend it in bad. I suspect he would now say that strategy is no longer valid—with debt-to-GDP at 100 percent, our fiscal ammo has already been spent. In this sense, we are in a fiscal trap, not a liquidity trap. And this applies equally to further tax cuts (this does not include real structural reform) or further wasteful and counterproductive government stimulus spending.

If you are looking for an historical example of this, we need look no further back than the period 2009 to 2011. If your theory were correct, our debt-to-GDP ratio would be falling, not soaring through the roof.


WWII spending was to defeat

the Nazis, but it had the effect of ending the 1930's output gap by making gov't spending soar. Once the economy was percolating along, the spending was no longer needed. The premise that 100% debt/GDP is a threshold beyond which additional debt can't be stimulative has been refuted. I leave it to readers to judge whose arguments are stronger.

"For those who understand, no explanation is necessary.
For those who don't understand, no explanation is possible."


PS

Two final points: 1. Re: 2009-2011, if my theory were correct, "our debt to GDP ratio would be falling", that's not true. Zandi/Blinder have documented that without the stimulus of that period, GDP in 2010 would have been about 11.5% lower: http://www.economy.com/mark-zandi/documents/End-of-Great-Recession.pdf
What we needed was a stimulus about twice as large as the one Republicans reluctantly allowed. That's what WWII spending accomplished: a "shock and awe" stimulus. 2. If Keynes were alive, he undoubtedly would agree with Reinhart/Rogoff, especially with Rogoff coming around in public statements in favor of the stimulus that you, V.D., argue against no matter what evidence is presented to you. Keynes was very much in favor of counter-cyclical spending, and thrift in times of growth.


vivian darkbloom = vladimir

vivian darkbloom = vladimir nabokov? great email address - I wish I'd have nabbed it first. How about Sebastian Knight?


It's a Coincidence

Rest assured that my e-mail address has nothing to do with Vivian Darkbloom (or Vladimir Nabokov). Any relation between the former and the latter is purely coincidental, although I must admit that coincidences (and Doppelgangers) are tantalizing:

"A certain man once lost a diamond cuff-link in the wide blue sea, and twenty years later, on the exact day, a Friday apparently, he was eating a large fish - but there was no diamond inside. That’s what I like about coincidence."

As for Sebastian Knight, I can't fault your taste in literature. However, I would suggest that if you are looking for a nom de plume with a chess board theme, Solus Rex would be a much better choice.


first, i just want to say,

first, i just want to say, great discussion guys. if we had more of this in congress, instead of ape-like name calling, maybe we would get something done. second, economics is all theory, no laws, thus making a discussion like this a lot of fun. while i agree w/ TMs assessment, i wanted to point out where, imho, TM and VD diverge. i think its a matter of timing. TM sees 2011 as akin to 1941. VD sees 2011 as 1945.

in '41, as the country dealt with a stagnant, depressed decade of economic growth and failed stimulus, it was hesitant to go into the necessary debt to fund the war effort until japan made that decision for us. surprisingly to most, the stimulative effect of the war helped mobilize the country [though many would argue that FDRs policies paved the way for the productivity gains that followed WWII] and our financing of two destroyed continents helped catapult this country forward. as VD points out, gov. spending was cut drastically after '45. that makes sense in a country where rubber, sugar, and gasoline were heavily rationed for 4 years and private industry basically ceased to exist. after the war ended, the private sector resumed its business and the economy took off for a number of reasons too complicated to mention here.

between 1939-1941 many in the U.S. argued that we could not enter the war because of our economy. today, many argue that we are not solvent enough to print more cash. as frank pointed out, deficits matter for countries that don't control their printing press [greece, et al] but as the market has consistently shown, the u.s. has no credit problems. it is definitely a growth issue. personally, i think we're far closer to '41 than '45 and we need to spend our way to growth. VD thinks [and please, correct me if i'm wrong] that's its '45 and its time to cut spending. personally, with 2 year rates at 0 and 5 year rates at 1%, i really don't see any reason to not spend in the short term [2-5 years] while significantly cutting spending in the 5-10 year budget window.

i would like to add something. why is it that keynesian economics a dirty word? its only the governing policy of ALL the world's greatest economies. we can look at historic examples, or contemporary ones. i can be pithy and say, 'even the austrians don't believe in austrian economics..' and i wouldn't be wrong. but lets look at current examples... Portugal, UK, Greece, have implement extreme budget cuts in the midst of a deep recession [maybe even depression]. their most recent GDP numbers came out in the last few days. not exactly stellar. socialist, communist, fancy, european [another strangely dirty word these days] germany grew over 4%, if i'm not mistaken. with their tax rates, labor laws [in favor of unions and such], and fairly left leaning government renders a lot of tea party arguments moot. in fact, all of socialist, communist, dirty northern europe is doing far better than their 'capitalist' counterparts [swe, nor, den, hol, ger, bel]. although calling southern europe capitalist is like calling a republican a deficit hawk.

but again, thanks for the respectful debate guys. keep it up.


Excellent points

I very much agree with Hal Horvath and pseudo-economist, whose observations about Keynesian economics are particularly on-target. I think the 1941 v. 1945 distinction is the correct one to make. Vivian is right to bring up Reinhart and Rogoff; i just think that their conclusion leaves wide latitude for an exception like the US with it's strong currency, low interest rates and the dire need to grow now. The bond market is telling us we can increase debt/GDP a bit more now provided we simultaneously instate a highly credible plan to cut debt in the medium and long term.


Revenues as a percent of GDP

Mr. Bartlett is a fallen supply-sider much like a someone who has lost their religion. To be sure, tax policy cannot be made in cookie-cutter fashion, but raising revenues is not the same as raising marginal tax rates.

For the middle class, most of whom have a supply of labor elasticity of close to zero with respect to tax rates in the relevant range. However, for a business that flows its tax liabilities through the personal income tax, even 35% is excessive. Assuming that the average small business has no special tax breaks, and the mortage and other deductions are non-marginal, the 35% creates a high hurdle rate for incremental investments and the willingess to take on more risk to finance a business venture. A more neutral rate of say 24% on all income with no deductions would be a shot in the arm to hundreds of thousands of small businesses that have to meet payrolls week in and week out. Of course, to avoid revenue loss, that 24% rate would come without any deductions whatsoever, including charitable contributions.

Moreover, the correct rate for corporate income taxes is zero. A corporation is just a flow through entity. Corporate decisions on how to allocate capital are based on the after-tax income that can be distributed to shareholders or reinvested in new business ventures. Since economist don't have a clue as to the true incidence of the corporate income tax - that is, who really pays, why not make it more transparent by taxing capital income once - when it is distributed to the owners - at the flat rate suggested above of 24%.

Even Mr. Bartlett understands that the total tax on capital income is in excess of 45% when factoring in the double taxation and additional marginal tax rates levied by some states. To suggest that marginal tax rates on capital income approaching and at times exceeding 50% has not resulting in reducing investment is to deny the core of economics, that there is a supply curve for capital that is upward sloping. Relying on past history as a guide for this judgment is equally fallacious as that was then and this is now!

Now it is undoubtably true that when income is derived from compensation, and it is in the millions, that individual can be taxed at a higher rate without experiencing significant reductions in the supply of labor and the comcomitant tax revenue. So to take Mr. Buffet's advice, let's raise the tax rates on millionaires - those earning in excess of, say $2.5 million back to 40% - with no deductions. That means in spite of the efficiencies of Mr. Gates's an Mr. Buffet's charitable activities, they cannot escape paying taxes on their capital gaines, only that it will be at the lower, neutral 24% rate on capital income.


Slam Dunk Stimulus

Reading all the comments and arguments, the original thesis that Reagans tax cuts won't work today still appears to stand. What we need is a plan for the hear and now. I heard about this plan on a radio station and think it does alot of what we need now. Since most of the discussion was sound and based on interpretation of facts that were well thought out, I am hoping to get some feedback as to this plan.

The Morgan Stanley research paper is http://www.morganstanley.com/views/gef/archive/2010/20100729-Thu.html#an...

The blog site is http://www.kmjbrad.com/Blog_Site/page_2246497.html

Your input would be appreciated.




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