Republican Economics and Other Fanciful Thoughts

June 24th, 2011 at 12:39 pm

Rep Cantor’s irresponsible canter notwithstanding, it’s worth clarifying a point he and other Republicans have recently raised.  They’ve signaled that they could actually live with raising more revenue through closing loopholes associated with tax expenditures, that $1 trillion or so we forego every year by giving tax breaks for things like mortgage interest and ethanol production.

So what’s the big difference between tax expenditures and “raising taxes” such that the former might be OK and the latter is the stuff of hissy fits?

Well, put aside for a second the strategic posturing and political theater and imagine, just for fun, that there’s actually some economics in play here.

Economists generally believe that higher marginal tax rates “distort” economic behavior.  They lower after-tax earnings, for example, and thus lower the price of an hour of leisure (non-work) relative to an hour of work, so the thinking is that if you raise taxes, people will work less.

At least that’s what you mostly hear these days.  Even in the theory, there’s an offsetting effect: if you lower my after-tax hourly wage, I might just want to work more hours to make up for the loss.  But that’s a less convenient argument to the anti-tax crowd so you don’t hear it a lot.

Put aside for another second whether these effects are even real.  My read is that the empirical literature doesn’t support either effect from small changes in the code of the type we’re contemplating, like raising the top marginal rate back to where it was in the Clinton years—35% to 39.6%–when working people apparently ignored the memo re “substitution effects” (the labor/leisure trade off noted above) and did all kinds of work.

My only point here is that we can have a budget plan that taps both spending cuts and more revenue without raising tax rates.  It would take the closing of some loopholes, not unlike the ethanol one that a bunch of R’s supported the closure of just last week!

To do so would actually be consistent with Republican economics, if there actually were such a thing.


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16 comments in reply to "Republican Economics and Other Fanciful Thoughts"

  1. foosion says:

    My impression is that raising rates would raise revenue more from high income earners and eliminating tax expenditures would raise revenue more from the middle class. Obviously this would depend on the details of the proposals, but assume rates back to Clinton levels and eliminating sufficient tax expenditures to raise a comparable amount of revenue.

    Can you or someone comment on the distributional aspects of the two approaches.

  2. pjr says:

    I don’t think the empirical literature would support this economic theory even if you’re talking 50 percent rates (Reagan/Kemp-Roth) for the current top bracket or even 70 percent rates (JFK-LBJ) for higher additional brackets. People don’t stop working, they pay the taxes, or exploit available investment tax credits, or concentrate on investments (some of which might be categorized as expenses to the IRS) to make future earnings still-larger, or accept non-taxable forms of remuneration. High tax brackets on the top-most earners probably have a number of beneficial effects (for the overall economy) and very little of the purported negative effects.

  3. steve says:

    For those not familiar with it, I am sure Jared is, here is the link to one of Goolsbee’s papers looking at the purported substitution effect. Has anyone ever seen a right of center writer even mention the income effect?


  4. Michael says:

    Every time someone assumes the Repubs are speaking in good faith, a baby kitten is eaten by a Galtian Overlord.

  5. Mary says:

    If you care to share some of this literature (I find it interesting), that would be great.

  6. readerOfTeaLeaves says:

    At this point, the term ‘Republican economics’ appears to be an oxymoron 8(

    One of my favorite Royal Society Animations is about ‘Drive’ and is relevant to this post: the RSA summarized scientific research into ‘motivation, drive’ and for most kinds of post-industrial tasks, ‘pay’ is *not* the sole driver in performance.
    A YouTube link of the summary is here:

    The GOP budget proposals (as I understand them) are oblivious of the information about economic motivations and performance that are presented in this RSA.
    In other words, the GOP is not even talking about the kind of economic behavior, nor the kinds of business models, that I encounter. Sometimes, I can’t even believe they are talking about the country my neighbors and I live in. Cantor and Boehner should be transposed into a 1930s black-and-white nostalgic musical, because that’s about the era that their economic assumptions belong to.

    If work tasks are straightforward, carrots and sticks work. Money motivates for simplistic, repetitive tasks.

    However, complex society requires focusing on your **work** and with very complex tasks, the quality of performance is not directly aligned with pay and/or taxes in a straightforward way.

    Once you get into the kinds of tasks that require creative, focused, open-ended problem solving, you pay people enough to meet their needs, but what they REALLY want is autonomy. And they want to make a difference.

    The GOP seems utterly clueless about this whole segment of American employment, which includes teachers, cops, firefighters, nurses, docs, hotel concierges, and a multitude of other employees. Every one of these employees are required to diagnose situations and create novel solutions. These employment sectors don’t lend themselves to the kind of assumptions mentioned in this post; these people are motivated by work group assignments, by the chance to make a difference.

    The GOP economic analysis and rhetoric misses this completely.

    Unfortunately, the tax assumptions of the GOP appear to be premised on financier tasks (including using offshoring and tax havens), and factory ownership assumptions — they assume that we need money *only* to invest in ‘capital’ equipment. They seem to represent some kind of bizarre ‘investor class’ that assumes the only ‘investment’ is always and everywhere EITHER in tax havens OR ELSE in factories.
    Those assumptions are relevant to capturing resources, controlling pipelines and natural resources. But they are completely, totally inept in the kinds of investment strategies that I see as being *badly* needed today, which require investing in people.

    In today’s world, the GOP economic and tax assumptions seem about as relevant as the Model T Ford. ‘Fanciful’ is too kind a term: they are economic malpractice.

    These are Legacy Economic Assumptions: they worked just fine in the era of the booming timber mills and the development of railroads and the factory model of economic activity.

    For any kind of creative endeavor, or for creating intellectual property or information services, they are downright dangerous. The link to the RSA video helps explain why.

    • John says:

      I think I may have posted that video link here before. In any case, I agree, I love it, and I’ve watched it now more times than I can still remember. As a Linuxer from its early days and an open source guy, I know the truth of it personally; it’s not just theory to me.

      I think it was Linus Torvalds who used to have the Usenet sig: “Sacred cows make the best burgers.” Tip of the iceberg, really.

      To the point of your post, JB. Be careful that you might be negotiating with terrorists. Republicans want to blow up the economy, plain and simple. Anyone who imagines they’re negotiating in good faith doesn’t know what good faith is.

      The KISS principle is in play here, but only one side is playing.

      When both sides of a question are smart and are acting in good faith, complex messaging may be appropriate, and maybe not. But in all other cases, KISS applies.

      Since you’re a musician, JB, you should get this: it’s better – and harder – to make a choir than to preach to one…

  7. Artie Gold says:

    Let’s try this one:

    “Depressing marginal tax rates distort income and wealth distribution.”

    So has it been — and it’s taken large amounts of our civil society with it.

  8. joe says:

    My grandfather was a successful trial attorney during the 50s when the top rate was 90%. He said the 90% rate discouraged him from taking cases but he also said it created opportunity for new lawyers since the case was still there and a attorney was still needed (ie: demand was there).

  9. jonathan says:

    A rough poll of economists generally came out at 60+% for marginal rates to have the Laffer Curve effect. I’ve found it absolutely amazing people argue with a straight face that 3% more in taxes meaningfully affects incentives. It’s saying that earning 62 instead of 65 out of 100 is then a bad deal.

    • urban legend says:

      Yes, I quit if I can only hold onto $620,000 of my million at the top marginal rate, instead of $650,000!

      Of course, in this example, it takes about a 5% hit on discretionary income — which, at these levels, isn’t spent on discretionary purchases anyway when the thrill of speculating on high-risk, high-reward derivatives beckons. To the extent any is spent, it’s more likely out of the U.S. — like that extra condo in Zermatt — so it creates zero U.S. jobs.

      If we make 20 middle income families make up that $30,000 difference that the greedy millionaire refuses to allow the government to collect — and it seems our millionaires indeed are fully capable of doing that — it virtually wipes out what little discretionary income they have.

      You might think the wealthy, with all their education and sophistication, even if they don’t give a crap whether it’s good for the country, might realize that it’s not good for the economy. That usually means their wealth is depleted, too, but I guess our power elite is too stupid to connect the dots. I guess Harvard should be ashamed.

  10. Shawn Smith says:

    Great job on the Lawrence O show tonight–keep up the good work.

  11. John Torrey says:

    The effect of marginal tax rate on a small business can also be counter-intuitive. If the tax rate is 90%, the proprietor can hire a “personal assistant” (or any other non-revenue position) for 10 cents on the dollar. The higher the rate, the bigger the write-off, as opposed to keeping the $$ as profit (= personal income to the proprietor) and letting it be taxed.

    The idea that a small business owner looks at his after-tax income at the end of the year and decides if can afford to hire employees is silly. He’s taxed on what he takes out of the business, and writes off what he puts into it.

  12. Jeff H says:

    1%, 3% here a % there a %, no big deal. Start taxing dividends like income, and then we’d see real BFD!

    I’m no economist, but I believe that that one rule change in 2000-1 stopped a ton of R&D, and investment in American companies. Not to mention the effect it had on risk taking.

    Why do I never hear economists speak of this truth? 😉

  13. Jock says:

    You’ve raised taxes for fifty years and didn’t solve the problem of spending too much.

  14. general c. san desist says:

    …two points:the elasticity of our indifference curve to the tax rates is an inverse of those being served the most (for them that have jobs)…and fighting over such rates at the moment is akin to rearranging the deck chairs. Is that Nero I hear in the background.

    At what point does kleptocracy become a tax issue? Where is the tipping point between piggery & thievery? The tax codes are the mechanism for recirculating the government issued money. It has worked well before Laffervision…why not now? One wonders!

    JB, carry a 3×5 card with the latest poll on taxing the rich & whip it out when the conservative brotherhood states that the people do not want tax increases on themselves…but on the rich it appears to be 3 to 1 for.