Site Meter

Wednesday, November 29, 2017

Optimal Capital Taxation and The Long Run

I do not like the argument that capital income shouldn't be taxed and I do not like the assumption that, in any good economic model, the economy will converge to a unique long run balanced growth path.

The two are related in two ways. First the mathematical case for zero tax on capital income states that as time goes to infinity the tax rate goes to zero. Many economists pretend this means that it should be cut to zero right now. This is utter nonsense.

The argument is that we wish people to have high consumption. For that to be possible they must save and invest. Capital income taxation penalizes saving and so prevents capital accumulaion -- by causing higher consumption now. The whole argument is based on the fact that, when one has a budget constraint, more now means less later. But this fact that the whole discussion is about doing the opposite now of what you want to do in the future is conveniently forgotten when it shifts from assumptions about desired consumption to conclusions about optimal taxation. I do not think that this can be an honest mistake.

The solution to the simplest version of the problem is that a state which wished to take wealth from investors and worries about their incentive to save should take the wealth as quickly as it can until it has taken all that it has any desire to take, then stop. The tax on capital income goes to zero if and only if the state does not wish to take from capitalists. Exactly when a lump sum tax which capitalists must pay no matter what would also be zero. As claimed, there is no tradeoff in the very long run between concern about incentives and other aims. But the reason is that the other aims are totally achieved as they would be if there were no problem with incentives.

The math is fairly simple (pdf warning). A slightly different and more realistic model has a more extreme result. The state takes from capitalists at time t even though it would rather let them keep the wealth in order to reduce their consumption at earlier times.

Here the trick is to assume the future is now.

A much more serious problem which actually affects political debate is the assumption that tax cuts will not lead to an exploding debt. This is just and assumption and it is part of the rhetoric of advocates of tax cuts, but it is also true of the models used by serious economists to analyse tax cuts. The reason is that the standard approach requires the economy to converge to a steady state. An exploding debt to gdp ratio is not allowed, because all such ratios are must converge to constants in all respectable models. Here the point is that this is required for the model to be respectable -- it does not follow from other core assumptions.

So, for technical reasons, it is assumed that the tax cut is paid for either by a tax increase or a spending cuts (often the assumed tax increase is a lump sum tax) which does not affect incentives. This makes the analysis useless. A more realistic assumption would be that the exploding growth will cause a future policy change involving taxes which have actually been collected without causing uprisings. This means that low taxes now imply high taxes in the future. If one considers only capital income taxes, it means the believe that they should go to zero as time goes to infinity implies they should be high now. If the choice is taxes in the future or in the present (and it is) then arguments that taxes should be low in the future imply they should be high in the present.

Of course the enthusiasts for tax cuts hope that the debt will lead to cuts in social welfare spending. But they don't admit it, because even discussing the possibility of such cuts in the future is political poison. Also, I think, they have short planning horizons and want low taxes at the time of the next election and don't care about the long run (but are willing to use analysis of the long run whenever it is convenient).v The assumption that something will be done to deal with the debt (and that this something won't have bad incentive effects) is almost always combined with the insane assumption of Ricardian equivalence that ordinary people keep track of the national debt, know what share will be paid by them and their heirs and adjust consumption accordingly. In the real world, government bonds create the illusion of wealth causzing higher consumption and crowding out investment.v I think there is another problem with journalistic presentation of the debate. Supply side loons say tax cuts will cause so much growth that they pay for themselves. Sensible people say this is nonsense. Ballanced journalists say the truth is probably somewhere in between -- they will cause more growth but not enough to pay for themselves. This means they can say that, on the one hand GDP will be higher and on the other the national debt will be higher. They don't explain why the second is a bad thing (people just assume it is). But if it is a bad thing, it is because the debt causes lower GDP (it isn't painful to carry it in itself). There is a logical contradiction between believing public debt is bad because it is bad for GDP growth and ignoring this effect when discussing GDP growth. This is so obvious that I think the popularity of pairs of inconsistent claims must be do to something very strong. I think it is the need to find something good to say about Republicans, which regularly drives US journalists crazy.

So the discussion suffers from two huge fatal errors based on playing around with the long run.

Tuesday, November 28, 2017

A Comment on Drum

Read this excellent post by Kevin Drum on, you guessed it, lead.

I guessed where it was heading after reading the title.

my comment

I have often thought of attempting to write this post and always thought better of it, concluding that you will write it better. And so you did.

I'd like to add one more explanation of resistance to the lead hypothesis. It is offensive to human dignity to argue that a mere metal can undermine human society and distort a human mind. You and I are atheists, but most people in the US believe in some kind of immaterial and (they hope) immortal soul. Any strictly materialistic explanation in psychology is threatenting to this hope (I don't have any such hope to lose). I think there is a similar cause of hostility to psychopharmacology. I think it is one of the reasons that people assert (assume really) that pills cover up the real problem (but don't assert that insulin covers up the real problem of diabetics).

I'd note another right wing hypothesis which competes with lead. There are many who think that the war on poverty had perverse effects by distorting incentives. Another theme of yours is the extreme hatred of "welfare" so of course you have grappled with the argument that welfare created the culture of poverty. The progressive (domestic) program was tried 65-68 & followed by increased social pathology. Totally aside from the fact that the war on poverty didn't last as long as the war in Vietnam (let alone Afghanistan) you can argue that it was a coincidence.

Finally, another left wing hypothesis threatened by lead -- which was I think the counterculter's hypothesis. There was a time when "the affluent society" was pejorative. I think it's (among other things) the title of one of the Galbraith books which I haven't read. The idea was somehow that the immense increase in material wealth in the 60s did something bad to our character or psyche or something. This isn't the explanaton that the counterculter was to blame. Rather it is the explanation which members of the counterculter (and some eminent Harvard economics professors) offered. It too is blasted by lead.

Finally speaking of blasting by lead, the easy availability of guns hypothesis is usually an explanation of US vs rest of rich world murder rates not of the rise in the 60s. It's doing fine.

Wednesday, November 15, 2017

Do Android Phones Dream of Electoral Sheeple in 1984

Signs of the times

A photo tweeted by the Russian Ministry of Defense Tuesday as "irrefutable" proof that the United States has allied with the Islamic State in Iraq and Syria turned out to be from a video game.

@umpire43 a bot who claimed to have joined the nave at age 5 then claimed to have served 22 years from 1970 to 1972 has deleted all its tweets But I have a screen capture

Dan Scavino retweeted him/her/and or it.

Umpire43's story is amazing. Roy Moore & his wife literally took an old letter of support by 53 pastors, and forged it to make it seem like he was still supported AFTER the allegations of sexual assault on minors came out.

So far, multiple people named in the letter have demanded they be removed from it.

But Russian cyber spies who are just interested in ethics in gaming journalism, stolen honor bots who defend pedophiles and Roy Moore himself bow down to Bernie Bernstein the fake man of the day

Wow: There's a fake, mysterious robocall in Alabama out there from someone falsely claiming to be 'Bernie Bernstein,' a reporter from the Washington Post, seeking 'damaging' info on Roy Moore for $

WKRG is on the Bernie Bernstein case

With notably rare exceptions Bernie Bernstein is aware of all internet traditions. A meme is born.

Jeff B/DDHQ‏Verified account @EsotericCD

I'm surprised they didn't go with "Shlomo Jewgold" instead of the infinitely more subtle "Bernie Bernstein."

Jeet Heer‏Verified account @HeerJeet

ME: "....and then the child molesting candidate tries to save himself by robocalls from a fake reporter called Bernie Bernstein."

PRODUCER: "Security!"

Brohibition Now‏ @OhNoSheTwitnt

Bernie Bernstein? Did Hanukkah Solo and International Banker Globalowitz sound too unrealistic?

The inevitable contrarian hot take (from Matt Yglesias of course).

Matthew Yglesias‏Verified account @mattyglesias

I have met people named Bernie Bernstein — it’s not *just* a Fake Jewish Media Name.

Oh hell just search twitter for Bernie Bernstein they are all wonderful

I think @Yair_Rosenberg wins the prize

((Yair Rosenberg)))‏Verified account @Yair_Rosenberg

(((Yair Rosenberg))) Retweeted Meridith McGraw

This is ridiculous. We didn't assign Bernie Bernstein to manufacture anti-Moore stories. He's currently rigging the Brexit talks.

The enemies of truth are ruthless, but they are also very very stupid.

Thursday, November 02, 2017

The Long Run and International Economics

I am still thinking about Krugman and the Gravelle Geardown

Do click the link if you are interested in understanding what I am typing about. Very briefly the question is: what effect would cutting the tax on profits have on the _US capital stock ? The particular issue is what difference does it make that most of US production is production of non traded goods and services. Gravelle claims that this implies a lower long run effect of the tax cut on US capital stock than would occur if all goods and services were traded (or that's what I think based on Krugman's explanation).

Here the key words are "long run" and, I think, an important issue is long run mysticism. This post is getting long. I will put the conclusion here. It seems to me that standard assumptions about the long run make even less sense in open than in closed economies and I think that is the key issue here. Macroeconomists have the most consensus and confidence about the long run. The reason is that it is all handled by simple assumptions made for convenience. In particular, it is standard to assume that there is a unique long run steady state determined by tastes and technology. This doesn't follow from other core assumptions. I think this is a terrible problem, because politicians think it is honorable to focus on the long run and that means they make policy influenced by the assumptions we make for convenience (austerity, the EU stability and growth pact, and European Single Bank single mandate). Over in the USA they talk about the effect of tax cuts assuming the government intertemporal budget constraint will be satisfied with equality -- this when commenting on GOP policy proposals which would violate it.

I will hint at a model used (by Krugman say) to assess the effects of a profit tax cut. It starts with two strong assumptions. First prduction is determined by technology and accumulated capital -- the model is solved as if there were full employment. This makes (some) sense if one assumes the unemployment rate is detrmined by monetary policy. Second it is assumed that consumption is not affected by interest rates. This assumption is based on the evidence -- it is radically different from the standard assumption made in theoretical macroeconomics. Finally Government consumption plus investment is taken as given.

With those thee assumptions, increased investment must correspond to reduced net exports. This matters a lot for short run dynamics. To get higher investment, the USA must run a higher current account deficit. Krugman recently argued that this has implications for exchange rate dynamics which, in turn, imply slow convergence to a new steady stated. But here I will just discuss the long run and assume it is a steady state.

I will now make an invalid argument as to why non-traded goods don't matter. In the long run, everthing will be in balance, The US after tax return on capital will be equal to the world real interest rate. The current account deficit will be zero. The real exchange rate will be that consistent with current account balance. It doesn't matter if all or onl ysome goods are traded.

Here the trick is that I assumed that there is a unique steady state even though the model must have a continuum of steady states. I assumed that each countries intertemporal budget constraint (that the present value of it's foreign debt must go to zero) is satisfied in the simplest way with each country having no foreign debt. Nothing guarantees that. Another steady state is one in which the USA is a net debtor and services the debt with trade surpluses forever.

Here long run mysticism has met representative agent mysticism, but an extreme representative agent assumption which is never made (but which I accidentally implicitly assumed). The assumption is that I can treat all countries as the representative country, so, in the long run, none is in debt to another. This is expecially crazy. It was an honest intellectual mistake I made.

In fact, I'm pretty sure I can guess what would happen if I actually worked through a model. The US cuts corporate taxes, foreigners want to buy US stock. This drives up the dollar and drives down net exports. The workers freed up by the reduced net exports build more capital in the USA until the after tax return drops to the world level. The dollar slowly depreciated until the world reaches a new steady state in which the US has more capital and the same rate of investment so the current account is at the constant level which satisfies national budget constraints. That does not imply zero net exports. The US has accumulated foreign debt while adjusting to the new higher capital stock. This means that the budget constraint implies positive net exports to service that debt. So the dollar will depreciate in the long run. The amount of capital which can flow in is limited by the amount of debt the USA can service. I think Gravelle gets her result, because this limit is binding.

Here my error was assuming that I could model the long run as a unique steady state in which all countries are symmetric -- none is a creditor nor a debtor. There is nothing in the model which implies this. It is an insane assumption about the representative country, which has no place in a model in which different countries have different tax policies. TThis is an extreme case of a very common error. Also in a closed economy, it doesn't really make sense to assume there is a representative agent. The assumption is just one of the many tricks used to get a single steady state when assumptions about tastes and technology are consistent with many different steady states.

A Comment on Krugman on Gravelle

Paul Krugman finds intuition for the calculations of Jennifer Gravelle difficult. Now even more than usually, you really have to click this link to know what I am typing about.

My comment.

yes that intuition is difficult. I have an attempt. So 1% of GDP is tradable. Also consumption and total production fixed. Mars cuts tax from t to 0. So to invest more Mars runs a current account deficit -- all cyberservice provided by earlhlings & martian cyberworkers go build capital. Note all the extra capital belongs to earthlings (I assumed martian savings are fixed).

In the long run, there will be current account balance. This means Mars will have a trade surplus required to pay the return on earthling owned capital on Mars. They owe us delta(k)r per year. They can run a trade surplus of only 1% of GDP so delta(k) less than or equal to 0.01 GDP/r

It seems to me the long run effect is entirely due to the fact that the tax cutting planet has to pay more capital income to the other one. This places a limit on the sum of their trade deficits and extra capital accumulation.

I think the limit on long run capital inflow is that hypothetical Mars (or the US in the real Solar system) can only owe the rest of the solar system liabilities which it can service. This is a long run limit -- a statement about the new steady state.

In the really real world, I think current US current account surplues are not sustainable forever, so the sum over the next century can't increase (or stay the same). So the long run effect of a profit tax cut is zero. But that's just a guess.