Tag Archives: Pete Boettke

Would You Oppose a Tax Cut on the Grounds that it Only Applied to a Few Firms?

A few weeks ago, Pete Boettke graciously invited me to speak at the Philosophy, Politics and Economics workshop at GMU. During the course of the talk, I extolled the virtues of what Hayek called “generality”—the idea that political action should not (positively or negatively) discriminate against any person or group of persons. (Note: generality goes beyond the 14th Amendment guarantee of equal protection under the law. That only prohibits discriminatory application of laws, but it does nothing to prohibit discriminatory laws such as taxes that apply to one group but not another. A true generality principle says that the laws themselves should not discriminate.)

Near the end of the talk, one of the attendees asked if I would oppose a tariff reduction for one (and only one) industry on the grounds that it violated generality. I believe many free-market advocates would say “No; we should always take any opportunity to expand economic freedom.” Milton Friedman expressed this view when he declared he’d “never met a tax cut I didn’t like”

My answer, however, is that in some circumstances the advocates of economic freedom should oppose such a tariff reduction. This is because I believe those of us who value economic freedom should also value generality. I have four reasons.

  1. Generality is morally intuitive. Kant called it the “categorical imperative,” others more prosaically call it the “golden rule.” Whatever you call it, it seems that lots of humans in lots of cultures value the idea that laws ought to treat us equally.
  2. Violations of generality make us poorer. When government discriminates in the way it taxes or in the way it spends, people change their behavior (note that in traditional public finance, a head tax creates no loss because it doesn’t discriminate between work and leisure or between consumption and non-consumption). And these changes in behavior are costly because they tend to discourage mutually-beneficial exchange. Economists call this the deadweight loss of taxation and these costs are greater when policy is more discriminatory. Thus, a tax that raises $100 million by taxing goods and services equally will involve less deadweight loss than a tax that raises $100 million by taxing only goods. What’s more, the tax rate on goods will have to be higher if the government wants to obtain the same amount of revenue. (I could mention other economic costs under this same heading. For example, knowledge problems and malinvestment, both loom large under discriminatory taxation).
  3. Violations of generality create rent-seeking loss. When government is in the business of privileging some and punishing others, citizens tend to invest resources (time, money, effort) in asking for their own privileges or in asking that others not be privileged. Quite often, these efforts produce no value for society and are a loss.
  4. Violations of generality make it easier to violate economic freedom. In the long run, I believe a norm which permits violations of generality will tend to make it easier to violate economic freedom. Consider a proposal to tax each of three people $10, plus one additional dollar in deadweight loss, in order to turn around and redistribute $10 to each of these same three people. None of our three citizens would be willing to vote for it. But now consider a proposal that costs each of three people $11 ($10 in tax + $1 in DWL) in order to turn around and redistribute $15 to two of the three. Now a majority coalition can easily be formed. The coalition is made viable only by violating generality. What’s more, the coalition will be even stronger if the proposal not only violates generality on the spending side but also on the taxing side. That is, if the proposal is to impose $33 in costs on only one person in order to distribution $15 to each of the other two, then the coalition will be especially strong. In fact, if it can shield itself from the pain of taxation, the coalition will be prone to ask for much more revenue. So in the long run, economic freedom is protected by adhering to generality, even if in the short run the two values appear as a trade-off.

None of this is to say that we shouldn’t also value economic freedom. To put it in terms that economists will quickly grasp, my indifference curves look like this:

 

 

 

 

 

 

Not like this:

 

 

 

 

 

 

Too often, in my view, conservative policymakers are suckered into violating generality because they believe they are advancing economic freedom. They end up supporting tax preferences for manufacturing, ethanol, housing, child bearing, and much else on the grounds that any tax cut is a good tax cut. Many of these tax preferences are the result of cronyism and each entails a host of economic and social costs. The end result is a tax code that is monstrously complex and that, too, is a cost.

The first-best solution is low and non-discriminatory taxation. Beyond that, I think we need to recognize that there are (short run) trade-offs.

 

Does Stimulus Work?

Dylan Matthews has a fascinating post over at the Washington Post Wonkbook. He surveys 15 studies of fiscal stimulus and concludes that 13 of them found a positive effect. Let me begin, as Pete Boettke does, by congratulating Mr. Matthews on his approach. He is reasoned, restrained, and apparently interested in looking at the facts. That is not so common in blog posts about stimulus.

Pete wonders how critics of fiscal stimulus might respond to this. Here is my shot.

I have three broad concerns:

  1. I believe that Matthews, like many stimulus advocates, continues to overstate the degree of unanimity among economists on the efficacy and wisdom of fiscal stimulus.
  2. Irrespective of the macroeconomics of stimulus, the public choice of stimulus implementation looks quite bad. Political actors do not behave as Keynesian models suppose they do. So governments do not implement stimulus as Keynesians say they should. And when stimulus is incorrectly applied, it is worse than ineffective. It is counterproductive.
  3. Matthews’s post ignores the short run / long run tradeoff. Not even the most strident Keynesians believe that permanent stimulus is the path to prosperity. At some point governments have to raise taxes to pay off the debt they have accumulated. That is costly and even if one accepts the possibility of short-term gain, it is irresponsible to ignore the certainty of future costs.

I’ll take each of these points in turn.

Stimulus Advocates Overstate the Degree of Unanimity Among Economists:

In introducing the 15 studies Matthews notes that the Romney campaign “left out” a few studies. I’d note that he, too, left a few out. Among peer-reviewed studies that suggest stimulus mostly crowds-out private sector economic activity, I’d include:

In fairness, I’d also include some additional studies which tend to find stimulus stimulates private sector economic activity:

Taken together, this does not look like consensus, does it?

Things get even murkier when one digs into the weeds. For example, some of the “big multiplier” studies only find big multipliers in certain circumstances. And there is reason to believe that these circumstances didn’t apply during the recession and are even less likely to apply now that we are in a weak recovery. To wit:

  • Multipliers are smaller as stimulus gets larger and we have already undergone massive amounts of discretionary and automatic stimulus.
  • Multipliers are smaller in economies that are open to trade.
  • Multipliers are smaller in economies with flexible exchange rates.
  • Multipliers are smaller in economies that are burdened by high levels of government debt.
  • Multipliers may be smaller in a balance sheet recession.

I think the most-recent Nobel Laureate, Thomas Sargent, was right to complain that “President Obama should have been told that there are respectable reasons for doubting that fiscal stimulus packages promote prosperity, and that there are serious economic researchers who remain unconvinced.”

But even this understates the problem. That’s because…

Stimulus Advocates Largely Ignore the Public Choice Problems with Implementing Stimulus:

In the words of stimulus advocate Lawrence Summers, “Fiscal stimulus is critical but could be counterproductive if it is not timely, targeted and temporary.” In my view, the biggest problem with stimulus is that it is very difficult for policy makers to simultaneously satisfy all three criteria.

Untimely: As the President acknowledges, it is very difficult to make stimulus timely, especially when one is dealing with infrastructure projects that involve planning, bidding, contracting, construction, and evaluation. This is why, as late as June 2011, “$45 billion in Department of Transportation infrastructure money had been appropriated, but only 62 percent ($28 billion) had actually been spent.”

Off-Target: It is also very hard to make stimulus targeted. For example, Keynesian theory tells us that to be effective, the money that went to the states needed to have been spent. Instead, 98 percent of it went to decreased borrowing, not increased spending. Worse, of those new hires that were made, many had been previously employed.

Not Temporary: As Paul Krugman has often stressed, stimulus should be temporary to be effective. But as the authors of one of the “large multiplier” studies put it, “it is much easier to start new government programs than to end them.” That’s why, historically, 95 percent of stimulus surges are still there two years after they are begun. It may also explain why the U.S. has spent 90 percent of the last 40 years in a deficit, despite the fact that Keynesian theory would have called for a surplus during most of that time (again, policy makers just don’t behave as Keynesians hope they would).

It’s also why Lord Keynes himself was a skeptic of big stimulus projects near the end of his life, writing:

Organized public works…may be the right cure for a chronic tendency to a deficiency of effective demand. But they are not capable of sufficiently rapid organization (and above all cannot be reversed or undone at a later date), to be the most serviceable instrument for the prevention of the trade cycle.

Stimulus Advocates Often Brush Past Long Run / Short Run Distinctions:

I won’t belabor this point since this is already probably my longest post on record. Stimulus is not a permanent path to prosperity. If all goes perfectly well, it can get a nation out of a pinch. But it has long run costs. Stimulus leads to future taxes and/or future debt and we know that both excessive taxation and debt are economically harmful. Stimulus also has a tendency to ratchet-up spending and we know that, excessive government spending is harmful in the long run. Finally, stimulus has a tendency to undermine economic freedom and we know that a lack of economic freedom is harmful in the long run.

In sum, if we have too much stimulus punch today, the economy will get a major headache tomorrow. Though most academic studies acknowledge this, too few policy makers and pundits seem to recognize it.