Wednesday, November 11, 2009

What Bruce Bartlett Really Meant to Say

Bruce Bartlett's The New American Economy is an odd mix of clear thinking and muddle. Let me briefly sketch the clear thinking and then see if I can explain him out of his muddle.

Start with the clear thinking. Bartlett has established himself as perhaps the one most independent commentator/analyst on issues of taxes and budget. Here, he doesn't disappoint. He says (a) that he hasn't given up his enthusiasm for small budgets and low public spending; but (b) he thinks it's a lost cause; so (c) he has decided to address the question of what of new taxation (sic) will best serve our needs. As he's done for a while now, he supports a European-style value-added tax (VAT). He presents the case for a VAT with crisp efficiency.

That's the last of seven chapters--about 30 pages of 200 (Bartlett writes tightly, and says a lot in a small space). The rest is virtually all--literally--history, perhaps best understood as Bartlett's own apologia for where he's been and how he got where he is now.

Of the history, the first half of the book is Bartlett at the top of his form. It is an able, even elegant, exposition of Keynesianism, its rise and fall. His core assertion is not exactly new: that Keynes was a conservative who wanted to refine capitalism in order to save it. This should be familiar to anyone except the raving ideologues (and perhaps to some of them). But in presenting the point, Bartlett offers the best brief, non-technical account of Keynes' program that I've ever seen. His analytical clarity also allows him to present a compelling account of where and how Keynesianism went off the tracks. Most of its defenders in the Democratic party had abandoned it by the beginning of the Reagan years, leaving them pretty much unarmed in the ideological wars (Bartlett says they embraced the cause of "industrial policy," but I think the embrace was pretty tepid).

But now, the 50-page heart of the book: an account and defense of supply-side economics. It--the account--is a mess. It is meandering, repetitive and tendentious, pure analytical porridge.
I think the problem here is that Bartlett is too close to his subject.Well he might be: he is one of the intellectual godfathers of supply-side, and whatever his gifts, you could hardly expect him to present it with critical detachment. At any rate, he certainly doesn't. So let me see if I can help.

In lieu of Bartlett, start with a core ambiguity. "Supply side" is really two different doctrines. One--call it "supply side lite"--is uncontroversial and widely accepted today, though to be fair, it was not so widely accepted in 1980. The other--call it "supply side steroids"--is mostly nonsense, and it has almost no empirical support.

First, supply side lite. How much extra income will we garner if we tax all incomes over $200,000 at 100 percent? The answer is none: no one will work for nothing. Taxes are incentives, and incentives change behavior. As Bartlett correctly argues, this is really nothing new. Taxes on heroin, shotguns, human trafficking, are designed not for revenue: they are designed to discourage disfavored behavior.

But the devil is int he details. Suppose we have a gross domestic product of 100 and a tax rate of 25 percent; we collect 25 in taxes.* Suppose we cut the rate to 20 percent. How much revenue will we lose? You can't say in the abstract, but the answer is almost certainly not five. Some people, incentivized by the new, lower taxes, will work harder and make more money. So in the end, we may lose only three or four. It's an empirical question and it is not easy to answer precisely in the abstract, but the general principle is inarguable.

It works the same the other way around. Suppose we have GDP of 100 and a tax of 20 percent, so we collect 20. How much extra income will we get if we raise the rate to 25? Again, the answer is unkowable, but it is almost certainly not five. At the margin, some people will lighten up on work, and we may get only three or four.

By now this ought to be axiomatic although it is amazing to recall that the government just didn't do this kind of accounting until about 30 years ago. It's tricky: it is hard to get right and easy to get wrong (and, therefore, vulnerableto corruption). But the principle is beyond dispute.

Now, supply side on steroids. The trouble is that the original supply siders weren't content to stop there. They went the whole nine yards and argued that a government could cut taxes without loss of revenue if it simply cut taxes.

There are so many things wrong with this idea that it is difficult to know where to begin, but stick to our example--GDP of 100, tax rate of 25 percent, so revenue of 25. Suppose we cut the rate to 20. The question again becomes: by how much will GDP have to rise in order to make up the loss? The answer is 25 percent --from 100 to 125 (it's the reciprocal of the 20 percent tax cut). Does anybody think that we can generate that kind of growth from that kind of cut?

As baldly stated, I think the short answer is "no," although supply siders have done a lot of tap-dancing to distract attention away from their bare backsides on this one. For example, Arthur Laffer (quoted by Bartlett) liked to talk about what you might call "secondary effects"--for example, if taxes were but, maybe people would work harder, make more money and therefore create new jobs and therefore get people off welfare. So we get not only new jobs, but welfare cuts. Or as another example, if you cut rates you may reduce the problem of tax evasion. Both of these points are plausible in the narrow sense, but they have a distinct aroma of ad hockery about them, and it is hard to conjure up numbers where they really carry the ball.

Perhaps there is one plausible scenario where supply side will actually increase revenue, but it is a special case and a one-off. I'm thinking of the capital gains tax. The point is that the capital gains tax is near-discretionary. For the most part, the investor doesn't have to sell if he doesn't want to. So if he thinks the capital gains tax is too high he simply holds on. It is entirely conceivable that if the capital gains tax is cut "enough," it will generate a flood of pent-up selling, perhaps large enough to compensate --or more than compensate--for the rate reduction. Perhaps this is particularly true if investors feel the rate will go up again later. In any event, it is a one-off: once the pig gets through the python, we are back to ordinary collections again.

Bartlett makes all of the points that I've made so far, sometimes glancingly and indirectly and often without stressing them (he makes no effort, for example, to press the distinction between lite and steroids). More that that, he seems to through in comments on a range of other issues which may be related to supply side-or may not be, but at best, whose relationship has to be defined and examined. I mean: the question of "rate progressivity;" of deadweight losses; of stocks v.flows--stuff like that. All important issues, but if you are going to talk about them, you'd better be prepared to spell out what you are saying and why it matters.

Indeed, Bartlett is similarly coy about the whole context of the early Reagan years when supply side was born. He talks about the 1981 tax cuts and (much later) about the later tax increases, but he doesn't make any general effort to assess the fiscal landscape of the early years. He doesn't say anything one way or the other about the extent to which the "Reagan recovery" is really a "Carter recovery"--the natural happy ending to the earlier bad times. And any book that can write about economics in the early Reagan years without mentioning Paul Volcker--I almost want to say it just shouldn't be taken seriously.

But Bartlett should be taken seriously. When he is on his game, he is a master of crisp and comprehensible analysis. He seems to have his thumb on just about everything thaat has happened in tax and spending policy over the last 70 years (possible exception: Paul Volcker). And you've got to be impressed by anybody with his independence of mind. So, read the Keynes stuff, it is first-rate. Read the policy prescription in the last chapter if you want to know why Bartlett favors a VAT. Even read the middle on supply-side if you like but on that one, you'll have to do the heavy lifting yourself.
*I have a vague sense I have used this example before. No matter, it's a good one.


Murali said...

But if I have a 0.5% higher growth rate, I could more than recoup my losses over the next 50 years.

And if I could say increase the economic growth rate at whole percentage point magnitudes you could make a killing in maybe a decade.

For example with a difference in growth rate of 1% per annum, in 25 years the economy is 27% larger. So while this is not the kind of stuff that would be visible over, say, the president's term. It is really good for policy to keep tax rates low. Over the long term, it will keep your budget balanced. (you could basically play with the numbers on excel. Key in the requisite formulae and adjust growth rates to see how much larger the economy will be 50 years form now. Grznted, 50 years seems like too long to plan, but whatever your ideology, you would want your growth rates to be higher. Now, there is possibly some point where the return on growth rate isnt so high, and we probably wouldnt want to wait too long. But taxing at 20% or less is not likely to lead to disaster, and will probably be good in the long term.

Also, as long as you're talking about tax cuts, you forget payroll taxes. Cutting the employer's contribution of the payroll tax during the recession is likely to save jobs. If profits dip 8%, an 8% cut in the payroll taxes will allow the company to continue employing at the same level as before. And when the economy is recovering, restore the payroll tax.

But then again, which politician would ever recommend cutting the employer's contribution to the payroll taxes during a recession? other than Singapore's PAP that is/

Anonymous said...

A couple of things that you might want to consider adding to your spreadsheet:
(1) The short term loss of revenue will tend to increase budget deficits. Unless offset by spending cuts (HA!--at least in the US) the government is going to have to pay to service that debt.
(2) Government expenditures will tend to increase, too. Expenditures will go up due to inflation, if that is in your spreadsheet. And, critically, expenditures will tend to go up as a function of economic growth, since some government functions scale up with economic activity. So, some of the extra revenue generated by the extra economic growth goes to extra government expenditures (regulation, infrastructure, etc.). Of course, this still ignores the possibility that politicians will choose to provide new government services as the economy grows.

When I fill out my spreadsheet, I see a lot of additional debt in the short to medium term, that takes a long time (at least 50 years--even with optimistic supply-side assumptions) to pay off the debt, let alone start paying dividends. I'm not confident that (a) the US government can engage in a constant economic/budget policy over 50+ years, and (b) that such a policy will have constant economic effect over the long run (though I have no particular argument in favor of this point--it is pure economic gut instinct).

AndrewBW said...

I haven't read Bartlett's book yet but to be fair to him, in his other writings he's clearly distinguished between "supply side lite" and "supply side steroids" and argued vigorously against the latter. Some months ago he wrote a column arguing that the supply siders should simply declare victory and close up shop because the ideology now was completely bankrupt. It's too bad he doesn't make this distinction clearer in the book, but it's not as if he doesn't know it.

Anonymous said...

Can you recommend a book on Keynesian economics suitable for an adult with a financial services background and an MBA? I want something more detailed than a "Dummy's Guide to" but not something that will cause me to research lots of things to understand each chapter (It's been 20+ years since MBA school and I barely remember the Black & Sholes option pricing model....)

axg said...

You seem to be nevertheless accept that lowering the tax rate increases the incentive to work and so pre-tax revenue (at least to some extent).
I can't see that this is true for all people (doesn't it it depends on one's the marginal utility of income at the increased total income one has after the rate change?). Is there some additional fact or argument that makes this "obviously" true in aggregate?

Buce said...

Responding to the most recent anonymous, go here:

Nathan Tankus said...

cutting payroll taxes does alot less to reduce job cuts then you imagine. during a recession employers cut wages and employees an attempt to recoup profits lost by less effective demand (demand of goods at a certain price, in context the prerecession price) and thus less goods produced. a cut in payroll taxes would make labor costs substantially lower but at a certain point they're simply isnt anything for additional workers to do because of lower effective demand for goods and recession conjured productivity increases. labor hoarding does occur to a certain extent, especially with workers who the company has invested alot of time and money in, but anywhere near the scope needed to justify a payroll tax holiday. if payroll taxes are used they should be targeted at specific industries especially export industries and should coincide with more opening up of foriegn markets.

Nathan Tankus said...

also tax cuts only increase economic growth when the budget is already and stays balanced through the tax cuts. structural deficits tends to divert money away from private investment during good times and reduce growth. gdp tends to hide this fact but if you look at net real gdp(gdp minus government spending) growth during 1950-1980 and 1996-2000(when clinton balanced the budget) was much stronger then 1981-1994 and 2001-2007.