What instead? 2

by on January 24, 2009 at 11:06 am in Economics | Permalink

Matt Ygelsias asks what’s the
stimulus-skeptics’ alternative prescription?  Tyler offers his recommendations below.  I'm somewhat less of a skeptic about fiscal policy than Tyler – there is a good case for moving up useful infrastructure spending (both public and private) today – but I agree with Tyler that it is too early to think that monetary policy is ineffective.  M1 is rising sharply, M2 is up.  Monetary policy works with lags.  As to what to do instead I have offered a number of possibilities including:

1) Investment Tax Credit Unlike traditional fiscal policy an investment tax credit cannot be
fully crowded out and it works best when it is expected to be
temporary. Cuts in income taxes stimulate the least when they are
expected to be temporary.  But in contrast, an investment tax credit
stimulates the most when it is expected to be temporary because a temporary
credit must be used now or lost while a permanent credit gives you the
option to wait.

2)  A supply side stimulus: The IRS knows how much income that each taxpayer reported last
year.  So let's cut everyone's marginal tax rate based on last year's
income.  In other words, suppose that last year Joe earned $66,520
which puts him in a 25% tax bracket.  Joe's tax schedule this year will
be exactly the same as last year except for every dollar earned above
$66,520 the tax rate drops

to 15%.   We do this for all
taxpayers so that each taxpayer has their own schedule and for each
taxpayer there is a decreasing marginal tax rate.Note that this plan increases the incentive to work and it doesn't
increase the deficit.  In fact, the Tabarrok plan increases tax
revenues!  The key is a marginal tax cut with a different margin for
every taxpayer based upon last year's return.

3). A cut in the payroll tax ala Singapore.  If employment is down reduce the cost of employing labor.  This policy has lot to recommend it because unlike a fiscal stimulus it lets the reallocation process work towards its long run equilibrium.  A construction stimulus, for example, pushes people into construction (or keeps them there) when perhaps labor could ultimately be more productive in other sectors of the economy.  The payroll tax cut enhances this reallocation effort it doesn't impede it.

4)  Don't PanicThis is the policy that has cured most recessions.  The do anything and do it now mindset feeds panic.  I do think this recession will be longer than average and quite deep, it is a concern that it is worldwide.  But recessions are normal and we have unemployment insurance and other assistance programs to help people through tough times.  The economy will recover and its very possible to make things worse by trying to make things better.

Bill January 24, 2009 at 11:42 am

Economists have long known the conditions when government can increase real wealth—providing public goods, mitigating negative externalities, etc. Macro models where generic government spending, or tax cuts, do the same don’t obviate all that and are, in some respects, little more than formalized wishful thinking regarding government’s ability to spin flax into gold. At a fundamental level, such models deny that market participants, given the costly information and uncertainties they face, are putting resources to their most profitable uses. (How else is it even possible for fiscal stimulus to expand real output?) Yet even a brief exposure to the realities of government decison processes makes it nearly impossible to believe that politicians and government bureaucrats have some kind of informational advantage over market participants. The likely outcome of all the stimulus spending currently being proposed will be increased government borrowing, monetized by the Fed, and all the attendant inflationary cost that entails. So to Yglesias’ question, Is the anti-stimulus idea to do nothing and hope for the best? my answer is yes so far as “stimulative” fiscal policy is concerned. Let government concentrate on not adding to economic uncertainty.

a student of economics January 24, 2009 at 11:58 am

“Note that this plan … doesn’t increase the deficit. In fact, the Tabarrok plan increases tax revenues!”

I like most of your suggestions but you’re overselling this idea. The plan will almost surely reduce revenues (which is okay, btw). If Apple makes a big profit and gives pay raises or capital gains to some people, then those people will pay less taxes under the Tabarrok plan than they would have otherwise. You seem to assume that employees, contractors and shareholders can fully control how much they get paid. If only that were true. Of course, then we wouldn’t be in the situation in the first place.

SickofHypocrites January 24, 2009 at 12:34 pm

Not panicking is an extremely wise plan if you are a tenured academic Phd in academia where
there never seems to be any busy cycle. If you work(ed) for Circuit City or Harley-Davidson
it might be more difficult.

MattYoung January 24, 2009 at 12:42 pm

The feeling of the abyss!

OK, so we have Hank giving his pals $450 billion, Obama’s people are going to get a trillion.

Since none of that addresses our problems, I have an idea. Take the trillion and subsidize six month and one year savings interest rates for the poorest. Thus, whatever changes we make, they have help in minimizing their proportionally larger volatility.

Bill Woolsey January 24, 2009 at 1:15 pm

5. STOP PAYTING INTEREST ON RESERVE BALANCES

obey January 24, 2009 at 1:36 pm

On the ‘don’t panic’ part of your plan: When exactly would be the appropriate time to panic? There is a 12 month recession that is just getting worse, monetary policy has no traction, negative feedback loops show no signs of diminishing. The point of a stimulus seems to be part of a general strategy to unwind those loops. Should the US just wait a couple more years to see if the quantitative easing will do the job, and only then, with GDP is down 15%, and the structural deficit prohibitively large, get creative with fiscal policy?

the general skeptical position of “we don’t know if it will work, so lets do nothing” seems like a non-sequitur. If it doesn’t ‘work’ there will be an extra trillion on the national debt, a few better schools and roads, and some tax credits sitting in savings accounts across the country. I really don’t see what there is to be so terrified of.

a student of economics January 24, 2009 at 2:03 pm

Here’s a puzzle:
Why are state and local governments slashing spending, canceling projects that are underway, raising taxes and fees and generally doing the exact opposite of stimulating the economy, while the Federal gov’t is scrounging around looking for new “shovel-ready” projects to identify, plan, and launch?

Before starting new project, which may or may not pass traditional cost-benefit tests, shouldn’t we make sure that projects that were already approved aren’t canceled? It’s crazy to freeze construction on a court house that’s already 90% complete to save money.

The simplest way to do fix both problems is to give large federal block grants to every state that they can a) spend project that they have under way or wanted to do anyway or b) simply rebate to their citizens if they don’t see good projects to spend the money on.

Someone needs to put the Federal gov’t in touch with state and local gov’ts.

Alex Tabarrok January 24, 2009 at 2:58 pm

Obey,

The correct time to panic will be announced on this blog – this way we can all panic at the same time.

Barkley Rosser January 24, 2009 at 3:46 pm

There is no doubt that fica is regressive and a cut in it would probably be more
stimulative than cutting many other taxes. However, we have all these hysterics
declaring that social security is in crisis, with them now having gotten to Obama
(probably in the person of Larry Summers) after he had reasonably put off such views
during the campaign and is now all for “reforms” entitlement spending. Generally when
we have had that done to social security, the outcome has been a cut in benefits and
an increase in fica, or a proposal to engage in some privatization, which simply
makes the fiscal situation of the program in worse shape.

So, how does a cut in fica sit with all this sort of nonsense?

Robert Olson January 24, 2009 at 3:58 pm

“Obey,

The correct time to panic will be announced on this blog – this way we can all panic at the same time.”

If by panic you mean SAKE BOMBS!!!!!!!!! Why worry when you can drink?

Steve Sailer January 24, 2009 at 4:49 pm

Our problem is much more severe than a temporary downturn. We now know that our wealth of 2007 was phony, based on a mountain of leverage teetering on the unquestioned assumption that some drywallers in Palmdale would actually pay off their half million dollar mortgages.

So, the real question is not: how do we stimulate consumption once again to unsustainable heights, but:

How do we get more productive?

The most obvious plan is to junk government mandated luxuries dragging down productive businesses that seemed affordable when California homes were “worth” a median half mil, but now are clearly unafforable.

For example, to build on an insight of Gary Becker’s in 1957, the EEOC and DOJ should restrict their lawsuits over purported patterns of discrimination in the demographic makeup of the workforce to organizations that enjoy some degree of monopoly power (police forces, utilities) and the like. In contrast, competitive firms are punished by the market for irrational discrimination, so they shouldn’t be harassed by the federal government and encouraged to hire less productive workers in order to avoid discrimination lawsuits.

Miriam January 24, 2009 at 7:38 pm

Anti-discrimination laws and suits do not require companies to hire less productive workers. Anti-discrimination is exactly that – a way to prevent companies from discriminating against people who are equally productive but happen to be black, or female, or (in some places) gay.

Eliminating anti-discrimination laws or suits will have exactly zero effect on the economy because the same number of people will either be employed or not employed – they will just be different people.

komik January 24, 2009 at 8:16 pm

Thanks

Steve Sailer January 24, 2009 at 9:19 pm

Right. And what all the anti-discrimination government activity leads to is companies imposing quotas on themselves so they won’t get sued for discrimination for not having enough of the right kinds of workers.

Moreover, it leads to bad hiring practices. For example, I started work at a small marketing research company in 1982. The hiring exam then was Marketing Research 402 final exam that one of the founders, a professor, gave to his students at U. of Iowa. I sweated over it for three hours. We used it for five or ten years, but after we became the dominant company in our segment of the industry, the feds found out about the hiring exam and told us we’d have to expensively validate that it wasn’t discriminatory. So, we stopped using it and the quality of our new hires went down noticeably.

Similarly, when I was at Dun & Bradstreet and needed to hire a computer programmer, I asked HR for their written programming test. They said they would never have such a thing because they would be sure to be sued over it as discriminatory. However, I was free to ask orally all the programming questions I wanted as long as I never wrote anything down.

The time is ripe for an attack on this vast superstructure of waste. What’s President Obama going to say — America is still too racist to give a black guy a chance?

a student of economics January 24, 2009 at 10:08 pm

David,

I actually like Alex’s idea very much. Follow his link to see my comment when he proposed it earlier: http://www.marginalrevolution.com/marginalrevolution/2008/02/a-real-stimulus.html

However, it is false to claim that it doesn’t reduce revenues. The Apple example I gave is not just “possible” it is 100% certain and non-trivial for many taxpayers, and thus those revenues will be lost under this proposal. Moreover, your points 1 and 2 are also false. With this plan the gov’t is “deciding” on the margin that people should be encouraged to shift to activities where their income fluctuates greatly, possibly for reasons beyond their control. Lottery tickets, for example would be incentivized, as would myriad other forms of highly variable compensation, even if their NPV is zero or negative, and even if they have zero “prospect of increasing output”. It doesn’t require “deficit spending” only if you don’t count targeted tax cuts, and the forgone revenue, as deficit spending.

Despite not having all the virtues that Alex and you claim for the proposal, I still think it is an interesting and possibly worthwhile way to cut taxes and increase the deficit during a recession. However, being a supporter does not obligate me to pretend the flaws don’t exist. On the contrary, by understanding them, we can fairly evaluate the proposal, and perhaps even improve on it.

Delirious January 24, 2009 at 10:12 pm

How would free-marketers, to the extent they would have govt. “incentivize,” incentivize companies to not outsource to India/China?

It seems like the inclination to reduce labor costs is at its apex during a recession, so one would expect an acceleration in outsourcing.

Which would increase unemployment domestically. Bad, at least right now.

Which is better? To have workers collect unemployment checks, or retain jobs through some sort of tariff mechanism?

I’m wondering because several of my professional friends have been laid off recently due to offshoring, and I can see it coming for myself. And it doesn’t feel like cyclical unemployment… more like structural. {gulp}

a student of economics January 24, 2009 at 11:35 pm

Careless,

I can see how Alex’s post might have given you that impression, but unfortunately it’s not true.

Here’s a more detailed example.

Suppose Joe earns exactly the same in 2009 as 2008 EXCEPT he gets $10,000 extra in capital gains from selling Apple stock just after they announce record profits. Without Alex’s plan, he would be in the 25% bracket and pay $2500 taxes on the short term gain. With Alex’s plan he pays only $1500 on the gain.

Thus, he pays $1000 less in taxes than he would have otherwise, and the government collects $1000 less than they would have otherwise.

Of course, the same analysis would be true for many other types of variable income, and in many cases, those fluctuations are not 100% under the taxpayer’s control.

Do I still get an F?

David Wright January 25, 2009 at 3:22 am

Mixed tenses, run-on-sentences, reversing 2008 and 2009, one factual error, one stuble point left unexplained. I do believe my underlying points are valid, but I better hope you are not looking for nits to pick, Student, because my writing tonight is not up to par. Sorry to inflict that on you.

Anonymous January 25, 2009 at 11:01 am

Alex, Why not permanent elimination of the payroll and conrporate income taxes? The case for raising the retirement age is not to “save Socoial Security” but to keep productive people productive longer.

mulp January 25, 2009 at 9:43 pm

When is it time to panic?

Employment peaked at the end of the Clinton era of crushing high taxes that stifled the economy, but since that Bush tax cuts, the economy has struggled.

Only Bush’s make-work public works project which digs holes, filling in some, known as the War on Terror has juiced the economy. (What else can you call war but mechanized hole digging using single use excavation machines? Of course, a byproduct is often human hole digging followed by filling in the hole, with a social gathering before and after with food consumed.)

But Bush’s make work program has been significantly off-shored; while earlier in the Iraq war, many Americans were hired to work in Iraq, but the American workers have significantly been replaced by foreign workers, still paid for by the US, but not going to US taxpayers.

Think about it. 1932 Hoover signs a tax hike, and in 1933 the four year contraction ends. Bush signs a tax hike in 1990 in the middle of a contract and within six months a long expansion begins. And several tax hikes followed and only a tax cut on capital gains which might have promoted the NASDAQ bubble as startups tried to convert earned income to lower taxed capital gains. But still, the 1991-2001 expansion didn’t end until the first of the Bush tax cuts.

I do know the JFK tax cuts signed by LBJ in 1964 are credited by conservatives with ending the 1960-61 contraction, but the negative aspects of the tax cuts were offset by the make work digging holes of the Vietnam War.

I think it is just as likely that doing the wrong thing, tax cuts, will seem to work because other actions provide the needed Keynesian boost to the economy, like the invasion of Iraq. But imagine the dilemna if the anti-war faction had succeeded and there was no Keynesian stimulous in 2003-4.

With Bush’s Keynsian stimulous long gone, and Republicans calling for more economy killing tax cuts and their efforts to block Obama’s Keynsian stimulous to right the economy, maybe its time to panic.

JSK January 26, 2009 at 9:48 am

Ah there is a next page…

Anonymous January 26, 2009 at 7:14 pm

“Every year virtually every American has different income from the year before. The median change in income is 20% and this has been increasing over time. Far more people have increases in income than decreases in most years. In recent years, about 14% of people had increases of over 50% in their income, and 7% had decreases of that size.”

So basically, Alex’s plan is looking after the people who do not happen to need more income at the time. Are the more likely to spend, or invest, or save during a recession.

Also, it is unworkable. A much simpler solution would be to have a holiday on all FICA taxes. For most people, that is 90% of our population, this would be basically the same dollar amount as Alex proposes.

Plus Steve Sailer, we get it, you don’t like black people and think they are stupid! Enough already!

TokyoTom January 28, 2009 at 12:20 am

Ending the “war on drugs” would be a great step towards improving the economy in many ways. Just as Prohibition fostered lawlessness, violence and corruption – and the growth in relative power of the “G-men”, so too has the war on drugs, which undermines law and order and investment in urban centers, and keeps way too many people locked up.

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louis vuitton 2010 September 24, 2010 at 5:45 am

What do you need to see to conclude that monetary policy is or is not working?

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