Category 2012 Election

Yglesias’s Faulty Economics

Danny Vinik Leave a comment

Matt Yglesias just penned a post in defense of Mitt Romney’s tax plan but I think he mixes up the economics quite a bit. He writes:

The good thing about taxes is they raise revenue, which can be used to do useful things. The bad thing about taxes is they may be a drag on economic growth. But here there are two considerations. One is the “incentive effect” of taxes—higher taxes mean less incentive to do economically valuable things. The other is the “income effect”—less money in your pocket means more incentive to do economically valuable things. The genius of Romney’s plan is that by eliminating deductions it leaves middle class families with less money in their pockets (so a pro-growth income effect) while also lowering the tax rate they pay on a marginal dollar of additional earnings (so a pro-growth incentive effect). Basically it’s a huge win. You get a bunch of revenue in a way that bolsters the country’s growth prospects.

Let’st start at the beginning. The first part about taxes raising revenue and hurting growth is correct. But then it gets murky. Yglesias writes “higher taxes mean less incentive to do economically valuable things” and just a line later says, “less money in your pocket means more incentive to do economically valuable things.” But higher taxes means less money in your pocket. They are different ways of saying the same thing. Yet, Yglesias comes to different conclusions for their effects on economic growth.

I understand his train of thought here. A lower marginal tax rate allows people to keep a larger amount of their income. However, fewer deductions allows them to keep a smaller amount of their income. And if the middle class pays more taxes overall (as Romney’s plan does), that means they are keeping a lower share of their income overall and paying a higher effective tax rate. However, this says nothing about whether people will work more or less (which is what I assume Yglesias means by “do economically valuable things”).

Here, there are two different effects: the “income effect” and “substitution effect.” The income effect says that because  the middle class has less after-tax income, people will work more to make-up for their lost earnings. The substitution effect, on the other hand, says that because the middle class will keep a smaller percent of each dollar they earn (remember, overall they are paying more in taxes), they will work less. The question is, which effect dominates the other? If the income effect is a larger, people will work more (or do more economically valuable things). If the opposite is true though, people will work less (or do less economically valuable things).

But we don’t necessarily know which one  would dominate; it depends on a number of different things. So it is wrong to say that it bolsters the country’s growth prospects.

Nevertheless, I agree with the rest of Yglesias’s post that using the extra revenue to pay for a lower effective tax rate on high-income earners is a bad idea. In fact, Romney’s tax plan has a number of major flaws, not to mention that it is mathematically impossible. And given that it doesn’t necessarily improve the country’s growth prospects (which are also more complicated than just the middle-class), it’s tough to defend any aspect of Romney’s plan.

How Can I Trust AEI?

Danny Vinik Leave a comment

I meant to write this a few days ago, but never got around to it:

I want there to be a respectable conservative think tank. I want there to be good research out of the right. I want there to be policy analysis that constructively analyzes both the right and left’s proposals. Right now, there are a number of left organizations that do that. The Citizens for Tax Justice leans leftward but produces good, quality work.

It would be nice if the right could actually attempt to put out an unbalanced report. The Heritage Foundation long ago lost credibility in my eyes. But I’ve always tried to give the American Enterprise Institute (AEI) a chance. For instance, its response to the Tax Policy Center’s analysis of Romney’s tax plan is something I can at least respect and debate:

Now I don’t have a problem with the general analytical approach here, nor am I surprised by the findings given that approach. The U.S. has an extremely progressive income tax system where the top 1% pay 40% of the income taxes, while the bottom 50% pay just 2%. Across-the-board tax cuts will favor upper-income folks and “paying for them” will make the system less progressive in terms of the tax burden.

But I do have some issues with the study, as well as an observation or two.

First, the study assumes that Romney’s corporate income tax will be paid for by eliminating about $100 billion in business tax breaks. Yet an AEI study suggests that the U.S. corporate tax rate is deeply on the wrong side of the Laffer Curve and a cut to 25% might well pay for itself. So that $100 billion could help pay for individual income tax reductions.

Second, the study offers one scenario that assumes the tax plan produces greater economic growth than the TPC baseline scenario with a revenue loss of around $300 billion instead of $360 billion. Apply that $100 billion in corporate savings, and the revenue loss — before scaling back individual tax breaks — would be around $200 billion. At that point, the supposed tax hike for those making under $200,000 would likely be much less than 1%.

Third, I would guess the Romney campaign is betting on even higher GDP growth estimates than Brookings-TPC, assuming the economy might get a confidence bounce from business, investors and consumers after a Romney win, especially if he is able to produce major tax and entitlement reform.

I haven’t seen any other study on the correct Laffer curve rate for the corporate tax rate than AEI’s. It’s great that AEI has done that research. And while I don’t necessarily agree with their points (corporate tax revenue isn’t just related to the Laffer curve, it also has to do with the international system), I think that reasonable people can disagree over them. And on top of that, the authors agree that “across-the-board tax cuts will favor upper-income folks and “paying for them” will make the system less progressive in terms of the tax burden.” It’s good stuff.

But then the President of AEI, Arthur Brooks, comes out with a trash column in the Wall Street Journal. It mainly focuses on the Administration’s decision to issue welfare waivers. This has been thoroughly debunked all week so I’m not going to go into it. What I do want to point out is how Brooks opens the op-ed:

Within the space of just two weeks, Americans have witnessed two radically different philosophies about the free enterprise system from President Obama. In his notorious Roanoke, Va., speech of July 13, he said “If you’ve got a business—you didn’t build that. Somebody else made that happen.” That is, Americans have not fully earned their success. (bolding mine)

Are you kidding me?! It’s dishonest and slimy for Romney to slice Obama’s words like that. For a supposedly respectable head of a conservative think tank to do so is disgraceful and despicable. Honestly, Brooks 100% knows what he is doing here. His entire goal is to trick the American public. How can I trust anything AEI produces when its president writes such garbage?

Harry Reid Off His Rocker

Danny Vinik 2 Comments

Can I just point how absurd Harry Reid’s comments have been the last few days? He’s been saying that Romney has not paid any taxes for ten years. Okay, I don’t think anyone possibly believes this, but Reid claims to have “extremely credible sources.” Uh huh, sure you do, Harry. It’s very unlikely that Romney did not pay anything in taxes the past decade.

Here’s Reid’s full statement:

“There is a controversy because the Republican presidential nominee, Governor Mitt Romney, refuses to release his tax returns. As I said before, I was told by an extremely credible source that Romney has not paid taxes for ten years. People who make as much money as Mitt Romney have many tricks at their disposal to avoid paying taxes. We already know that Romney has exploited many of these loopholes, stashing his money in secret, overseas accounts in places like Switzerland and the Cayman Islands.

“Last weekend, Governor Romney promised that he would check his tax returns and let the American people know whether he ever paid a rate lower than 13.9 percent.  One day later, his campaign raced to say he had no intention of putting out any further information.

“When it comes to answering the legitimate questions the American people have about whether he avoided paying his fair share in taxes or why he opened a Swiss bank account, Romney has shut up. But as a presidential candidate, it’s his obligation to put up, and release several years’ worth of tax returns just like nominees of both parties have done for decades.

“It’s clear Romney is hiding something, and the American people deserve to know what it is. Whatever Romney’s hiding probably speaks volumes about how he would approach issues that directly impact middle-class families, like tax reform and the economy. When you are running for president, you should be an open book.

“I understand Romney is concerned that many people, Democrats and Republicans, have been calling on him to release his tax returns. He has so far refused. There is only one thing he can do to clear this up, and that’s release his tax returns.”

Yes, Mitt Romney should release his tax returns. But Reid is taking an outlandish position for calling on him to do so. Not to mention, the Democratic Senate Majority leader calling on Romney to release his returns isn’t going to surprise anyone. Reid’s hyperbole just further reduces the (small) potential persuasiveness of his comments.

James Downie had a bit of a different take on this than me:

I know Greg isn’t sure how this helps, but I think it’s a smart play from Reid: It keeps Bain in the headlines. And ask yourself this: If there’s nothing damaging in his returns, Romney could now, in one stroke, annihilate Harry Reid’s reputation in Washington. So why hasn’t he released them?

Well, I think Reid made a (very) calculated play here. Just because Romney has the ability to “annihilate Harry Reid’s reputation in Washington” doesn’t mean it changes any of the calculations Romney made about the impact releasing his tax returns would have on his presidential chances. If it was a bad play to release them before Reid spoke, it’s still a bad play now. Harry Reid knew Romney wouldn’t call him on it. As for keeping Bain in the headlines, I still think the hyperbolic nature of his comments will cause many people to immediately disregard them, but we can agree to disagree there.