Economic Medicine

Imagine you had just been diagnosed with a rare and debilitating disease.  Defining rare, there have been only 14 previous cases.  Still, there are two medical treatments that have been tried on those 14.

Here are the results:

Results of two trial medicines

OK, I’m sure you guessed that this wasn’t about medicine, unless you agree that our economy is sick and needs treatment.  But what treatment?

I’ve been debating with some of my libertarian friends what I think is the folly of their preferred course of treatment, and utterly stunned that the political debate seems to be leaning toward letting the same crew that screwed up so badly have their hands on the economic controls yet again.

This chart came from the web site set up by two enterprising people who are busy combing through the data on the US economy over the past 14 Presidents.

They’re looking at what happened with unemployment, recessions, tax policies, and yes, even whether each President had his own party or the opposition controlling Congress at the time.  They’re also looking at lagged effects, as another chart in today’s blog post shows:

What happens after tax receipts are increased.

I’m so impressed with people willing to look at the facts without the filter of pre-conceived notions that I’ve included a link to their blog on the main page (right hand column).

From the blog post today, a paragraph that shows how unconventional a reality-based review of our economy might be:

“Notice… administrations that cut the tax burden early saw mediocre increases in private investment later. On the other hand, administrations that started out by increasing the tax burden enjoyed big increases in private investment in the remainder of their term. This is yet another instance where real world results contradict just about everything that standard economic theory teaches, particularly the Chicago School, Austrian, and Libertarian variety. And sadly, that theory has so permeated our collective thought processes that it has come to be referred to as “common sense.” Just as it was common sense at one point that the earth was flat, and the center of the universe.”

Let’s get out of our mental straightjackets and get out of those two party ideological boxes while we’re at it.

hh

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15 Responses to Economic Medicine

  1. Fred says:

    Howard,

    If I get this reasoning right, the more we tax people, then the more investment we will get later on.

    Now to follow this line of reasoning to its final conclusion, then all income should be taxed 100% so the gummint can distribute it properly.

    Fred

  2. hhill51 says:

    Fred…

    That goes right along with the conclusion the supply-siders push that lowering tax rates increases government revenues. Taken to its extreme, a tax rate of zero pays off the national debt in the first year.

    Just as logical, and not worthy of your intellect.

  3. I Sonsino says:

    tax changes are not all legislated. Planners, and “global” opportunity rates affect taxation more than rates. The relation of Chinese tax holidays to taxes collected from US multinationals might be measured, but the obvious result is lower taxes on unrepatriated profits subjected to no taxes. Unintended consequences may include unemployment, future lower levels of education, lower prices! Contraction !
    Also, federal income taxes aren’t the only ones: property taxes, sales taxes (regressive), and higher oil prices act as taxes. Rents and interest also act like taxes, dampening excess profits.
    The regressive effect of some of the levies is to dampen demand, while the decrease in taxation spared Chinese profits spurs supply. As lower prices and profits affect growth, the demographic of the middle and upper class birth rates over the past fifty years’ contraction creates a perfect storm!

    • hhill51 says:

      Isaac….

      I assume that’s you. Thanks for the response.

      I’m quite aware, as was the author of the article, that there are more than two degrees of freedom here. At least they normalized some key variables in a way most political economists fail to – by looking at the entire tax burden vs. the economy and putting it, and the subsequent private investment in per capita terms.
      It still leaves the plain fact that the fundamental assumptions of the “tax cuts first, tax cuts next, tax cuts forever” crowd are in question, as are the “free market” believers’. For some reason, they can’t seem to tolerate even looking critically at the results their policies created in the past.

      Why is that?

  4. Tom D says:

    Howard,

    It’s an oranges and orangutans argument, Howard. Only fourteen instances, each of which had totally different starting conditions at the time of inauguration of the president and his tax policy? Not statistically meaningful. It’s more like a political campaign argument: “Raise taxes and benefit the economy!” Ha!

    Tom

    • hhill51 says:

      One thing I think you should admit is that the “cut taxes to spur future investment” mantra chanters have got some explaining to do.

      The burden of proof is most definitely on the shoulders of the supply-siders, given the historical reality.

      hh

      • Tom D says:

        My point was that the statistics of that very simple and minor exercise don’t make a case for either side. Too bad it isn’t that simple a choice.

  5. Sechel says:

    Howard

    A couple of problems with stimulus(apologize for the lack of original thought as I’ve read this elsewhere).

    1) Does not assign any quality to what the stimuls/investment is. The
    government could just buy rocks from people
    2) The money must be repaid by tax payers and in the mean-time we borrow the money and pay interest on it. You cannot kick the can down the road forever.

    We have spent two trillion on stimulus and have not gotten anything fOR it. Essentially we’ve done two things taken future economic activity and brought it into the current period(cash for clunkers, housing tax credit) and just like an athlete taking performance enhancing drugs, the day after is one bad day.

    Additionally government is a terrible allocator of capital. Businesses build factories and contribute to an increase in GDP. In the current environment business and individuals build expectations of future economic weakness and increased taxes into their decision making and curtail consumption and investment.

    I’m a little torn on that last point because the zero interest rate policy of the Fed also discourages savings….

    Japan ha

    • hhill51 says:

      Sechel….

      While the original topic was whether tax cutting actually does encourage private investment, your comments on the nature of stimulus bring things back to the current “control knobs” policy-makers have at their disposal.

      We’re now a year plus into the spending stimulus, but it was a bad bargain at the time, with half the “spending” consisting of tax breaks that did nothing at all to encourage job formation. As you correctly point out, businesses and individuals are building future expectations into the their investment decisions. I think you’ve missed the elephant in the room by ignoring deflation.

      On an individual basis, in March of 2009, there was certainly no reason for people to think they had to move quickly to buy a house, the single biggest job-creating decision a family. On the business front, if anything, the incentives were even more skewed against investment. Corporate management and institutional investors were being rewarded hugely for retrenchment.
      Just look inside the rally in financial companies that began at the same time as the government stimulus. Banks were being rewarded for announcing layoffs and curtailment of private lending. That reward came in the form of stock and stock option compensation, and holders of those stocks and options enjoyed 300% increases in the most downtrodden stocks.
      I would maintain that it was misguided underlying government policy in the form of tax differentials between capital gains and ordinary income that provided that huge incentive to eschew productive investment in favor of job cutting instead of hiring and allocation to government guaranteed debt instead of private debt.
      The bottom line is that we’ve been taking more and more of the cost of government from the productive wage earner, and handing it to the speculator. As I pointed out in Supertanker E-Z Pass and Death by Tax Cuts, the shift toward taxing labor and giving capital a free ride swung too far in the New Millenium, and the collapse of the whole system was nearly inevitable as a result. Even though individual companies could get a pop in their stock prices (and manager compensation) by announcing layoffs and factory closings, eventually when every company has done so there are no customers left.
      This is now a deflationary recession driven by lack of demand. Lower interest rates and lower corporate tax rates do absolutely nothing to spur employment in that kind of environment.
      The only exception is the employment of former Congressmen as lobbyists, because they get hired by companies to make sure they get the choicest piece of meat off the carcass of the dying economy, provided by the hapless taxpayer.

      It’s easy to criticize something like “cash for clunkers” as an effort that only pulls future demand into the present, but there were other deficit-increasing corporate giveaways put into that package as an attempt to create “bipartisan” support. Those created zero demand. So which do you want? I say increasing demand and employment is needed. Others say rewarding those who can hire the most-connected lobbyists.

      hh

      • Tom D says:

        The neo-Keynesians assume that consumer demand can be created and should be. And if it doesn’t work the first time, double down. It didn’t work in the 1930’s, and it isn’t working now.

        “We have tried spending money. We are spending more than we have ever spent before and it does not work… We have never made good on our promises… I say after 8 years of the Administration we have just as much unemployment as when we started, and an enormous debt to boot!” Henry Morgenthau, U.S. Secretary of the Treasury during the New Deal, May 1939.

  6. hhill51 says:

    Tom —
    How appropriate that you were able to find that quote by Morgenthau, who knew he was writing falsehoods at the time, but shared it with his diary.
    One example is the unemployment rate, which was down from 22% to 11% over that 8 year period (The Journal of Economic History, Vol. 43, No. 2 (Jun., 1983), pp. 487–493).
    As you probably know, Morgenthau was the architect of the early spending cuts and attempt to balance the budget before recovery was firmly under way that many feel precipitated the 1937-38 recession.
    This article in yesterday’s Boston Globe might explain why you are willing to buy into Morgenthau’s revision of the facts.

  7. Alex says:

    Some additional food for thought: There could be a weak form of Ricardian Equivilence at play here? If the President raises taxes shortly after assuming office, would it be unreasonable to expect that there are more tax hikes to come?

    • hhill51 says:

      If that were the case, then the observed correlation between early increases in tax burden and increased future private investment would be inverted, something Laffer incorrectly assumed.
      That’s the point here. Following the “supply-side” policies nearly gave us economic Armageddon, and did double our national debt (twice – both Reagan and Bush2). Unless they can explain why following their preferred policies gave us the opposite results from their stated goal, we have to conclude that they are just plain wrong, and that only those seeking to destroy our country for selfish gains would pursue more of that set of policies.

  8. Openminded? says:

    Howard, I assume that the results posted by Mike Kimel and his collaborators over at the Presimetrics Blog support your view of the role of government. You would have to admit however that they are counterintuitive and as such, much more difficult to digest for those of us who may tend to oppose the confiscatory nature of taxes beyond what is necessary. Its doubtful that anyone every considered the flatness of the world to be common sense, more likely a given fact. Their empirical results challenge a very logical theory and will be interesting to dig into. I’ll try not to be too skeptical as I do.

    • hhill51 says:

      This chart came from their blog, as did that paragraph I quoted that laid out the fundamental “counterintuitive” premise.
      We all fail to examine our assumptions far too often. Even the phrase “confiscatory” shows where that is. In fact, the cost of government has been surprisingly constant since Eisenhower days, as were Federal taxes, except for Bush2 and now Obama, both of whom presided over massively lowered tax rates (14% vs. historical average nearer to 18%).
      The overall tax “take” didn’t decline in any meaningful way under Reagan, though the increase in spending was impressive. What did change was the amount taken from wages vs. that taken from “unearned” income.
      My basic thesis is that the shift in tax burden was deleterious to our economy, essentially rewarding those who extracted retained earnings rather than those who created new sources of income by building our national wealth. We became a subprime “cash-out refi” nation under Reagan, and that continued to its absurd and devastating end point under Bush2.
      Those extractions took many forms, always encouraged by the tax code — conversion of corporate income into deductible debt on junk bonds was one version.
      Conversion of retained income embedded in pension funds another, tax deductions for the “value” of stock options (combined with defined contributions vs. defined benefits for worker retirement plans) was yet another. Sale-leasebacks of corporate real estate and capital equipment yet another. It wasn’t until the tax-free incentive of $500K in capital gains on a house (for primary and secondary homes) that Joseph Beaujelais (Joe Sixpack’s slightly upscale cousin) got in on the game, then we had a flood of liar loans on house flipping.
      By the way, I still can’t believe so many alleged free marketeers blame Fannie and Freddie for the meltdown, when the market share for those Agencies dropped from 70% to 50% under Bush2. It seems obvious on the face of it that the parties who took away that 30% market share were driving the bubble, no?
      hh

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