Thoughts on Tax Cuts

Tony, the question you ask assumes that there's only on thing that can happen when you mess around with taxes.  The point I constantly try to make is that there are different effects.  Before, we spoke about whether someone would decide to work more or less when he was taxed more (someone who's not necessarily a business owner).  My point then was that there's an income effect (he wants to make his car payment, so he'll actually work more if he's taxed more), and there's a substitution effect (which pushes him to work less, if he's taking home less each hour, then leisure gets "cheaper").

In this particular case, focusing only on businesses, we're both now on the other side of the argument.  Before, you were arguing that the hourly worker would work less when he was taking home less money per hour.  Now, you're arguing that a business owner will work more (by firing the help) when he's confronted with taking home less per hour.  As before, I don't think that the business owner's actions are that easy to predict.

There are a couple of fairly strong forces at play.  First off, I don't think you can ignore the fact that a salary is something that's not taxed on the business' end.  If the tax on the business, or the business owner, is higher relative to the tax on what the worker takes home, keeping workers on starts to make more sense.  Think about it- if you have some menial task, like cleaning, and assume that the business owner is as good as the professional cleaner (unlikely), he can either pay $50 to the cleaner (who will keep, say, $40 after taxes) to do the job, or he can do it himself, pay tax on that $50 and keep $25 for himself.  Also, if you're talking about businesses that produce things (like Pepsi making cans of soda), you can usually put together some equation where an employee can produce x cans per hour.  Pepsi should hire employees as long as they're producing cans of soda that are worth more than their hourly wage.  Since the business doesn't pay tax on the money that is paid to the workers, a change in the tax rate won't change the optimal number of workers.  I think that's a hugely important point that gets glossed over all the time.

Let me go off on a bit more of a tangent here:  businesses are always (theoretically at least) making profit-maximizing decisions.  A restaurant doesn't charge $15 (instead of, say, $20) for a steak because it's being nice, it charges $15 b/c it thinks that particular price will yield the most profit (after considering the cost of buying the meat, paying employees, etc., and estimating the number of customers that it will have if the steak is set at $10, $15, or $20).  It frustrates me when people say that businesses can no longer "afford" to sell tacos for $.50, or whatever else.  If they were doing it before, it was either calculated to help the business or the decision makers are retards (and actually breaking the law if there are shareholders).

Finally, I will concede that higher taxes can slow investment.  I don't think that it (higher taxes) makes it more likely that a business will fail, but investors are essential bettors- if there's more taxes that's like a bigger house cut on the bet, so the sharper ones will be less likely to invest.

Your Answer is Too Simple

Tony,

I did answer that allowing the tax cuts to continue could potentially hurt the economy, for the exact same reason that spending a bunch of money might.  Now, whether the negative of increasing debt is outweighed by any sort of action taken by people (or corporations) keeping more money is a difficult question.  There's uncertainty, and I think that intelligent people could fall on either side.  Limiting it to "short term" doesn't make it (the tax cuts) any more clearly positive, because the strongest positive of a tax cut is more investment in business, which arguably won't necessarily happen immediately.  As we discussed before, I believe that a rational corporation will hire approximately the same number of employees regardless of the tax rate.*

Then, your next question "then why not continue them?" basically removes any sort of "short term" modifier that you wanted in the first place.  The argument against keeping them is that it amounts to increased debt, and that the money might be better "spent" elsewhere.

Which gets us to the next question- how does taxing/printing money help the economy?
It helps the economy in that it goes straight to the demand curve.  Basically, the more stuff that is produced and sold, the better off our economy is.  The choice is between having more cash in consumer's hands to buy Coca-Cola, or allowing Coke to keep more from every can sold.  My argument is (and always has been) that most of the people arguing we will all be better off if Coke keeps more from every can of Coke sold are either highly educated and happen to own shares of Coke, or not particularly qualified to speak on the issue.

Then, the question about whether the stimulus should have had a bunch of tax cuts- it's the same question, but framed a different way.  Again, I don't know the answer, but it's definitely not obviously "yes".

Finally, regarding "deregulation", that seems like a totally separate issue.  You might argue that with more regulation in the first place, the stimulus would have been unnecessary.  Not sure what it's worth, but I think you'd be echoing Alan Greenspan if you took that position.

In summary- I don't really know anything.  I do know that some of the conclusions I've heard are wrong, or at least not clearly right.  And, I really object to labels- (not saying you're guilty of this), but we wrote briefly about the mosque.  A bunch have people have made up their minds knowing nothing more than the religion of the people behind it, without understanding the religion.  In this particular issue, like two years ago w/ "socialists", Murdoch has spent the past year introducing "Keynesian" as a term to describe a bunch of people as outcasts lacking in common economic sense.



*You might argue that having more employees is a riskier position, and with taxes diminishing the maximum "reward" for a successful corporation, that the companies will hire fewer workers.  But, if you take the approach that dollar amounts are known (it costs x/hr. for an employee to make y widgets, and the price is z), then the optimal number of employees will be the same at any tax rate.

Did you read the article?

Tony,

I have a few things to say in response to your recent posts.  First is that "Keynesian" has become the new "socialist", in that it's thrown around in a semi-descriptive half-truth sort of way; I would lay 5-1 that the majority of people using it couldn't even define it.

A basic principle of Keynesian economics is that the invisible hand doesn't always work exactly right (that a bunch of self-interested actors, left to their own devices, won't necessarily lead us to an optimal position).  Sometimes, it's necessary for the government to step in and guide the economy, whether it's spending in one place, taxing in another, or cutting taxes someplace else.  My reading of her conclusion wasn't that we need to adopt a Reagan-esque (the myth, not the man- he actually spent a buttload of money) tax-cutting and spending-slashing policy- it was basically a "deficit be damned we need to do everything we can to breathe life into the economy now; cut taxes and spend".

I don't disagree that that might be a good short-term strategy, but it's obviously not sustainable in the long run.

The second thing I want to say is, even if Keynesians believed that it is important to steal from the rich and give to the poor, and assuming that Ms. Romer changed her beliefs, why is that like a smoking gun?  Just like the Muslims with no knowledge of what might go into the "Ground Zero Mosque (Eff you Jesus, America, and football)"  (which I think is the new official name for the thing) shouldn't be able to speak on behalf of the Muslims who want to build the thing, I don't think that her words should carry any more weight when she falls on the other side of an issue than they have for the past couple years.

Finally, to get back to the question that you asked a week ago, whether it could possibly be good for the economy to let some tax cuts expire, the short answer is yes.  The argument is:
(1) tax cuts will lead to less tax revenue (a position that's generally difficult, but not impossible, to argue with)
(2) all else being equal, less revenue will mean less of a surplus or a larger deficit (impossible to argue with- depending on a person's intellectual honesty, he might succumb to the temptation to throw "you liberals could just spend less" in there, but that would be ignoring the "all else being equal" part.  If you allow finger-pointing, then it gets very difficult to make subtle points)
(3) a larger deficit (or less of a surplus) makes it harder for the country to borrow money, it also means that there is less faith in the dollar, which will make it weaker relative to other currencies.  (tough to argue w/ this)
(4) if the dollar seems to be weakening, people w/ capital and the ability to invest elsewhere will, which will slow down the economy.

Basically, if you believe that a deficit is bad for the economy, then you have to be at least partly behind the idea that a tax cut could be bad for the economy.  If you don't believe that a deficit is bad for the economy, then you're probably not one of the people complaining about out of control spending.