June 25, 2003

Bill Gale on JGTRRA

The Brookings Institution's Bill Gale on the economic effects of the recent Bush tax cut:


The Brookings Institution: Thank you for inviting me to testify at this hearing on the effects of the Job and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA) on jobs and growth. My testimony is divided into a summary of the major conclusions and the analysis supporting those conclusions. My principal conclusions are as follows:

Taxes and short-term stimulus: In the short run, in an economy operating with excess capacity, increases in aggregate demand can raise output and income even without raising the capital stock.

JGTRRA and short-term stimulus: JGTRRA will boost aggregate demand in the short term and thereby generate higher short-term levels of income and employment than would occur if no policy were enacted. But this is a very minor accomplishment. Almost any increase in spending or cut in taxes would boost a sluggish economy. JGTRRA was not the only policy option: policy makers could have provided more progressive tax cuts, increased federal spending or transfers to the states, and extension of unemployment benefits. In comparison to those other policies, JGTRRA is a poor way to stimulate the economy in the short-term: the same or bigger stimulus could be obtained with a lower long-term cost, simpler rules, a more equitable distribution of benefits, and less deterioration (or stronger preservation) of basic social needs. The two principal components of the plans?acceleration of the 2001 tax cuts and dividend/capital gains tax cuts?are regressive. This implies that they will be less effective in stimulating current activity, holding the size of the tax cut constant, than more progressive options, since high-income households are less likely to spend available resources immediately than would low- or moderate-income households.

Taxes and long-term growth: In the long run, economic growth reflects expansions in the capacity to produce goods and services. Such expansions, in turn, reflect increases in labor supply and capital, improvements in the allocation of labor and capital, and technological advances. Tax cuts can increase growth by providing incentives to raise the level, and improve the allocation of, labor supply, saving, and investment. But tax cuts can reduce long-term growth by raising after-tax income (which discourages work), by providing windfall gains (which encourages consumption rather than saving), and by reducing public and national saving (which reduces the capital stock owned by Americans and hence reduces future national income). The net effect on growth depends on the balance between these various impacts.

JGTRRA and long-term growth: Although the tax cut is called a "Jobs and Growth" package, this moniker is extraordinarily misleading. The Joint Committee on Taxation has analyzed the tax cut passed by the House of Representatives (which is essentially JGTRRA with the sunsets removed). This analysis explicitly incorporates macroeconomic feedbacks, as tax cut advocates have demanded for years. Using a variety of models and assumptions, the JCT shows that the House plan would reduce the size of the economy in the second half of the decade, and by implication would reduce the size of the economy by increasing amounts after that. The reason why JGTRRA, extended, would reduce growth is that the impact of the tax cuts in raising individuals' after-tax income holding work constant, the increase in the stock market, and the increase in the deficit, will reduce net work, raise consumption, and reduce national saving. In the long-term, all of those effects reduce the size of the economy. In the case of JGTRRA, those effects outweigh the positive impacts on incentives to work and save...

Posted by DeLong at June 25, 2003 05:04 PM | TrackBack

Comments

tax cuts for the wealthy= jgtrra

war is peace

hate is love

After all, we have always been at war with Eurasia...

Posted by: non economist on June 25, 2003 06:40 PM

On a superficial note, if the Democrata want to win people over in 2004 when arguing against the Bush tax cuts, they should refer them as EGTRRA and JGTTRA.

Posted by: Bobby on June 25, 2003 08:16 PM

...tax cuts can reduce long-term growth by raising after-tax income (which discourages work)...

Hmmm. This backward-bending labor supply curve stuff may be a hard sell. Even taking for granted the special nature of the labor supply curve (which tax cut advocates may not), a great deal depends on where you are on the curve. "Which discourages work" seems a bit too strong a statement. Am I missing something?

Posted by: K Harris on June 26, 2003 04:47 AM

Ms. Harris, I personally don't have any problem believing that high enough wages would reduce our overall incentive to work. I'm pretty sure most of us need to be compelled to work :). That said, I agree that we probably aren't nearly far enough up the curve to have problems maintaining the needed compulsion. Its not like we are all going to pay off our mortgages tomorrow.

Posted by: Stan on June 26, 2003 05:59 AM

Gale's testimony is STANDARD economics. The only possible controversy is over the estimated coefficients for each of the various effects he discusses. And his other writings have carefully reviewed the evidence on these estimates. Any one who wishes to address real policy concerns will have read his writings and concluded that the Bush fiscal plan is anti-growth. Then again - if one wants to be a partisan advocate, one can simply ignore good economics. Alas, most of the D.C. talk does ignore good economics.

Posted by: Harold McClure on June 26, 2003 06:34 AM

What my Borjas Labor Economics says are consensus estimates of labor supply elasticity are very close to zero for men and women -- that is the elasticity on the part of the labor supply curve where our economy is now. I think it's something like -.1 for women and .2 for women. Since any of these tax cuts in question are approximately local changes of the after tax wage, we can treat these as changes along a linear labor supply curve (which happens to be about vertical locally according to these elasticities).

Posted by: Bobby on June 26, 2003 07:13 AM

So Gale's comment that labor supply decreases is likely correct or close.

Posted by: Bobby on June 26, 2003 07:25 AM

Mr McClure,

As I read your comment, we are to take Gale’s writings as holy writ, not only reading them but accepting their conclusions whole heartedly. That is how one proves one's to “address real policy concerns.” I like what I have seen of Gale’s work (and willingly admit to not having read anything near all of it, including any that estimate the effects of rising after-tax income on the amount of labor supplied), but I am not yet ready to make a religion of it.

Gale is quoted as saying. “But tax cuts can reduce long-term growth by raising after-tax income (which discourages work)…” There it is -- raising after tax incomes discourages work. That was the only point that had been questioned here as of your writing. So, if I am paid more for my work, I will supply less of it. I am not convinced, no matter how upper case the assertion, that such a bald statement is standard economics. Perhaps he meant to limit this statement to a particular set of circumstance, but he did not do so.

One could offer references to back up the assertion that Gale’s “other writings have carefully reviewed the evidence on these estimates” so we could know which estimates you have in mind.

Stan,

Why am I "Ms"? I hope I'm pretty. :-)

Posted by: K Harris on June 26, 2003 07:55 AM

Bobby,

Thank you, very helpful. Question -- with elasticities at -0.1 for one sex (can't tell which) and 0.2 for the other, wouldn't the impact of two be nearly offsetting? If so, then the conclusion that Gale is "correct or close" comes down to not much change in labor supply in response to more take-home pay?

Posted by: K Harris on June 26, 2003 08:08 AM

Whoops typo -- it should say:
-.1 for men and .2 for women

" If so, then the conclusion that Gale is "correct or close" comes down to not much change in labor supply in response to more take-home pay?"

Yes. I'd guess that any labor supply decreases that Gale is talking about are small. Anyway, I don't think it's worth debating whether the labor supply change is > 0 or 0, the growth effects of this tax cut are not > 0 according to the Solow model. Of course if Gale actually saying that the labor supply decreases are large, he is employing estimates that I don't know about.

Posted by: Bobby on June 26, 2003 08:30 AM

Damn. another typo. DeLong's message board erased the middle of my post I think.

It should say:

" If so, then the conclusion that Gale is "correct or close" comes down to not much change in labor supply in response to more take-home pay?"

Yes. I'd guess that any labor supply decreases that Gale is talking about are small. Anyway, I don't think it's worth debating whether the labor supply change is > 0 or 0, the growth effects of this tax cut are not > 0 according to the Solow model -- hence the tax cut has nothing to do swith increasing long run growth. Of course if Gale actually saying that the labor supply decreases are large, he is employing estimates that I don't know about.

Posted by: Bobby on June 26, 2003 08:44 AM

Yup. DeLong's board just erased the middle of my post again!

Posted by: Bobby on June 26, 2003 08:47 AM

I see what happened I put some words between asterisks and they didn't get posted (that's strange!) Anyway, this is what it should say.

It should say:

"If so, then the conclusion that Gale is "correct or close" comes down to not much change in labor supply in response to more take-home pay?"

Yes. I'd guess that any labor supply decreases that Gale is talking about are small. Anyway, I don't think it's worth debating whether the labor supply change is actually > 0 or 0, the growth effects of this tax cut are not > 0 according to the Solow model -- hence the tax cut has nothing to do swith increasing long run growth. Of course if Gale actually saying that the labor supply decreases are large, he is employing estimates that I don't know about.

Posted by: Bobby on June 26, 2003 08:56 AM

OKay. Brad's Message board erased the middle of my message again.

I posted what I was trying to write here:

http://www.hotboards.com/plus/plus.mirage?who=pkarchive&id=9900.3092710184920

Sorry to everyone about the clutter

Posted by: Bobby on June 26, 2003 09:11 AM

http://www.nytimes.com/2003/06/26/business/26TAX.html

Socialism ----

The 400 wealthiest taxpayers accounted for more than 1 percent of all the income in the United States in the year 2000, more than double their share just eight years earlier, according to new data from the Internal Revenue Service. But their tax burden plummeted over the period.

Posted by: lise on June 26, 2003 09:21 AM

http://www.nytimes.com/2003/06/26/business/26SCEN.html

Why Tax Cuts Will Not Pay Off
By ALAN B. KRUEGER - NYTimes

A CORE tenet of supply-side economics is that people will work more if their take-home pay rate rises.

Support for this proposition has proved surprisingly difficult to find, however, especially in regard to men.

Studies of annual hours worked among individuals turn up a wide range of estimates of the effects, but typically indicate that work hours are only weakly associated with pay. To the extent there is a consensus among economists and there is more than the usual amount of disagreement here it is that a 10 percent rise in wages leads to less than a 1 percent increase in work hours for men and a 3 percent increase for women.

With such small responses, tax cuts clearly will not pay for themselves....

Posted by: lise on June 26, 2003 09:24 AM

Thanks Lise -

As Warren Buffett wrote: This is class warfare, and my class is winning.

Posted by: bill on June 26, 2003 09:32 AM

June 26, 2003

Very Richest's Share of Income Grew Even Bigger, Data Show
By DAVID CAY JOHNSTON - New York Times

...The rate actually paid by the top 400 in 2000 was about the same as that paid by a single person making $123,000 or a married couple with two children earning $226,000, according to Citizens for Tax Justice, a labor-backed group whose calculations are respected by a broad spectrum of tax experts....

Posted by: dahl on June 26, 2003 09:49 AM

Most women are pretty. If you're not female, my apologies.

Posted by: Stan on June 26, 2003 11:20 AM

What Gale is saying is that increasing income HOLDING WORK LEVEL CONSTANT - that is, giving people a non-wage bonus - will decrease work hours. If, before, you worked for 40 hours and got $15/hr, and now you still get $15/hr, but also receive a $5000 windfall, might you work fewer hours? It doesn't rely on labor supply elasticity, which is the change in work hours in response to a change in the wage. It relies on elasticity of labor supply in response to non-labor income, which would be a measure of the leftward shift of the labor supply curve. For this curve there are no factors to drive the curve rightward, so the windfall would clearly reduce work, or have no effect at all if all people are completely insensitive to outside income when making work decisions.

Posted by: rvman on June 26, 2003 12:16 PM

http://www.nytimes.com/2003/06/26/business/26SCEN.html

Why Tax Cuts Will Not Pay Off
Alan Krueger - Princeton University Economics

"Why is the supply of labor so unresponsive to pay? Two theoretical effects work in opposite directions. On the one hand, workers substitute more hours at work for time spent in leisure if the wage rate rises, as leisure time has become relatively more expensive. This is known as the substitution effect. On the other hand, if workers are paid more, they like to use their extra income to consume more of the things they enjoy, including leisure time. This is known as the income effect. The income and substitution effects roughly offset each other.

Another factor is that many employers dictate the number of hours employees must work, so they cannot work more or fewer hours if they want to. And, of course, in a weak economy unemployment prevents some people from working at all."

Posted by: jd on June 26, 2003 12:37 PM

OK, so the effects of the tax cut are not what the Republicans said they would be. It isn't about creating jobs, etc.

With everything Republicans SAY these days, you have to put your hands over your ears, and look at the effect of their ACTIONS to discern why they are doing something. What they SAY is just a smokescreen - a diversion. The EFFECT of these tax cuts is that the government has to borrow perhaps $400 billion this year, and maybe even more, and continue to do this every year from now on. This means we won't be able to pay Social Security, Medicare, or do anything else the government needs to do. And it means we'll instead be paying out massive debt interest checks to ... well guess who! (Over $300 billion interest payments this year.)

Maybe what the tax cut DOES is why they DID it.

Posted by: IssuesGuy on June 26, 2003 01:58 PM

K Harris

I don't take anything as holy grail but having read his papers, they are well researched and argued. As far as this backward bending supply curve, he does not reply on the premise that income effects dominate substitute effects. Quite the contrary, his models often assume as generous a supply-side effect as one will find in the literature. What he does rely on is long-run crowding-out, which is nothing more than the most basic premise of all economics - the law of scarcity. Think about the following two facts: national savings was near 10% of NNP from 1950 to 1980 and has been near 1% of NNP for the past two years. Is it not a reasonable premise that a massive reduction in the rate of capital accumulation will overwhelm a modest one time increase in labor supply? Those that argue that these unfunded tax cuts raise growth are denying the law of scarcity - which I do take as the holy grail. Name me one real economist who does not.

Posted by: Hal McClure on June 26, 2003 04:20 PM

I am only a tax CPA, but what is the difference between a funded tax cut and an unfunded tax cut?

Posted by: andy on June 26, 2003 07:21 PM

Unfunded is a loose term so CPAs might chuckle at this. But the idea is that if the government wants to permanently "give us our money back" it should be reducing government spending as a share of GDP. Government spending has risen as a share of GDP but tax revenues have fallen. Now ask anyone familiar with discounted cash flows thinking - doesn't this create a negative net present value?

Posted by: Hal McClure on June 26, 2003 09:35 PM

Covering ones ears and looking at effects is good policy when dealing with any politician, Republican or Democrat. Intentions and claims aren't what matter, only effects. (Or do you think massive subsidies to big agriculture really are protecting family farms, food stamps really are getting people out of poverty, and raises for existing teachers really is a way of improving education?)

Posted by: rvman on June 27, 2003 06:31 AM
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