November 03, 2004

Vague Thoughts on Modeling Dynamic Scoring

NBER MONETARY ECONOMICS PROGRAM MEETING, NOVEMBER 5, 2004

Discussion of N. Gregory Mankiw and Matt Weinzerl, "Dynamic Scoring: A Back-of-the-Envelope Guide"

J. Bradford DeLong
U.C. Berkeley

Let me start by raising a doubt about one of the purposes of the paper--a doubt that I am not sure that I endorse, but that I do think is worth taking seriously. When I worked for the Treasury, I asked the career civil servants why they were so opposed to "dynamic scoring." Their answer was that every administration's bozo political appointees come in with their own model that says that their particular policies are absolutely flawless and totally great. The model errors that administrations bring with them, they said, are much bigger than you would believe: in fact, they hinted, my own model errors were bigger than they dared tell me. Confining analysis to "static scoring" was, they said, a way of minimizing the impact of model error over a sequence of administrations. It generated results that were wrong, yes, but the sum-of-squared-policy-errors was less than if each administration got to claim that its own particular model were true.

It seemed to me then that this might well be wrong: that the Congressional Budget Office, at least, had the expertise and the independence to do "dynamic scoring" in a sane and consistent way over time. I can't claim to have settled views on this, however. All I have are vague worries.

Let me say, next, that I definitely share another of the underlying motivations for this paper: I very much fear that our current system of capital leaves not just $20 bills on the sidewalk but $1000 bills, and not just one but millions. In quite a number of models the best way to tax capital is to impose a large capital levy at time 0, and immediately thereafter reduce capital taxation to the minimum amount necessary to meet the constraints imposed by one's distributional goals. (Dynamic consistency considerations modify this, of course, but I have never been able to figure out how in an appropriately general manner.) Our current system of taxing capital in no way fits any part of this pattern, and I have never heard a convincing argument that distributional goals cannot be met by taxing other forms of income.

My fear his risen substantially in the past few weeks as I have been trying to write my review of Peter Lindert's _Growing Public_. Peter narrates the growth of social insurance states across the OECD. One of his central questions is why, given the huge burden that raising the revenue to pay for the benefits of European social insurance states places on their economies, western European economies aren't poorer today. They are within striking distance of the U.S. as far as real output per capita is concerned. They are by and large even as far as real output per hour worked is concerned (but I do not believe that lower levels of hours per capita in western Europe are fully the result of differences in preferences). They accomplish this with much lower land endowments per capita than the U.S. does--and land is an important input in the U.S. production function. Why, if tax systems do have first-order effects on economic activity, isn't Europe much poorer?

Peter Lindert's answer is that western Europeans have crafted tax systems that lie lightly on the economy. Open economies keenly aware that capital is mobile and that their citizens by and large have not, they have faced incentives to reduce the possibility of business flight to a minimum and to make sure that their tax codes encourage domestic investment. The U.S., by contrast, has not. Lindert's judgment is that western Europe's tax system raises much more revenue without imposing a significantly larger burden on the private economy. He thus echoes Adam Smith's judgment in the fifth book of the _Wealth of Nations_, comparing late eighteenth-century Britain and France, that Britain's tax system raises three times as much revenue per capita as the French, and is felt to be only one-third as burdensome. And the French tax system was burdensome: it was, after all, the fiscal crisis of the late eighteenth-century French monarchythat was the trigger for the French Revolution.

These fears are magnified even further if you don't believe that the big prices in the economy accurately reflect social marginal valuations. If there are important labor rents earned by workers in capital-intensive industries, then the excess burden from capital taxation will be magnified and will fall on the fortunate rent-sharers in labor as well. If total factor productivity does not fall from the sky but is instead linked to investments in any of a number of ways, then any capital tax that reduces investment will reduce productivity growth as well. As far as American economic growth is concerned, the big thing in the past two decades has been the extraordinary reduction in the real price of computers and the concommitant incredible surge of capital deepening in information technology--a surge of capital deepening to which Steve Oliner and Dan Sichel attribute more than half of the surge in American labor productivity growth since the early 1990s.

Do we really believe that this technological progress in making computers was independent of investment in information technology--that Moore's Law would still have held had our businesses invested nothing at all in computers over the past two decades? No, we do not. Then by how much would more capital-friendly tax policies in the 1970s and 1980s that encouraged investment, including investment in information technology, have brought forward in time the high-tech productivity boom of the 1990s and 2000s? This is a first-order question to which I do not know the answer. But it is hard to think about this question seriously and not conclude that it is a powerful factor making it likely that this paper's estimates of growth effects and revenue offsets are more likely to be low than high.

But that there are other, I think more powerful, factors making it likely in my estimation at least that the estimates are more likely to be high than low. It's not that there is anything wrong with their modeling. It's that what they call a "tax cut" is not quite what my friends in the reality-based community think that a "tax cut" really is.

In this paper, a "tax cut" is a permanent and credible reduction in taxes accompanied instantaneously by an equally permanent and credible reduction in the permanent level of government spending. But that's not what a "tax cut" is here in America. Consider that the Congressional Budget Office tells us that in fiscal 1981 federal spending gross of offsetting receipts was 23.4% of GDP. Then came the Reagan tax cut. And revenues--including offsetting receipts--did fall from 20.8% of GDP in 1981 to 18.5% of GDP in 1983. But spending did not: 23.3% of GDP in 1984, and still nearly unchanged at 22.5% of GDP in 1993. Similarly for our latest round: revenues that peaked at 21.9% of GDP in 2000 are projected to be about 17.2% of GDP in the current year, fiscal 2005--with roughly one-third of the share decline the result of the collapse of the dot-com bubble, one-half the result of the Bush tax cuts, and the rest due to cyclical and other factors. But spending? 19.2% of GDP in 2000, and projected to be 21.4% of GDP in the current fiscal 2005.

Perhaps if we had a return to the caps on discretionary spending and the Budget Enforcement Act rules for revenues and entitlements that were in force during Clinton's term--during which federal spending fell from 22.5% of GDP to 19.2% of GDP--a "tax cut" in the real world would correspond to a "tax cut" in the models of Mankiw and , for then passing the tax cut would require that the Congress pass and the CBO score offsetting spending cuts. But that's not the world we live in. In the world in which we live in, a "tax cut" is a change in policy that leaves the question of how the government budget constraint is going to be enforced hanging wide open.

For example, the Clinton administration's fiscal policy was a direct result of Reagan's 1981 tax cut, and during the Clinton administration federal taxes as a share of GDP were higher than at any time since the Korean War. A temporary tax cut followed by an increase of taxes to a higher level is a supply side loss, not a win, even if you are a believer in Ricardian equivalence and convince yourself that the fall in national savings rates in the 1980s was unrelated to Reagan fiscal policy.

If we were going to get concrete, and, say, take the Bush tax cuts of 2001 and 2003 and try to assess their dynamic supply-side effects within a model in which the government budget constraint is satisfied as it will be satisfied, what would we have to do? I believe that we would have to model the satisfaction of the government budget constraint as a probabilistic combination of three different possibilities:

  1. Recognize that there is a chance that the tax cut will be reversed. Perhaps once again, as in the early 1990s, an unwillingness to cut spending combined with mounting debt and debt servicing costs changes the complexion of politics. I would have said that the chances of this are high given the 7% of GDP long-run fiscal deficit that America appears to have, and the unwillingness of any politician to propose cuts in the growth rates of Medicare and Social Security spending. But the chances of this have dropped since Kerry reached his peak bubble value of 80% on the Iowa Electronic Markets Tuesday afternoon.
  2. Recognize that there is a chance that there will be a long period of rising debt and debt burdens accompanied by cutbacks in spending shares as various institutional mechanisms force the legislature to face and try to meet the government budget constraint. We know what George W. Bush thinks of the pay-as-you-go mechanisms that restrained Congressional action so effectively in the 1990s: he thinks they are a joke: "You know what pay-go means? It means you pay--and [Kerry] goes and spends!" I would say that the chances of this have also dropped since Tuesday afternoon.
  3. Last, there is the remaining possibility: that the government budget constraint itself will take its own non-policy steps to make sure that it is met, and generate an Argentina-style meltdown. By the principle that probabilities sum to one, I conclude that the chances of this have risen since Tuesday afternoon.

Now it seems to me that the Ramsey model is likely to be far off in its assessment for any of these three scenarios, even the second.

In the absence of *effective* institutional constraints on Congressional action along the lines of the 1990s Budget Enforcement Act, and given the current complexion of American politics, it seems to me that the paper's estimates of offsets are much more likely to be high than low. Indeed, I fear that the current Congress will ignore the government budget constraint until asset prices bring it to its attention in a striking way--which means that they will ignore it until the markets conclude that option 3 has a significant probability. If true, I would think that with the current Congress the offset would be negative--that the static revenue cost of the tax cuts understates the expected value of the burden imposed by reduced government spending and other effects.

The paper's results are conditional on the existence of some effective institutional framework, like the Budget Enforcement Act, to make sure that the government budget constraint is satisfied the way we would like it to be satisfied. The paper simply doesn't work if the government budget constraint is satisfied in a way that it would be unsuitable for the ears of the sensitive and high-strung (for example, the characters of "The Importance of Being Earnest" who are told to skip the chapter on the fall of the rupee) to hear.

Posted by DeLong at November 3, 2004 05:47 PM | TrackBack
Comments

Gee thanks, Brad. I was depressed enough already.

Posted by: Bernard Yomtov at November 3, 2004 07:00 PM

One thing I think has not been sufficiently considered is a likely effect of shifting the tax burden from income from property to income from work. A higher (relative) tax burden on income from work reduces the (relative) return to investments in human capital. I find that a rather perverse outcome, and one I am disinclined to accept.

Posted by: Donald A. Coffin at November 3, 2004 08:13 PM

Oddly, I am strangely encouraged to read that the reality based community still exists.

This morning I woke up thinking that maybe I’ve been wrong all these months. Maybe gay
sex is the only important issue, and that prisoner torture, illegal wars and Argentine
budgets are piffle.

It’s nice to read that grown-ups still think about things like this.

Thank you, Dr. DeLong.

Posted by: de Coriolis at November 3, 2004 08:13 PM

Interesting commentary Brad. You make a great point bringing up the Wealth of Nations discussion of tax revenue versus tax burden. I think when tax reform is brought to the table next year, we should look at ways to minimize the burden of taxation. I'm afraid that whatever method of taxation this president and Congress comes up with will sacrifice progressivity, but perhaps there are enough Republican senators interested in ways to more efficiently raise revenue (though surely the "starve the beast" crowd WANTS inefficient taxes).

Whether its a VAT or some sort of financial transaction taxation, such as Feige's Automated Payment Tax (www.apttax.com), perhaps there is some way to both cut income taxes and increase tax revenue.

Posted by: beowulf at November 3, 2004 08:16 PM

ahh yes i forgot about my contingency plan in the event of what happened yesterday, time to dust it off.

budget constraint #3 reminded me again.

1. Make sure to convert student loans and mortgage to a long term fixed rate.

2. Learn how to make change for a euro

3. short sell the dollar

In the coming dark days we won't be able to help our marginalized democratic bretheren if we ourselves are in need of help. I just hoped it wouldn't come to this. We know where Bushs misleading policies are taking us, whether or not Bush does, we would be foolish not to take advantage of it.

It'll be sad/funny to see how the repuglican propagandists blame stagflation or god forbid hyperinflation on the remaining minority dems.


Posted by: Clayton at November 3, 2004 09:40 PM

Are there still rumors floating of losing the dollar as the unit of oil trade?

Posted by: Clayton at November 3, 2004 09:45 PM

Brad DeLong wrote, "He thus echoes Adam Smith's judgment in the fifth book of the _Wealth of Nations_, comparing late eighteenth-century Britain and France, that Britain's tax system raises three times as much revenue per capita as the French, and is felt to be only one-third as burdensome."

But there are *three* classical factors of production---labor, capital, and *land*.

My recollection is that Britain taxed land rents much more heavily than France.

THE TRADEOFF BETWEEN TAXING LABOR AND CAPITAL is limited. You can also tax land.

Posted by: liberal at November 3, 2004 10:21 PM

Anyone here listen to the debate between Jim DeMint and Inez Tenebaum for the seat of Fritz Hollings of SC? There was a shorter interview on Meet the Press with Tim Russert. DeMint, who won the election, believes in the idea of replacing the income tax with a national sales tax. Tenebaum with more orthodox economic views accused DeMint of wanting to increase taxes on the middle class with the guess that a sales tax rate of 32% would be needed. I'm afraid to say that this new Congress will be the domain of the crazies with unimaginable schemes being foisted on a largely unsuspecting country.

Posted by: Ralph at November 4, 2004 01:06 AM

Interesting point about encouraging investment. One downside of success here is that heavy investment in the past in computer technology has been at the expense of employment. Didn't the US once upon a time favour labour reducing techniques because of its relatively scarce population. Changed days.

Budget enforcement rules? Examples: the European Union has moved some distance in this direction; the US is moving the other way. A model for the global economy, if globalisation stands a chance of continuing, is surely a priority.

Perhaps the G8 will consider these matters next year, when the UK chairs it.

Posted by: IJ at November 4, 2004 02:18 AM

As a practical matter, the best way to tax capital is through a proxy, ie, via a progressive consumption tax. Indeed, why bother with anything else? We have the tools -- computerized banking and the internet -- and it would work well with the need to control terrorist financing and tax evasion made possible through hidden bank accounts. Let's get started.

Posted by: Luke Lea at November 4, 2004 04:27 AM

Luke Lea wrote:
"As a practical matter, the best way to tax capital is through a proxy, ie, via a progressive consumption tax. "

Exactly why 1. would taxing capital be a good idea, and 2. would a progressive consumption tax achieve that goal? Regarding the first point, Peter Lindert made the point that Europe's social model is feasible just because it's ultimately paid by labour itself. The second point finds me in agreement, but precisely for the opposite reason: taxing consumption rather than income favours accumulation of capital and re-investment in the economy. That doesn't need to be necessarily done with a (regressive) sales tax: there could be 100% tax allowances for approved investments, and higher marginal rates for what is left.

Posted by: Enzo Michelangeli at November 4, 2004 05:24 AM

As cynical as it might be, option 3, is what the country needs and will experience. Paul Volcker, the former Fed chairman, has predicted that this country will experience a financial crisis in the next 5 years. Bill Gross, "Mr. Bond Market" and head of PIMCO is of the same opinion (you can read his November newsletter on the PIMCO site: www.pimco.com). I think a financial crisis is needed to guide the country back to reality and sanity. However cynical as it may sound, it will be an oppertunity for the Democrats as the very flawed Republican ideologies will be exposed and their constituency will be rewarded for their very ignorance and stupidity. A deep financial crisis will marginalize and fracture the Republican Party, which is basically an unstable alliance of Rockefeller (fiscally conservative) Republicans, Dixiecrats and Big Business, just like it did in the 1930s.

Posted by: Nescio at November 4, 2004 05:50 AM

Nice to see that we're back to discussing economics again.

The unavoidable reality of the post WWII period, is that revenue as a % of GDP has mostly fluctuated between 17% and 19%. With very few exceptions. To avoid "a fiscal crisis", you have to keep spending close to that % too.

We've had all kinds of different tax rates in the last 60 years, but they all produce about the same results; 17-19% of GDP. Put that in your reality based pipe and puff.

Posted by: Patrick R. Sullivan at November 4, 2004 06:10 AM

Luke,

Surely two of the main problems with consumption taxes is that it is hard to make thm progressive even if everyone consumed proportionately and that people don't consume proportionately.
Since it is only on consumption and not income such a tax also favours capital even more because it grows faster thus the rich would be disincentivised from consuming so even more of the burden would fal on the poor. Consumption tax is almost the opposite of a wealth tax.

If tax was only on consumption there would be no need for surveillance of ordinary bank accounts and fewer records of where money has changed hands (unless you are expecting terrorists to charge a sales tax on their survices when they recieve fundin from the Saudis).

Have I missed the joke?

Posted by: Jack at November 4, 2004 06:25 AM

The probability of outcome three has moved materially higher. Mankiw and other "conservative" economists are guilty of being enablers of a potential slide into financial instability. But it could be a while before asset prices become the effective enforcement mechanism for the government budget deficit. Consider Japan, with gross government financial liabilities above 160 percent of GDP, and deficits of 7 percent of GDP as far as the eye can see. Interest rates are still low, and the yen is strong. Consider Europe, with demographics that make the collapse of the today's welfare state a virtual certainty.

Posted by: Matt at November 4, 2004 06:26 AM

"budget constaint" not "budget deficit"

Posted by: Matt at November 4, 2004 06:28 AM

Matt, the probability of outcome 3 has increased dramatically with the re-election of this -in every way- inept administration. There is a crucial difference between Japan/Europe and the United States. Japan and Europe have ample capacity to accomodate government budget deficits because they save far more than the United States. Personal savings rates in, for example, Japan and France are in the 10-20% range. In the United States it is about 1%.

Posted by: Nescio at November 4, 2004 06:43 AM

Enzo,
why would favouring living off rents be such a good idea?
Surely the effect of shifting the burden of taxation from the well capitalised to the salaried would have unsustainable effects on the distribution of wealth. As far as promoting capital accumulation goes, it will make it harder for those not accumulating much at the moment to do so while providing a massive boost to those who already have. I mean, look who you have to be to run for President these days. What you propose wouldn't change that for the better.

Posted by: Jack at November 4, 2004 06:57 AM

The GOP Congress cannot even agree on a budget. How can Congress be expected to agree on spending cuts?

Posted by: bakho at November 4, 2004 07:25 AM

When does the meltdown begin?
What are the leading indicators?

Posted by: Nemesis at November 4, 2004 07:38 AM

Nemesis, it will happen sometime in the next 5 years. Leading indicators of such a meltdown will be credit spreads (will increase sharply), exchange rates (US dollar will take a dive), gold price (will spike) and long-term interest rates (will increase significantly as Asians and Europeans dump treasuries). If you want help a little to bring about a meltdown and make a nice profit in the meantime, I'd advise you to divest yourself from as many US assets as possible and invest in a diversified portfolio containing foreign currencies (Yen, Euro, Canadian Dollar), foreign stocks (companies with little exposure to the US) and commodities (gold etc.)

Posted by: Nescio at November 4, 2004 08:03 AM

Enzo, your points about Luke's post are right on, but I think he may be talking not really about a consumption tax but on a transaction tax, an idea I've seen floated around. This would be a .03% tax on every financial transaction. I'm assuming this based on his mentioning "computerized banking". Luke my apologies if I'm putting words in your mouth.

Posted by: Issa at November 4, 2004 08:32 AM

I begin to believe that the Bushites are fully aware of this situation rather than actually believing their own nonsense about huge taxcuts slanted upward in the income ladder is good for the economy and revenues. Many of the Administration are "Starve the Beast" people, seeking to drive the government so far into debt that any remnant of the social safety net is eliminated out of desperate necessity. Furthermore, I believe that they are hoping that the coming fall will occur in 5 years or so, just in time to fall into the next Administration which will, in all liklihood, be Democratic. Thus, the Administration that inherits the mess that henceforth leads to utter collapse gets blamed for fall and its consequences.

Posted by: Praedor Atrebates at November 4, 2004 02:29 PM

By the back of my envelope, IF Bushian tax policy plays out to completion, it would take an extended period of 2 x present income tax rates to restore balance.

And that just won't happen. Current income earners wouldn't -- and couldn't -- bear the burden. We'd need a serious wealth tax to carve revenue out of Bush-era subsidized top-share asset accumulation.

And that just won't happen. Capital is very mobile, and so are high net worth individuals. People with nest eggs $10M and up can reflag themselves and relocate their assets, and they're out from under theier share of US public debt. (Play it right, and they might go from shared debtor status to shared creditor status.)

Sentimental attachments? As foreign nationals with incidental business in the US, they can spend about as much time here as they do now.

Big money and smart money leaves first, steepening the parameters, and priming the pump, and pioneering expatriate colonies with favorable institutional amenities.

Posted by: RonK, Seattle at November 4, 2004 02:35 PM

RonK, Seattle, wrote, "We'd need a serious wealth tax to carve revenue out of Bush-era subsidized top-share asset accumulation."

Yeah. It's called "monetizing the debt."

Posted by: liberal at November 4, 2004 03:16 PM

Nescio,

Those aren't leading indicators of a financial crisis. Those are symptoms of a financial crisis.

The problem with financial crisis, before the fact, is that leading indicators keep changing with the nature of the financial economy. By the time we recognize a set of leading financial indicators, the set changes. Once, looking at short-term import cover was thought to do the job, but having figured that out, short-term import cover stopped being a good leading indicator of financial troubles. Most recently, a currency mismatch in private lending and borrowing was a pretty good indicator, but few observers were looking in that direction till after the fact. We can have all the leading indicators we want in hindsight, when they don't do much good.

The presumed leading indicators of a US financial crisis would be the high ratio of the current account deficit to GDP, the very low national savings rate, unfunded contingent obligations on public and private retirement plans and so forth. Trouble is, if those actually are leading indicators, we don't know what the leads are. There is nothing magical about the 5 year window being bandied about. Our savings rate has been low, unfunded obligations large and current account deficit wide for some time, with borrowing rates very low, credit spreads narrowo and the dollar relatively stable. Knowing the lead time of a leading indicator is important in making use of it. We don't know that there will be a financial crisis (though it's hard to think there won't be), much less when it will happen.

Posted by: kharris at November 4, 2004 03:40 PM

liberal -- First, for sake of argument say you could make the debt disappear with a wave of a monetary wand. Say you just want to bring current revenue up to current expenditure, and you can't rely on excess Soc Sec contributions any more, and you've created a bunch more tax-free savings plans, and between the loopholes you built and the corporate tax paying community's adaptation to those loopholes there's no corp tax revenue to speak of, and there's no more estate tax revenue, and probably a bunch of stuff I forgot. You are in a realtime hole even without the debt.

Second, monetizing the debt only "taxes" limited classes of dollar-denominated token assets ... and smart money can smartly see that coming. (Maybe that's the "leading" indicator of financial crisis onset.)

Posted by: RonK, Seattle at November 4, 2004 04:12 PM

Jack, at November 4, 2004 06:57 AM posted:

"Enzo,
why would favouring living off rents be such a good idea?"

Profitable investment is not risk-free: the returns in real terms of risk-free investments are tiny, and sometimes negative, which makes living off rents a quite difficult proposition. Anyway, here I'd like to stick to a realistic assessment of fiscal strategies based on their results, rather than arguing about moral principles.

"Surely the effect of shifting the burden of taxation from the well capitalised to the salaried would have unsustainable effects on the distribution of wealth. As far as promoting capital accumulation goes, it will make it harder for those not accumulating much at the moment to do so while providing a massive boost to those who already have. I mean, look who you have to be to run for President these days. What you propose wouldn't change that for the better."

Most of the money spent in presidential campaigns does not come out of the candidates' pockets. The main reason why they are wealthy is that American voters, for some reason, seem to trust for that job wealthy people more than, say, intellectuals.

Back to the issue, the basic point is that capital is mobile and scarce, and labour is neither: unless you want to change this state of things (and past experience has proved that to incur much heavier costs) taxing capital more lightly than labour seems to be an economic necessity, _especially_ in EU-style social-democracies where the funding requirements of the governments are higher.

By the way, European large corporations, on average, receive in subsidies more than what they pay in taxes. Last April, in its "Special report: Structural reform in Germany", the magazine "The Economist" reported:
"[...] For big companies Germany is a kind of tax haven, according to Lorenz Jarass, an economics professor at Wiesbaden University. In aggregate, the top 30 listed companies tend to get more credits back from the government than they pay in tax. For example, in 2002, DaimlerChrysler reclaimed a net EUR 1.2 billion ($1.5 billion), while the tax payments of Thyssen Krupp and Lufthansa netted out at zero."
Probably this comes from one of the sources referenced at http://www.jarass.com/jarass.de/eng/dat/taxes.html , but unfortunately they are mostly written in German, a language I'm not familiar with, so I can't be more specific.

Enzo

Posted by: Enzo Michelangeli at November 5, 2004 01:27 AM

Regarding:
Those aren't leading indicators of a financial crisis. Those are symptoms of a financial crisis.

What about this for an indicator: China begins to unhinge its currency from the dollar and tie it to more robust currencies such as the Euro, Aussie, etc. Since they are heavily involved in bankrolling our deficit, I would think that when/if they shift from locking their yuan fast to the dollar, that might well indicate that they are about to stop financing our debt and seek to ensure their currency is stable first.

Posted by: Praedor Atrebates at November 5, 2004 05:23 AM

Enzo, give me a billion and I'll give it a shot!

It may or may not be easy to live off rents but I'm not sure why we should try to make it easier.

I made the point not on directly moral grounds but to namecheck famous sources of economic inefficiency. Consumption taxes are inefficient because they cause the highest deadweight losses in incentivisation. Rents too.

Capital is already taxed more lightly than income and lightly in absolute terms, cf Warren Buffett, so I'm wondering why giving that up altogether is desirable. It seems a perverse conclusion to draw from the Lindert study since US capital taxation is lighter than in Europe, the US economy apparently has less need to tax things lightly anyway.

To borrow Brad's analogy of ancient French and British tax systems your proposal seems to head towards the French.

Posted by: Jack at November 5, 2004 05:31 AM

Enzo, give me a billion and I'll give it a shot!

It may or may not be easy to live off rents but I'm not sure why we should try to make it easier.

I made the point not on directly moral grounds but to namecheck famous sources of economic inefficiency. Consumption taxes are inefficient because they cause the highest deadweight losses in incentivisation. Rents too.

Capital is already taxed more lightly than income and lightly in absolute terms, cf Warren Buffett, so I'm wondering why giving that up altogether is desirable. It seems a perverse conclusion to draw from the Lindert study since US capital taxation is lighter than in Europe, the US economy apparently has less need to tax things lightly anyway.

To borrow Brad's analogy of ancient French and British tax systems your proposal seems to head towards the French.

Posted by: Jack at November 5, 2004 05:36 AM

Enzo, give me a billion and I'll give it a shot!

It may or may not be easy to live off rents but I'm not sure why we should try to make it easier.

I made the point not on directly moral grounds but to namecheck famous sources of economic inefficiency. Consumption taxes are inefficient because they cause the highest deadweight losses in incentivisation. Rents too.

Capital is already taxed more lightly than income and lightly in absolute terms, cf Warren Buffett, so I'm wondering why giving that up altogether is desirable. It seems a perverse conclusion to draw from the Lindert study since US capital taxation is lighter than in Europe, the US economy apparently has less need to tax things lightly anyway.

To borrow Brad's analogy of ancient French and British tax systems your proposal seems to head towards the French.

Posted by: Jack at November 5, 2004 05:55 AM

There are two key differences that make an Argentina-type dollar meltdown unlikely. First, the dollar is not a pegged currency as the peso was in the currency board days. Secondly and most importantly, foreign savers could flee from their financial assets in Argentina without concern for adverse international consequences.

In contrast, two of the major financers of the U.S. deficits are China and Japan. Both countries depend on exports to the U.S. as a critical component of their domestic economic growth. If either country were to dump dollar assets in a rapid capital flight, the resulting plunge in the dollar and rise in U.S. interest rates would push the U.S. economy into a likely recession and China and Japan would quickly follow as their exports to the U.S. drop significantly. There would also be the potential for a global financial and economic crisis that would further devastate the Asian countries. For this reason, there is little chance that our Asian financers flee U.S. treasuries.

There are scenarios for capital flight and the worst-case scenario. A sudden and painful recession in China and/or Japan could dry up the surplus funds that flow to the U.S. financial markets as the money is used for domestic purposes. Or a terrorist attack that cripples the U.S. commercial distribution system for an extended period of time would have an even worse result. If terrorists attack our ports, shipping, oil refineries, or other transportation systems, American consumers would no longer have easy access to imports. Supply shortages would drive up prices so even with a drop in consumption private savings would not increase. Asian exporters would lose access to U.S. markets and the ability to help finance the resulting jump in the already tremendous federal budget deficit. Rising interest rates could lead to the next Great Depression.

The irony is that since 9/11, the Bush deficits have made the U.S. much more exposed to a terrorist attack that could severely cripple the U.S. economy for a prolonged duration of time.

Posted by: Jay at November 5, 2004 06:19 PM