Why does no one confront the Club for Growth et al with this factoid:

In the 1950-64 period, one of the two strongest sustained U.S. economic expansions in the 20th century, the top marginal tax rate was 91%.

Progressive taxation is not incompatible with economic growth.

NM

ps

http://home.att.net/~Resurgence/TaxTimeline.htm

Brad:

What's wrong with claims being 'too analytically distinct?' I never realized before that that can be a problem.

[Well, you shouldn't then lump them together--you should talk first about one and then about the other...]

Nicholas,

No, it isn't incompatible with growth. What it is incompatible with is the ability of the wealthy to channel most of the benefits of said growth into their own pockets, instead of having to share the benefits with the common working man. Rather unpatriotic, that.

I found the tax debate always pretty unrational. Is the _real_ size of the income loss through taxation the problem? If so, people in the 50s, earning less than half of todays income should have virtually no incentive to work at all.

If on the other hand, only _relative_ income matters - above some threshold of welfare reached decades ago - then the absolute amount of taxation does not matter at all. All you need to preserve is the ratio. That ratio could be preserved at a much lower level than today. As an example, the highest tax bracket could leave a person at $100k instead of $300k+ as long as the lowest bracket is lowered from $15k to $5k.

This shows that the tax-is-bad-for-productivity is nothing than a myth.

It could be that people in the highest tax-bracket couldn't get out of their minds that the government steals 70% of their money (while preserving relative incomes) and get into a prolonged depression over that.

It was Paul Krugman who said in a PBS debate with Allan Meltzer that most economists do agree that double taxation is a bad distortion, but that that they advocate spending cuts and/or tax increases to make up for the difference. That makes a lot of sense.

I remember reading that the Clinton administration in 1997 pushed forward a 33% cut in capital gains taxes, or something like it. Yet it also pushed through income tax hikes a few years earlier and expanded the EITC and so on and so forth.

Well anyway, I'm open to ways of making our system more efficient and more progressive, but how can we do that? If we are to use a revenue-neutral approach, what else is going to be taxed if not capital? Would a sizable increase in the income tax do the trick?

And are you moving towards that camp of the neoconomists, who wants to eliminate all of the texation except for that on income? If so, why? Do you consider their arguments that credible?

I worry about two things. We will clearly need more revenue for meeting our obligations for things like Social Security and deficit and debt reduction, but if we are going to expand health care, put more money into education, provide assitance for trade dislocation, and so forth, we will need more of it. Where is it going to come from?

I'm curious about the defense of the "shortage of capital" argument that JBD agrees with here.

From the perspective of someone who has on occasion run in entreprenurial circles, the thing I've heard constantly is that money is NEVER the problem: getting the right team together around a good idea is far more difficult. I was at a conference last year where a CalPERS rep talked an $8 billion "overhang" they have - capital they're trying to invest but there just aren't startups to invest in.

Is there really a shortage of capital? Aren't both of these supply-side claims a bunch of hooey?

Bravo! I discovered you webcite when some (pre-Google) search engine pointed to a yet unfinished paper on trying to capture the net impact on savings and growth from a reduction in tax rates that failed to be accompanied by a reduction in government spending - with the conclusion being that the crowding-out effects likely dominate. Alas, I don't think you finished this very interesting line of thought but Bill Gale writing with Tamara Potter did in his excellent paper on the 2001 tax cut proposal, which appeared in the National Tax Journal. IMHO, Dr. Gale should have given Dr. DeLong at least a footnote. Of course, many, many other excellent discussions have appeared on this webcite in the interim.

[Bill Gale cites me more than I deserve as it is...]

As a NY Times subscriber I am overjoyed at Nicks appearance. They need all the help they can get.

There is no shortage of capital for investment. 2005 is not 1980. We are in a credit bubble right now because of all the excess money looking for investments. Record mortgages, record junk bond issuances, record reit bond issuances, record treasury issuances, record consumer debt, and asset backed securities, historically high stock values based on p/e multiples, extremely low insurance premiums per dollar of coverage. Investors have more money than they know what to do with. A good problem to have for sure if you are an investor. But the answer to our current economy lies in getting money to the middle class for consumption without added debt.

It seems as though the goal of encouraging capital accumulation is completely compatable with progressive taxation. A very steep inheretance tax with more progressive income tax on labor would do the trick, especially since most of the rich in america are "working rich" CEOs and media stars, not the rentier class of the past.

It may or may not be that the world is awash in financial capital, but it is clearly short of human capital (highly skilled team members and brilliant ideas, but also electricians and nurses' aids). Why then does it seem that those most eager to exempt dividends and financial capital gains are less concerned with tax paid on the returns to human capital? Perhaps it reflects their own portfolio balance.

When you look at the way the system actually works you see why the supply-side argument is largly irrelevant. The overwhelming bulk of capital spending is financed by business savings. If the economy finds that something is in short supply, that industry will be able to raise prices and earn above average profits. With the superior profits the executives in that industry will go out and spend like druken sailors until they create enough new capacity that the industry is no longer in short supply and they no longer earn superior profits. So they quit investing. Such swings from excess to shortage generally take about a decade. But the tax rate on personal income has nothing to do with this process as personal savings are not used to finance capital spending. Personal savings might have some minor impact in bring a new product to market, but I have never seen any evidence that it is significant to the overall level of investment.

If you look at the flow of funds data you find that personal savings is essentially used to finance housing.

>most of the rich in america are "working rich"
>CEOs and media stars

I recommend "The Millionaire Next Door" for actual research on who the rich are. The typical millionaire is a small business owner in an unglamorous business, living a frugal lifestyle in an unfashionable neighborhood, driving an unfashionable car, wearing cheap clothes, and most importantly with one marriage to a frugal wife.
Make $80K/year, spend $50K, invest $30K and repeat for 25 years. Not what you would guess (and you probably see them every day on the streets without realizing it).

Media and sports stars often blow through their money as fast as they earn it.

If you were to view the Laffer curve as an actual function between tax rates r and revenues f(r), then you can say a few things. Let's assume that people are not pathologically irrational (doubtful), and that f(r) is actually continuous and positive at all points other than r=0 (obvious) and r=1 (according to Laffer), where f(r) = 0. What we can tell from this is that one, there is a maximal revenue from taxes that is attainable, and two, there are only two locations where you have a strategy where revenue is guaranteed to increase, r=0 and r=1. In other words, you can be guaranteed to get more income from lowering taxes only if you have taxes at 100% of people's income, and are earning nothing from it. History has shown time and time again that taxes must be at truly oppressive levels before lowering them will increase tax revenues. We can come up with all sorts of controversial statements about this, but what we do know is true is that supply-siders are full of crap.

Dan,

There are two parts to the question of availability of capital. One is the issue you raise and dismiss, and your answer seems the correct one, at least for now. There is no shortage of capital. Capital is "scarce" only in the sense that it isn't free. Corporations are loaded with cash. Our savings rate is low (which is the basis of the "scarce capital" worry), but has been very well augmented by foreign inflows. Snoop through DeLong's archive for his comments on the downright perverse flow of investment from capital poor countries to the capital rich US. So yes, there is no shortage of capital.

The second part to the question has to do not with availability of capital, but with who makes capital available. Every month that foreigners ship $60 bln to US capital markets, US residents lose the income from investments in their own economy. It is not a bad thing for people outside the US to have an interest in the US doing well – far from it. It is a bad thing when residents of the US squander the benefits of owning another $60 bln chunk of a very dynamic economy every month. Big deficits are part of that problem. The Steve Roach piece you'll also find around here somewhere notes that tacking private accounts onto Social Security won't change the national savings picture at all – it just shuffles cash between accounts.

So we have a very serious problem with a capital shortage – we aren't supplying enough capital.

"It was Paul Krugman who said in a PBS debate with Allan Meltzer that most economists do agree that double taxation is a bad distortion"

And here I thought that double taxation was a fair trade-off for the rather sizeable benefits of incorporation.

res higher taxes, less working. it seems to me that there is one case where this can and does happen. if a couple have widely disparate incomes, and there are children to look after, it often does not make sense for the lower income partner to continue working. and that level of income can be fairly high, even 50-74k for the math to come into play.

1. The New Yorker ran a series back in the late 1930s collectively entitled "Where Are They Now?" Time for a piece on Arthur Laffer, don't you think?

2. If Grover Norquist really thought "...that [cutting taxes] would create a permanent increase in most Americans' standards of living....", he would NOT be trying to cut taxes.

KHarris,
I agree the dependency on foreign capital is very bad for the US. However, the foreign capital is primarily financing consumption by Americans, not investment. When I speak of an abundance of capital I am thinking about investment capital - not just dollars looking for a home. We know the options for investment are weak because long-term interest rates are so low.

Bottom line, we would be more financially sound if corporations had less cash, the govt had lower deficits and the middle class had higher wages and therefore less debt. That scenario would do wonders for investment options. The trick is finding the middle ground; which we are not at now.

vovo
Nominal tax rates were 90%. Real tax rates were much lower, probably around 30%, but you would do better to ask someone who studies tax rates, if you can find one who is intellectually honest and isn't on the pad as a consultant, speaker, or columnist. They do exist.
cownie
Most wealthy people are self made in the sense that they started out with only 50 thousand dollars forty years ago and have a million now. That's better than they could have done in treasury bills and real estate, unless you count the salary they could have earned doing something else instead of running a small business.
If you count that, they could have done as well in treasury bills and real estate.
See that Aviator movie about Howard Hughes. He really inheirited the money from his inventor father and merely managed not to lose it, mostly by dumb luck. Like having the government force him to sell his airline stock at the top of the market.
There are people that get rich by hard work, too. There just aren't as many of them as there are the ones that got rich by the hard work of their great grandparents.
Not that that means you should steal their money. The ones that earned that money left it to them, and it was their money, wasn't it?

Isn't it quaint that as recently as the 1980s, the GOP's big concern was taxes on wages to get people to work harder?

Sure, they also wanted capital gains indexed to inflation, so there wouldn't be phantom gains. But they weren't yet to the stage of seeking to place the entire tax burden on wages.

Of course, the best tax, in terms of efficiency and fairness, is the tax on the unimproved value of land.

Land value taxes are the one of the few forms of taxation where the tax is more efficient than the tax-less regime. Why? Because taxing land prevents hoarding that occurs when speculators seek gains through increasing land values.

It's also a very progressive tax---valuable land tends to be owned by the wealthy. In fact, re Richard Cownie's reference to _The Millionaire Next Door_, I would bet that a very large fraction of those who become quite wealthy do so via real estate speculation. And taxing land, when combined with better zoning decisions (promoting higher-density structures) is a godsend to the working class, because it makes housing much more affordable. (Taxes on *structures* and other improvements do have a distortionary effect, because they're a form of capital.)

One important problem is that modern economics has lost its classical roots---everyone references capital and labor, and ignores land (in general discusssions, anyway). One of the few exceptions to this was William Bernstein of www.efficientfrontier.com, who claimed that the long-run (and persisting) returns to labor, capital, and land, were 80/10/10 (percent). I think he underestimates the return to land (I wouldn't be surprised if it were 15% of GDP), but my impression is that national income accounting doesn't properly examine Ricardian land rents.

Dan,

I don't know how we distinguish between foreign inflows financing consumption and foriegn inflows financing investment. Money is money, and investment grew pretty nicely in 2004. If there is too much money chasing too few investment opportunities, that might tell us something about Fed policy - but I think that's probably intentional on their part. You build a plant, then hire people to work in it.

But whatever the cash from abroad is financing, the implication for income flows off US assets is the same - when foreign investors hold the asset, they get the income. We get paid for our labor, but they get paid for ownership. The skew between returns to labor and capital in recent years suggests to me we ought to want to own as well as work.

kharris and Dan,

It seems to me that savings follows opportunity and people will save less when it seems to be a losing proposition and save more when money put aside now will be worth far more after inflation in the future.

I think we are in a credit bubble and cash is having a hard time finding adequate returns on investment despite holding bonds pretty clearly being a losing investment in terms of US dollars per US capita. (with money supply growing 8% a year and US population growing 1% a year and US bonds in the 4% range that is a 3% a year negative unless you think that the long term value of dollars doesn't correlate to dollars per person in some rough way)

Some investments are hard to track too. A new roof certainly should qualify as an investment. It has a long useful life and a valuable utility stream (keeping you dry) if rented this probably works into investment accounts but if purchased it looks like consumption where only the amortized useful life component would truly be consumption 1/30th of a 30 year roof.

Purchasing durable tools from china while they are giving them away might be a beter investment for a handy home owner than putting the same $2000 in savings. He might also be able to use those specialized tools to do more work himself around the house, which would decrease the interchange economy but the activity of value would have been performed none the less.

While it is hardly proof, I'd suggest that the plethora of do-it-yourself shows on TV lends a bit of support to the notion that people are seeking alternative methods of "investment".

The anecdotal evidence from Japan suggests similar actions occurred there. Despite huge savings rates and low interest rates new investment opportunities (rather than shuffling ownership of existing investments) were next to impossible to find. Zero percent interest rates weren't attractive if you feared the loss of capital.

People, in a deflationary mode, began saving by finding ways to cut expenses, eventually by cutting their consumption (ok I'm widening the definition of "savings" rhetorically)

I'm at a loss to understand this economist fascination with savings. Savings, like production, seems to follow opportunity to make large returns and dwindles as real returns shrink.

As money committed to investment can compound I don't necessary see why a society would necessarily need to save from ordinary income of individuals if corporate and endowment funds committed to investment grew quickly.

A separate issue is whether extra investment stimulates the economy. Certainly it does, like all consumption. Consumption that is directed at boosting productivity would both stimulate and grow the economy even if no direct flow of income (other than their tiny societal share) would be secured by that party making such a consumptive investment for the benefit of science or the greater good. I don't see the connection between tax rates and that sort expenditure.

In many regards any labor supply side response from the tax cuts would be reduced due to the fact that the majority of the benefits accrue to high income earners (particularly with this administration). Depending on the shape and position of the labor supply curve, these high income earners may be expected to reduce their labor supply as real incomes rise due to decreases in marginal tax rates. As a result, tax cuts would be even less likely to spur income growth.

Dan and KHarris are absolutely right. There is not only no lack of investment capital, but more actually a vast over-supply of capital. There may well be $500 billion or much more in risk investment capital that is parked on the sidelines that the owners/managers of said capital have very little idea what to do with (I'm an assistant junior flunky-person to a manager with an very tiny slice of that money - and we can't figure out what to do with our tiny slice better than anybody else).

There are corporate loans being made right now at 4-5%. I've seen hyper-risky deals, which really should be priced at 18-25% IRRs (or higher), being priced at 10-13%. The competition for even semi-reasonable deals is absolutely brutal. I've seen private deals in which 50 or more players have expressed interest.

The main problem right now isn't lack of capital, but rather that we're facing a future of low foreseable technological change, and where many industry sectors are already highly concentrated and monopolized. Plus, there doesn't seem to be much solid entrepreneurial activity going on right now. I haven't seen a business plan that really impressed me (in the sense of "wow, this is a really unique idea that fills a huge need") in a very long time.

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