Consistency in tax talk

When reading a post on public address I came across this gem from NZI.

the next two tranches of the proposed income tax cuts should be cancelled on the grounds that they would contribute to the structural deficit, are unlikely to do much for growth, and do not support the most vulnerable households

Ok, so they are saying that the tax cuts will both significantly increase the deficit, not lead to growth, and won’t help poor households.  Now:

Very few of the benefits of these proposed tax cuts flow to the most vulnerable families during the recession: most of the benefits accrue to upper-income households

Right, so that covers off the third point.  And:

Nor are these tax cuts especially well-designed for growth creation, with the top marginal income tax rates left virtually unchanged

And that covers off the second point.

Now, when I look at this, it doesn’t make sense to me and I can’t see all three things to hold with the tax package.

The future take cuts are only for high income earners so don’t have a direct benefit for the poor (debatable given that out credit markets are still functioning and labour types are complements, but I’ll give them that for fun).

The future tax cuts DO involve cutting the top marginal tax rate, so if they do believe marginal tax rates are important for growth this is a bit funky.  This sounds like they are presuming that the cut is TOO SMALL.

They then say that the cost is substantial – but if the cost is too much the cut in the top MTR must be TOO BIG.

When the tax package involves cutting tax rates, it is pretty much impossible to say it fails in all three ways.  It is like the impossible trinity.

Either the package is too expensive for the return or the structure is wrong (either on equality or efficiency grounds).  A tax cut CAN’T fail (in the same direction) on all three grounds.

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  • “Nor are these tax cuts especially well-designed for growth creation, with the top marginal income tax rates left virtually unchanged”

    What they mean is that the difference between the top and the second-to-top rate is 38% minus 21%. The 2010 tax cut brings the 38 down to 37, but the 2011 cut will bring the second-to-top rate down to 20, so the *step change* in marginal rates is the same. I think that’s what they mean.

  • “They then say that the cost is substantial – but if the cost is too much the cut in the top MTR must be TOO BIG.”

    The cost is in the long-term. Sorry, this was quite an important point but it kind got lost with all the political nitpicking/fightpicking in my PA post. Sigh-o.

    Dropping the top tax rate changes the relationship between wage levels and tax revenue *more* than any other kind of changes to the tax structure, because it reduces revenue at the top end (which is disproportionately large), and because it reduces the impact of fiscal drag. And because both of these effects are related to wage growth, it’s less apparent during a recession.

    Two tax changes that have similar fiscal and stimulatory impacts in the short-term can have very different fiscal impacts in the long-term. So, it can be both too small (in terms of stimulatory impact during the recession timeframe) and too big (in terms of its contribution to the deficit over the long-term).

    (That’s a rough hypothesis at the moment. I’ve adding another 80 columns to my model, so we’ll see how well it pans out. 8-))

  • FreneticMonkey

    I think that a proposed tax policy CAN fail on all 3 grounds. Digging a hole and filling it back in again is too expensive and doesn’t do enough to stimulate the economy and is inequitable(damn shovel retailers). Now you might argue that it cant be too expensive and too small because i should have asked for a larger hole at a larger cost or a smaller hole at a smaller cost. BUT WHY ARE WE DIGGING HOLES. A tax cut fails on all 3 grounds because YOU assume that tax-cuts of whatever form are the only possible use of this public money.

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  • @Keith Ng

    @Keith Ng

    Hi Keith,

    Thanks for the comments.

    “so the *step change* in marginal rates is the same. I think that’s what they mean.”

    The step change doesn’t matter either – the key thing is the return on an extra dollar, which is simply the actual marginal tax rate. As that is the rate that drives increased labour supply and increased investment – the factors that increase “long-term growth”.

    “Two tax changes that have similar fiscal and stimulatory impacts in the short-term can have very different fiscal impacts in the long-term. So, it can be both too small (in terms of stimulatory impact during the recession timeframe) and too big (in terms of its contribution to the deficit over the long-term)”

    Indeed. But in this case the stimulus is X and the impact on the long-term deficit should be lower than other ways of causing X because it increases long-term growth.

    A “tax change” that focused on equity instead would lead to a more substantial long-term structural deficit than the current package.

    As a result, it can’t both not be equitable enough (defining equity as equality pretty much), not be efficient enough, and not be big enough – even in the long term.

  • @FreneticMonkey

    Hi FreneticMonkey,

    Digging holes isn’t tax cuts – that is public spending that offers no output. That is indeed a waste.

    Also tax cuts aren’t “handing out public money” – they are letting private agents keep the claim on resources that they’ve earned. These resources are used to buy things (leading to a stimulus) or to save (which give our credit markets work will lead to investment and is a stimulus).

    Digging holes is a waste of time – tax cuts are not.

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  • FreneticMonkey

    I just use digging holes as an example, tax cuts “cant fail on all 3 grounds” only if you assume that tax cuts are the only possible use of the dollars in question.

  • @FreneticMonkey

    My presumption is indeed that there isn’t any government spending that would be more productive than tax cuts – indeed. Given our credit markets are functioning I’m comfortable with that 😉

  • FreneticMonkey

    As most people are not willing to invest in home insulation that pays a pretty decent return in lower energy bills and improved health…….. but hey lets assume everyone is perfectly rational and tax cuts are the best possible response to the current recession.

  • @FreneticMonkey

    If the government had instead told people about the benefits of insulation then they could make the choice that is in their interest – it is an issue of information, not an issue where government needs to just do what they think is best.

    When did I say tax cuts are the best thing to do in the current case – so far I’ve only said that tax cuts are nothing like digging a hole 😉 .

  • FreneticMonkey

    your whole argument that tax cuts cant fail on grounds of expense, effectiveness and equity relies on the assumption that said dollars can only be spent on tax cuts and not public investment. I consider that assumption to be a equivalent to you saying “tax cuts are the best thing to do in the current case”.

  • FreneticMonkey

    “When did I say tax cuts are the best thing to do in the current case”

    right here?

    “My presumption is indeed that there isn’t any government spending that would be more productive than tax cuts – indeed. Given our credit markets are functioning I’m comfortable with that ;)”

  • @FreneticMonkey

    Indeed – I am assuming that we don’t need to structurally increase public spending on public goods. Public good investment is a structural issue after all it isn’t simply stimulus. People frame it as stimulus because they want it – not because it acts as a temporary boost 🙂

    @FreneticMonkey

    Just because they are more productive does not mean that I think they would be the best thing to do in the current case.

    e.g. society values keeping people in jobs in certain industries – government spending can target those industries when tax cuts can’t.

    I am not trying to say that we SHOULD just do things through tax cuts – but I am saying that if we want to compare the aggregate ideas of “efficiency”, “equality”, and “total cost” we have to note the trade-off between them. On the flip side this implies that a tax cut can’t fail on all three grounds.

    Now, if there was some project the government could do, which the private sector couldn’t (because it is blind or it is a public good) we can always say that there is a free lunch here. However, I am skeptical of free-lunches, and I haven’t had one shown to me yet. In the absence of said free lunch (which is what I stuck with by assuming government spending would be fixed in the post) we cannot criticise the tax cut on ALL three grounds.

  • FreneticMonkey

    don’t you think the example i have given all ready of home insulation is a free lunch?

    Insulation pays for itself in energy bills and future health care costs. With a public health system people don’t bear the full costs of their health care so it is understandable that they wouldn’t purchase the ‘efficient’ amount of insulation. Although the savings on their power bills would probably be enough to justify insulation as an investment.

    I was flatting last year in an uninsulated house and it was the coldest damn winter. I was unable to convince our landlord to insulate the house paid for by an increase in rent that would be smaller than the decrease in our power bills. Everyone in the flat was sick that winter which im sure was related to the cold damp environment we were living in.

    once you have public institutions distorting people’s incentives its pretty easy to justify further public investment 😉

  • @FreneticMonkey

    “don’t you think the example i have given all ready of home insulation is a free lunch?”

    I would prefer to have a policy where we informed people of the benefits and costs and then let them make up there own mind. I’m not a fan of telling people that something is a good idea and then doing it to them 😛

    “With a public health system people don’t bear the full costs of their health care so it is understandable that they wouldn’t purchase the ‘efficient’ amount of insulation”

    I see what you are saying here – you are appealing to an externality. However, there are two other solutions I may prefer:

    1) Make areas of health care that involve externalities user pays,
    2) Subsidise home insulation to the amount of the externality, after providing the education.

    Again I see this as a structural issue though – if the policy is good then we should be doing it regardless of the recession 🙂

    “once you have public institutions distorting people’s incentives its pretty easy to justify further public investment”

    The old second best argument 🙂

    I still like to try and steer back to whatever information I can get from prices – without prices I can’t tell what weird and wonderful things people actually value and prefer 😀

  • FreneticMonkey

    we have to protect the freedom of people who want to live in cold damp homes and their freedom to rent cold damp homes to people who freely choose to live in them, ahhhhh liberty 😉

  • FreneticMonkey

    “Again I see this as a structural issue though – if the policy is good then we should be doing it regardless of the recession :)”

    well doing this during the recession DOES have extra benefits as all those tradespeople who were employed building houses……

  • @FreneticMonkey

    If they value the improvement at a sufficiently low rate, and given that the cost is positive, I think it is fair to give them the option 😉

    @FreneticMonkey

    Although the cost of that is that the builders are being given work now when they could be upskilled to move into sectors that may be more highly valued when we are out of the recession and no longer in a housing bubble 😉

  • FreneticMonkey

    the cost is only positive with a myopic discount rate

  • @FreneticMonkey

    No the cost is definitely positive irrespective of the discount rate – even if it all falls in one period it is still positive 🙂

  • FreneticMonkey

    sure sure the cost is positive but the cost minus the decrease in electricity/gas bills will not be positive

  • FreneticMonkey

    only looking at the costs and not the benefits reminds me of a certain report on alcohol…

  • @FreneticMonkey

    I would term the decrease in power bills as a benefit myself – as I always try to define costs very very narrowly.

    However, if it turns out that people would make back the money in power bills in a very short amount of time – then the key is to tell them so, and to help inform people how they can get the job done.

  • @FreneticMonkey

    I’m not just looking at the costs – our conversation just moved onto discussing the measurement of costs 😉 Remember I said:

    “If they value the improvement at a sufficiently low rate, and given that the cost is positive, I think it is fair to give them the option”

  • FreneticMonkey

    well i’m sure the kind of scheme advocated by Labour or the Greens would not entail busting peoples doors down and forcing insulation on them. Can we agree that myopia and the externality effect on the public health system justifies some government intervention to insulate homes and that this would employ people who would otherwise be out of work.

  • FreneticMonkey

    “then the key is to tell them so, and to help inform people how they can get the job done.”

    so rationality is so limited that people cant get on teh interwebs and inform themselves about insulation

    but not limited enough to justify the heavy hand of the state offering to insulate their homes?

  • @FreneticMonkey

    “Can we agree that myopia and the externality effect on the public health system justifies some government intervention to insulate homes and that this would employ people who would otherwise be out of work”

    Not quite. We can agree that when these things are an issue it can justify government intervention.

    But I can’t go as far as stating that this is what I believe. In an objective sense we agree – it is the value judgments that we differ on, which is good 🙂

    @FreneticMonkey

    Why would people randomly be researching insulating their homes – providing information helps people recognise choices and make decisions for themselves 🙂

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  • FreneticMonkey

    😉 it is the value judgments we differ on and that’s why i don’t like your original post. The implicit value judgment that we are choosing between alternative TAX CUTS when assessing cost, effectiveness and equity.

  • @FreneticMonkey

    The initial post was based on an NZI discussion solely focused on the nature of tax cuts – government spending issues were left to the side. Given they were only discussing taxes, my criticism of their critique seemed war rented methinks 😉

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