Random Observations for Students of Economics
Readers of this blog might like to know:
The
Center for the History of Political Economy at Duke University will be hosting
another Summer Institute on the History of Economics this summer from June
20-29, 2022. The program is designed for students in graduate programs in
economics, though students in graduate school in other fields as well as newly
minted PhDs will also be considered.
More information on the Summer Institute is available at this website.
I have long favored a carbon tax to deal with global climate change. But I understand that if our leaders lack the political courage to propose one, targeted subsidies, such an electric vehicle tax credit, can be a substitute, albeit an imperfect one. In today's paper, I learned that, unfortunately, the design of this credit in the so-called Build Back Better bill aims not only at addressing climate change but also at reducing competition in the labor market and impeding international trade:
The credit is $8,000 if the vehicle is made at a non-union U.S. plant, but rises to $12,500 if it’s made in a union-organized plant. The credit drops $500 if the car’s battery isn’t made in America, and after 2026 only cars assembled in the U.S. would qualify for the basic $7,500 credit.
So the bill neglects the obvious first-best policy, starts with a second-best policy, and adds various extraneous provisos to make it worse.
In the discussion of President Biden's so-called Build Back Better plan, a common refrain among its proponents is that the bill will not increase inflation because it is paid for with tax increases on corporations and wealthy individuals. There are four problems with this logic:
1. The bill is likely to include permanent tax increases along with spending provisions that will sunset. The proponents want the spending to be extended later. So, in a true sense, it is not paid for.
2. The key issue is not what the plan does to the economy over a 10-year budget window but what it does over the next few years. So look at the path of fiscal policy, not just the 10-year totals. While I wait for CBO's budget projections, I will guess the bill will expand the budget deficit in the near term.*
3. Even paid-for increases in spending can expand aggregate demand and thus be inflationary. Recall the balanced budget multiplier.
4. If the wealthy have especially low marginal propensities to consume, as some research suggests, and they are the people on whom the new taxes are to be levied, then the increase in aggregate demand could be large. That is, the reduced spending by the wealthy taxpayers would not offset the increased spending that the new taxes are financing.
A final thought: The BBB plan should not be judged by its impact on inflation. Whatever its inflationary effect is, monetary policy can offset it. The plan should be judged by whether we want a substantial increase in the size and scope of government social spending.
*Update (11/18): As predicted, the CBO says the bill will increase the budget deficit by about $750 billion over the first five years. The additional revenue will cover less than a quarter of the additional spending.
From Paul Krugman today:
The most famous example is the research that Card conducted along with the late Alan Krueger on the effects of minimum wage. Most economists used to believe that raising the minimum wage reduces employment. But is this true? In 1992 the state of New Jersey increased its minimum wage while neighboring Pennsylvania didn’t. Card and Krueger realized that they could assess the effect of this policy change by comparing employment growth in the two states after the wage hike, essentially using Pennsylvania as the control for New Jersey’s experiment.
What they found was that the increased minimum wage had very little if any negative effect on the number of jobs....
So the empirical revolution in economics undermines the right-leaning conventional wisdom that had dominated discourse.
From David Henderson today:
Messrs. Card and Krueger conducted a famous natural experiment by studying employment at fast-food restaurants in New Jersey and Pennsylvania before and after New Jersey raised the minimum wage while Pennsylvania didn’t. Contrary to what one might expect, employment in New Jersey’s fast-food restaurants rose slightly relative to employment in Pennsylvania’s. On this basis, they challenged standard supply-and-demand models of the effects of minimum wages. Unfortunately, Messrs. Card and Krueger’s data weren’t so great—they gathered it by phoning restaurants.
University of California Irvine economist David Neumark and Federal Reserve economist William L. Wascher, using the restaurants’ payroll data, found what most economists would have expected: The minimum wage increase in New Jersey caused employment to fall in the New Jersey restaurants relative to Pennsylvania restaurants’ employment.
There is an interesting article in The New Yorker about one of my competitors in the intro textbook market. A notable tidbit:
Jonathan Gruber, who teaches introductory economics at M.I.T., felt that core might introduce too much complexity for a foundational course. He worried that so much emphasis on the ethical and political dimensions of economics might make the subject feel like a different discipline altogether. “The question is, do you want the students to feel like they’re coming out of, you know, to be blunt, a sociology class or an economics class?” Gruber said.
A new paper by Kevin Corinth, Bruce Meyer, Matthew Stadnicki, and Derek Wu finds the following (emphasis added).
The proposed change under the American Families Plan (AFP) to the Tax Cuts and Jobs Act (TCJA) Child Tax Credit (CTC) would increase maximum benefit amounts to $3,000 or $3,600 per child (up from $2,000 per child) and make the full credit available to all low and middle-income families regardless of earnings or income. We estimate the anti-poverty, targeting, and labor supply effects of the expansion by linking survey data with administrative tax and government program data which form part of the Comprehensive Income Dataset (CID). Initially ignoring any behavioral responses, we estimate that the expansion of the CTC would reduce child poverty by 34% and deep child poverty by 39%. The expansion of the CTC would have a larger anti-poverty effect on children than any existing government program, though at a higher cost per child raised above the poverty line than any other means-tested program. Relatedly, the CTC expansion would allocate a smaller share of its total dollars to families at the bottom of the income distribution—as well as families with the lowest levels of long-term income, education, or health—than any existing means-tested program with the exception of housing assistance. We then simulate anti-poverty effects accounting for labor supply responses. By replacing the TCJA CTC (which contained substantial work incentives akin to the EITC) with a universal basic income-type benefit, the CTC expansion reduces the return to working at all by at least $2,000 per child for most workers with children. Relying on elasticity estimates consistent with mainstream simulation models and the academic literature, we estimate that this change in policy would lead 1.5 million workers (constituting 2.6% of all working parents) to exit the labor force. The decline in employment and the consequent earnings loss would mean that child poverty would only fall by 22% and deep child poverty would not fall at all with the CTC expansion.
Later this week, registration will open for the 17th Annual Economics Teaching Conference sponsored by the National Economics Teaching Association (NETA) and Cengage. This conference will be held virtually on Thursday, October 28 and Friday, October 29. I am one of the speakers.
Readers of this blog have an opportunity to register now using this link.A magician tricks his audiences by distracting them. While people focus on something that is attractive but irrelevant (a shiny object, the magician's beautiful assistant in a skimpy outfit), the magician can more easily hide his deception.
In a new CEA blog post, the Biden economics team does something similar. It asks what the average tax rate of the 400 wealthiest families would be if unrealized capital gains were included in the measure of their income.
This is a mildly interesting question. But why is the Biden team taking the time from their busy schedules to ask it? Because they want to convince you that the rich aren't paying their fair share in taxes.
The problem is that this question has little connection to the policies now being discussed. As I understand it, the essence of the plan under consideration is not a tax on the unrealized capital gains of the 400 richest families. Instead, the plan aims to raise the corporate tax rate, which in turn is paid by the many shareholders, workers, and customers of the companies. (Economists debate the relative incidence.) In addition, the plan aims to raise the tax rates applied to the already-taxed income earned by people making more than $400,000 a year. I would guess that this latter group includes about 1.5 million taxpayers. Needless to say, 1.5 million is a much larger number than 400. And the finances of the 400 are in no way representative of the finances of the 1.5 million.
Don't get distracted by this shiny object.
In my recent Times column on the expanded social safety net, the following passage was cut in the editorial process, but it is an important point, which I am afraid is being lost in the Congressional rush to get something done:
Team Biden says they won’t pass the bill onto future generations in the form of higher public debt. Whether that’s true is hard to say. The Congressional Budget Office and Joint Tax Committee have not yet scored the bill because it hasn’t been written. Let’s hope that Congressional leadership is patient enough to let the scorekeepers do their jobs before bringing the legislation up for a vote.
In my most recent Times column, I did not have the space to fully explain the body of work that follows up on the Prescott hypothesis that higher tax rates explain lower work effort and national incomes in Western Europe. For interested readers (that is, the more nerdy ones), here are a some relevant references together with brief excerpts (emphasis added):
1. Steven Davis and Magnus Henrekson
"Lastly, let us return to the recent studies by Prescott (2002, 2003), which consider the output, employment and welfare consequences of personal taxes in an equilibrium model with one production sector and a simple labor-leisure choice for the representative household. Our evidence supports the view that tax rate differences among rich countries are a major reason for large international differences in market work time. At the same time, however, our evidence strongly suggests that labor and consumption taxes operate with powerful effect on several margins: substitution between legal and underground activity, substitution between home and market production, the mix of market production activity, and the composition of market expenditures."
2. Indraneel Chakraborty et al.
"Americans work more than Europeans. Using micro-data from the United States and 17 European countries, we document that women are typically the largest contributors to the cross-country differences in work hours. We also show that there is a negative relation between taxes and annual hours worked, driven by men, and a positive relation between divorce rates and annual hours worked, driven by women. In a calibrated life-cycle model with heterogeneous agents, marriage and divorce, we find that the divorce and tax mechanisms together can explain 45% of the variation in labor supply between the United States and the European countries."
"Our punch line is that Europeans today work much less than Americans because of the policies of the unions in the 1970s, 1980s, and part of the 1990s and because of labor market regulations. Marginal tax rates may have also played a role, especially for women's labor force participation, but our view is that in a hypothetical competitive labor market without unions and with limited regulation, these tax increases would not have affected hours worked as much. Certainly micro evidence on the elasticity of labor supply is inconsistent with a mainly tax-based explanation of this phenomenon, even though social multiplier effects may help in this respect."
"Based on our reading of the micro evidence, we recommend calibrating macro models to match Hicksian elasticities of 0.3 on the intensive and 0.25 on the extensive margin and Frisch elasticities of 0.5 on the intensive and 0.25 on the extensive margin. Hence, it would be reasonable to calibrate representative agent macro models to match a Frisch elasticity of aggregate hours of 0.75. These elasticities are consistent with the observed differences in aggregate hours across countries with different tax systems."
As I noted in my column, economists disagree about the how far the tax-based explanation goes. A reasonable reading of the literature is that lower labor effort and incomes in Europe are likely due to a combination of higher tax rates, stronger unions, and greater regulations.
Remember this?
Mr. President, I rise today to talk about America’s debt problem. The fact that we are here today to debate raising America’s debt limit is a sign of leadership failure. It is a sign that the U.S. Government can’t pay its own bills. It is a sign that we now depend on ongoing financial assistance from foreign countries to finance our Government’s reckless fiscal policies....
Increasing America’s debt weakens us domestically and internationally. Leadership means that ‘‘the buck stops here.’’ Instead, Washington is shifting the burden of bad choices today onto the backs of our children and grandchildren. America has a debt problem and a failure of leadership. Americans deserve better. I therefore intend to oppose the effort to increase America’s debt limit.
That was Senator Barack Obama opposing an increase of the debt limit in 2006, when government debt was 35 percent of GDP. Now it's 98 percent.
Of course, not raising the debt limit in 2006 would have been bad policy, as not raising the debt limit now would be. My own view is close to that of Jason Furman and Rohit Kumar, who advocate repealing the debt limit entirely, so we don't regularly have these artificial legislative crises.
But I recognize that is unlikely. And as long as we have a debt limit, politicians will use it to play politics. That is what Senator Obama did in 2006, and for better or worse, that is what Senate Republicans will likely do over the next few weeks. The open question is what political advantage they will get from doing so.
Blog readers might be interested in an upcoming interview of me, at 7 pm on October 20, 2021. Information available here.
I am the Robert M. Beren Professor of Economics at Harvard University. I use this blog to keep in touch with my current and former students. Teachers and students at other schools, as well as others interested in economic issues, are welcome to use this resource.
