Amy Traub
Again with the Tax Cuts
On Monday, John discussed the politics behind the newly announced tax cuts planned for the new stimulus package. Whatever the political wisdom of this approach, the policy implications are troubling.
Media reports suggest that the main tax provisions of the bill will include allowing businesses to accelerate tax write-offs, providing incentives for business investment, and a tax credit for companies that make new hires or avoid layoffs. But these corporate tax cuts are unlikely to be effective. Commentators on this blog have already discussed the analysis of Mark Zandi – former economic advisor to the McCain campaign – whose economic models indicate that corporate tax cuts will generally provide less bang for the stimulus buck than public spending (Zandi’s calculation for the return on accelerated depreciation of new investment – similar to what the Obama team seems to be contemplating – is actually an abysmally low 27 cents on the dollar).
But the economic rationality behind the numbers is equally compelling. Simply put, businesses don’t make decisions about hiring, firing, and investment based on a nominal federal tax cut. They decide based on economic demand for their products or services. If there’s demand for more widgets, management at the widget factories will invest in more equipment and hire more widget-makers. If demand is stagnant or falling, tax cuts will have to be lavish indeed to induce companies to invest more in churning out a product for which there is little demand. (If the public interest in widget production in itself is that great -- as I’ve argued in the case of the auto industry –- we ought to find a more direct and efficient way than broad corporate tax cuts to incentivize it).
Finally, I’m skeptical of the argument that there aren’t enough productive ways to quickly spend the amount of money necessary to shore up the economy.
Certainly the number of shovel-ready infrastructure projects is limited, but with 46 million Americans without health coverage, $350 billion in state budget gaps prompting states to cut programs that serve the most vulnerable citizens, and millions of Americans facing the imminent loss of their homes because they cannot keep up with mortgage payments, Obama’s spending plans seem far from exhausting the opportunities to put cash into the hands of people who will spend it quickly and improve the country at the same time.
I critiqued Obama’s willingness to buy into the right’s framing of tax issues during the campaign. Yet despite his efforts to portray himself as an ardent tax cutter, exit polls suggest 71% of voters believed their own taxes would increase if he were elected. He won anyway. Maybe the politics of this issue, at least when it comes to the public, are not as ironclad as they once appeared.
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Posted at 8:23 AM, Jan 06, 2009 in Congress | Employment | Federal Budget | Infrastructure
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If there’s demand for more widgets, management at the widget factories will invest in more equipment and hire more widget-makers.
If not qualified with "All else being equal," this is false. Widget factories will invest in making more widgets if the expected marginal profit of making widgets increases. This profit can go down even while demand for widgets goes up--when a simultaneous increase in marginal costs of making widgets offsets gains from new demand, for example.
You say:
If demand is stagnant or falling, tax cuts will have to be lavish indeed to induce companies to invest more in churning out a product for which there is little demand.
But, just a few moments earlier, you say:
...businesses don’t make decisions about hiring, firing, and investment based on a nominal federal tax cut.
Isn't this just a little bit self-contradictory? Businesses do not take tax cuts into account in making their investment decisions. A tax cut that is "lavish indeed" would induce companies to invest more in churning out their product. Which one is it?
Posted by: przemek | January 7, 2009 01:33 PM
Thanks for the thoughtful comments. "All else being equal" should indeed qualify that sentence. As for tax incentives, there is no contradiction: nominal incentives won't make a difference, lavish ones might. If we want to get bang for our bucks, we should take care that the substantial subsidies are well-targeted.
Posted by: Amy Traub | January 7, 2009 06:41 PM
Oh. I thought you were using the word "nominal" in its "economic" sense, as in nominal vs. real interest rate. (If you were, then I still maintain you've contradicted yourself.)
Some more general issues about your post:
First, you're not differentiating between types of tax cuts. You write about tax cuts as if they all meant same thing. There's different types of tax cuts because, well, there's different types of taxes; and they can have very different effects on incentives. For example, the source you cite estimates a multiplier effect of 1.29 for payroll tax cuts (which add up to about half of the amount of cuts proposed by Obama). Compare this with the estimated federal spending multiplier of 1.5 and all of a sudden it doesn't sound so bad. On the other hand, I do agree with (what I think is) your view that refundable tax credits for hiring new workers (or not laying current workers off) are unlikely to have much of an effect on anything.
Second, you take Zandi's analysis as gospel. Why? It's not peer-revied, nor does it reference peer-reviewed research. Furthermore, economists disagree on the magnitude of the multipliers rather drastically, and it's very easy to find (peer-reviewed) research suggesting that tax cuts are better fiscal stimulus than spending (see here). My point is not to argue that the latter is actually the case (few economists believe that). Rather, it is to say: given how wild the disagreements are it's fairly safe to say no one knows exactly what the multipliers are. What makes you think it's Zandi who does?
It seems to me that most economist see the bottom line as follows: Right now we're in a recession, and in a situation where there's very little room for monetary policy. We need a fiscal stimulus. Fiscal stimulus is increased government spending and tax cuts. We need to figure out which tax cuts, who and how should pay for them, and who should benefit from them.
Posted by: przemek | January 8, 2009 03:20 PM
As I think my post makes clear, I discuss Zandi as a continuation of a previous conversation on this blog which I've linked to. There a commenter mentioned his analysis in particular. Zandi is one credible analyst among many -- just because I've mentioned his analysis doesn't mean I take his word as Gospel. Nor, I think, does my post imply that I believe every tax cut is the same as bonus depreciation, one of the three types of corporate tax cuts Obama staff specifically mentioned as part of their plan which seems particularly unlikely to provide efficient stimulus. Obama's economic advisers have themselves argued that this type of tax cut does not appear to be very effective in stimulating economic activity.
Posted by: Amy Traub | January 9, 2009 10:45 AM
The previous conversation was a link to Paul Krugman, whose argument against cutting taxes is that the Republicans will want to cut more taxes. I have nothing but respect for Krugman's economic analysis, but when it comes to politics, he's as bad as Grover Norquist.
Posted by: Alon Levy | January 9, 2009 02:59 PM