Wednesday, June 1, 2011

The Lucas Explanation of the Persistence of the Great Recession: The Barro Objection

Robert Lucas offers the following as one of his reasons for the persistence of the Great Recession:

Likelihood of much higher taxes, focused on the “rich”

Gavyn Davies and Paul Krugman argue that the Lucas attempt to explain the persistence of the Great Recession on purely classical principles lacks credibility with Davies noting:

As yet, there has been no increase in taxation, on the rich or anyone else. Nor have the Obama administration’s medical and financial sector reforms really taken effect. It would take a remarkably far sighted private sector to have already reacted adversely to this set of long term reforms, even if they might do so eventually.

One could argue, however, that the Barro reformulation of Ricardian Equivalence would argue that it is not current taxation that matters but the expectation of future taxes when government spending outstrips taxes. But if one is basing one’s argument thusly, I don’t see what has fundamentally changed in the past few years. We knew back in the 1980’s that Reagan’s fiscal policy has spending outstripping taxes until we got the return to fiscal sanity during the Clinton years. Of course, that changed when a new Administration took office but that new Administration took office in 2001 – not 2009. Professor Lucas does not explain to us why he believes that the Obama Administration signals an even further long-term commitment to more government spending. In fact, the medical reforms he mentions were designed to reduce long-term spending. So if the rich were forward looking ala Ricardian Equivalence, the likelihood of much higher taxes would have been realized well before the Great Recession.


TheTrucker said...

It seems that the "Richardian Equivalence" nutters want to argue that if the "investors" see higher taxes looming in the future then the "investors" will focus on short term gains as opposed to longer gains (longer gains being from actual investment as opposed to squeezing out the last drop of rent from current assets).

So why not make "Richardian Equivalence" a friend. Why not raise the taxes _NOW_, realizing that if this actually harms the economy we will have to reduce the taxes in the future?

The simple fact is that truly "unearned income" is FREE MONEY. And nobody is going to turn down FREE MONEY even if it is heavily taxed. And the fact is that really extreme incomes are ALL unearned and are FREE MONEY. That is why progressive taxation is right and proper. It turns out that all money is "earned" (except that which is created by the banks including the FED). But in the case of truly unearned income, the recipient of the income isn't the persons who earned it.

wellbasically said...

The Dems were destroyed in 2010 on their promise to raise taxes. Obama has already stated that he will run in 2012 with tax increases on his agenda. The Republicans could easily have won again in 2012, but they decided to commit suicide by presenting an austerity plan instead of a growth plan. Business, which might have expected a Republican victory, now has to factor in that Obama might win again.

Expectations of course play a role. For instance, Bill Clinton signalled to all that he would make a deal with the Republicans in 1996, when his actual tax cuts on housing and investment didn't take place until 1997. Even so, the economy began roaring during his re-election year, and he won.

TheTrucker said...

Good grief.....

Barkley Rosser said...

What is really funny is that quite aside from the fact that B.O. has not increased taxes on the rich so far (and is unlikely to be able to do so with the current Congress), what he was most likely to do was to put the tax code back to what it was under Clinton, at least that is what he proposed for the rich, only to be blocked. So, if fear of such a tax code for the rich explains persistence of the current recession, why did that same code in actual practice coincide with a major boom of the economy, including fiscal surpluses?