Saturday, June 7, 2008

Supply-Side Econ rides again!

after knocking McCain's gas-tax holiday proposal, hot-shot economist and former Mitt Romney guru, Greg Mankiw wrote:
... Lost in this hubbub, however, is a bigger idea that Mr. McCain and his economic team have put forward: a cut in the corporate tax rate, to 25 percent from 35 percent. It is perhaps the best simple recipe for promoting long-run growth in American living standards.

Cutting corporate taxes is not the kind of idea that normally pops up in presidential campaigns. After all, voters aren't corporations. Why promise goodies for those who can't put you in office?

In fact, a corporate rate cut would help a lot of voters, though they might not know it. The most basic lesson about corporate taxes is this: A corporation is not really a taxpayer at all. It is more like a tax collector.

The ultimate payers of the corporate tax are those individuals who have some stake in the company on which the tax is levied. If you own corporate equities, if you work for a corporation or if you buy goods and services from a corporation, you pay part of the corporate income tax. The corporate tax leads to lower returns on capital, lower wages or higher prices — and, most likely, a combination of all three.

my comments in boldface, while his original column is light-weight:
I don't believe that the corporate tax really affects the return on corporate equities, except in very special situations and in the short run. The fact is that those who buy US corporate equities can always buy them in places where corporate income is not taxed -- or can buy the stocks of US companies that don't pay any corporate taxes at all. That bids up the return on the taxed assets, so that after-tax rates of return are equalized.

The main case where I can see the corporate tax actually lowering returns on equity would be that where the companies reap large raw-material scarcity rents. But those companies often (usually) get "depletion allowances" and the like, more than compensating them for their loss. As discussed below, I do think the corporate tax affects returns on stock prices in the short run.

In other words, in the long haul (about a year or so) I see the corporate income tax as mostly being reflected in higher consumer prices and/or lower wages. Since that tax isn't very large these days, I don't see this as being very important.

A cut in the corporate tax as Mr. McCain proposes would initially give a boost to after-tax profits and stock prices,

Initially stock prices would rise, but the arbitrage I describe in my first paragraph above would cause this to end in the long haul (even a period as short as a week). Then the corporations and the stockholders would hunger for a new tax cut to get another transitory boost in returns. This seeking of a short-term fix is an important reason why the corporate tax keeps on being lowered (even though in the longer haul, the owners don't really pay the tax). It's a bit like a drug addiction: the stockholders want transitory pleasure. Because it doesn't last, they want it again & again.

but the results would not end there. A stronger stock market would lead to more capital investment.

This connection between stock prices and corporate investment is very weak and likely non-existent, as Doug Henwood and others have pointed out. It's amazing that Mankiw so blithely assumes that this connection is automatic. It is especially weak given the way in which the SM fluctuates so wildly and the way in which arbitrage would get rid of the extra return pretty quickly.

More investment would lead to greater productivity.

This assumes that the investment is real, rather than purely financial, like buying up other companies. It assumes that it's in actually producing some commodity rather than in marketing and the like. It assumes that the investment is done inside the US.

Greater productivity would lead to higher wages for workers and lower prices for customers.

Greater productivity leads to higher wages? since when? it hasn't worked that way for about 30 years. Real wages of nonsupervisory employees have generally stagnated since the early 1980s, even though labor productivity has soared (though not as much as it soared in earlier decades). Most of the productivity gains have gone to stock-owners and CEOs. For Mankiw's story to work, the one-sided class war would have to end. He isn't calling for an end of the war. Instead, he has instead tried to provide ideological ammunition to the other side.

Consumer prices might fall (assuming US productivity rises) but only relative to existing inflation. And given all of the weak links in the chain above, that wouldn't be a big thing.

Populist critics [who shall be slammed but unnamed, of course] deride this train of logic as "trickle-down economics." But it is more accurate to call it textbook economics. Students in introductory economics courses learn that the burden of a tax does not necessarily stay where the Congress chooses to put it. That lesson is especially relevant when thinking about the corporate tax.

has Mankiw ever contemplated why "trickle down" has such a bad rep? maybe because it hasn't worked within recent memory?? (Maybe it worked during the 1960s, but the US political economy was completely different from nowadays.) I'll ignore the cheap rhetoric of the rest of this paragraph.

In a 2006 study, the economist William C. Randolph of the Congressional Budget Office estimated who wins and who loses from this tax. He concluded that "domestic labor bears slightly more than 70 percent of the burden."

Mr. Randolph's analysis stresses the role of international capital mobility. With savings sloshing around the world in search of the highest returns, he says, "the domestic owners of capital can escape most of the corporate income tax burden when capital is reallocated abroad in response to the tax." When capital leaves a country, the workers left behind suffer. (According to Mr. Randolph, however, some workers do benefit from the American corporate tax: those abroad who earn higher wages from the inflow of capital.)

A similar result was found in a recent Oxford University study by Wiji Arulampalam, Michael P. Devereux and Giorgia Maffini. After examining data on more than 50,000 companies in nine European countries, they concluded that "a substantial part of the corporation income tax is passed on to the labor force in the form of lower wages," adding that "in the long-run a $1 increase in the tax bill tends to reduce real wages at the median by 92 cents."

It's quite possible, if not likely, that all else equal US corporate taxes make corporate fixed investment in the US more expensive, so that it goes elsewhere. Thus, all else equal, wages have to be depressed to compensate companies doing fixed investment in the US. Or environmental laws have to be weakened to provide this sop. Taxes, wages, environmental laws (along with labor productivity, the availability of infrastructure, access to markets, etc.) are important parts of the corporate decision about investment location. That's a key reason why we see international competition among governments to attract corporate investment. (It's worse among states of the US union.) That's a key reason why we see the international creep to the bottom, the downward harmonization of labor and environmental standards. (This "creep" is a major reason why the current political economy is so different from that of the 1960s.)

Mankiw ignores this context in order to propose a corporate tax be cut to draw investment in from other countries. But that simply encourages the creep toward the bottom, along with lowering wages and paring government regulations.

Despite these findings, a corporate tax cut as a way to help workers may strike some people as needlessly indirect. Why not just pass an income tax cut aimed squarely at working families, as Senator Barack Obama proposes?

The answer is that while most taxes distort incentives and shrink the economic pie, they do not do so equally. Compared with other ways of funding the government, the corporate tax is particularly hard on economic growth. A C.B.O. report in 2005 concluded that the "distortions that the corporate income tax induces are large compared with the revenues that the tax generates." Reducing these distortions would lead to better-paying jobs.

I'd like to see the assumptions behind that report. Mankiw also seems to be saying that Obama's proposal would "distort incentives and shrink the economic pie." How would that happen, Greg? It would promote aggregate demand (all else constant) which would raise the size of the economic pie that's realized as actual sales, something that seems needed in the midst of a recession. I don't know the details of Obama's plan, but I'd like to hear more about how it would undermine workers' incentive to work. In hard times, facing bills rising relative to income, most people want to work as much as possible, trying to moonlight with two or even three jobs if they can. The problem is not the incentive to work but the availability of jobs.

Of course, a corporate tax cut would affect the federal budget. And any change in tax policy has to be made against a background of a looming fiscal crisis, which threatens to unfold as baby boomers retire and start collecting Social Security and Medicare.

There must be a typo here: Mankiw must be smart enough to know that there is no "looming fiscal crisis" associated with Social Security, so it's wrong to unite it with Medicare in a single package.

In 2007, corporate taxes brought in $370 billion, representing 14 percent of federal revenue. Cutting the rate to 25 percent would seem to cost the Treasury about $100 billion a year.

Part of that revenue loss, however, would be recouped through other taxes. To the extent that shareholders would benefit, they would pay higher taxes on dividends, capital gains and withdrawals from their retirement accounts.

this won't happen if taxes are cut again on dividends, capital gains, and IRA withdrawals, as Mankiw would likely advocate.

To the extent that workers would benefit, they would pay higher payroll and income taxes. Increased economic growth would tend to raise tax revenue from all sources.

this assumes that Mankiw's cock-and-bull story about the wonderful effect of cutting corporate taxes actually works. Calling Dr. Laffer...

SOME economists think that these effects are strong enough to make a corporate rate cut self-financing. A recent study by Alex Brill and Kevin A. Hassett of the American Enterprise Institute [a very objective source, natch], looking at countries in the Organization for Economic Cooperation and Development, supports exactly that conclusion. But even if that turns out to be too optimistic, both theory and evidence make it reasonable to expect a significant discount from the sticker price. In the end, the net budgetary cost of the tax cut might be, say, $50 billion a year.

Great, a totally worthless guesstimate!

Senator McCain wants to fill that hole in the budget by restraining spending. If he can stop bloated legislation like the recent $300 billion farm bill from becoming law, more power to him.

How about ending the $3 Trillion war before it gets even more expensive? how about avoiding the renewal of the Bush tax cut for his rich friends? even better, how about a Bill Clinton-type tax hike for them? These guys haven't been running the economy very well of late. Why reward them for poor behavior?

But in case that quest proves quixotic, I have a back-up plan for him: increase the gasoline tax. With Americans consuming about 140 billion gallons of gasoline a year, a gas-tax increase of about 40 cents a gallon could fund a corporate rate cut, fostering economic growth and reducing a variety of driving-related problems.

Indeed, if we increased the tax on gasoline to the level that many experts consider optimal, we could raise enough revenue to eliminate the corporate income tax. And the price at the pump would still be far lower in the United States than in much of Europe.

I'm all in favor of raising the gas-tax. I notice, however, that Mankiw elided the usual addition to gas-tax hikes, i.e., a tax cut or credit for those at the bottom of the income distribution. That would hurt his ability to earn thousands of dollars doing public speaking for business groups, of course.

Don't laugh. I'm serious.

I can't laugh. He's too stupid.

Jim Devine

1 comment:

Econoclast said...

I'm just fixing it so that blogger sends any comments to my e-mail.