OK, someone has to do it. There was a dreadful column on tax policy in today’s New York Times, and none of the usual suspects (Dean, where are you?) has jumped on it yet, so I guess it’s up to me.
The column tells us that shifting from an income to a consumption tax is something that “many economists in both parties applaud”. We learn that “Democratic economists, like their Republican counterparts, say taxing consumption encourages savings, investment and greater economic growth.” The only trick is to avoid making a national sales tax too regressive, so we’ll have to work on that.
Now tell me: exactly how is a consumption tax supposed to increase investment? Like, by what channel? Is there a dearth of savings that prevents business from being able to finance new projects? We have a savings glut. Will a flood of savings lower interest rates? Current rates on business borrowing are just about all risk premium at this point. And what’s the evidence that savings rates are so responsive to taxes anyway? Yes, I know that countries with VAT’s tend to save more, but there’s massive endogeneity there. Look at it this way: I live in Washington State, which finances itself with an 8% sales tax, while our next door neighbor, Oregon, has an income tax. Is there any evidence that savings are so much greater here than there?
So exactly what is the channel that’s supposed to lead from taxing consumption to greater business investment?
Incidentally, if you happen to be of a Keynesian persuasion, you believe savings are more a consequence of investment than a cause of it, and you would also expect that, at times of macroeconomic slack, consumption crowds in investment through rate of return effects. Just saying.
8 comments:
I agree. But is there a statement made by economists that isn't subject to the same criticism?
For example, my friend, one quarter owner of a software consulting company with revenues around half a billion dollars explained that they were so busy with other things, they didn't even know they were qualifying for R&D tax credits until the accountants explained what was happening when they filed.
Is there a branch of academic economics that considers such a fact to be worthy of study?
Peter,
You fail to understand the relationship between spending, saving and consumption in relation to economic growth. In a supply side world the more you save the less you have to consume. No problem since growth is dependent on economic production regardless of demand. Or is it the less you consume, the more you can save with the result being that businesses will be investing more for the future demand which is predicated on pent up demand created by saving, for a rainy day?? Many economists agree that consumption is a function of savings rather than either supply or demand. While demand and consumption may seem to be similar to those with less insight into economic phenomenon. It is well understood by the economics profession that consumption trumps demand since the latter is only a manifestation of desire and without savings demand cannot materialize into consumption. Those in the know also understand that while consumption is being curtailed by a tax on such behavior, such a delay is only temporary and provides the business community with additional time to prepare for the pending spending spree brought on by the consumption tax investment policy favored by those economists closest to the business community and therefore knowing best how such cycles perform.
I hope that I have clarified supply side ideology, if not the theory behind the concept. One additional issue will, of course, be the failure of the consumption tax process to adequately create the savings envisioned by knowledgeable economists. This phenomenon, understood by most working class savers, results from the fact that their consumption is not generally discretionary. Most Americans spend all that they earn in order to pay for necessities. Savings requires cutting back on spending, as noted above, but such reductions in consumption are limited to purchases that can be delayed. Those are purchases that one generally regards as unnecessaries or luxuries. These are the consumables that supply side economists and politicians understand best and, thereby, the genius of the consumption tax. We can all do without luxuries so the best source of government revenue is the VAT because no one is going to purchase luxuries if there's a big tax on them.
One additional issue is, of course, that the individual states already tax such consumption and the long term effect of double dipping on the growth of the economy is not well understood. But such a lack of comprehension should not dissuade the supply side ideologist. The potential drop in consumption brought on by the VAT Savings Plan is likely to be well off set by the demand for luxury spending which is likely to occur following the replacement of the income tax with the consumption tax.
I hope that I have clarified the consumption vs. income tax debate for you. It is best understood as a means to an end, an end to the working class's ability to consume what they don't require. Thereby allowing the business class to save the reduced amount of their tax liabilities and be prepared to increase their consumption resulting in economic growth. Growth is good, even if only at one mode in our bi-modal economy.
The God of the market says -- you must not place another social goals above Me for I am the One who IS.
In contrast, you are merely the one that LM.
There is a channel - but it is a once off (it relies mainly on sticky prices in a sense - in this case the sticky price is the exchange rate). VAT taxes imports but not exports, income tax exports but not imports.
Brad DeLong recently reminded to Krugman,1998 (the Liquidity trap paper) with a call for inflation, to lower the real rate. The neo-Fisherite offers a hand: it takes the real rate given, but it knows how to raise inflation. Another help: Costpush-inflation can be brought by annual wage-rise and an annual increase in indirect taxes; the former is superior to the latter in stimulating economic activity in underspening, but to generate general product-price rise, both will do.
It may be that the broader aim was lost out of sight, when another opportunity came in sight: make taxation more regressive.
Jack wrote: "no one is going to purchase luxuries if there's a big tax on them." So, Jack, you mean that Larry Ellison won't buy any more $200 million yachts, because he might have to drop an extra $20 million to the tax man on top of the $200 million?" Poor Larry, poor boat builders, poor Jack. Boo hoo.
So much for Jacks observation that supply siders like him are so much smarter than working people.
Jack, if you wrote that as irony, sarcasm, or satire - it sailed right over my head. Like Larry's yacht.
P.S. "Poor Larry,... boo hoo." That was meant as sarcasm from me. In reality, I do not feel sorry for Larry nor his boat builders.
"Please prove you're not a robot reCaptcha
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Mr. Captcha, You should also ask us to prove that we are not trolls.
"There's an excess of savings". Yes. Because there's a dearth of investment options, according to Greenspan.
Drop the need for a rate of profit and the dire need for urgent investment (in renewable energy, water and energy conserving infrastructure, home gardens etc) becomes obvious.
Drop the need for an interest charge on money and the finance becomes available enable continued existence on this planet.
Jim,
I guess I didn't plant my tongue deep enough into my cheek for the sarcastic character of my comment to be obvious to all. Yes, Larry and his cohorts have more than enough income and unspent wealth to disregard a VAT on luxuries. There is already a sales tax in most states on such items and also on item of a less than luxurious character. That's the point. The wealthy can absorb a VAT far more easily than can the working class consumer. Their expendable income, virtually all that they earn, cannot withstand a continuously increasing spending tax. Larry's wealth can withstand any such tax far more readily than a more appropriate tax on his out sized income.
The troll is in the eyes of the beholder. I think this site does a good job of keeping the trolls under the bridge and out of sight.
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