Steven Landsburg. Is He Crazy?

I don’t think he is. I enjoyed his book, “The Big Questions”, and I even made a set of desktop images for him, which (if you’d like) I can send you the full sized images and you can use them for free if you enjoy them (p.s. I also do design work)!

In any case, his recent post has gotten play from Alex Tabarrok, Brad DeLong, and tonight, Noah Smith.

The only thing I find wrong is the fact that you can’t do economics from accounting identities. If you could, then Steven’s basic model would be correct, as a matter of arithmetic, and a matter of reality. To my mind, that is where you stop.

Start with GDP: Y = C + G + I + Nx. I think we can probably disregard Nx to make the model easier. In this case, consumption is constant, as the assumption is that our idle millionaire consumes zero at $84 million, and you can’t consume less than zero (even when dead!). In this case, we’ll hold C constant at $100. Now say G is currently 0, but the government sees a nice pile of money, maybe $84 million, sitting around in a bank account. Well, that money isn’t just sitting there, S (savings) is related to I in our GDP model! So assuming a quick 1:1 relationship between S and I, what the government is doing, in order consume $84 is reducing investment by $84. Assuming there is some sort of relationship between I and C, than in future periods, C will have to be reduced by a cumulative total of $84.

Of course, none of that is literally true. As I (and Noah) said before, doing economics from accounting identities leads to patently absurd conclusions. There are no concrete relationships between savings and investment. They are both dependent variables. Neither is there a concrete relationship between I and C. Both depend on other economic variables, as well. But, zero-sum accounting would get you this result.

But I think there is a deeper fallacy that Landsburg’s experiment falls into, and that is the myth of government as consumer. It is very common to hear in right-wing (usually non-economist) circles that the private sector produces wealth, and that the government produces nothing, it only consumes wealth that is generated in the private sector. The fact is that the state produces the exact same amount of wealth as the market. That is none at all.

The fact is people produce wealth, and people consume wealth. The state and the market are simply institutions which people have arranged to coordinate production and consumption. The socialist calculation debate was not regarding how the state stole wealth from the market, it was regarding the limitations of the state as an institution for coordinating economic activity. Corporations in-and-of themselves do not produce any wealth, either. The organization of a corporation is wealth enhancing, but that is only to the point that it is more efficient than other such arrangements that bring people together to produce and consume.

Per James Buchanan’s excellent analysis [JSTOR] of the political economy, the (tax and spend*) state is largely concerned with providing club goods, that is: goods that are largely non-rival, and at least partially non-excludable. So to assume away transaction costs, deadweight loss, and the like…in this simple model, a society is choosing to purchase some goods as the “club of everyone”, instead of as individuals. Consumption increases when the government steals “idle millionaire’s” money, and doesn’t decrease at all (assuming no effect on I, or rather, that he government’s investment produced a form of capital to substitute for direct savings) because the types of goods provided by the “club of everyone” wouldn’t necessarily be purchased by the individual, but individuals are (presumably) wealthier for having them.

Brad DeLong is actually correct (and this fallacy is what he is pointing out in his post, although he doesn’t explicitly state it). “We” are the state. Arnold Kling is also correct, “lose the we”…the catch is that he just wants a different arrangement of the provision of club goods. Kling is re-stating Milton Friedman’s sentiment when he said (paraphrasing), “I’ve never seen a tax cut I didn’t like”. Friedman was stating a preference for institutional arrangements, not a statement about consumption.

Note: This isn’t an argument that allows the government to run roughshod over “idle millions” sitting around. Our capital stock does determine investment in the long run. Savings do have a role in the economy. In a hypothetical situation, if the government can get a higher ROI from stealing a millionaire’s money from under his mattress, then society is richer. But if not; if the government simply determines that government mattresses are where money goes, society is no worse off, and if the government consumes goods or invests the money in a ridiculous fashion, then society is worse off.

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*I specifically point to the tax and spend state because the “tax to finance regulations” state is a completely different animal. And so you can see how you can get mislead by simple accounting identities!

Canada: A Real-World Liberaltarian Model?

Here is a chart of Federal revenue as a share of GDP in Canada, posted by Livio De Matteo, one of the newer bloggers at Worthwhile Canadian Initiative:

Many a contemporary American libertarian dreams of the day when US Federal spending is confined to ~15% of GDP. However, in the real world this happens in a country that has a fairly robust single-payer basic health care system*, early-childhood-on education initiatives (a previous Conservative government even passed a fairly robust school choice plan that was subsequently killed by a Liberal government after 2 years), and a generally higher level of simple transfers. Some transfers don’t make a whole lot of sense, and kind of get caught in backflips, but nevertheless, there it is. Canada seems to take in ~15% of GDP in taxes, although there is a fit about the budget deficit, which is measured in the happy-go-lucky millions.

I think this lends some credence to the notion that I know Matt Yglesias and Kevin Drum are partial to. That is, ‘largely release people from sources of grave uncertainty (like spells of unemployment, extreme health care and education bills, etc., which can be done at a relatively cheap cost), and sensible market reforms become much more popular’. I can see Canada leading the way in replacing their income tax with a revenue-neutral carbon tax.

But there is a chicken-and-egg story here, as noted by Joseph Heath**:

…it is important to observe that this lack of a correlation [between redistribution and long-term growth of GDP per-capita per Peter Linder’s work] does not show that economic theory is false, that incentives don’t matter, and that government cna do whatever it wants. The lesson to be learned is exactly the opposite. One of the major reasons that big-spending governments tend not to be penalized by the market is that, due to their very bigness, they need to operate more efficiently, and they need to work harder to get incentives right.

The US government, by contrast, has a tax code that is seemingly designed, from the ground up, to keep tax accountants and attorneys employed. Our institutional structure is to blame for most of this, but our relatively low individual tax rates (compared to other rich democracies) enable it.

This is an important story since we’re wading into a battle between spending cuts and raising revenue. As I think about the issue more, I notice that few of my complains come from the entitlement state at all, and the ones that do are about the structure of programs, not the programs themselves. In contrast, I have major complaints about the revenue side of government, and still more major complains about the regulatory side of government (at the local, state, and Federal levels). I think a lot of self-styled libertarians or people who lean that way feel the same way. I don’t think that utilitarian redistribution is a bad trade for some of my other goals (which would likely uncomfortably expose certain segments of the population to the cold whims of the marketplace). How about you?

Note: Provincial spending in Canada pushes government/gdp up to ~32% vs ~28% in the US.

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*With the option of pursuing private insurance above and beyond. Not my preferred plan, but it seems work on average.
**Filthy Lucre, pp57-61

Tax Like the South? Why Not?

I swear it isn’t “pick on Ezra Klein day” here at Modeled Behavior, but he has been covering fairly thoroughly the proposal in the Senate (?), signed by every GOP member, for a balanced budget amendment to the Constitution. Unfortunately, it is not just a balanced budget amendment — and end in and of itself, and one that I would consider if done properly — but an amendment to a) limit Federal spending to 18% of GDP and b) make raising future revenue extremely difficult.

I think “stupid” is the wrong word. “Dangerous” is more like it. And maybe “radical.” This isn’t just a Balanced Budget Amendment. It also includes a provision saying that tax increases would require a two-thirds majority in both houses of Congress — so, it includes a provision making it harder to balance the budget — and another saying that total spending couldn’t exceed 18 percent of GDP. No allowances are made for recessions, though allowances are made for wars. Not a single year of the Bush administration would qualify as constitutional under this amendment. Nor would a single year of the Reagan administration. The Clinton administration would’ve had exactly two years in which it wasn’t in violation.

I agree with most of what Ezra (and Bruce Bartlett) say about the proposal. I’m not a fan of large government, but I’m also not a fan of creating problems. This proposal seems to be all about creating problems under the auspice of “starve the beast”. Or rather, creating a big enough problem, and engineering your preferred solution from the front end, which is cuts (ostensibly to Medicare and discretionary spending). This is a poor way to govern, whether you like or dislike the welfare/warfare state.

However! Ezra has a follow-up post in which he ties California, taxation in the south, and the likely effects of the GOP’s amendment together, noting that by blocking the ability to directly raise revenue, the government would be forced into regulatory and budgetary tricks to fund itself. Tricks that would likely be more inefficient and economically damaging than simple direct taxation itself.

It’s fairly obvious why rules making it hard to pass new taxes would lead to more regressive taxation: If passing taxes is extremely difficult, then passing taxes plus overcoming the opposition of powerful interests becomes almost impossible. And so you focus on passing taxes that don’t arouse powerful interests. In practice, that means passing more regressive taxes, as the poor have less political power than the rich. It’s an amplified version of the reason it’s easier to cut spending on programs that benefit the poor, like Medicaid, than on programs that benefit the rich, like Social Security — which is, incidentally, exactly what Republicans appear to be proposing in their 2012 budget.

All of which is to say, the Republican Balanced Budget Amendment, which requires a two-thirds majority in both houses of Congress to raise taxes, would probably lead to much more regressive taxation. Our budget process would look like California’s and our tax code would look like the South’s. That’s winning the future!

Here is Ezra’s graph of the composition of revenue generation in four regions:

Low and behold, taxes in the south are much closer to my own vision for taxation! No, the taxes are not exactly the same, but I would welcome a shift toward consupmtion taxes and away from (capital/labor) income taxation. You can design a VAT or carbon tax to be as progressive as you would like. I also prefer a tax on the value of land, and not on the “improved value” of building (which, along with eliminating land use regulations would incentivize dense construction). The final piece of the puzzle is a progressive payroll tax. I think you could copy this model on both the state and Federal levels. It is almost the exact opposite of the “Northeastern” model of high income and property taxation. I think it’s a better model.

If we shifted our taxation toward consumption it would, in fact, be wining the future.

The New Rich

Robin Hanson critiques Chrystia Freeland’s take on our billionaire overlords.

It doesn’t seem to matter to Freeland how deservingly the rich obtain or spend their wealth; they still must be taxed to help average Americans, even if that slows the lifting of Chinese and Indians out of poverty. It isn’t clear why she recommends the rich eagerly submit to such taxation; she suggests taxation will happen whether they like it or not. Why fear “populism” beyond its taxation? The point seems more to scold the rich, in order to reassure the rest of us that we are justified in taxing them.

It may be the case that many calling for higher taxes on the rich are belittling or even demonizing their contributions as a way to justify higher taxes.

I am starting to believe that the belittling and demonization are at least as important to many of the new rich as the taxation itself.

That sets up the possibility for a trade. We praise the rich as we redistribute their money. I am not completely joking when I suggest there might be room to turn taxation from a welfare destroying necessity to a welfare enhancing activity for everyone involved.

Suppose we start a government website which shows the taxes paid by the wealthiest Americans but instead of listing them in terms of dollars we list them in terms of “kids treated under CHIP” or “soldiers sponsored” or some other meaningful measure of government spending.

Right now paying taxes is a sign of low status. You allowed the government to get your money. However, if we advertise broadly what the money pays for then we can push tax paying as a high status activity.

This is crucial because most of the spending among the wealthy whether it is for a giant yachts or malaria vaccines is ultimately a status competition. Its either who has the biggest toys or who has done the most to save the world.

This is not a dig at the rich. Human are programmed to focus almost exclusively on status competition whenever material survival becomes a non-issue. This is why both high schools and senior homes are full of cliques.

What we want is not destroy status competition, that would be impossible even if it was desirable. What we want is to channel it.

Some status competition is obviously destructive. Tax evasion as a status competition – see Leona Helmsley– is destructive. However, if tax paying is promoted as a status competition it becomes productive. It serves the same function for the people in the competition but it serves an improved function for society.

Now, a key question Robin would be sure to ask is, why should we think paying taxes is productive. What about giving money to the poor in India. Isn’t that better than paying taxes.

There is a longer moral case to be hashed out. However, my short answer is that maintaining a pro-market polity is productive and this is becomes less likely when the average person sees the market as primarily benefiting others.

Spot the Dumb Rules

First, I’m sorry about my extended absence from blogging, both to my co-bloggers and audience. My schedule has been very full, and I’ve been battling mysterious fatigue and abdominal pain which makes it hard to concentrate on anything. I’ve been seeing multiple doctors and am heading to a specialist here at the end of the month. They have ruled out Chron’s, celiac sprue, acute intermittent porphyria, and irritable bowel syndrome…along with the more common stomach problems. I know that is not a real excuse, and I should battle through it for the good of you readers. For that, I’m sorry.

In any case, the story that caught my eye today is that Obama has issued an order to government to trim rules that are not “cost-effective and cost justified, transparent, coordinated/simplified, flexible, science-driven, or necessary and up-to-date.”

And then there were flying pigs. The NYT identifies a few rules that are simply dumb:

There is a federal regulation that dictates that place names on new highway signs must be spelled with just one capital letter — like This, not THIS.

Federal rules say that beef from a state-regulated slaughterhouse cannot be sold in other states, but bison from the same slaughterhouse can.

And as President Obama told the nation on Tuesday, one federal agency until recently listed saccharin, a common coffee sweetener, as a form of toxic waste.

Of the stupid rules listed above, only the second has any real material consequence. The NYT Economix blog also has a discussion of further stupid rules.

And then there was pie in the sky. I don’t have much faith that this is of much consequence. As noted above, we may be able to get rid of some quirky rules that are left over because no one notices that they are there…but most dumb rules exist because they benefit somebody, somewhere. Perfect competition is a very cruel mistress. If there is a rule that is of material (economic) consequence, it is likely that it exists because some interest agitated that it be so. Thus, trimming the government of rules that aren’t cost-effective, or aren’t coordinated or flexible is a political battle.

However, I can think of something that is of extreme consequence, that is not cost effective or cost justified, flexible, coordinated/simple, science-driven. It’s also of dubious necessity and certainly not up-to-date. I wonder if it’s on the chopping block?

Very Interesting on Taxes

Canadian readers may catch themselves in a fit of exasperation to learn that I don’t spend a lot of time understanding the Canadian tax code. I know the basics, and I know that it generates revenue much more efficiently than the American tax code (although you do have an odd propensity to take money, give it back, and then take it again — a la the child care tax dividend). In any case, the following description strikes me as novel…but also ridiculous at the same time. From Frances Wooley, of Worthwhile Canadian Initiative:

Under the current system, Canada’s corporate income tax acts as a withholding tax. When a corporation makes a profit, it pays corporate income tax. But the government doesn’t keep that money forever and ever – it just withholds it for a time.

When a corporation pays out its profits to shareholders in the form of dividends, shareholders get a dividend tax credit – which credits the individual with the taxes the corporation paid on her behalf.

If it wasn’t for the fact of deadweight loss, this would be an incredibly ingenious tax scheme. Basically, a loan to the government, which they pay on a margin call. It does incentivize investment though, so provides Canada with a higher capital stock than otherwise. However, deadweight loss is a reality, and this reeks of the type of idiocy that the conservatives made out of the lunacy of the liberals’ child care tax dividend.*

Here’s another absurdity:

Professor Kent also proposes taxing capital gains equally with salary and interest income – so a $100 capital gain would be taxed at the same rate as $100 in interest income.

?

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*The gist of the story is that there existed, at the behest of liberals, a universal child care dividend (regardless of income). A check that you received every month, simply for having children — regardless of your income (or if you have children, as I understand it). The idea is that you would use it to pay for daycare, and then you could have a higher marginal income as a family. However, in the infinite wisdom that conservatives have shown in recent history, they decided that it was unfair that “rich people” got the dividend as well. Their grand plan was that they would tax, give the dividend out to everyone, and then tax the money back from households over a certain income threshold. As far as I know, that is the way it works today (don’t quote me!). I hope everyone understands how that represents the behavior of a drunk person.

Quick Note on the Tax Compromise

I’m a tad bit late on commenting on the tax compromised reached between the White House and Republicans, but I think that there has been some fairly high-quality commentary around the blogosphere. I stand mostly with the reasonable left in supporting what was put into the package, even though we got the wrong payroll tax cut, and a strange and potentially politically deadly compromise on the Estate tax (which I otherwise oppose, but wouldn’t let my positing get in the way of providing economic stimulus, like some on the left).

Mark Thoma worries that the payroll tax cut will become permanent (edit: found the link). This is the mirror of the argument that government spending tends to become permanent, as well…which I have an inkling that Mark doesn’t mind that feature so much.

I think Kevin Drum misses a grand opportunity to call out to the left to articulate a better way forward here:

In the end, this is the second stimulus we all wanted. It’s not a very efficient stimulus, and it sadly caves into the conservative snake oil that the sum total of fiscal policy is tax cuts, but them’s the breaks. Anyone who doesn’t like it needs to spend the next two years persuading the public not just to tell pollsters they don’t like tax cuts for the rich, but to actually vote out of office anyone who supports tax cuts for the rich. That’s the only way we’ll win the replay of this battle in 2012.

I’m not looking to go tit-for-tat on whether direct government spending/investment is “more efficient” than providing payroll tax cuts, as it’s pretty clear which side we are both on (as I’m much less sanguine on the Keynesian consumption function, for a reasonable view from the other side, see here), however I do want to address his prescription of a public awareness campaign in order to return to “normal”, with normal being defined as roughly “Clinton-era tax rates” on capital and high incomes.

I view this very compromise as a golden opportunity for the left to reinvent themselves with regard to taxation, win an adjacent political battle (and a dear progressive goal), and wrap it all up in a bow that not only makes our government funding more efficient, but lowers tax rates for virtually everyone. And that is to begin a campaign of gradually removing the income tax, in exchange for a revenue-neutral tax on carbon, which would be gradually instituted as the income tax was phased out. In addition, offer an automatic stabilization policy of payroll tax cuts (all of them, or at least all of the “employers share” — the better side to cut — in exchange for a sharply more progressive payroll tax, used to fund Social Security and Medicare/caid. Institute a progressive VAT or GST with a standard deduction of the first $25,000 of income for all taxpayers, and expand a means tested EITC, as well. You could trade this for elimination of minimum wages, but that’s not a real pressing problem in my mind. At the end of the line, offer a land tax in exchange for really whatever the right happens to want for it. Repeal of the estate tax, maybe?

That would be a real “progressive” package that would end the debate regarding the level of income taxation (from any source; labour, capital, etc). It would simplify our tax code, and get rid of ridiculous inefficiencies like the mortgage income tax deduction. More importantly, contrary to our current tax code, the new consumption-based funding of government would encourage a greater savings and investment equilibrium.

Beyond the scope of this post — but relevant — is different ways that you can find to streamline efficiency of the government. I seem to remember an argument put forth by Matt Yglesias that I personally agree with (and can’t find the link to currently), and find it baffling that it is so often overlooked; and that is that there are some government workers whose marginal utility is so low, that paying them anything at all constitutes overpayment. So it’s not a question of overpayment, it’s a question of marginal utility. At the margin, is society gaining utility by paying various individuals? If yes, then pay them. If not, then don’t.

That aside, I do think that this is a unique opportunity for Democrats to articulate a new vision for government funding that better enables elements of the welfare state that they hold so dear, this is highly progressive, removes the distortions and bad incentives created by the income tax, and genuinely makes the economy more efficient — facilitating growth. It could be a popular platform, and one that I would vote Democrat for, and I’ll be that many other pragmatic libertarians would feel the same way.

Of course, at the end of the day, I still believe that monetary policy is the last mover. The Fed has quietly indicated that it is looking at extending QE2, which is definitely good for the prospects of any pet fiscal policy.