The Argument for the Deficit

Here’s a pop quiz. If we raised taxes it would:

  1. Increase private sector economic activity.
  2. Decrease private sector economic activity.
  3. Have little or no effect on private sector economic activity.
  4. It depends.

Although I actually think the correct answer is D, all other things being equal I think that increasing taxes will decrease private sector activity and I honestly can’t see how anyone could believe otherwise. Note that we’re not talking about increasing public sector spending here. We’re just talking about increasing taxes without increasing public sector spending.

Now let’s turn to Robert Samuelson’s latest column:

We Americans are having the wrong debate. Almost all the arguing over the Trump administration’s proposed tax cut centers on two issues: Will the tax reduction stimulate faster economic growth? And is the proposal too generous toward the wealthy and too stingy toward the middle class and poor?

Interesting questions, to be sure — but mostly irrelevant to the nation’s long-term well-being.

The truth is that we can’t afford any tax reduction. We need higher, not lower, taxes. What we should be debating is the nature of new taxes (my choice: a carbon tax), how quickly (or slowly) they should be introduced and how much prudent spending cuts could shrink the magnitude of tax increases.

Mr. Samuelson never explains why he wants lower private sector growth but apparently he does.

IMO at our present rate of economic growth we can run a deficit of 2% of GDP indefinitely without inflicting harm on our economy. We’d be running at a deficit but the deficit would actually be decreasing as a percentage of GDP. U. S. GDP is around $18.5 trillion. 2% of that would be around $370 billion. The present deficit is around $440 billion or, in other words, we should trim spending by about $70 billion. It would seem to me that we could accomplish that just by doing things we should (or shouldn’t) be doing anyway. We shouldn’t be fighting wars of aggression. There are also changes we should make in Social Security and health care spending. $70 billion of cuts sound pretty reasonable to me.

21 comments… add one
  • Gustopher

    Corporations are sitting on boatloads of cash right now — raising corporate taxes could make corporations take less profits and reinvest that money into the corporation, creating more jobs. We may want to futz with some of the deductions and other taxes: lowering the payroll taxes at the same time, for instance, would help labor intensive businesses. Use the tax system to incentivize job growth.

    A similar plan could work for the upper tax brackets for personal income taxes, but it would require some very creative new deductions, like a negative sales tax.

  • Corporations are sitting on boatloads of cash right now — raising corporate taxes could make corporations take less profits and reinvest that money into the corporation, creating more jobs.

    You’ve got it backwards. Raising corporate taxes (presently the highest among OECD countries) would cause more large companies to relocate overseas and reduce domestic investment.

    They’ve got lots of cash; most is held overseas because of our high corporate taxes.

  • Guarneri

    “…raising corporate taxes could make corporations take less profits and reinvest that money into the corporation, creating more jobs.”

    I see. So increasing expense A, called taxes, will encourage corporations to increase expenses B, C and D to minimize profit, and they will reinvest, creating jobs. And we don’t even consider capital investment, generally not expensed, but a use of cash.

    Well, its a theory. So is blood letting in medicine.

  • steve

    If you just look at the history of tax rates, it is clearly D. There are many reasons why a tax raise might improve the economy, and many reasons why it might hurt. Depends upon too many factors to predict, and the baseline level of function in the economy in which they are raised.

    Steve

  • Is there an example of a tax increase in the United States that resulted in increased economic activity? I can think of cases in which a tax cut did not result in increased economic activity but none in which an increase did.

  • Jimbino

    I favor a breeding tax. Not only are humans directly responsible for the increase in carbon pollution, bu they are also the ones responsible for devastation of habitat and species and for wars over lebensraum.

    Not only does the gummint have no plan to tax breeding, but it seems to be encouraging it through tax deductions and credits, not to mention spending on public healthcare and education for breeders’ problem progeny.

    The irony is that it is the breeders’ progeny who will mostly gain from higher taxes on the lifestyles of the living.

  • walt moffett

    Increased taxes normally lead to increased black market/off the books activity, whether its truck load lots of cigarettes or got left on the dock washers and dryers. However, difficult to make happy numbers from that.

  • jan

    #B is the rational answer. When you raise taxes, people look around for low tax opportunities. If that means going to another state, country, barter, deal in black market commerce, or simply reduce one’s productivity, that’s what they do. I don’t get people who wistfully look at martyrs who work hard, are taxed to the hilt and somehow think that’s a fair and wonderful way to encourage more reinvestment of their time, energy and money.

    As for the never-ending tax bill discussions, they appear to be going nowhere fast. I think the more people parse objectives, get too detailed, trying to please everyone, the more out-of-hand said bills become. One thing for sure, Republicans can be counted on to be inept and directionless. As for the dems they are ruthless, cut-throat in their demagoguery, and completely clueless on how to grow the economy, only how to grow more government!

  • steve
  • CuriousOnlooker

    Isn’t the deficit 667B for FY2017? That’s about 3.5% of GDP. The norminal GDP growth that matters for deficits is 3.9%.

    The US is actually running a lot closer to the limit on deficits once we factor in which part of the economic cycle we are at and that debt to GDP is very high at 100%.

    On the other hand raising taxes / cutting spending is likely to trigger a recession that blows up the deficit problem. It’s a very Japanese sounding dilemma.

  • Gray Shambler

    I know there’s a plan out there, I think it’s called the “fair tax”, I like the sound of. A national sales tax in the neighborhood of 14% they say would allow us to eliminate the payroll income tax, FICA tax, the IRS along with corporate taxes, estate taxes, and all the tax accountants and lobbyists employed to evade or navigate the present system.
    It would even collect taxes from illegal drug sales when the dealers bought their gold teeth, 21 inch rims, glocks, ammo, bling, on and on.
    14% is a lot, but you’d receive you’re whole earnings on payday. And that 14% is “progressive”in that lower wage earners actually spend less.
    Now. Shoot that down.

  • Guarneri

    The state of IL is the poster child for increased costs of doing business, whether taxes, regulation or graft. The surrounding states thank them.

    The same can be said for the relatively prospering SE and SW.

  • Guarneri

    Dave and Andy

    See Korea options responses if you wish. At this point I think the issue has become sit back and see.

  • Guarneri

    The biggest issue with a plan that envisions a steady debt to GDP ratio is the giant bulge in SS and health care spending that is looming. And that’s before the public sector pension bailouts.

    Maybe we should bring B Clinton back to raise taxes to finance it all………

  • I like the Fair Tax, too, but the rate usually quoted is 23% not 14%.

  • steve

    “. And that 14% is “progressive”in that lower wage earners actually spend less.”

    Just to clarify terms, such a tax would be very REGRESSIVE. Low wage earners need to spend most of their income, so with this plan essentially all of their income would be taxed. High wage earners spend a lower percentage of their income and save more or invest or whatever.

    Steve

  • steve:

    From the post you cite:

    A tax cut may increase economic growth by inducing individuals to work more, save more, and invest more, what economists call a “substitution effect.” However, a tax cut also increases an individual’s income which means that individuals can maintain their lifestyle by working less, saving less, and investing less, known as an “income effect.” Gale and Samwick (2016) conclude that tax cuts designed to target new economic activity, reduce distortions to the allocation of capital, and are not deficit financed are more likely to lead to economic growth.

    which I largely agree with. It explains neatly why I’m skeptical that the cut in the personal income tax being discussed is likely to increase economic activity. BTW, Andrew Samwick, cited above, once characterized a blog post of mine as the best blog post he’d ever read on any subject.

    As to the growth in the 90s, one of the interesting aspects of it is that those who believe that the tax increases caused the growth have yet to come up with credible explanations of the mechanism by which that happened. IMO a far better explanation is the very high rate of real business investment over a protracted period that took place during the 1980s, mostly PCs and networking equipment. Without that there would have been no Internet revolution. Today’s managers just don’t engage in that kind of investment. Or, in other words, tax rates are largely a side show.

  • CStanley

    The Fair Tax proposal gets around regressivity by using a prebate, explained here.

  • Yeah, I’ve explained that here many times.

  • PD Shaw

    I wasn’t familiar with Samwick’s name and found he had a blog post on this issue that was pretty clear about how tax reform that should encourage growth in theory runs into some obstacles:

    http://samwick.blogspot.com/2017/11/stumbling-blocks-between-tax-cuts-and.html

  • steve

    Dave- I think taxes are a fairly small factor in growth. When you look at tax rates, there isn’t that much linkage to growth or no growth and increasing or decreasing. Other factors are more important. However, just as targeted cuts, as noted above might actually work, rather than just the broad tax cuts for the rich we usually get, tax increases for specific things should work. If an area had very low tax rates, but no effective police, judiciary, transportation, adding new taxes to create this things likely leads to new growth. In our current scenario, this may not apply, but the generally small changes we have seen over the last few years are secondary to other effects.

    Steve

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