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David Andolfatto and Tyler Cowen are confused:

In grandma’s liquidity trap, the real interest rate is too high because of the zero lower bound. Steve argues that in our current liquidity trap, the real interest rate is too low, reflecting the huge world appetite for relatively safe assets like U.S. treasuries.

If this latter view is correct, then "corrective" measures like expanding G or increasing the inflation target are not addressing the fundamental economic problem: low real interest rates as the byproduct of real economic/political/financial factors.

My reaction to this is two-fold:

1) Umm…what?
2) OK, here’s how it goes – there are two interest rates at work here, the "true" interest rate, ie, the rate at which people would be willing to invest; and the "prevailing" interest rate, what you’re actually getting in the market. The former reflects the sum of underlying preferences, the latter a mix of the expression of those preferences along with a helping dose of central bank regulation. A liquidity trap is when the former is less than zero. That’s it. What is the difference between the two liquidity traps they discuss? In the former scenario, the prevailing rate cannot be brought below zero to match the true rate, and therefore: liquidity trap. In the latter scenario…the true rate is lower than zero, and the prevailing rate is stuck at zero. Same scenario. In both scenarios, the key is low growth expectations and low inflation expectations means a flight to safe, liquid assets with a low real rate. When the prevailing rate is 5%, and the true rate declines to 3%, then the Fed cuts their rate to 3% and everything is fine. When the true rate goes below zero, though, then the central bank’s ability to guide the economy through the signal of the prevailing interest rate is handicapped and therefore you need something else (debt-financed public spending, QE, NGDPLT, whatever).

I really don’t get this. If I’m missing something, please tell me.

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So Radley Balko brought up on Twitter a "Challenge To Lefty Bloggers" that he published back in 2009. Some of his questions are perfectly reasonable: I think we should target NGDP in a way commesurate with 4% inflation, for example; I’m also in favor of marginal (not total or average) tax rates of ~90% under certain circumstances. Some of his questions are irrelevant (the "unfunded liability" of Social Security is a non-sequitur), confused (I think he scrambles marginal and average tax burdens), or just silly (our average tax rate is close to the median – what greater suffering dare you inflict!?).

But some of them are conceptually flawed in a way I think is interesting. Firstly, his "size-of-government" metric is hopelessly flawed. More interestingly, though, are the questions about income inequality and progressive taxation – what are the optimal levels of each? The trick here is that claiming to have a theoretic or empirical basis for an exact number is a fool’s errand. The real answer to this question is "less and more than we currently have, respectively." So let’s use a little more of the latter to alleviate some of the former, and see what happens! It doesn’t have to be radical – we could just nudge up top marginal tax rates, perhaps create a new millionare’s bracket, and use the money to expand the EITC (which I know doesn’t directly affect pre-tax income inequality on either end but just roll with me here). Will that devastate innovation? Will Atlas shrug? Meh – I doubt it. In fact, Galt’s Gulch was a rather lonely place even when top marginal tax rates in the United States were 90%+. So rather than demand anyone decare a single optimal point, let’s agree that "too few people claim too large a share of national income" and nudge it a bit and see what happens. That’s what democracy is for!

So Ashok and I sparred a bit on Twitter re: the meaning and effect of taxation and spending (and probably pestered the heck out of James Pethokoukis and Joe Weisenthal in the process). I’m not sure how to embed Twitter conversations (if anyone knows how, I’m all ears), but the long-and-short of it is that the actualities of taxes and spending are weirdly different from the optics.

The trick is to remember that every policy change is a change from some baseline. So, from whatever the baseline currently is, there is no fundamental or economic difference between:

1) Cutting taxes by X on some activity, and
2) Spending X subsidizing that activity

assuming that they are both funded identically (though identical tax hikes, spending cuts, or debt incursions).

Now, in practice, there will be differences. Scott Sumner’s thought experiment about the society that taxes 100% of GDP by taxing 100% of income then writing welfare checks equal to taxed income demonstrates that, since we would expect that society really would look different than the one that taxed nothing at all (if only because such a program would have some overhead). But those differences would be based in behavioral economics, not classical or neoclassical economics.

And the same in real-world examples. There would definitely be differences between these two alternative scenarios:

1) A 2% payroll tax cut (debt-funded).
2) A check mailed to every American for the exact same amount (debt-funded).

But those differences would be instutional, not economics (the check-cashing industry, for example, would obviously prefer the second policy to the first). But there’s no reaosn to think they would "crowd out" (or for that matter, "crowd in") different activities.

The real point is, as Matt Yglesias says, the tax share of GDP is a very poor to think about the “size of government.”

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Steve M. has a really great post totally eviscerating the right-wing trolling of the office and compensation of White House Calligrapher which ends, unfortunately, on a false note:

Oh, and that $277,050 salary expense? If you fired all the calligraphers and pocketed their salaries, that would give you approximately one one-millionth of the $28.7 billion in cuts this year to domestic discretionary programs from the sequester.

I don’t want to pick on Steve here because this is a common trope in the leftwards blogosphere, but I think it’s a really bad one, for a couple reasons. Firstly, eventually you can get a big cut from aggregating lots of little cuts. If you took all the little seemingly-goofy-sounding-but-actually-probably-valuable-and-useful things the government does and cut them all you probably would have a decent chunk of change when all is said and done.

But secondly I just think this is a weak talking point because waste is waste and value is value. Steve spends the whole poist making a great argument for the value and traditional nature of the program, then concludes by undercutting himself by saying "well even if we did cut it it wouldn’t save us much anyway." A program that brings a net benefit to society that oughtweighs the cost of funding it is a good program that we should keep! If deficits are a problem but all of our programs are valuable than we should raise taxes.

The reason right-wingers dig for these anecdota is that they perpetuate a story that goes "government spending is rife with waste so we should cut it deeply." If left-wingers respond to each individual instance of right-wing trolling with "and this would only cut 3.7 gazillionths of the deficit so it hardly matters" they will convince exactly nobody. Convince people that good government is worth spending money on. Is calligraphy absolutely vital to good governance? Probably not. Is it befitting the office of the President of the United States that formal invitations sent to the Prime Minister of India aren’t laser-printed on white letter paper from awful and goofy MS Word templates? Absolutely.

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