Blogroll Me! How This Old Brit Sees It ...: Flat Earth Economics: 'corporate income tax' edition

08 February 2009

Flat Earth Economics: 'corporate income tax' edition

Economic thought from the folks who pushed the economy off a cliff

Writing in Reason, a Libertarian monthly, Jeffrey Miron proposes that we eliminate the corporate income tax as a way of saving the economy:

One policy change can stimulate both the economy in the short-run and enhance efficiency in the long-run: repeal of the corporate income tax, which collects up to 35% of the difference between revenues and costs of incorporated businesses.

Repeal means higher stock prices and improved cash flow. Corporations would respond to this change by investing in plant and equipment, and by hiring additional workers. These investments would be more productive than the ones funded by stimulus projects, since corporations respond to market forces, not to political influence. Since corporations could more easily invest out of retained earnings, repeal would also circumvent many banks' reluctance to lend.

The budgetary impact of a corporate income tax repeal—roughly $300-350 billion per year—might seem daunting, but this amount falls well short of the Obama fiscal package. The long-run impact will be less than what is implied by current revenues, since repeal will expand economic activity and therefore increase other kinds of tax revenue.

The stimulus impact of a corporate income tax repeal is likely to be substantial. Recent estimates by Christina Romer, the head of Obama's Council of Economic Advisers, suggest that tax cuts have a multiplier of three, meaning that repeal would increase GDP by roughly $1 trillion. By comparison, the administration's assumption that the government spending multiplier is about 1.5 suggests that the $500 billion in the Obama stimulus package would increase GDP by about $750 billion.
There you have it: repealing the corporate income tax would cost less than Obama's package, and even Obama's top economic adviser thinks it would create more jobs. What's not to like?

Well, one thing I don't like is Jeffrey Miron's dishonesty. Here's respected economist
Brad DeLong on Christina Romer's alleged views on the multiplier effect of tax cuts and spending:

There appears to be an error in N. Gregory Mankiw's "Economic View" column of January 11, 2009. The error is the association of Christina Romer with the proposition that the tax multiplier--the effect on GDP of a tax cut--is twice the spending multiplier. The Romers' article does not distinguish between the two, referring only to the "substantial multiplier... due to the procyclical behavior of investment" (p. 37 of the working paper version, at David Romer in conversation two years ago characterized the paper to me as "hyper-Keynesian... suggesting very large multipliers..." The Romers believe in a tax multiplier no larger than the spending multiplier, and they certainly do not believe that a balanced-budget equivalent reduction in taxes and spending provide any Keynesian stimulus at all.

Mankiw's comparison of the 1.4 estimated spending multiplier from Valerie Ramey's study with the 3.0 estimated tax multiplier from the Romers' study is inappropriate. The two studies use very different methodologies. They are not comparable.
For example, the Ramey study on the effects of government spending--while a superb contribution to the literature, and one that I have assigned to my graduate students--does not fully control for the tax increases that often accompany spending increases. Thus it is very likely to understate the effects of spending increases alone: her study assesses the impact of the Korean-War military spending increase without taking account of the fact that it was accompanied by a large tax increase.

What Romer and Romer's study (and their earlier work on monetary policy) shows is not that tax cuts are uniquely effective, but rather that failing to consider the reasons for policy changes leads to underestimates of the effects of all types of stimulus. Because these issues of omitted variable bias are likely to be as strong for spending as for tax changes, the most reasonable interpretation of their paper is that all types of fiscal stimulus are more potent than conventional estimates would lead us to believe.

It is somewhat puzzling that Mankiw appears to believe that the Romers do think that tax multipliers are larger than spending multipliers, as they do not, and this is something that he could have very easily checked.

(emphasis added)
As DeLong says, this is all easily checked. So why is Miron pretending that Obama's own chief economic adviser has advanced arguments that she apparently ignored while crafting Obama's stimulus plan?

Also, why is Miron pretending that a massive reduction in the corporate income tax hasn't already been tried? During the Bush years, the effective corporate tax rate was reduced by adding loopholes and tax breaks. Did that increase overall tax revenues, as Miron asserts it would? According to the Center for Budget and Policy Priorities,
it did not:

A weak economy, new tax breaks, and aggressive tax sheltering have pushed corporate income tax receipts down to historically low levels, both relative to the size of the economy and as a share of total federal revenues. According to the most recent budget projections of the Congressional Budget Office, corporate revenues will remain at historically low levels even after the economy recovers, and even if the large new corporate tax breaks enacted in 2002 and 2003 are allowed to expire on schedule.
That study was written in 2003, and it came with a prediction that has, sadly, come true:

Deficits over the next decade are now projected to be enormous in size. A joint analysis by the Center on Budget and Policy Priorities, the Concord Coalition, and the Committee for Economic Development projects deficits totaling $5 trillion through 2013. An analysis by Brookings economists reaches a very similar conclusion, while Goldman Sachs projects deficits totaling $5.5 trillion. Despite the deteriorating fiscal outlook and the historically low corporate revenue collections we already face, Congress nonetheless seems poised to shower more tax breaks on corporations that would cause deficits to grow substantially larger over time.
Corporate tax rates were cut so far during the Bush years that now the effective corporate tax rate in the US is substantially lower than it is in most of the developed world. And in developed countries where the corporate tax rate is lower, taxes on individuals is substantially higher.

As it turns out, Jeffrey Miron's analysis of the multiplier effects is wrong, and his assertions regarding the stimulative effect of reducing the corporate income tax is wrong. The policy he advocates is a policy that Bush tried during his own presidency, with disastrous results. So I wasn't very surprised to learn that Miron teaches at Harvard Business School. That's the same Harvard Business School that taught George W. Bush everything he knows about economics.


In their zeal to oppose anything that Obama proposes, the wingnuts are employing flat earth politics as well as flat earth economics. Here's Rich Lowry of the National Review, saying that Obama's economic policies
deserve no special consideration, just because he won the election:

Obama has to make a case for the bill on the merits, a surpassingly difficult forensic task. In a Washington Post op-ed, Obama called for "swift, bold and wise" action, but it's possible to have at most two of those things at once. The current legislation is swift and bold (indeed, shameless) but not remotely wise.
First of all, it is possible to be swift, bold, and wise at the same time. Second, the fact that Obama won the election means that the burden is on his detractors to show that his policies are wrongheaded.

Unlike Lowry thinks, Obama hasn't asked that his policies be implemented just because he won. He and his team have offered solid arguments in favor of a stimulus, for the idea that the stimulus has to be substantial in relation to the overall economy, and for the idea that the stimulus has to be implemented immediately to avoid sliding further into recession. And their position isn't particularly controversial among economists, either.

Americans had the opportunity to vote for flat earth economics and the idea that we could avoid recession by implementing a series of tax cuts on the rich. We decided instead to vote for Obama. It's time for wingnuts like Rich Lowry to get over their hurt feelings and either show evidence that Obama's plan wouldn't work, or start doing what they can to ensure that it does work.

(cross posted at appletree)



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