Tom Church

Yesterday’s Wall Street Journal op-ed by Peter Diamond and Emmanuel Saez received quite a reaction. Diamond and Saez advocate raising the top marginal tax rates on the rich to between 50-70%. Their recommendation is based on a 2011 paper they published in the Journal of Economic Perspectives (PDF) where they advocated 1) Raising marginal tax rates on the very rich, 2) Subsidizing earnings (phasing out at a high rate) for low earners, and 3) Taxing capital. Their paper was widely discussed when it was published, and it is serving as a justification for many on the left to raise taxes on high-income earners. It’s their first recommendation that I would like to address.

There are several key limitations with the authors’ methodology used to conclude that raising marginal tax rates is optimal social policy. Two I’ll mention here are the dynamic effects of raising marginal tax rates in the medium and long term, and the volatility that comes with higher rates on a small portion of the population.

First, and this is the most important issue with the paper, Profs. Diamond and Saez are unable to produce estimates of the effect higher marginal tax rates have on economic growth or tax revenues in the medium or long term. (I’d note that Scott Sumner highlighted the following excerpt months ago. Still, it should be front and center of the criticism of their recommendation.) From their paper:

It is conceivable that a more progressive tax system could reduce incentives to accumulate human capital in the first place. The logic of the equity-efficiency trade-off would still carry through, but the elasticity e should reflect not only short-run labor supply responses but also long-run responses through education and career choices. While there is a sizable multiperiod optimal tax literature using life-cycle models and generating insights, we unfortunately have little compelling empirical evidence to assess whether taxes affect earnings through those long-run channels.

Translated: We don’t know what will happen in a few years as a result of this change.

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Paul Gregory

A Caveat for Krugman

Critics of my blog post How Krugman Would Ru(i)n Steve Jobs’ Apple point out that Paul Krugman has a Nobel prize in economics and I do not. I should shut up in the face of a superior authority. If Krugman were writing about his specialty, international trade theory, I might indeed shut up. When Krugman puts on his political hat, he is fair game.

In his Jobs, Jobs, and Cars, Krugman uses bad economics that would shame an introductory economics lecturer. He criticizes Apple because its labor force is too productive. (His figures show that Apple has about the same sales revenue as GM but has one fifth the work force).  By being so productive, Apple creates too few jobs! Let economists chew that one over. Krugman would be in agreement with Marx’s discredited technological unemployment.  I guess the solution is for Apple employees to become as unproductive as GM workers.

In the same article, Krugman criticizes Apple for outsourcing routine manufacturing operations to Asia. Isn’t this what trade economists call the international division of labor? How can a trade theorist be against this practice? I guess he thinks Apple should keep routine manufacturing jobs at home even if it means higher consumer prices, loss of market share and profits.

Krugman seems to hold the strange opinion that the business of business is to create as many jobs as possible. Last time I looked at a principles of economics text, I learned that business are there to produce products that people want as cost-effectively as possible, in the course of which the business earns profits for its owners. I guess we need to recall all economics texts.

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Charles Blahous

Today Avik Roy of Forbes kindly provided me with a forum for responding to some of the questions that have arisen about my study showing that the 2010 health care reform law will add substantially to federal deficits.

The full paper, again, is here.

The Forbes blog is here.

Excerpts from the Forbes blog post:

The paper was subject to a double-blind peer review process, which means I did not know who was reviewing the paper, and the reviewers did not know who had written it.  Prior to this review process, I also independently had the paper reviewed by several fellow federal budget and health care financing experts to confirm that the analysis was correct.  Few of the criticisms of the paper have been substantive. I do not believe the few substantive criticisms hold water for the following reasons:

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Gary Becker

Posner is clearly correct that the analytical differences between “super Pacs” and direct campaign contributions to candidates are not large enough to justify disparate treatments. Yet, because they should be treated the same way does not necessarily imply that spending by super Pacs should also be sharply controlled. I believe that it is very likely  preferable to apply the reasoning in Citizens United v. Federal Election Commission to direct contributions than to extend the limits on direct contribution to super Pacs.

I agree with Posner that candidates with political positions attractive to rich individuals may obtain considerable funds that give these candidates political advantages in appealing to voters. Such political contributions may well also affect the policies supported by candidates and elected officials. This is the corruption issue raised by Posner and by much of the literature that supports sharply limiting campaign contributions.

Sharp restrictions on campaign contributions would make more sense if monetary contributions were the only major force that shapes who wins elections and the policies goverment officials support.Yet that is very far from the situation that prevails in American politics, and in the politics of most other democratic nations. One reason for this is that interest groups can often avoid the intent of restrictions on campaign contributions through other ways to influence political outcomes. For example, many industries hire lobbyists and spend other monies to try to persuade legislators, regulators, and others in important political positions to subsidize their industries, or to reduce the taxes on their industries, or to gain other advantages.

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Paul Gregory

A “counterfactual” is an analysis of “what would have happened if.” President Obama’s claim that “the stimulus added as many as 3.3 million jobs” is the most famous example of this genre.

Counterfactual analysis of the effects of the 2010 election on federal spending can be executed, unlike the jobs-saved analysis, on a more solid foundation with nothing more than a pocket calculator. The procedure is simple: First, we find what the Obama administration intended to spend in 2011 and 2012 on the eve of the November 2010 election (and not knowing that an electoral disaster lay in store). Second, we compare these figures with what was actually spent in 2011 and what is likely to be spent in 2012.  For example, if the administration planned to spend $3 trillion in 2011 but actually spent $2.5 trillion after the Republicans gained the House, the “counterfactual saving” for 2011 is $.5 trillion.

According to my arithmetic, the unanticipated Republican November 2010 sweep of the House with victories of fiscally-conservative freshmen saved or will save taxpayers at least $300 billion dollars for the two-year period 2011 and 2012 alone – a figure that may understate the saving by another two hundred billion.

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Kori Schake

Back to the (Uncertain) Future

President Obama has not taken our country’s precarious debt situation seriously. When forced by Congress to revise his budget earlier this year, Defense was the only department targeted for cuts. Last summer’s Budget Control Act legislated further reductions for this year’s budget and portends even more significant cuts in the out years of the coming decade. Obama and Defense Secretary Leon Panetta recently unveiled a sensible set of choices for the coming year, but unfortunately failed to account for hundreds of billions of dollars that still must be found under the terms of last summer’s legislation. Unless they provide a better blueprint for spending, across-the-board cuts will come into effect in January 2013. And, as Panetta himself has said, not just the budget choices but the entire Pentagon strategy would collapse with any further cuts.

In addition to producing a budget willfully ignorant of further cuts, the White House has avoided any serious discussion of the hazards of cutting spending this deeply. The president is trying to have it both ways, cutting defense while pretending there is no risk associated with the cuts. At his Pentagon press conference in January, Obama said that “yes, our military will be leaner, but the world must know—the United States is going to maintain our military superiority.” But neither he nor Panetta has produced a plan that gives credence to the claim.

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Robert Barro

Scrap the Euro Now

Until recently, the euro seemed destined to encompass all of Europe. No longer. None of the remaining outsider European countries seems likely to embrace the common currency. Seven Eastern European countries that recently joined the European Union (Bulgaria, the Czech Republic, Hungary, Latvia, Lithuania, Poland, and Romania) have announced their intention to revisit their obligations to adopt the euro.

Two non-euro members of the European Union, the United Kingdom and Denmark, have explicit opt-out provisions from the common currency, and popular opinion has recently turned strongly against euro membership. In Sweden, which lacks a formal opt-out provision (but has cleverly refused to fulfill one of the requirements for membership), a November poll on whether to join the euro was overwhelmingly negative: 80 percent no, 11 percent yes.

In light of the political response to the ongoing fiscal and currency crisis—which is leaning strongly toward a centralized political entity that will probably be even more unpopular than the common currency—I suggest that it would be better to reverse course and eliminate the euro.

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Victor Davis Hanson

Dependent No More

There is a revolution going on in America, but it is not driven by the tea party or the Occupy Wall Street protests.

Instead, massive new reserves of gas, oil, and coal are being discovered almost everywhere in the United States, thanks to revolutionary methods of exploration and exploitation such as hydraulic fracturing (fracking) and horizontal drilling. Recent prices above $100 a barrel make even difficult efforts at recovery enormously profitable.

There were always known to be additional, untapped reserves of oil and gas in the petroleum-rich Gulf of Mexico, off America’s shores, and in the American West and Alaska. But even the top energy experts never imagined just how vast was the energy there—or beneath far more unlikely places such as South Dakota, Pennsylvania, Ohio, and New York. Some studies suggest that the United States has now expanded its known potential gas and oil reserves tenfold.

The strategic and economic repercussions of these new finds are staggering, and remind us how a once energy-independent and thereby confident American economy soared to world dominance in the early twentieth century.

America will soon again be able to supply all of its own domestic natural gas needs—and do so perhaps for the next ninety years, at present rates of consumption. We have recently become a net exporter of refined gas and diesel fuel, and already have cut imported oil from OPEC countries by one million barrels per day.

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John Taylor

Getting Back on Track

A lot of people are wondering what we can do to restore America’s prosperity and create more jobs. Both the president and his Republican rivals have offered their ideas in this election year. I believe the fundamental answer is simple: government policies must adhere more closely to the principles of economic freedom upon which the country was founded.

At their most basic level, these principles are that families, individuals, and entrepreneurs must be free to decide what to produce, what to consume, what to buy and sell, and how to help others. Their decisions are to be made within a predictable government policy framework based on the rule of law, with strong incentives derived from the market system, and with a clearly limited role for government.

The history of American economic policy displays major movements between more and less economic freedom, more and less emphasis on rules-based policy in fiscal and monetary affairs, more and less expansive roles for government, and more and less reliance on markets and incentives. Each of these swings has had enormous consequences. Taken together, they make for a historical proving ground to determine which policy direction is better for restoring prosperity.

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