Taxes for Trillions

Remember in Top Gun, when the bald carrier Captain is grilling Maverick and Goose? He says, "Son, your ego is writing checks your body can't cash." That about sums up my sense of a talk I'd like to have with Uncle Sam right about now.

The overriding concern with deficits that run in the trillions of dollars is not whether expenditures can be fruitfully spent. The concern is: Who will pay? At best, Keynesian expenditures are a possible path to recovery, but even proponents would not claim for them to be real growth. Instead, proponents of big government spending (I think we should call them the Trillionaires) seem to be suggesting that by getting America back to the trend line, the magic of economic growth will just happen.

Let's pause and reflect.

Economic growth is a miracle. It does not come from the barrel of a gun. It does not come from a 5-year plan. And it does not come from nationalized anything. The Trillionaires in power should acknowledge that returning to the growth path is not a sure thing. 

For any economy operating at the productivity frontier, economic growth is a result of two things. One is innovation. Two is re-organization of labor flowing from scale (which is a long run result of some market expanding innovation). Many innovation scholars believe that a healthy environment for entrepreneurs is the essential ingredient for growth, a climate that includes property rights, rule of law, freedom, and easy taxes.

So, back to the overriding concern. Who will pay? In the immediate present, nobody has trillions to lend the Treasury. You may have read some wonky stories about the unimaginable but rising risk of U.S. default, or wonkier stories about the unimaginable scenario where an offering of U.S. debt fails. But that won't happen - even though it should - because the Federal Reserve will buy anything on the table. You have to know that there already plans to monetize most, if not all, of the Trillionaire's debt. But that's just the down payment.

Eventually, the debts must be paid, and that means taxes. The President has promised "not one dime" will come from anyone but the wealthiest 5 percent of Americans. You may complain, but his seems a fair reflection of public attitudes. And yet, aren't these attitudes dangerous?

People seem to think that the rich are not paying their fair share. What is fair? A tax rate of 90 percent? Because what is in store is a massive, indeed radical, increase in tax rates on anyone who makes a high income. By definition, that means America will soon take more than half of all the income from successful innovators. And I'm sorry, but the possible negative impact on innovation is profound concern.

The economics of this center on a question of labor supply and its elastic response to tax rates. You would hope that centuries of economists have determined what labor supply elasticity is with certainty, but it happens to be one of the most unsettled questions in economics. A lively discussion of this question is the focus of numerous essays in the 2000 book, Does Atlas Shrug? edited by Joel Slemrod.

Top marginal tax rates are already around 40 percent. Raise them another 10 or 20 or more and you either slash the long-term growth rate (let's say by half) or you don't. Nobody knows. Is that a smart gamble?

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Endnote: In exploring this question of labor supply and taxes, I am interested in what experimental economics has to say. Not much, it seems. The literature is dominated by empirical studies and "natural" experiments (when policies change suddenly and behavior can be monitored). I'd love to get some pointers, if you have any.  So far, I have found one interesting paper from the lab. This is "Are Income and Consumption Taxes ever really Equivalent?" a 2008 CES paper from Blumkin, Ruffle, and Ganun:

Two often-raised arguments in favor of a shift to a consumption tax are the administrative advantages it offers over an income tax (i.e., simplicity of measuring consumption versus labor income and ease of collection and enforcement) and the elimination of the inter-temporal distortion of consumption allocation caused by the taxation of capital income. Our paper uncovers evidence for an additional, perceptual advantage: post-paid consumption taxes encourage higher labor supply than equivalent pre-paid wage taxes.

Comments

[Rahul Deodhar]

Fabulous post! and thanks for the link to consumption tax paper.

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The comments seem to be talking all around the question but not addressing the heart of the entreprenurial debate. The issue should be: How to get state capital around the financial logjam and into the hands of the entrepreneur.

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Unfortunately, mathematical laws make extended growth impossible, regardless of the 'greenness' of the growth.

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