Wednesday, October 18, 2017

Furman and Summers revoke Summers' academic work on investment

Former CEA chair Jason Furman writes “The economic debate about the %age of the corporate tax paid by labor ranges from 0% to 100%. The new CEA study puts it at 250%.”

Larry Summers reiterates Furman’s argument, calling the CEA and its estimate “dishonest, incompetent and absurd.”

Furman’s first sentence has the economics of investment completely backwards.

I will point to academic papers in a minute, but they can be understood with capital supply and capital demand, as shown below.



The red area (R) is the revenue from a capital income tax.  The red and green areas (R + G) are the losses from that tax suffered by owners of the factors of production, combined for capital and all other factors.  The revenue is a LOWER BOUND on the factor owners' loss.

In the long run, all of the factor owners' loss from a capital income tax is a loss to labor (the area below the horizontal dashed line is negligible; see A below).  Therefore, in the long run, capital-income tax revenue is a LOWER BOUND on labor’s loss.  Furman and Summers have it backwards.

(A) Why would labor bear all of the burden in the long run?  Well, ask Larry Summers back when he used to be an academic studying these matters.  His 1981 Brookings paper, which even today is an article commonly used by me and others to teach this in graduate school, says so on page 81 equation (7).  The left-hand-side of that equation is a perfectly elastic long-run supply of capital: it says that the supply curve in my picture is, in the long run, properly drawn as horizontal.  See also Lucas (1990, p. 303, equation 4.3).

(B) OK, the long-run Furman ratio must be greater than 100%, but how big is it?  If we (i) begin, as is today’s reality, with a high tax rate, and (ii) conservatively assume that the only channel for benefits is a higher capital stock (more on that below), then 250% is about right for cuts to somewhat lower rates.

Using a Cobb-Douglas aggregate production function with labor share 0.7, and a 50% capital-income tax rate (combining corporate, property, and the capital components of the personal income tax), I get a Furman ratio of 350%.  With a 40% tax rate instead, the Furman ratio is 233% (algebra here; these refer to modest tax-rate reductions -- not going all of the way to zero).

If the current CEA said 250%, then it got Furman's ratio much closer than Furman did, who puts it less than 100%.

Note that Summers now calls the 250% "unprecedented in analyses of tax incidence," yet I am getting it from his own paper about how the corporate-income tax works (see esp. p. 95)!

(C) Are there labor benefits not shown in the picture?  Again, let’s go to the academic incarnation of Larry Summers.  He once made contributions to supply-side economics!  In his chapter in “The Supply-Side Effects of Economic Policy,” Summers wrote that labor likely benefits from corporate income tax cuts even WITHOUT ANY increase in the aggregate capital stock because that capital would be “better allocated to the corporate sector.”

Update on (C): Greg Mankiw points out still more labor benefits not shown in the picture.  His source -- you guessed it! -- Larry Summers.

To summarize, anyone using Larry Summers’ academic work for policy analysis, is, according to Larry Summers, “dishonest, incompetent and absurd.”

Sunday, October 8, 2017

How government employment can undermine democracy

Citizens in a democracy can criticize their government and its laws without government reprisal.  But what happens when your government is not only the enforcer of law, but also your boss?  Your boss, of course, is less willing to have you in his employ if you are speaking out against him.


I spoke to a young woman who was shortly due to sit examinations to become a judge. She thought there was a good chance that her role in assisting the local [Catalan] referendum process would destroy her chances of becoming a judge, and said that one of her fellow students was too scared to even vote for the same reason.

Of course a judge is an occupation naturally in the public sector, but the point is: the more occupations that are pushed from private to public sector (or any huge employer -- but what private organization employs as many as government?), the more people who are unwilling to speak out against harmful government policies.


Read here to feel the Joy of Voting

The economic analysis of voting primarily takes voting as instrumental: like a bank account, a vote is supposed to be nothing more than a means to an end. A few of us have argued against this: e.g., Geoffrey Brennan, Bryan Caplan, and recently Becker and Mulligan, but that is a small minority.

Another way to appreciate the same point is to see what actual Catalan voters had to say last weekend:

The polling station workers thought that if they had computers with older technology they may be able to connect to a wifi system [the Spanish government was blocking polling stations' internet access] ... we all started clapping – it had worked! They were connected. One man inside excitedly ran to inform the others... “I’m going to be the first to vote!” he yelled excitedly, to laughter. The two elderly women and a handful of others inside took up their ballot papers and voted.

Then the gates opened and the first round of people walked through. Everyone was cheering and applauding jubilantly ...the faces of those who came through were still calm and resolute but some became tearful after they voted. It was a really moving moment, and it’s hard to accurately put it in words. The best way I can describe it to say there was an overwhelming sense of dignity about both the moment and the people.

You can read the full account here.

That voting is to many people not merely a means to an end is better understood by Catalan separatists than the Spanish government.