Wednesday, December 27, 2017

Some Immediate Benefits of the Corporate Tax Cut


By cutting the statutory corporate tax rate and by permitting investment expenses to be immediately deducted from corporate income, the new tax law encourages corporations to enhance their workers' productivity by investing in structures, equipment and software.

The additional investment will accumulate over several years, which means that the full effect on productivity and wages will not be felt for several years.

However, Economics Nobel Laureate Paul Krugman further asserts that there are essentially no benefits for workers in 2018, despite the fact that a number of corporations have announced bonuses for workers while saying that the bonuses derive from the new tax law.

The simplest model of investment and worker productivity agrees that aggregate wage increases would not be discernible in the first year following a permanent and unanticipated capital income tax cut because of the time that it takes for investment to be planned, executed and translated in to greater worker productivity.

But Krugman, Obama economic adviser Larry Summers, and I, among others, agree that our economy and this tax cut have some meaningful differences from the simple model. One of those differences is that President Trump's signature last week was not an entire surprise.

The U.S. had been behind most of the world in cutting its corporate rate, and it was largely a matter of time until the U.S. did the same, especially in 2016 when Republicans won the White House and both houses of Congress.

Throughout 2017, businesses were making plans understanding the very real possibility that federal corporate tax rates would be lower, and the execution of those plans are already adding a bit to worker productivity.

The simple model also ignores that a lot of businesses are not organized or taxed as U.S.-based C-corporations, which are the types of corporations that have been subject to high statutory rates by worldwide standards.

This has resulted in too little business activity occurring with the legal and organizational advantages of the C-corporation, and productivity has suffered as a result of companies' keeping activities away from the high C-corp rates.

Reallocating activity to U.S.-based C-corporations can happen more quickly than the building of new structures or manufacturing new equipment does. This means that part of the productivity effect can occur quickly too.

The simple model also treats labor costs as variable, which is a reasonable treatment for multi-year time frames. But over a period of a few weeks or months, which is the time frame discussed by Professor Krugman, much of the labor costs are slow to adjust, due primarily to the fact that it takes time to attract and sign good employees.

With businesses anticipating productivity growth over the next several years, it makes sense for them to take some immediate steps to solidify their workforce. (It's odd that Krugman missed this effect: he frequently writes about the "JOLTS" labor data, the entire point of which is that labor costs adjust slowly from the perspective of weekly or monthly data).

I agree with Professor Krugman that actions speak louder than words in matters of economics. Although they sometimes agree, often businesses say one thing and do another. This is especially true when the federal government uses its regulatory might to encourage businesses to say the "right thing," as it did when it rolled out the Affordable Care Act a few years ago.

But it is inaccurate to claim that workers must wait before seeing any benefits of the corporate tax cut.

Monday, December 18, 2017

At 21% or 20%, new corporate tax rate will boost US economy


Since the 1990s, U.S. corporations have been subject to one of the highest statutory tax rates in the world. The high rate has caused them to rearrange their affairs to avoid investing, especially in lines of business subject to the full rate, and thereby reducing productivity and workers’ wages.

But now Republicans in Congress appear to have agreed on reducing the rate by 14 points, to 21 percent, plus the applicable state rate, bringing the total into line with the statutory rates elsewhere in the industrialized world.
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President Trump had originally insisted on a federal corporate rate of no more than 20 percent, but Congress appears to have chosen 21 in order enhance the bill’s revenue outlook. It is worth assessing how much revenue was gained, and worker wages lost, by this deviation from the president’s plan.

Although I expect that the federal government will be getting less corporate tax revenue than it would without any tax reform, it is possible that the change from 20 to 21 percent by itself has little or no effect on revenue.

That one extra point may prevent the U.S. from undercutting a number of countries such as Spain, the Netherlands, Austria and Chile and thereby reduce the amount of business activity that relocates here from those nations.

So, as compared to the president’s plan, the IRS will be collecting an extra point on corporate income, but there will be less corporate income than there would have been.

The tax reform’s expensing provisions — generous deductions for new investment projects — also encourage business investment apart from the rate cut, and it has been argued that expensing provisions by themselves create a lot of the economic growth generated by the reform.

Thus, even if adding a point does little to enhance revenue, it may also do little to limit the wage gains that come with reforming corporate taxes.

It is important to remember that much business is not corporate business, but rather organized as partnerships, S-corporations, etc. Ideally these organizational decisions would be made for real business, rather than tax reasons.

It remains to be seen how the new corporate rate meshes with the reform of taxation of non-corporate businesses, because it depends on how the IRS and tax accountants interpret the new rules.

But I expect that there are some non-corporate businesses whose rates would have been a couple of points higher than a 20-percent corporate rate (plus the relevant personal income and state corporate taxation), so that adding a point to the corporate rate mitigates some of the unintended consequences on that margin.

Finally, future Congresses may be willing to further change the rates, especially to the degree that the changes are small. Recall that the last big corporate rate cut in 1986 was followed by a one-point change during the Clinton administration.

For all of these reasons, the consequences of a one-point deviation from the president’s plan are small compared to the overall economic benefits from a long-overdue reform of the corporate tax.

Monday, November 20, 2017

The ACA's Employer Penalty is Distorting Business

Taxes and regulations are known to affect the size distribution of businesses, due to the fact that smaller businesses are less subject to enforcement.  Large informal sectors are an obvious result in developing countries, but measurement challenges have hindered quantifying the size distortions’ impact on developed-country employment and productivity.  This paper uses new and unique data that is readily linked to a specific regulation: the 2010 Affordable Care Act’s (ACA) employer mandate.  The mandate’s size provision took effect in 2015 and is especially interesting, not only due to its notoriety, but because of its bright-line threshold and enforcement by monetary penalty.  This paper quantifies the size incentive of that penalty, develops a framework for combining evidence on size with evidence on voluntary compliance, and uses a new survey of businesses to quantify the number of businesses that changed from large to small as a consequence of the law.
The key size threshold in the ACA is 50 full-time equivalent employees (FTEs), which establishes the legal definition of a “large” business that is subject to the employer mandate.  Momentarily ignoring the distinction between FTEs and total employment, I display in Figure 1 a time series of the share of employment by small businesses, by a 50-total-employees criterion, among private businesses sized 25-99.  The data is sourced from the tables prepared by the Agency for Healthcare Research and Quality from the insurance/employer component of the Medical Expenditure Panel Survey. Both the 2015 and 2016 shares are well outside the range observed in the recent history 2008-14, and in the direction to be expected given that large employers were subject to a new regulation.

Garicano, Lelarge, and Van Reenen (2016) show how the distortionary effects of size-dependent regulations appear muted when the observer uses a different measure of size than regulators do.  This is the case in Figure 1, which looks at total employment as opposed to the full-time equivalents specified by the ACA and has total employment binned rather broadly (25-49 and 50-99).  Both Garicano, Lelarge, and Van Reenen (2016) and Gurio and Roys (2014) therefore obtain size measures that are especially close to regulator measures and find large size distortions in the French economy.  They do not link the distortions to specific regulations, but instead focus on France where there are many size-dependent regulations thought to be binding.  One of their estimation methods is to compare the actual firm size distribution to a Pareto distribution and measure the nonmonotonicity of the actual distribution in the neighborhood of the threshold.
The Mercatus-Mulligan data used in this paper has five measurement advantages.  First, it separately measures full- and part-time employment and therefore can produce good proxies for FTEs.  Second, the size distortion can be linked to a specific and relatively new regulation, which permits a before-after analysis as shown in Figure 1.  Third, voluntary compliance – that is, offering employer-sponsored health insurance (ESI) even when exempt from the mandate – can be measured.  This allows the measurement of size distortions to focus on businesses for which the employer mandate is binding.  Fourth, the survey was not conducted at the corporate level and therefore did not require any corporation’s approval to publish results.  Rather, individuals were confidentially surveyed, and these individuals happened to be managers at businesses.  If the sample aggregate happens to reveal politically-incorrect business practices, such a finding cannot impugn any particular business.  Fifth, the managers of the sample businesses were asked whether and how the law changed their hiring practices, with answers that can be compared to size and compliance.
Before-after comparisons between the Census Bureau business survey and the Mercatus-Mulligan survey show little change in the size distribution of businesses between 2012 and 2016, except among businesses in the total-employment range 40-74.  Among the latter businesses, the employment percentage of those with less than fifty employees has increased from 37 to 45, and this does not count the fact that a number of 49ers reduce employment below 50 full-time-equivalent employees (FTEs) without reducing their total employment below 50.  Annual time series from the MEPS-IC show an extraordinary jump in the employment percentage of those with less than fifty employees, beginning in 2015, which is the same year when the large-employer designation began its 50-FTE threshold.
            The size distortion is closely linked with whether a business offers employer-sponsored health insurance (ESI) to its employees.  Even by comparison with businesses employing fewer than 30 full-time workers, the propensity to offer ESI is low among employers with 30-49 full-time employees.  The size of this dip in the ESI propensity indicates the prevalence of 49er businesses: they do not offer ESI and thereby keep employment low enough to avoid the ACA’s large-employer designation.  The cross-section finding is my second and strongest piece of evidence that the ACA’s employer mandate is pushing a significant number of businesses below the 50-FTE threshold.
My point estimate is that the United States has 38,327 49er businesses that collectively employ 1.7 million people.  This translates to roughly 250,000 positions that are absent from 49er businesses because of the ACA, but the Mercatus-Mulligan sample by itself is not well suited for accurately assessing the average number of positions that the 38,327 49er businesses eliminated.  The sample also indicates that businesses continue to adjust their employment over time.  For example, many of them reported that, because of the ACA, they hire fewer workers or at least fewer full-time workers, but tried not to adjust the situations of their existing employees.  If the ACA and its employer mandate remains in place, perhaps the prevalence of 49er businesses will increase over time.
            By definition, the 49er businesses have less than 50 FTEs and do not offer ESI.  But it appears that a majority of them had been offering it in the prior year.  Employers with 30-49 FTEs are also disproportionately likely to report that they hire less or have shorter work schedules because of the ACA.  This is my third finding pointing toward an economically significant effect of the ACA on the size distribution of businesses.  To my knowledge, this is the first paper to find a business-size distortion that is readily visible in aggregate U.S. data.  It is also remarkable that the distortion can be linked to a specific regulation with a precisely known penalty for violations.
            Individual-based surveys of businesses are rarely used in economics, but that is bound to change as the survey industry is becoming more efficient (i.e., cheaper for the researcher).  It is worth noting the contrast between the Mercatus-Mulligan survey design and in-depth studies of a particular business (e.g., (Einav, Knoepfle, Levin, & Sundaresan, 2014; Handel & Kolstad, 2015)).  The former design has the advantage of representing a wide range of industries and geographic areas.  Moreover, this study is not sponsored by any business and therefore does not require a corporation’s approval for its release.  Corporate approval is a concern for studies of a particular business, especially when the topic involves public-relations-sensitive issues such as distorting business practices to lessen the cost of well-intended federal regulations.  Another dividend from using a professional survey research firm is that every respondent completed the survey.
            This paper does not put its estimates into an equilibrium framework. Future research needs to estimate the number of eliminated positions at 49er businesses that resulted in jobs created at businesses that compete with 49ers in product or labor markets.  To the extent that the employer mandate shifts employment from 49ers to other businesses, future research needs to assess the aggregate productivity loss from the shifts, recognizing that the ACA’s large-employer definition is just a vivid example of a more general pre-existing enforcement phenomenon.  Even without the ACA, businesses are taxed and regulated, and understand that adding to their payroll tends to increase the enforcement of those rules, albeit not discretely at 50 FTEs (Bigio & Zilberman, 2011; Bachas & Jensen, 2017).  One ingredient in such productivity calculations would be the number of positions shifted, which I found to be roughly 250,000.
From the equilibrium perspective, another interpretation of my cross-section finding – the nonmonotonic relationship between ESI and employer size around the threshold – is that businesses below the threshold did not adjust their size but merely dropped their coverage, in which case, I have mislabeled them as 49ers.  Indeed, I find that such businesses are disproportionately likely to have dropped their coverage in the past year.  However, this alternative explanation does not by itself explain why (i) so many businesses were added to the 25-49 (total employment) size category, (ii) so few were added 50-99, or (iii) coverage rates are not particularly low for businesses with less than 30 FTEs.
The implementation of the employer penalty in January 2015 coincides with a sudden slowdown in the post-recession recovery in aggregate work hours per capita, with 2016 national employment about 800,000 below the trend prior to the implementation of the employer penalty (Mulligan, 2016).  This paper’s estimates permit us to gauge the aggregate importance of the 49er phenomenon, not counting the marginal employment impact on non-ESI businesses that continue to employ 50 or more FTEs.  If 250,000 positions were the aggregate employment effect of 49ers (see the equilibrium caveat above), that would be about one third of the recovery slowdown.  Perhaps more important would be the social value of those positions, given that employment and income are substantially taxed by payroll, income, and sales taxes even without the ACA thereby creating a wedge between the positions’ social and private values.  If that wedge were $20,000 annually, that would be $5 billion of lost annual social value, plus the usual Harberger triangle, which is 38,327 businesses in the quantity dimension and up to $68,987 annually in the price dimension (about $1 billion annually).

Monday, November 13, 2017

Low effective rate not an argument against corporate tax cut


President Trump says that U.S. corporations face the highest tax rates in the world, whereas opponents of his tax reform say that “actual” corporate tax rates are in line with other countries. What gives?

The president is referring to the rate that applies to taxable corporate income, known as the “statutory rate.” The federal statutory rate is 35 percent, and the combined federal-state corporate rate is typically about 39 percent. This rate is greater than anywhere in the industrialized world.

But the statutory rate does not apply to all of the income-generating activities of corporations, because some of those activities create deductions that can be subtracted from business income for corporate-tax purposes.

Debt-financed activities are a good example, because the income they generate goes corporate-tax free to the extent that it can be distributed to investors as interest income.
Intellectual property investments are another example, because they are not obviously attached to a physical location, thereby helping accountants assign their returns to Ireland and other low-tax jurisdictions.

As a result, corporations are paying less than 39 percent of their income to state and local treasuries. The Government Accountability Office estimates 17 percent, which it calls the “effective rate.”
It might seem that the 22-percentage-point difference results in a free lunch for corporations at the government’s expense. But the opponents of corporate tax reform are mistaken to ignore the fact that the corporate tax has corporations paying a lot more than the checks they write to government treasuries.

The Internal Revenue Service (under the Obama administration) estimated that corporations and partnerships pay over $100 billion annually in complying with business-tax laws, including their costs of recording, keeping and hiring paid tax professionals. Compliance costs are not checks written to the government, but are real costs nonetheless.

In fact, the high compliance costs are a symptom of the low effective rate because business-tax deductions are a complicated enterprise. Corporations are paying for some of their 22-point savings in terms of the extra compliance costs that come with complicated tax strategies.

More important, our economy is less productive because taxes have induced investors to pursue tax-favored activities beyond what value creation would dictate. The most vivid example is the housing sector, where returns have been depressed by a factor of two or three because those returns are essentially tax free.

In other words, by having so many deductions, the corporate tax involves a substantial hidden tax on businesses beyond what they pay the government, with the extra payment in terms of lost income.

The chart below illustrates by splitting the economy into two kinds of activities: those that pay full tax and those that are tax favored.

If nobody adjusted their investment plans, the tax-favored activities would be a great deal — they would earn the amount up to the dashed line and owe no tax. But there is no free lunch. The tax favors induce investors to engage more in those activities.

Their movement depresses the income accruing there — otherwise nobody would be willing to do the activities subject to full tax. The chart illustrates this by showing how the income ultimately earned has been depressed enough so that the net-of-tax earnings is the same for both types of activities.

The low effective corporate tax rate is therefore not an argument against President Trump’s call for tax reform. That low rate is further evidence of the economic damage done by the tax, as businesses pay to comply and pay by accepting comparatively low-return investments.

Because the effective rate only counts costs in the form of payments to government, a low effective rate is telling us that cutting the corporate tax will benefit economic performance far more than it will cost government treasuries.

Sunday, November 5, 2017

Does Communism have a universal constant? From the October Revolution to Bernie Sanders

To acknowledge the 100th anniversary of the Russian revolution, I have assembled data -- from Holmes (2009), Pipes (2001), Fontova (2013), and others -- on Communist regimes that lasted more than 5 years.
[Communists] openly declare that their ends can be attained only by the forcible overthrow of all existing social conditions. Let the ruling classes tremble at a Communistic revolution. The proletarians have nothing to lose but their chains. They have a world to win. Working men of all countries, unite!

(1) The chart below counts Communist state killings -- war deaths not included -- of its own people by purge, massacre, concentration camp, forced migration, famine, or escape attempt.

The counts are expressed as a percentage of population. 6% is a typical result.

You might say, "94% of people survive Communist regimes." But that's a lot less than the percentage of people who survived history's major tragedies. The U.S. Civil War was especially deadly, but "only" killed 2% of the population and, unlike the 6% above, this counts war deaths (civilian deaths were more like 0.2%). AIDS/HIV killed "only" 2% of Africa's population.

(2) Facts about Communist results are not part of the standard training in economics. Indeed, as recently as 1989, they were denied by some of our best and brightest. E.g., Samuelson and Nordhaus' best-selling textbook asserted "the Soviet economy is proof that, contrary to what many skeptics had earlier believed, a socialist command economy can function and even thrive."

(3) Another example: this year's New York Times commemorated the Russian revolution with fantastic claims such as "Women had better sex under socialism." That article shows a photo of a smiling woman on "a collective farm near Moscow" without mentioning how the Communist system left women and men so malnourished that their bodies no longer functioned normally. Take a look at the birth rate in Ukraine under Stalin:
Click here for a similar picture for China under Mao.

(4) The above are examples of the intellectual class indulging their fantasies about the effects of apparently well-intentioned public policies. But the more general phenomenon was that results were suppressed, both outside and inside the Communist countries, because they were unpleasing to those in power.

(5) Disastrous results can more easily become public when there is competition both in the media and in the public sector. Obviously the Communist regimes operate in a one-party system. But even in our political system, the competition is far from perfect, and both media and state officials sometimes work together to attract attention away from negative results.

It is not so easy to have a government that tightly controls economic resources, but is unable and unwilling to exercise control over ideas. 

Perhaps even Senator Bernie Sanders, who has admired more than one Communist regime and insists that government should freely provide everything from health care to college to housing, might now notice as much: his presidential campaign was one of the most recent victims of the Party Line and political collusion.

Friday, November 3, 2017

Stanford University findings on the ACA and the labor market

Stanford Economics Professor Mark Duggan was quoted as concluding that

"While the Affordable Care Act had a significant effect on health insurance coverage, it did not have a substantial effect on the U.S. labor market as many had expected" and

"the Affordable Care Act has not had the negative effect on jobs the law’s critics claimed it would."

He was referring to a working paper distributed by the National Bureau Economic of Research, which states that

labor market outcomes in the aggregate were not significantly affected.”

Theirs is a working paper and I'm sure that the authors are eager to add data and analysis, so I understand the above conclusions to have been modestly offered. With that said, it is worth recognizing that the above conclusions are not what the working paper shows.

  1. Table 4 (the paper's first table on labor market outcomes) shows that the ACA reduced nationwide labor force participation by 349,190 in 2016, plus however much the ACA reduced labor force participation in a geographic area that was fully insured before the ACA, which I call the HFIA (Hypothetically Fully Insured Area).  This effect is economically significant and, when combined with items (2) and (3) below, is easily in line with "the negative effect on jobs that the law's critics claimed it would be."

    [Admittedly, the 349,190 is probably not statistically significant by the usual criteria, but the quotes above are not claiming that either side could be correct. Rather they claim to decisively reject "critics" who made claims right in line with the Duggan-Goda-Jackson point estimate. See below for the derivation of the 349,190]

  2. The paper assumes, without much explanation, that the HFIA part of the ACA's impact is zero.  But other work has shown that near-elderly insured people were given a tremendous incentive to retire early.  In other words, basic economics tells us that the HFIA part is likely positive (i.e., in the same direction as the 349,190) and we should not assume it to be close to zero until we have further measurement.

  3. The empirical methods in the paper, which emphasize differences among geographic areas such as Medicaid expansion states versus other states, are not designed to detect effects of the employer penalty.  The employer penalty is the same amount throughout the nation.  The penalty creates large labor-market distortions; those distortions that have been measured in other studies have proven to be similar across geographic areas.  Moreover, the employer penalty did not apply until the 2016 coverage year, whereas 8/9 of the working paper's data is before that date. This is an especially serious problem for the low-income population, where the employer penalty in effect has them working 50-60 days per year for the government, on top of the implicit and explicit employment/income taxes they would pay even without the ACA (this fact is nowhere mentioned in the paper). For this reason, the authors' claim than that "lower income individuals were actually incentivized to work more" is especially incredible.

To derive the 349,190, look at the first "Out of the labor force" column of that table.  The first row says that the M variable reduces out of the force by 0.0847 on average for each working-age person in the U.S.  The second row says that the E variable increases out of the labor force by 0.0962.  The mean of the M and E variables are, respectively, 0.073 and 0.086 (p. 11 of the paper). So, relative to the HFIA, their regression says that the U.S. has increased out of the labor force by 0.0021 per working-age person:

0.0021 = 0.073*(-0.0847) + 0.086*(.0962)

To get a number of people, multiply by the number of working age people (difference between these two), and you get 349,190.

Tuesday, October 24, 2017

Delong and Krugman make "math error", while falsely accusing Greg Mankiw of making math error!

Delong and Krugman are now claiming that the Furman ratio -- defined by Furman himself to be the ratio of wage gains from a corporate-income tax cut to a "static" revenue loss defined as rate change times corporate income -- is equal to one, rather than being greater than one (namely, equal to 1/(1-t)) as Greg Mankiw showed.

They go on to claim that Mankiw made this supposed mistake as a political ploy.

But it is they who are making a mistake, in "Dem's favor" (purely accidental, I'm sure).

Specifically, Krugman says that his blue rectangle is the wage gain from a small tax cut. I agree. But it is wrong to equate that to Furman's static revenue loss, because that loss is strictly smaller than his rectangle. As Jason Furman confirms, Delong makes the same mistake algebraically by equating Furman's static revenue loss to his term "(a)" plus term "(b)" when in fact the loss is just his term "(a)".

Krugman's blue rectangle, and DeLong's (a)+(b), cannot be Furman's static revenue loss, because they incorporate an equilibrium price change in the calculation of the corporate-income tax base. The static revenue loss from the corporate-income tax must, by Furman's definition of "static," hold corporate income constant.

[Unlike DeLong, Krugman does not actually use the word "static."  He says "direct" -- it is possible that he understands Furman's static and Krugman's direct to be different, and just failed to indicate the distinction to his readers.

It's fine if he prefers his blue rectangle to Furman's "static" revenue loss, but remember that by all accounts the blue rectangle is about $400b/year -- close to CEA's estimate of the wage gain.

In other words, when you change to the blue-rectangle definition of "static" you not only reduce the theoretical Furman ratio by a factor of (1-t), you also increase the static revenue number by the same factor.  The CEA's $4k per family is fixed.

This is like measuring things in yards or meters or fathoms -- the standard you choose does not change the answer, as long as you are consistent about the standard ... let's watch to see if they are.]

Later Krugman talks about yet another concept of revenue loss, namely the actual (a.k.a., dynamic) loss.  Mankiw had already explained the static-dynamic distinction to his readers.  This morning I tried to help Mr. Krugman with this by posting on his twitter:

What @delong is seeing is that "static" revenue loss is arbitrary:

the static revenue loss from a per-unit tax cut [what Krugman shows with his blue rectangle and calls "direct"]

is different from [Furman's] static loss from an ad valorem tax cut [what a corporate-income tax cut would be],

even when those cuts are scaled so that both have the same effects on revenue and the surplus of all parties.

That is why I use actual revenue loss.

The ratio between the two "static" concepts is the (1-t) factor that has Delong and Krugman so confused.

You may also be interested in a previous instance when, with important public-policy issues at stake, Krugman failed to appreciate what supply and demand really says and neglected to admit his error.

Sunday, October 22, 2017

What does Summers 1981 say about the long-run incidence of the corporate-income tax?

I already explained that in two different ways: cutting the tax increases wages more than it reduces tax revenue.

Contrary to Summer's claim, this result is not "unprecedented in analyses of tax incidence" rather it is one of the most ubiquitous results in analyses of tax incidence.

Notice that Summers' response this morning fails to claim that I am wrong about the LONG-RUN incidence in HIS MODEL (It should already be obvious that I am not wrong -- my early post already provided the algebraic analysis of, and precise citation to, the relevant equation from his paper).

Perhaps Summers really means that he thinks that the long-run incidence in HIS MODEL can be safely ignored. If that's what he means, he should say it directly and then I will respond.

Summers also either (i) fails to read what I wrote, or (ii) is lying. A cue: he fails to directly quote me. Specifically,

  1. He claims that "Mulligan also fails to recognize that a corporate rate cut benefits capital and hurts labor outside the corporate sector because it draws capital out of the noncorporate sector, raising its marginal productivity and reducing that of labor." [emphasis added]  But of course I did -- it is my item (C) -- and pointed readers to one of Summers supply-side-economics papers on that very subject.
  2. He claims that Greg and I overestimate the effect of Trump's plan on the incentive to invest (see his "a cut in the corporate tax rate from 35 to 20 percent in the presence of expensing of substantial or total investment has very little impact on the incentive to invest").  But Greg and I are looking at INFINITESIMAL changes -- it doesn't get any smaller than that!
(For your reference, my item (C) says "...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." [emphasis added])

Regarding Summers other points this morning, not specific to Summers 1981, I had already anticipated them.

(Update: The Wall Street Journal referred to "a 1981 paper" where Summers wrote about "the increase in gross wages which results from the increased capital intensity arising from eliminating capital taxation." That's a different paper, published in the American Economic Review.  As shown from my link, I am referring to the Summers paper published in the 1981 Brooking papers)

Public Policy Suffers when Price Theory is Ignored

Jason Furman and Larry Summers weighed in this week about the quantitative amount that labor can benefit from a capital-income tax cut.

It soon became clear that they had failed to carefully use price theory in coming to their conclusions.

Furman and now Krugman (update: and now Summers) are admitting that simple supply and demand vividly contradicts what they said/say about taxes, but assert that the world is more complicated. I agree.

But they are dead wrong to further assert, without evidence (and I suspect without thinking), that adding complications will overturn the simple supply and demand conclusion or at least weaken the contradiction contained in their original proclamations.

(So far, Summers has wisely refrained from trying to defend his mistake.  Update: he replied 2 hours after I posted this -- see the update at the very end of this post.)

Supply and demand can do more than I have already shown.  Supply and demand also:

  1. can give quantitative answers.  Greg Mankiw writes "I must confess that I am amazed at how simply this [quantitative formula] turns out. In particular, I do not have much intuition for why, for example, the answer does not depend on the production function."  Supply and demand can answer his question, without any algebra.
  2. can deal with complexities, such as "imperfect competition."  The simple supply and demand model assumes perfect competition, but that assumption can be and has been modified.  Guess what?!  Making that modification shows that even the simply supply and demand model, let alone the proclamations of Furman-Summers-Krugman, understates the wage impact of capital-income taxation.
    [Hints: what new rectangles appear when the factor-renter is selling his product for more than marginal cost? What determines the equilibrium size of those rectangles?  Why should we use the corporate tax to rather than the DOJ to fight monopoly?]
  3. can deal with complexities, such as debt finance.  Having uneven taxation of different types of capital tends to reduce the denominator of the Furman ratio more than it reduces the numerator.  i.e., Furman still has it even more backwards than I thought (update: Summers too).
  4. explains why horizontal capital supply is not an "extreme" caseGary Becker and I explained why capital supply probably slopes down somewhat in the long run (thanks Kevin M. Murphy for reminding me about this -- not to mention for teaching so many of us about price theory!)
  5. shows you how to process the economic data.  Furman and Krugman make evidence-free proclamations about the elasticity of capital supply.  Supply and demand shows what economic data is needed to measure that elasticity (spoiler: it's not complicated, and shows a very high elasticity).

I will post on these individually next week (week of Oct 30). In the meantime, you may be interested in a previous instance when, with important public-policy issues at stake, Krugman failed to appreciate what supply and demand really says.

Update: 2 hours later Summers posted a reply that reiterates the "it's complicated," "monopoly profits," and "debt finance" excuses for ignoring what the simple model says.  See my points 2 and 3 above.

He also hopes that you forget that he referred to CEA's result -- which is generally in agreement with the simple supply and demand model -- as "unprecedented in analyses of tax incidence."

Regarding Summers' other replies, see here.

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.  They don't seem to understand that the wage gains from a cut come not only from the Treasury but also the economic waste created by the corporate tax.

(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.”

(update: Summers' reply now revokes academic work more generally.  He also wants you to forget that he said CEA's Furman-ratio result to be "unprecedented in analyses of tax incidence."

Moreover, he digs his hole deeper with his critiques of the simple model.  I.e., President Trump should be thanking Summers for unwittingly strengthening the case for corporate tax reform.

See my comments on Summers 1981 here.)