More thoughts on Marginal Tax Rates

Alan Greenspan recently alluded to the fact that he doesn't support keeping tax rates low if it means increased debt. I couldn't agree more: It's called classic fiscal conservatism, not this low-tax rhetoric of today's Grand Old (really old) Party.

There are plenty of sophisticated studies that show that there is virtually no impact on investment from higher marginal tax rates on individual income. Other studies (equally (sophisticated) say that high levels of debt are damaging to economic performance, investment, and growth. But, as my graduate econometrics professor once told me, "if you torture the data enough, it will confess." In other words, maybe these studies are doing something high-falootin that is getting the data to tell us something that really isn't there. So, take these scatterplots (pictures) on for size (longitudinal data from World Development Indicators, 1998-2006):

Investment v. Government Debt:

Negative relationship. Classic fiscal-conservative result.

Investment v. Highest marginal corporate tax rate:

Negative relationship, not so bad, but now...

Investment v. Highest individual marginal tax rate:


Nothing!!! Even if there were, it's a positive trendline! Maybe some fancy-pants regressions will help:

	Coefficients	Standard Error	t Stat
Intercept	27.33017	1.984217	13.77378
Government Debt	-0.0221	0.010433	-2.11784
Highest Marginal Individual Tax	-0.0238	0.031682	-0.75128
Highest Marginal Corporate Tax	-0.0927	0.059525	-1.55728

Whew! At least that straightens out the signs to be as expected: Lower taxes (especially on individual incomes) are only useful for stimulating investment all else equal, i.e. if they don't lead to higher debt levels (exactly what Greenspan said!). Even then the impact of the debt is significant; the effect of taxation is not significant (in a statistical sense - significance roughly requires column 3 (t-stats) greater than 2 or less than -2).

Here's the punchline: anyone who tries to sell lower individual income taxes as a boon to investment is full of hooey (technical term).

What?

The WSJ today published an opinion piece, "The Deeper the Downturn, the Quicker the Recovery." I can scarcely think of a sillier premise to start from. Has he studied history, and the economic volitility of the US and world economies prior to WWII?

If you get past the silliness of his title and basic premise, the author (Christopher Wood) makes some interesting points about moral hazard and "debt deflation," but it would be unwise to conclude from those ideas that a steeper fall will mean a quicker recovery and a better long-term outlook. If the fall is deep then most of that "quicker recovery" will be wasted just trying to catch back up to where we were before.

Tax Cuts vs. Debt Reduction

More to come on this topic, but recently Greenspan was asked if he favord across-the-board taxcuts that would result in a net loss in revenue, a la the cuts Sen. McCain proposes. His response: “I’m not in favor of financing tax cuts with borrowed money,” (which is exactly what "W" has done, and what Mac proposes). Bottom line: Debt Reduction is more important for investment and growth than willy-nilly tax cuts. See also: classic fiscal conservatism.

Global Institutions

The bloggers at The Economist apparently don't read their own posts. This institutional report card for global institutions take a pithy route to imply that these institutions have done poorly.

However, these posts and articles (1, 2, 3), most published last spring, suggest that those same institutions have done "OK." Has the world spun off it's wheels since they took these positions? Methinks not.

Voting and Economic Interests

There's some notion running around that folks aren't voting their economic interests or that they are being somehow irrational when they vote Republican. I don't know if I agree with this. I mean, it may be correct, on average, but not necessarily evidence that they are being in any way irrational. Maybe middle-class families are simply making a "high" guess at their chances of moving upward in the income distribution (becoming rich). If we think of the market economy as partly based purely on hard work, partly on ability, and partly on luck, then at least part of the outcome is based on a sort of lottery, and there's plenty of anecdotal evidence that suggests that many people overestimate their chances in a lottery. Perhaps middle class voters who support McCain's tax structure are (often wrongly) estimating that they will be one of the few who move upward into the $250,000+ income range, the top 5%.

Thoughts on Evacuations

Do people undervalue their own lives? I found this doing a google search for "evacuation fines." An interesting point rises. If people are valuing their worldly possessions over their lives (in hurricanes, etc.) and do not evacuate, then what is our responsibility to help them? Furthermore, what is their responsibility if we do? Here's thought: maybe we should announce "mandatory evacuations" with the warning that anyone for whom the authorities have to provide emergency rescue gets fined some large amount, say $5,000. This might help ensure higher evacuation rates, and also curb some of the costs of risky rescue operations.