I have only one quibble, and that’s that Greg is very sure we should eliminate the mortgage interest deduction in accordance with his first principle: “Broaden the Base and Lower Rates”. I think we should maybe keep it in accordance with his second principle: “Tax Consumption Rather than Income”. (Though I certainly agree that after the second principle has been implemented, it will be time for the mortgage interest deduction to go.)

How sad that so much wisdom is sure to go unheeded.

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Umm…Paul? They pay both. I’d lift Krugman’s own favorite dismissive phrase and say “That’s Economics 101″, but actually it’s probably standard knowledge among middle schoolers.

To review the details:

First, Krugman reposted (from the website of a left-wing advocacy group) a highly misleading chart purporting to illustrate the federal tax burdens borne by various income groups. The chart accounts for payroll and income taxes, but omits corporate taxes, thereby making the burden on high-income tax payers appear substantially smaller than it is, because corporate taxes reduce dividends which are disporportionately paid to high-income taxpayers.

Next, he got called on it by lots and lots of people, including, for example, Greg Mankiw.

Next, Krugman acknowledged his error. But, as always, he did so with the least possible grace, suggesting that his critics, by virtue of pointing out Krugman’s mistake, have somehow undermined their own principles.

In particular, his position is that by acknowledging that corporate profits benefit shareholders, “conservatives” have undermined their own ability to claim that corporations benefit anyone other than shareholders (e.g. workers). He relies, in other words, on the cockamamie notion that if something is good for group A, it can’t possibly also be good for group B.

If Krugman’s point is that all profits are paid to shareholders, well duh. Surely nobody, nowhere, never, nohow, has ever suggested otherwise.

But if his point is that you must claim a share of those profits in order to benefit from capital accumulation, then he really has stopped even pretending to be an economist. As Professor Krugman is surely well aware, the accumulation of capital is the primary driving force behind the growth of wages.

In other words — and this is exactly what Krugman is denying — if you work for General Electric, you might have a good reason to be glad that General Electric is around. Even if you don’t own any stock.

(Actually, it’s not just GE’s employees who benefit from GE’s capital accumulation; it’s workers everywhere. Example: GE hires a bunch of workers, which makes it harder for IBM to hire workers, which forces IBM to pay higher wages. But if that’s too subtle for Paul Krugman, we can focus on just the GE workers and still devastate his argument.)

In summary: Everybody who knows any economics knows that corporate capital accumulation can benefit both workers (via wages) and stockholders (via dividends) at the same time. (Well duh again.) Krugman makes some bogus argument about taxes that ignores the existence of the dividends. Mankiw and others point out that the dividends exist. Krugman says: “Okay, you’re right, but I hope now you’ll finally stop claiming that wages exist!”

I’d love to find the perfect closing sentence to capture the flavor of this peremptory illogic, but I’m stumped. What should the final line of this post have been?

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For at least the eighth time on this blog, I want to point out that this widely believed “fact” is not true.

To understand Mitt Romney’s tax burden, you have to compare him to his doppelganger Timm Romney, who lives on a planet with no taxes. In the year (say) 2000, Mitt and Timm both earned (say) a million dollars. Timm invested his million dollars, saw it double over the past decade or so, and cashed out his investment this year, leaving him with two million dollars. Mitt, by contrast, paid 35% tax in 2000, leaving him with $650,000. He invested it, saw it double, and cashed out last year, paying 15% tax on the $650,000 capital gain. That leaves him $1,202,500, which is about 60% of what Timm’s got. In other words, the tax system costs Mitt almost 40% of his income.

By contrast, people on our planet without investment income collect their wages, pay 35% in taxes, and spend what’s left. The tax system costs them 35%, while it costs Mitt almost 40%. In other words, people with investment income bear a higher tax burden, as a percentage of their income, than anyone else — and that’s before you even start accounting for the taxes on dividends, interest, corporate income and inheritance.

It’s true that there are some hedge fund managers out there who manage to game the system by disguising their wages as capital gains and thereby avoiding the wage tax altogether. That in no way undermines the main point.

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(Slightly higher quality video here.)

Edited to add: There were apparently some problems with the video stalling somewhere around the one-hour mark (during the post-talk question period.) I believe this is fixed now.

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1. Public debt has redistributive effects and incentive effects. We all agree on this. There remains the question of whether there is a “burden-of-the-debt” effect over and above these well understood effects. The right way to approach that question is to ask “Would there be any burden of the debt in a world with lump-sum taxes—i.e. a world in which the redistributive and incentive effects are assumed away?”.
2. In that world, as in any world, government spending is costly.
3. Deficit financing offers the older generation a mechanism to shift some of that cost to future generations. Individuals will take advantage of this mechanism if and only if they want to.
4. Therefore nobody currently alive (or, in Bob Murphy’s Abraham-and-Isaac model, no member of the older generation) has any reason to object to deficit financing. Deficit financing expands your opportunity set, which you cannot be a bad thing (for you).
5. I called Nick Rowe “wrong” for overlooking point 4; that was, in his words, a rhetorical flourish. Nothing he said was actually wrong except (in my opinion) for his choice of emphasis.
6. Speaking of Bob’s Abraham-and-Isaac model: This introduces a minor twist. Instead of the choice between taxing one cohort today or another cohort tomorrow for the benefit of the former, Bob offers the choice between taxing a single cohort either today or tomorrow, in order to benefit an older cohort. But this changes none of the fundamental issues. Regardless of whether Isaac is taxed today or tomorrow, Abraham has the opportunity to restore the status quo, and has no cause for complaint if he chooses not to.
7. When the government runs a deficit, some people miscalculate the effect on their grandchildren and therefore save the wrong amount. It would be good to educate these people.
8. The people in the preceding point might, a priori, either underestimate or overestimate the costs of current spending to their grandchildren and hence might either oversave or undersave. Therefore it’s possible we’d do these people a service by raising alarms, but it’s also possible we’d do them a service by quelling their fears.
9. As far as future generations are impoverished by the greed of the current generation, their main beef should be not with deficit financing but with the underlying greed. Indeed, a greedy current generation is perfectly capable of impoverishing future generations without deficit spending, by depleting their inheritances.
10. Bob seems to disagree with the preceding point. I still don’t understand why. But this is not fundamentally a disagreement about what happens; it’s a disagreement about how to describe what happens.
11. Bob’s got some cockamamie story to tell about going into the future with a time machine and stealing pizzas; he observes that the time machine enables the theft and therefore it is natural to talk about the “burden of the time machine”. This is true, but the difference between a time machine and deficit finance is that a time machine enables you to transfer resources across generations in a way you might not otherwise have been able to, while deficit financing is just a new way of doing something you could have done anyway.
12. There’s an exception to the above: People who are credit-constrained can consume more (and hence impose greater costs on their grandchildren) when the government borrows. The grandchildren of those people might find Bob’s time machine analogy perfectly apt.
13. On the other hand, even with credit constraints, deficit finance does not allow an entire generation to increase the burden on its descendants beyond what it could have done anyway (and in that sense is nothing like a time machine). It only allows some families to increase the burden on their descendants. The greatest damage one generation can inflict on the next is to consume everything in sight, and this is always possible without deficit finance.
14. None of this has anything whatsoever to do with whether the debt is held by domestic citizens or by foreigners. The analysis runs exactly the same either way. Krugman got this wrong.
15. All of the above holds government spending fixed. Don’s argument (for which he credits Buchanan) is that this is a bad assumption. Here’s why: Deficit finance creates the option of passing costs on to the next generation. Some taxpayers will choose that option. Those taxpayers, having successfully pushed part of the cost of spending onto others, will vote for more spending, and sometimes they will prevail.
16. Don’s argument makes perfect sense and could well be empirically important. (I don’t know whether it is.) But it’s not the same thing that people are usually referring to when they talk about the burden of the debt. What’s usually meant by that is an additional burden over and above the burden created by a given level of government spending.

I am guessing we can get near-unanimity on all of these, with one exception: Bob Murphy keeps insisting there’s something the rest of us aren’t seeing, and I can’t figure out what it is. (Perhaps it’s just point 12 above, in which case I have to tell him that everybody else already knew this; it’s a commonplace observation in the literature on Ricardian Equivalence. Please don’t read that as snarky; we all have our blind spots and every one of has somehow overlooked a thing or two that everybody else has been onto forever.) I like Nick Rowe’s model a lot, but I don’t see where it teaches us anything we didn’t already know. (That’s not a criticism! It’s extremely important to find new ways of verifying the things you “already know”!). Bob, however, somehow sees it as revelatory. Exactly what it revealed to him is still a mystery to me.

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Murphy objects to formulations along the lines of “government debt is not a burden because we owe it to ourselves” and offers a parable that he thinks illustrates all the key issues. I agree that his parable illustrates all the key issues, so let’s review it — and see what it really illustrates.

In Year One, Abraham (who is old) owns an old apple tree and Isaac (who is young) owns a young apple tree. Each tree delivers 100 apples to its owner. Shortly thereafter, Abraham’s tree dies and Abraham follows suit. In Year Two, Isaac’s tree delivers him another 100 apples, and then both the tree and Isaac die.

Now in Year One, Abraham’s government decides to give him a present of 10 extra apples, which it borrows from Isaac. As a result, Abraham gets to eat 110 apples and Isaac eats only 90. In Year Two, the government owes Isaac 11 apples (including interest). It gets these apples the only way it can, by taxing Isaac. Therefore Isaac pays 11 apples tax, receives an 11 apple bond payment, and eats 100 apples. Bottom line: The government policy has increased Abraham’s lifetime apple consumption at the expense of Isaac’s. Therefore, says Bob, it’s clear that the government’s debt constitutes a burden to Isaac.

Fine. Here’s my counter-parable. In Year One, Abraham’s government decides to give him a present of 10 apples, which it gets by taxing Isaac. In Year Two, the government does nothing. The government policy has increased Abraham’s lifetime apple consumption at the expense of Isaac’s exactly as in Bob’s story. The Landsburg-Isaac feels exactly the same burden as the Murphy-Isaac, even though there is no debt in the Landsburg world. Therefore debt cannot be the source of Isaac’s burden.

Indeed, the source of Isaac’s burden, plain and simple, is that his government decided to transfer resources from him to Abraham. Whether they do this via debt or via taxation is as irrelevant as whether they deliver the apples to Abraham by truck or by train.

If the apples are delivered to Abraham in a wheelbarrow, one could, I suppose, blame everything on the wheelbarrow and talk about the “burden of the wheelbarrow”. And in some very contorted sense, one could defend that position. But why would you want to?

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I want to explain what that means, and why it’s wrong.

To make sure we’re all talking about the same thing, I’m going to adopt all of Nick’s assumptions, most critically that all taxes are lump sum. I’ll come back at the end and say a little more about why this obviously false assumption is the right assumption to make.

Now: Suppose the government borrows money to finance a tax cut. That makes us feel richer. We therefore buy and consume more stuff, which leaves less stuff for our grandchildren to consume. (Nick tells a very nice detailed story about how this might play out across generations; I applaud that kind of detail, but it’s not important for this response.) Government debt is therefore a burden to our grandchildren.

Unless! If we — the current generation — foresee all this, and care about our grandchildren, we’ll choose to (in effect) undo what the government has done by saving our tax cuts and giving them as gifts to our grandchildren (presumably as part of their inheritance). This restores every generation’s consumption to the original status quo.

Ricardian Equivalence is the economist’s jargon for the assertion that we will foresee all of this, and will care about our grandchildren, and therefore will give them our tax cuts as gifts. Nick Rowe’s claim is that unless you make the very strong assumption that Ricardian equivalence holds, government debt enriches us at the expense of our grandchildren.

Here’s why that’s wrong: There’s no “us” that decides whether to save these tax cuts. Some of us can save them, while others spend them. That’s a failure of Ricardian equivalence, but it’s not a burden on all of the next generation. It’s only a burden on that part of the next generation that had greedy grandparents. If you’re not interested in living well at your grandchildren’s expense, then you won’t — and your grandchildren, therefore, won’t suffer.

Here, then, is the main point: Your grandchildren suffer only if you want them to. Bert wants to live well at his grandchildren’s expense; Ernie doesn’t. Therefore Bert spends his tax cut and thanks God for the public debt, while Ernie saves his tax cut and considers the public debt a matter of indifference. In this story, nobody who is alive today actually objects to the public debt. So Nick cannot use this story as a reason for you, me or anyone to become a deficit hawk.

Three more points:

1. This is not to say that government debt won’t affect your grandchildren. If I don’t save my tax cut, my grandchildren will be poorer, which means they’re more likely to turn to your grandchildren to finance their Medicare and Social Security. That’s a real effect—but it’s not the effect Nick is talking about. It can’t be, because he assumed lump-sum taxes (as is standard in these discussions, in order to focus on one issue at a time), which means that he’s ruled out this effect.

   We all agree that deficits can matter because they have redistributive effects and incentive effects. But those are not at all the same as the alleged burden-on-the-next-generation effect — and the real effects are typically much smaller than the imagined effect. (The whole point of assuming lump-sum taxes is to make these agreed-upon effects go away, so we can see what the other effects might be.) So deficits do matter, but not for the “usual” reasons, and not nearly as much as is widely imagined. This is exactly what both Krugman and I said earlier this week.

2. Note that this all plays out exactly the same way whether the American public debt is held by Americans, or by Chinese, or by Martians. Paul Krugman muddied the waters when he pointed out that American debt held by Chinese is largely offset by Chinese debt held by Americans. That might be true, but it has nothing to do with the fundamental issues.
3. There seems to be a widespread assumption (at least among econo-geeks) that Ricardian Equivalence is likely to fail because people misperceive the effects of current tax cuts on future generations. There seems to be a further widespread assumption that all those misperceptions will be in the same direction. But why should that be? Politicians, journalists and bloggers admonish us every day that our grandchildren face disaster because of our government’s fiscal irresponsibility. Some taxpayers will take those warnings too lightly, and therefore undersave; others will take them too seriously and therefore oversave. The grandchildren of the first group will be impoverished by our debt; the grandchildren of the second group will be enriched by it. Who can say which group is larger?

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]]> http://www.thebigquestions.com/2012/01/04/you-your-grandchildren-and-the-public-debt/feed/ 64 http://www.thebigquestions.com/2012/01/03/actually-we-owe-it-all-to-ourselves/ http://www.thebigquestions.com/2012/01/03/actually-we-owe-it-all-to-ourselves/#comments Tue, 03 Jan 2012 07:01:40 +0000 Steve Landsburg http://www.thebigquestions.com/?p=6893 Paul Krugman has a very good column on government debt and why it doesn’t matter nearly as much as many people believe. There’s just one spot in the column where I think Krugman misses the point, and therefore makes a weaker case than he could have made. He writes:

U.S. debt is, to a large extent, money we owe to ourselves.

…

It’s true that foreigners now hold large claims on the United States, including a fair amount of government debt. But every dollar’s worth of foreign claims on America is matched by 89 cents’ worth of U.S. claims on foreigners. And because foreigners tend to put their U.S. investments into safe, low-yield assets, America actually earns more from its assets abroad than it pays to foreign investors. If your image is of a nation that’s already deep in hock to the Chinese, you’ve been misinformed. Nor are we heading rapidly in that direction.

All true, but all beside the point. Even if 100% of U.S. debt were held by foreigners, and even if Americans had no offsetting claims on foreigners whatsoever, the U.S. debt would still be money we owe to ourselves.

To see why, suppose the defense department wants to buy a precision screwdriver for $100 million. The government could, of course, pay for that by raising our taxes. Suppose that instead, they borrow the money from China, implicitly promising to tax us in the future to pay off that debt.

Here’s how that affects you as a taxpayer: It’s exactly as if the government had collected your taxes and then lent them back to you, with a promise that they’ll be along in a few years to collect the debt. Let me say that again: When the U.S. government borrows from Chinese investors, it’s exactly as if U.S. taxpayers had borrowed from the U.S. government. (That is, the effect on Americans is the same either way.) Since the assets of the U.S. government are, ultimately, the assets of the taxpayers, it’s exactly as if the U.s. taxpayers had borrowed from themselves.

Krugman says that we largely owe the debt to ourselves because of offsetting claims by Americans on Chinese assets. I say we entirely (for all practical purposes) owe the debt to ourselves because of general principles that have nothing to do with the existence or non-existence of offsetting claims. We both conclude (for this and other reasons, which are well articulated in Krugman’s column) that the debt is much less of a big deal than partisans on both sides of the aisle would have you believe. In particular, debt, by itself, is not a terribly compelling reason either to cut entitlements or to raise taxes.

As Krugman point out, this is not to say that all government debt is harmless. It is to say that if it’s harmful, it’s harmful for different reasons, and probably to a much lesser extent, than is commonly believed.

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]]> http://www.thebigquestions.com/2012/01/03/actually-we-owe-it-all-to-ourselves/feed/ 57 http://www.thebigquestions.com/2011/12/25/merry-christmas/ http://www.thebigquestions.com/2011/12/25/merry-christmas/#comments Sun, 25 Dec 2011 07:01:32 +0000 Steve Landsburg http://www.thebigquestions.com/?p=6847 Merry Christmas. For those of you who are actually surfing the net today, you might enjoy Art Carden’s Forbes piece on how economists ruined Christmas.

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]]> http://www.thebigquestions.com/2011/12/25/merry-christmas/feed/ 7 http://www.thebigquestions.com/2011/12/23/happy-holidays/ http://www.thebigquestions.com/2011/12/23/happy-holidays/#comments Fri, 23 Dec 2011 07:01:34 +0000 Steve Landsburg http://www.thebigquestions.com/?p=6842 I’ll probably blog very little over the next ten days or so, in recognition of the fact that most of you won’t be reading. (On the other hand, if, say, the New York Times publishes something sufficiently egregious, I might not be able to restrain myself. Meanwhile, for your holiday pleasure, here’s the Christmas column I published in Slate in 2004:
What I Like About Scrooge

Here’s what I like about Ebenezer Scrooge: His meager lodgings were dark because darkness is cheap, and barely heated because coal is not free. His dinner was gruel, which he prepared himself. Scrooge paid no man to wait on him.

Scrooge has been called ungenerous. I say that’s a bum rap. What could be more generous than keeping your lamps unlit and your plate unfilled, leaving more fuel for others to burn and more food for others to eat? Who is a more benevolent neighbor than the man who employs no servants, freeing them to wait on someone else?

Oh, it might be slightly more complicated than that. Maybe when Scrooge demands less coal for his fire, less coal ends up being mined. But that’s fine, too. Instead of digging coal for Scrooge, some would-be miner is now free to perform some other service for himself or someone else.

Dickens tells us that the Lord Mayor, in the stronghold of the mighty Mansion House, gave orders to his 50 cooks and butlers to keep Christmas as a Lord Mayor’s household should—presumably for a houseful of guests who lavishly praised his generosity. The bricks, mortar, and labor that built the Mansion House might otherwise have built housing for hundreds; Scrooge, by living in three sparse rooms, deprived no man of a home. By employing no cooks or butlers, he ensured that cooks and butlers were available to some other household where guests reveled in ignorance of their debt to Ebenezer Scrooge.

In this whole world, there is nobody more generous than the miser—the man who could deplete the world’s resources but chooses not to. The only difference between miserliness and philanthropy is that the philanthropist serves a favored few while the miser spreads his largess far and wide.

If you build a house and refuse to buy a house, the rest of the world is one house richer. If you earn a dollar and refuse to spend a dollar, the rest of the world is one dollar richer—because you produced a dollar’s worth of goods and didn’t consume them.

Who exactly gets those goods? That depends on how you save. Put a dollar in the bank and you’ll bid down the interest rate by just enough so someone somewhere can afford an extra dollar’s worth of vacation or home improvement. Put a dollar in your mattress and (by effectively reducing the money supply) you’ll drive down prices by just enough so someone somewhere can have an extra dollar’s worth of coffee with his dinner. Scrooge, no doubt a canny investor, lent his money at interest. His less conventional namesake Scrooge McDuck filled a vault with dollar bills to roll around in. No matter. Ebenezer Scrooge lowered interest rates. Scrooge McDuck lowered prices. Each Scrooge enriched his neighbors as much as any Lord Mayor who invited the town in for a Christmas meal.

Saving is philanthropy, and—because this is both the Christmas season and the season of tax reform—it’s worth mentioning that the tax system should recognize as much. If there’s a tax deduction for charitable giving, there should be a tax deduction for saving. What you earn and don’t spend is your contribution to the world, and it’s equally a contribution whether you give it away or squirrel it away.

Of course, there’s always the threat that some meddling ghosts will come along and convince you to deplete your savings, at which point it makes sense (insofar as the taxation of income ever makes sense) to start taxing you. Which is exactly what individual retirement accounts are all about: They shield your earnings from taxation for as long as you save (that is, for as long as you let others enjoy the fruits of your labor), but no longer.

Great artists are sometimes unaware of the deepest meanings in their own creations. Though Dickens might not have recognized it, the primary moral of A Christmas Carol is that there should be no limit on IRA contributions. This is quite independent of all the other reasons why the tax system should encourage saving (e.g., the salutary effects on economic growth).

If Christmas is the season of selflessness, then surely one of the great symbols of Christmas should be Ebenezer Scrooge—the old Scrooge, not the reformed one. It’s taxes, not misers, that need reforming.

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