Friday, July 30, 2010

Mankiw's brilliance

Greg Mankiw nails it
To Obama-administration economists, as well as to many others, the recession that followed the financial crisis of 2008 seemed like a classic case of decline in aggregate demand. Because of the credit crisis, people were not able to obtain loans — for homes, cars, business equipment, or any of the countless other transactions that rely on credit in today's economy. And because people were unable to obtain loans, these sales and purchases couldn't take place, resulting in a significant drop in demand across the economy.

So, inspired by the view that fiscal policy can prop up aggregate demand, Obama's advisors (and their congressional allies) began to design a stimulus plan heavy on direct government spending. A few days before President Obama's inauguration, his economic advisors released a document titled "The Job Impact of the American Recovery and Reinvestment Plan," in which they detailed some of their economic assumptions. They determined that the "government-purchases multiplier" — that is, the multiplier for direct spending — would be 1.57, while the tax-cut multiplier would be 0.99. In other words, every dollar spent by the government would yield $1.57 in aggregate demand, while every dollar in reduced taxes would yield only 99 cents in increased demand. And because 1.57 is larger than 0.99, the Obama team concluded it was better to increase spending than to cut taxes.

Obama and his advisors arrived at these numbers through a standard macroeconometric model of the sort economists have been using for years. Such models take various past relationships among economic variables (inflation and unemployment, for instance) and extrapolate them into the future. In essence, the economy is modeled as a system of equations, each describing how one variable responds to many others. University of Chicago economist (and Nobel laureate) Robert Lucas famously criticized these models for lacking an appreciation of people's changing expectations; many economists, however, still find such models valuable, and have continued to employ them for forecasting and policy analysis.

The question for economists now is whether the administration's assumptions, and the model based on them, were correct. After all, if we could be sure their model was right, we would know what to conclude when their stimulus plan was followed by 10% unemployment: The patient was sicker than they thought, and unemployment would surely have been higher still if not for the stimulus. (Indeed, since Obama's advisors do believe their model was right, this is the conclusion they have reached.)

The trouble is, we have no way of knowing for sure if the model was in fact correct.

Corporate executive schools Krugman

Warren Meyer:
Here is my first law of economic growth: When we encourage more investment, and ensure this investment is being channeled to the most productive uses, growth will follow.

For all the talk about fiscal stimulus and jobs creation at the federal and state level, almost no one in government is doing anything about reducing the roadblocks to investment. For example, millions of people are newly unemployed, and in past recessions a large number of these folks have eschewed looking for a new corporate job and have started businesses of their own. Unfortunately, such prospective entrepreneurs will face a tangle of registration, regulatory and licensing hurdles, many of which have been backed by established businesses that want to avoid just this kind of new competition. Even steps like the extension of unemployment benefits tend to discourage such entrepreneurship by increasing the opportunity cost of working for oneself.

Some people never learn.

Wednesday, July 21, 2010

State taxes do not matter?

Richard W. Rahn at the Cato Institute:
Why is it that some of the states with the biggest fiscal problems have the highest individual state income tax rates, such as New York and California, while some of the states with the least fiscal problems have no state income tax at all? High-tax advocates will argue that the high-tax states provide much more and better state services, but the empirical evidence does not support the assertion. On average, schools, health and safety, roads, etc. are no better in states with income taxes than those without income taxes. More importantly, the evidence is very strong that people are moving from high-tax states to lower-tax-rate states — the migration from California to Texas and from New York to Florida being prime examples. (Next year, the combined federal, state and local income tax rate for a citizen of New York City will be well over 50 percent, as contrasted with approximately 38 percent for citizens of Texas and Florida.) If the citizens of California and New York really thought they were getting their money's worth for all of the extra state taxation, they would not be moving to low-tax states.

The obvious question then is: Where is all the extra money from these state income taxes going? It is going primarily to service debt, and to pay for inflated salaries and employee benefits. It is interesting that the high-tax-rate states also, on average, have much higher per capita debt levels than states without income taxes. (Alaska is an outlier because it has its oil reserve to borrow against and actually gives its citizens a "dividend" each year.)

Wednesday, July 7, 2010

How business leaders view tax credits

The best take-away is from Todd Dagres, General Partner, Spark Capital:

“I am not a big fan of tax incentives because they are a Band-Aid for an unfavorable tax environment.”

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