Thursday, September 08, 2011

Real Equivalence? Taxing the Rich During a Recession

-- Posted by Neil H. Buchanan

Last Thursday, in my Verdict column and my companion post here on Dorf on Law, I discussed Warren Buffett's recent call to increase taxes on the wealthy (including himself). My focus in both pieces was on the personal nature of the attacks on Buffett, especially the claim that he should not call for higher taxes on the wealthy in the name of improving the government's finances, because he is free to give the government his money voluntarily, without imposing his values on other wealthy people. The superficial appeal of that argument is difficult to counteract in a soundbite, yet it is utterly without merit. However, in a world where certain politicians continue to repeat other meritless attacks on, say, evolution or global warming, we should hardly be surprised by the repetition of these embarrassingly silly attacks on Warren Buffett.

My writings last week were ultimately concerned with the nature of taxation, especially the false idea that taxes are little more than voluntary contributions to a charity called the government. Today, I turn to the direct merits of Buffett's argument. His policy prescription, as I described last week, is based on two premises: first, that it is necessary to reduce the deficit right away, and second, that the wealthy are currently undertaxed.

As an unrepentant Keynesian economist, I am generally opposed to the idea that it is important to close budget deficits when the economy is weak (even setting aside the question of the appropriate long-term deficit target). What, then, is the argument for taxing the wealthy now? To analyze that question, I will first assume away what are admittedly the most interesting aspects of the current situation, in order to tease out what really motivates calls for taxing the rich under a variety of conditions.

Suppose that the economy were perfectly healthy (under whatever definition of health one prefers, including being at an acceptable level of "full employment," and so on). Suppose further that the tax system had already been calibrated to reflect a broad social consensus about the appropriate after-tax distribution of income, taking into account any efficiency/equity tradeoffs and anything else that one might care to include. If the economy then fell into a tailspin, with the inevitable increase in the budget deficit that would ensue, what should the government do?

The standard Keynesian concern is that trying to reduce the deficit by either cutting spending or increasing taxes across the board will worsen the downturn. Given that wealthy taxpayers are not constrained in their spending, however, there is little or no danger that increasing taxes on the wealthy would reduce their consumption or harm the economy. Essentially, a tax on rich people would simply transform their private saving into public saving, reducing the government's deficit without worsening the recession.

Even if all of those assumptions are true, however, it is still unclear why it is important to tax anyone at all during a recession. If, as now, there is no evidence that the federal government is anywhere near a market-imposed limit on its overall borrowing, we could leave taxes on the rich unchanged for the duration of the downturn, taking whatever steps are necessary to bring about recovery in the meantime, and wait to return to happy days with the tax system's overall degree of progressivity (with which, by assumption, we were quite satisfied before the recession began) intact.

One argument for adjusting taxes in this hypothetical situation would be to smooth overall government borrowing over the long term. If one believes that any negative consequences of deficits are nonlinear (that is, that they become increasingly bad as levels of borrowing go up), then the idea would be to temporarily increase taxes on the rich. Importantly, however, this would require us to temporarily decrease taxes on the rich after the economy regains its stride, so that the overall progressivity of the tax system would be maintained.

Of course, if we were worried about nonlinear harms from temporary increases in the government's deficit, we would also need to worry about nonlinear consequences of temporarily high taxes on the wealthy. If, for example, there is any merit at all to trickle-down economics, then it is possible that taxing the wealthy at unusually high levels could harm the economy in a way that outweighs the benefits of reducing recession-inflated deficits.

The argument, then, for taxing the wealthy during a recession -- again, under the completely unrealistic assumption that we were happy with the distribution of incomes before the recession began -- ultimately rides on some rather obscure empirical questions. We could smooth long-term borrowing by taxing the rich, but it is not clear that doing so is even beneficial on its own terms, much less that it is beneficial enough to outweigh potential harms. The case for any change in taxes is, at the very least, not a slam dunk.

Back in the real world, we know that the distributions of income and wealth have been becoming ever more skewed over the past generation or so (essentially, ever since the Reagan era began). We also know that those who believe in trickle-down economics (as well as those who merely claim to believe in that theory, in the service of allowing the wealthy to reduce their tax burdens) are ever on the march.

Those of us who believe in progressive redistribution will, under current conditions, see Buffett's call not as a means to reduce the budget deficit, but rather as a welcome recognition that the tax system is -- and has long been -- skewed toward preserving this country's highly unequal distributions of income and wealth. Of Buffett's two premises above -- deficits must go down, and the wealthy are getting special treatment and could easily shoulder more of the burden -- only the second one has real purchase. In that very limited sense, therefore, the call for increased taxes on the wealthy because of the economy's condition today is opportunistic, using the recession's effects as a reason to increase progressivity for what are really non-recession-related reasons.

Those who oppose taxes on the rich would thus appear to be engaged merely in mirror-image opportunism, using the recession as an excuse to reduce taxes on the wealthy "to spur job creation," when in fact their goal is to reduce taxes on the wealthy even when there is no need to create new jobs.

In light of my recent blog posts decrying "false equivalence," therefore, this is a surprising instance where there appears to be genuine equivalence. People who favor greater progressivity would use the recession to achieve their long-cherished goals, just as those who would redistribute downward now claim that tough times require tax cuts for the rich.

The equivalence, however, ends there. The forces of regressivity are not merely trying to reduce taxes on the wealthy (or, at least, prevent even mild increases in taxes on the wealthy) but to take away from the non-wealthy, too. All of the false claims about "half the people don't pay taxes," as well as calls to cut spending on programs that help the middle-class and the poor -- especially the bizarre and cruel insistence on holding disaster relief spending hostage to cutting other spending that helps the non-rich -- are not only inhumane but affirmatively damaging to the economy.

Even though the calls for increasing the progressivity of the tax-and-spending system are ultimately independent of the state of the economy, therefore, at least they would not actually damage an already weak economy. By contrast, the regressive agenda is not only wrong on its broader merits, but it is uniquely damaging today. Even if both sides are using the recession as an excuse to get what they really want, only one side would do so by making matters worse. That is the worst combination of greed and cynicism.


Charles said...

Any thoughts on the paper here?

All our data are from the OECD 1997Economic Outlook Database (1997). Our sample includes 18 countries: Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Japan, the Netherlands, Norway, Spain, Sweden, United Kingdom, and United States, and covers a maximum time span from 1960 to 1996...

...After the fiscal profligacy of the seventies and eighties, several OECD countries have stabilized and reduced their debt to GDP ratios by means of large fiscal adjustments. In contrast to the prediction of standard models driven by aggregate demand, many fiscal contractions have been associated with higher growth, even in the very short run. Similarly, economic activity slowed during several episodes of rapid fiscal expansions...

...First, increases in public spending increase labor costs and reduce profits. As a result, investment declines as well...Second, increases in taxes reduce profits and investment...Labor taxes have the largest impact on profits and investment. Third,...fiscal stabilizations that have led to an increase in growth consist mainly of spending cuts, particularly in government wages and transfers, while those associated with a downturn in the economy are characterized by tax increases...

Neil H. Buchanan said...

My thanks to Charles for his query and the link. Unless something big comes up between now and next Friday, I'll address these issues then. (I have a 9/11 post for tomorrow, and a companion post to my next Verdict column set for next Thursday.) The short answer is that the paper Charles cites is actually very supportive of my position, even though it might not seem to be.

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