TaxProf Blog

Editor: Paul L. Caron, Dean
Pepperdine University School of Law

Saturday, March 29, 2014

Krugman and Mankiw Debate Optimal Tax Theory, Economic Models, and Civility

New York Times:  Wealth Over Work, by Paul Krugman (Princeton):

It seems safe to say that Capital in the Twenty-First Century, the magnum opus of the French economist Thomas Piketty, will be the most important economics book of the year — and maybe of the decade. Mr. Piketty, arguably the world’s leading expert on income and wealth inequality, does more than document the growing concentration of income in the hands of a small economic elite. He also makes a powerful case that we’re on the way back to “patrimonial capitalism,” in which the commanding heights of the economy are dominated not just by wealth, but also by inherited wealth, in which birth matters more than effort and talent. ...

Despite the frantic efforts of some Republicans to pretend otherwise, most people realize that today’s G.O.P. favors the interests of the rich over those of ordinary families. I suspect, however, that fewer people realize the extent to which the party favors returns on wealth over wages and salaries. And the dominance of income from capital, which can be inherited, over wages — the dominance of wealth over work — is what patrimonial capitalism is all about. 

To see what I’m talking about, start with actual policies and policy proposals. It’s generally understood that George W. Bush did all he could to cut taxes on the very affluent, that the middle-class cuts he included were essentially political loss leaders. It’s less well understood that the biggest breaks went not to people paid high salaries but to coupon-clippers and heirs to large estates. True, the top tax bracket on earned income fell from 39.6 to 35 percent. But the top rate on dividends fell from 39.6 percent (because they were taxed as ordinary income) to 15 percent — and the estate tax was completely eliminated. ...

This tilt of policy toward the interests of wealth has been mirrored by a tilt in rhetoric; Republicans often seem so intent on exalting “job creators” that they forget to mention American workers. ...

Many conservatives live inside an intellectual bubble of think tanks and captive media that is ultimately financed by a handful of megadonors. Not surprisingly, those inside the bubble tend to assume, instinctively, that what is good for oligarchs is good for America.

Not Class Warfare, Optimal Taxation, by Greg Mankiw (Harvard):

Today's column by Paul Krugman is classic Paul: It takes a policy favored by the right, attributes the most vile motives to those who advance the policy, and ignores all the reasonable arguments in favor of it.

In this case, the issue is the reduction in capital taxes during the George W. Bush administration. Paul says that the goal here was "defending the oligarchy's interests."

Really? As Paul well knows, there is a large literature in economics suggesting that an optimal tax system imposes much lower taxes on capital income than on wage income (or consumption).

New York Times:  Too Much Faith In Models, Capital Taxation Edition, by Paul Krugman (Princeton):

Yesterday I offered a rousing defense of the use of simplified models in economics. So maybe it’s appropriate that today I offer a caution: you should use models, but you should always remember that they’re models, and always beware of conclusions that depend too much on the simplifying assumptions. And I have a case in point, which ties into one of my other big concerns: the appropriate taxation of capital income.

Greg Mankiw is upset at my suggestion that the Bush administration was motivated by class interests in its determination to slash taxes on capital income and eliminate estate taxes. He wants us to know that it was all about optimal taxation, as dictated by economic theory.

Well, we could have a political discussion: How many people really, truly believe that George W. Bush chose to slash taxes on dividends and phase out the inheritance tax because Greg Mankiw and Glenn Hubbard told him that this was the conclusion from economic theory? Can we have a show of hands?

But let me instead point out that the case for zero or low taxation of capital income rests on very strong, very unrealistic assumptions — basically perfectly rational intertemporally optimizing agents, with dynasties behaving as if they were infinitely lived individuals. Question those assumptions, and the whole case falls apart. Don’t take my word for it — read Peter Diamond and Emmanuel Saez, who also point out that the intertemporal optimizing model of saving is in fact rejected by lots of evidence. ...

The point here is that the economic case for not taxing capital rests on a stylized model that we know does a bad job of capturing real behavior; the case for taxing capital rests on considerations of equity and concerns about excessive concentration of wealth that are very much grounded in real-world observation. You don’t have to be a know-nothing to argue that the second case trumps the first.

Using models without believing that they represent The Truth is hard; it’s very easy to fall off that tightrope one way or the other. But it’s what you have to do if you want to do useful economics.

Too Little Faith in People, Tax Policy Edition, by Greg Mankiw (Harvard):

Paul Krugman responds to my post about a recent column of his.  He is correct that not all economists agree that low capital taxation is desirable; he appropriately cites Diamond and Saez, who are on the high-capital-tax side of this debate. FYI, here is another recent paper, written in part as a response to Diamond and Saez, which finds that optimal rates of capital taxation, while positive, are quite low.

But that is not really the issue. If Paul had said "reasonable economists disagree, here are the arguments, and here is why I tend to favor one side rather than the other" I would not have objected.  Instead, in his original column, he wrote as if there were no reasonable arguments for the policy pursued by the Bush administration, and he attributed the most vile motives to those who advanced the policy.

This episode illustrates a fundamental difference between Paul and me.  I try not to assume the worst in other people, just because they disagree with me.

New York Times:  America’s Taxation Tradition, by Paul Krugman (Princeton):

As inequality has become an increasingly prominent issue in American discourse, there has been furious pushback from the right. Some conservatives argue that focusing on inequality is unwise, that taxing high incomes will cripple economic growth. Some argue that it’s unfair, that people should be allowed to keep what they earn. And some argue that it’s un-American — that we’ve always celebrated those who achieve wealth, and that it violates our national tradition to suggest that some people control too large a share of the wealth. ...

The truth is that, in the early 20th century, many leading Americans warned about the dangers of extreme wealth concentration, and urged that tax policy be used to limit the growth of great fortunes. ...

Nor was the notion of limiting the concentration of wealth, especially inherited wealth, just talk. In his landmark book, Capital in the Twenty-First Century, the economist Thomas Piketty points out that America, which introduced an income tax in 1913 and an inheritance tax in 1916, led the way in the rise of progressive taxation, that it was “far out in front” of Europe. Mr. Piketty goes so far as to say that “confiscatory taxation of excessive incomes” — that is, taxation whose goal was to reduce income and wealth disparities, rather than to raise money — was an “American invention.” ...

So how did such views not only get pushed out of the mainstream, but come to be considered illegitimate? Consider how inequality and taxes on top incomes were treated in the 2012 election. Republicans pushed the line that President Obama was hostile to the rich. “If one’s priority is to punish highly successful people, then vote for the Democrats,” said Mitt Romney. Democrats vehemently (and truthfully) denied the charge. Yet Mr. Romney was in effect accusing Mr. Obama of thinking like Teddy Roosevelt. How did that become an unforgivable political sin?

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When CS Lewis was being pestered by JBS Haldane for not having the proper positive attitude towards Stalin, he came up with the word "Bulverism".

Bulverism is now one of the several named varieties of the argumentum ad hominem – broadly, the evasion of the actual topic by directing the attack at your
opponent. The particular ad hominem called Bulverism: rather than engaging someone’s argument, the opposing debater assumes the argument is wrong, and tries to ascribe a character flaw to the opponent that leads him to make this wrong-headed claim. This is the URL for the CS Lewis essay in which he defined
Bulverism, and which readers of this blog may find fun:

Posted by: Dave Schutz | Mar 30, 2014 8:05:20 AM

I find it most amusing to see Krugman furiously attack his opponents because of rising inequality because he favors the very Obamunist policies that have so clearly worsened the outcome he most decries. Ironic - soon you will be Hamlet!

Posted by: Orson | Mar 31, 2014 4:59:06 AM

Krugman was warning against inflation 10 years ago and even traded in his variable rate mortgage for a fixed rate - a dumb move by any measure, in retrospect. Now that a Democrat is President he's as certain as he was 10 years ago.....but of the exact opposite view. It's comical that he's still taken seriously as anything more than a partisan pundit.

Posted by: East Bay Jay | Mar 31, 2014 10:58:27 AM

I'd say Dr. Krugman has the better of the argument. The Bush tax cuts are the single thing most responsible for the budget deficit other than the reduced tax receipts of the recession itself. Even more than the wars which were fought entirely on credit.

Given the deficits generated by the Bush tax cuts, there was either a colossal, and I mean colossal, miscalculation of the revenue effects of the cuts, or Dr. Krugman is correct; the Bush tax cuts were motivated by class interests. Pretty plainly the second is more likely than the first.

Posted by: jimharper | Mar 31, 2014 11:34:58 AM

Krugman's nostrums seem dedicated to the erection of the very patrimonal shell-games he claims to decry - namely, the assault on productive investment, in favor of government-licensed and tax-policy-favored investment classes designed to preserve established wealth (IE, government and municipal bond funds, politically-directed investments in renewables and other "virtuous" gentry causes), all the while proclaiming the moral value of these favored investment classes.

Meanwhile, the "striving" entrepreneurial investments which might result in the disruptive creation of new wealth are to be suppressed, taxed, and generally hazed by their established betters. Frankly, I think Mankiw's disinclination to throw ad hominem stones leaves him disarmed in the face of the Krugmans of this world. Their motives *should* be impugned, because something sharp is required to cut through the cocoon of self-curiated ecomiums they wrap around themselves.

Posted by: Mitch H. | Mar 31, 2014 11:39:58 AM

It's not as if Democrats tax the he11 out of rich people - just ask Jeffry Immelt, Timmy Geithner, Harry Reid - my fingers grow tired...

Posted by: Psuedonym | Mar 31, 2014 12:14:28 PM

Nice point about Bulverism! Notice how Krugman also keeps appealing to "widely" held viewpoints (in his formulation, that means his own), and also political necessity? In other words, rather than believing something because it's true, believe it because my opponents are evil, lots of my allies agree with me, and because it's politically advantageous for my opponents to say what they do.

To me, this gives a much better view into the mind of Paul Krugman than into the minds of his opponents. If he had good arguments to make, surely he'd simply make them? Instead, he paints a picture of scheming propagandists advancing The Cause in the face of a hostile public. Which sounds much more like Paul Krugman than Greg Mankiw.

Posted by: asdf | Mar 31, 2014 12:29:26 PM

>>Given the deficits generated by the Bush tax cuts, there was either a colossal, and I mean colossal, miscalculation of the revenue effects of the cuts, or Dr. Krugman is correct; the Bush tax cuts were motivated by class interests. Pretty plainly the second is more likely than the first.<<

What makes that plain?

Posted by: Squints | Apr 1, 2014 8:14:09 AM

What makes it plain? I presume that no competent or honest economists would support tax cuts that create larger deficits than the recent stimulus package and even larger than the cost of two wars, absent some kind of transitory economic emergency greater than the recent economic collapse. That clearly wasn't present when EGTERRA was passed. The architect and steward of the cuts, Glenn Hubbard and Greg Mankiw are respectively the chairs of the Columbia business school and the Harvard economics department. They aren't incompetent, so the solution is that they were venal.

Posted by: jimharper | Apr 1, 2014 4:46:10 PM

"Not wrong, not ever" isn't mere competence. It's infallability. That's a high bar for testing good faith.

Venality on the scale suggested would be a disqualifier from the chairmanship of the Economics Departments at Harvard or Columbia. I'd think so, anyway. But I assume those fine institutions know more than I about the gentlemen.

The only FY deficits during GWB term north of $400B were in FYs 2004 and 2008, the latter being pre-crisis but certainly mid-recession. (WH Budget tables, 2014.) Adjusting for the military exercises would make them smaller still. I'd have to see better documentation of purported revenues foregone on account the 2003 tax cuts. The bump in the deficit from FY 2002 (most of calendar 2003) to FY2003 was $220 billion. The increase in outlays alone was $149 billion, with revenues falling by only $72 billion. I don't see that even on an inflation adjusted basis that those numbers are larger than any purported stimulus since FY 2010 (Not FY 2009, in fairness to the current administration).

Posted by: Squints | Apr 2, 2014 1:12:54 PM

If EGTERRA isn't the worst economic decision in the past fifteen years, it's definitely in the top three. Yes, you would think being the architects of such a failure would be a career-stopper. Its anything but. That's the problem. There's good money in bad economics.
To be sure, vast amounts of money is corrupting, but that's no excuse. We as tax professionals don't give a million dollar advance on a textbook to the guy who concocted the third worst tax shelter scheme of the past fifteen years, let him shrug his shoulders and say, "Its all a matter of opinion." The economists do and its a real black mark on their profession.

Posted by: jimharper | Apr 3, 2014 11:13:28 AM

Again, I'm not seeing evidence, in the mere bourgeois facts of the actual data, of the adverse revenue effects on anything resembling the scale you assert. Never mind any alleged tax-sheltering policies, examples of which aren't offered. The major components of that bill were the rate reductions for ordinary income, dividends and capital gains. Those aren't "shelters." Those are straightforward rate reductions.

Venality appears to be not so much a conclusion as a premise.

Posted by: Squints | Apr 3, 2014 11:45:09 AM

I'm surprised anyone would deny the deleterious effect the Bush tax cuts had on our deficits. The effect was well-known and predicted at passage. The bill of course, had the the intellectual backing of Drs Hubbard and Mankiw.
The deficit-making nature of the Bush tax cuts was known at the time of its passage That's why the law had an unusual sunset provision to disguise its true effects to the ten year budgeting analysis required by the Senate.

The circumstance of EGTERRA being responsible for more deficit is described in the Washington Post.

So Drs Hubbard and Mankiw can't say they weren't warned, because they were warned. They can't say they didn't know because they knew. They did respond to class interests. It shouldn't require some kind of a celebrity economist to point out their catastrophic gaffe. Tax professionals would not hesitate to point this out among their own. Economists should have the backbone to own up to this too.

Posted by: jimharper | Apr 3, 2014 5:08:13 PM