Fiscal Policy and Everything Else

2024-05-27

All the things I write the most about, whether it is monetary policy, climate change policy or trade/industrial policy, all involve fiscal policy.

1.    Monetary policy works best when fiscal policy responds predictably to changes in monetary management of supply and demand shocks.  And it helps if lurches in fiscal policy do not _become_ such a shock.

2.    The least-cost way to get to net zero CO2 emissions is taxing them and using the tax rate as a shadow price for any non-tax regulatory interventions or public investment or subsidies.  And those investment use real resources that have to come from somewhere.

3.    One of the most important trade measures is the real exchange rate and fiscal policy is an important determinant.  Industrial policy is basically targeted public investments and subsidies.  Again this is the use of resources that the government mobilized for this purpose

Therefore, I was particularly interested in Lael Brainard’s address to the Hamilton Project, a Brookings initiative that, “offers a strategic vision and produces innovative policy proposals on how to create a growing economy that benefits more Americans.”  Notwithstanding her technocratic background – MIT, Treasury, member of the Fed’s Board of Governors -- she made a thoroughly political presentation to the effect that Biden fiscal proposals for 2025 are better that Trump’s.  In this she succeeded in clearing one of the lowest bars imaginable.  In the remainder of this mainlyu critical post, let it be stipulated that Biden’s proposals are less bad than Trump’s and some are positive.

I will, however, criticize Brainard’s rhetoric for referring to Republican tax policies, even though meant as a pejorative, as “Trickle Down.”  “Trickle Down” implies that at least _some_ additional wealth is being created and poured like vinaigrette over the rich who do not manage to absorb all of it, allowing a bit to drip down on the rest.  This totally mistakes the effect of the Reagan, Bush, and Ryan-Trump policies of tax cuts for the rich and deficit creation.  Deficits destroy wealth; they represent the shift of resources from investment to consumption; that makes future incomes lower than otherwise.  Therefore, the benefits to the rich – and they were massive – were pure upward redistribution.

Now let’s look at the five principles of tax policy Brainard enunciates.

First, our tax system should be fair. It should reward work, not wealth. It should give tax cuts to working- and middle-class families to give them a fair shot while asking the wealthiest households to pay their fair share

So far so good. Three rounds of Republicans cutting taxes on the rich does mean that we need to make the personal taxes more progressive, collecting more from the already well off.  The problem is the accompanying “pledge” not to raise taxes on anyone making more than $400,000.  This is pretty silly even if meant to apply only to personal income tax rates as many reforms touch what is counted as “income.”  But more, the size of the deficit – 6.2% for fiscal 2023 (mercifully smaller than Trump’s pandemic deficit of 14.7% in 2020 and Biden’s relief of 11.8%in 2021) -- is far too big to deal with by collecting revenue only from those receiving more than $400,000. 

The “pledge” would be even worse if it were applied to all taxes.

Less problematic is the proposal to extend subsidies for purchases on health insurance under Affordable Care Act (not “Obamacare” as it was in fact a very clever idea of the erstwhile serious Heritage Foundation) and Child Tax Credits that Brainard labels as “tax cuts,” (as if that were a good thing!) but are really just expenditures managed by the IRS instead of HHS.  If paid for with other taxes as sort of promised in point 2 below, both make perfect sense.

Second, tax policy in 2025 should raise revenue consistent with the President’s strong commitment to fiscal responsibility.

Hooray!  But unfortunately, the way that cashes out is, again, higher taxes on the rich (good but not enough) and raising corporate tax rates.  Wrong!  Business income corporate or otherwise is income of its owners.  Business income should not be taxed at the firm level.  It should be imputed to owners and taxed there at the owner’s marginal tax rate.  The janitor with a pension fund and the CEO of the company where they work have different marginal tax rates; why tax them at the intermediate “corporate” rate.  It is unfair for the former and an unjustified break for the latter.

In addition, the corporate income tax code is splattered with exemption, loopholes, and special treatment that mean that investments are distorted and do not have the same before-tax rate of return for every activity, a basic principle of economic efficiency.  If some corporate activity generates a positive externality – reducing net CO2 emissions for example -- that we wish to encourage, we should give it as a straight subsidy linked to the externality that will flow through to owners, not a special tax treatment of _investment in_ technology to increase the externality. At zero there is no distortion.

Brainard under this point takes a well deserve pot shot at Republic plans to narrow the deficits of the Social Security, Medicare by reducing benefits.  Unfortunately, may say “cowardly” she is silent on what _Biden_ will do to close this deficit.

Third, corporations that are making record profits should contribute their fair share.

I have already pointed out that corporations, per se, should pay nothing.  Their “fair share” is zero.  Fairness comes at the level personal taxes levied on owners.  If Republicans planned to further reduce corporate rates AND would make up the lost revenue with higher personal taxes, I’d give them this one on points.  If pigs could fly!  Three tax cuts over 40 years show what Republican notions of “fairness” lie: upward redistribution, growth be dammed.

Fourth, taxpayers should pay what they owe and play by the same rules.

This refers to Biden’s giving IRS more resources to detect and penalize tax fraud.  Whether its shoplifting or cheating on your taxes, the best way to prevent it is certainty of apprehension.  This is one of the best things Biden has done and it infuriates Republicans.  The fury itself is not a good thing but is does indicate that Biden was onto something that would nibble at the incomes of the rich.

Finally, our tax system should avoid an international race to the bottom on tax.

No, provided as always that the revenue lost from reducing corporate taxes is made up (or more!) with personal taxes the US should _lead_ the race. But with straight rate reductions, not phony repatriation rules.

So much for what Brainard said.  Let me go on to what Brainard _should_ have said.  As you may guess, I want the sum of these measure to essentially eliminate [1] the federal deficit.

Make the progressive personal income tax a progressive _consumption_ tax.  To move along this continuum means allowing much higher contributions to savings plan.

Tax capital gains as ordinary income but a) index the gains for inflation and b) use the taxpayer’s average marginal rate over the holding period.  No rebasing on inheritance, but no tax until realized.

Tax favored consumption – mortgage interest (if that’s desirable), charitable contributions, medical expenses -- should be given as partial tax credits, not deductions from taxable consumption.  The favored consumption dollar should be as valuable to the person with the lowest level of consumption as to the one with the highest.

Transfers of consumption to people in time and circumstance of special need – advanced age, illness, disability/special needs, unemployment, child rearing years -- should be financed with a VAT, replacing the wage tax or

other financing forms now in use.

Levy Pigou taxes on negative externalities, especially net emissions of CO2 and methane.

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No, I have not forgotten that deficits can be reduced by lower spending.  But even the worst -- farm price supports, ethanol subsidies, subsidized flood insurance, failure to price Western water at its scarcity value -- are inefficient in themselves and should be eliminated on those ground, but their effect on the deficit does not, as we say in East Texas, “amount to a hill of beans.”

[Standard bleg:  Although my style is know-it-all-ism, I do sometime entertain the thought that, here and there, I might be mistaken on some minor detail.  I would welcome comments on these views.]

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[1] My deficit rule is that it should be no larger than the sum of investments with NPV > 0