. . . for public choice problems addressing long run fiscal issues.
Matt Yglesias has a post on consumption taxes:
The great egalitarian political philosopher John Rawls wrote that he preferred the idea of a consumption tax to an income tax “since it imposes a levy according to how much a person takes out of the common store of goods and not according to how much he contributes.” In response to a very similar argument from Scott Sumner, a smart Steve Roth post replies that financial saving is not the same as saving real resources:
This makes absolutely no sense. If you forego a massage this week, or wait a few years to get your house painted, is the labor for that massage or paint job “saved”? How about this year’s sunlight “” the ultimate source of that labor power? Can you use it next week, or next year? Understand: services comprise 80% of U.S. GDP. And that’s before you even think about Apple and similar, with their just-in-time, on-demand supply chains “” when you buy it, and only when you buy it, they produce it.
If you don’t buy it, it doesn’t get produced.
I think that to understand the Sumner/Rawls view you have to remember that both are assuming that the economy is always operating at full employment. Rawls doesn’t specifically say anything about this, but it’s the only way to make his viewpoint make sense. Sumner writes extensively about business-cycle issues, however. One of his main themes is that a competent central bank can always guarantee full employment and that it always should guarantee full employment in part because the full employment macroeconomy of steady national GDP growth is one in which all these nifty neoclassical ideas actually work. So the way the story goes is that the people thrown out of work when you switch from consuming to saving will be reemployed in the production of capital goods. We all become thriftier, stop dining out so much and start cooking at home, and all those unemployment cashiers and waitresses get jobs building houses and manufacturing tractors. Thus society’s stock of capital goods does in fact increase through a big shift toward a higher savings rate.
I absolutely do not assume the economy is at full employment when advocating consumption taxes. And “financial saving” is a meaningless term, so I won’t comment on that. Saving is saving; it is defined in all the textbooks as the funds that go into investment. (You are free to have your own definition.) There are actually three errors embedded in the Roth/Yglesias critique:
1. There is no paradox of thrift, so saving doesn’t cause higher unemployment. Oddly, the most common error on this topic is exactly the opposite; most people think high saving/CA surplus economies steal jobs from low saving economies, a view that is equally wrong. Periods of higher than normal unemployment are caused by either NGDP shocks (bad monetary policy) or bad supply-side policies (think France/Italy/Spain.)
2. OK, most old-style Keynesians don’t agree with me on the paradox of thrift, but today even old-style Keynesians accept the natural rate hypothesis, which says than demand doesn’t affect the long run average level of output, just the volatility. So even if higher saving did cause high unemployment, it would have no bearing on long run decisions over what sort of tax regime to implement, which affect the level of saving, not the volatility.
3. Now let’s say I’m wrong about both the paradox of thrift and the natural rate hypothesis. Suppose that we are permanently at the zero bound and the central bank is too conservative to push unemployment all the way down to the natural rate, but instead targets an unemployment rate that is 2% above normal. (Put aside the question of why wages and prices don’t eventually adjust. Let’s suppose there is some sort of “hysteresis” that keeps the unemployment rate fluctuating around a trend line 2% above normal.) In other words, I’ll take the most extreme Keynesian assumption I can think of. What then? Even in that case a consumption tax is optimal. Even if we are not at full employment. That’s because what matters is not the level of saving but rather changes in the share of GDP that is saved. And in the long run those net out to zero.
The day we start making long run optimal tax regime decisions based on their implications for the business cycle is the day we become a banana republic.
Much better are Yglesias’s comments on the difficulty of distinguishing between consumption and investment. Of course to some extent those problems are just as severe for an income tax (think 3 martini lunches, corporate jets, etc.) FWIW, I’m actually pretty progressive on those questions. I favor treating education as
consumption investment (no VAT) and business lunches and corporate jets as consumption.) BTW, when proposing egalitarian income redistribution programs, do progressives allow the perfect to be the enemy of the good? Obviously not, and I salute them for that attitude.
[The original version had a typo of consumption instead of investment for education]
I should comment on one of Roth’s statements:
This is not really revelatory; I know these economists understand the paradox of thrift.
But they ignore and eschew it in their real-good, barter-based mental economic models. I would suggest that the explanation for this error of composition is revealed by Scott’s words: “morally grotesque.” Moralistic beliefs about how individual humans should behave make it impossible for many economists to embrace an aggregate economic reality of which they are fully cognizant.
I do agree that beliefs about what is “morally grotesque” make it impossible for economists to “embrace an aggregate economic reality of which they are fully cognizant,” which is why I ignore all progressive analysis of income inequality.
More seriously, it’s not so much that I have moralistic beliefs about how people should behave, but rather how they should be treated by the state. I believe that people should not have to pay a higher tax rate simply because they prefer future consumption to current consumption.
PS. For you new readers, Yglesias was stretching the truth a bit when he said I favored having the central bank “guarantee” full employment. I favor NGDP targeting, which would (hopefully) minimize sub-optimal employment fluctuations.