It seems like there are new questions being raised almost every day.  Previously I asked whether the border tax/subsidy scheme would apply to service imports and exports.  I never got a clear answer.

John Cochrane raises an even more important issue.  The House proposal is not a stand alone tax and subsidy, but rather a revision of the corporate income tax. Here’s Cochrane:

The corporate tax reform question has gotten mixed up with the border adjustment issue. Several readers have asked for my opinion. I have to admit I’m confused. Feldstein likes it Summers hates it. If sold as a VAT, which is border adjusted it makes sense. But it’s not a VAT — wouldn’t apply to non-corporate business and, I hope dearly, not to direct imports and services. When I read some of the other blogs it seems like a complex mess ripe for exploitation by clever tax lawyers. Perhaps it’s not as bad as a uniform tariff (not much could be worse), but that’s weak praise.

Anyway, I’ve spent a day or so trying to figure it out, and can’t get to solid ground. That by itself seems an important weakness. I’m not the smartest person on earth, but I am a reasonably trained economist, and I have put a day into figuring this out. Tax reform ought to be really simple, and transparent to the American people, if for nothing else to put out the smoldering fire that people feel the system is rigged and fancy people with fancy lawyers are getting away with murder.

I buy stuff directly from overseas and have it shipped to my house.  I’m not a corporation—will I have to pay a border tax?  Do I have to report eBay packages to the Treasury?  If John’s right that this only applies to corporations, it will create massive distortions.  And if the House GOP can’t get someone like John Cochrane to understand their proposal then it deserves to fail.

Update:  Ant1900 directed me to a appear by David Weisbach, which is outstanding.  Looks at all of these issues in detail.  Best tax paper I’ve ever read.

I also recommend Cochrane’s discussion of the corporate income tax, which is excellent.  We both favor consumption taxes.  Some of his commenters suggested that consumption taxes are regressive.  That’s not true, they are proportional to consumption.  Yes, they are regressive if compared to income, but since income is a meaningless concept, you want to compare them to consumption, which is what matters.  The optimal tax system is something like the following:

1.  Start with Pigovian taxes on negative externalities (such as a carbon tax), which produce a deadweight gain.

2.  Add a small land tax.  The rate should be by area, not value, with different rates for each zip code, depending on average property value by zip code.

3.  There should be a 25% VAT, with an exemption for education and training classes.  That levels the playing field between human and physical capital formation.

So far the tax is roughly proportional.  But it should be strongly progressive for utilitarian reasons.  That is achieved with the fourth leg of the system:

4.  A steeply progressive wage tax, that goes from strongly negative rates for low wage jobs to strongly positive rates for high wage jobs (perhaps topping out at 75% for wage earners making more than $100,000,000/year.)  Recall that in the long run a wage tax is identical to a VAT—they are both consumption taxes.

If needed, of if negative wage taxes are too administratively complex, the additional progressivity can come from a (modest) lump sum rebate to people over 18, so that no one below the poverty line has to pay any VAT.

In my proposed system, most people with wage jobs (like me!!) don’t have to fill out any 1040 forms.  Self-employed and those with large capital income would still need to do tax forms, to make sure wage income is not being falsely classified as capital income. (I.e. “capital income” from companies that employ you should be viewed as wage income, unless proven otherwise.) I hope it goes without saying that there are no deductions for business lunches.  That’s consumption.

That’s my federal tax system.  Local governments like New York City currently have highly regressive property taxes, where the rich pay a far lower rate of tax on their property than the poor.  That should be reversed, those $100 million penthouses should pay higher rates of property tax than Archie Bunker.

In recent years, the unemployment rate has fallen to low levels (4.7%).  Some people continue to argue, however, that there is a lot of labor market slack.  They point to data such as the U-6 unemployment rate, as well as the labor force participation rate. But with today’s jobs report, it’s becoming almost impossible to continue arguing for labor market slack.  The labor market is clearly tightening:

There is no longer any respectable argument for monetary or fiscal stimulus.  There are arguments for stimulus that deny the natural rate hypothesis, but having lived through the 1970s once, I’d just as soon not experience it again.

Time for supply-side policies, beginning with a repeal of those idiotic overtime rules.  Then on to tax reform.

PS.  I am at the AEA meetings, so blogging will be sporadic for the next few days.

Scott Alexander recently had this to say about a Vox article on Brazil:

Brazil has just passed the most extreme austerity measure in history in the middle of a recession, locked in with a clause making it impossible to repeal for 10-20 years. A…bold…choice. If nothing else, it’ll provide good data for future generations of macroeconomists. Register your predictions now!

I predict success, in the sense of faster growth.

I doubt, however, that the experiment will actually prove very much, as I know of no theory that predicts Brazil’s austerity would cause slower growth, and I know of no evidence that Brazil will in fact engage in extreme austerity.

Brazil has high interest rates and high inflation, and hence even Paul Krugman would not regard fiscal austerity as being contractionary in Brazil. Instead, the Brazilian central bank determines the rate of Brazil’s nominal GDP growth.

Might austerity hurt the supply-side of Brazil’s economy?  I suppose anything is possible, but it’s hard to see how.  Unlike China, Brazil’s high government spending goes to things like public pensions, not infrastructure.  In addition, Brazil’s government sector spends much more (39.1% of GDP) than other countries that seem to have at least as productive supply-sides, such as Chile (23.2%), Mexico (26.6%), Costa Rica (18.2%), Uruguay (32.6%), and Australia (35.3%).  It’s not clear to me that spending 39.1% of GDP makes your economy more efficient, especially if very little of the money goes to infrastructure.  To be fair, Venezuela spends 40.1%.  So Brazil is the not highest spender.

Perhaps the austerity will fail by increasingly inequality.  Brazil is already very unequal, although a bit less so than 20 years ago.  But that depends on which programs are cut.  In the past, government spending in Brazil has been regressive, mostly going to relatively well off government employees and pensioners.  Unfortunately, the Vox article that Scott links to doesn’t tell us where the cuts will come.

Nor does it say that there will be any cuts at all:

Americans worried that Donald Trump will try to shred the nation’s social welfare programs can take some grim comfort by looking south: No matter what Republicans do, it will pale in comparison with the changes that are about to ravage Brazil.

On Thursday, a new constitutional amendment goes into effect in Brazil that effectively freezes federal government spending for two decades. Since the spending cap can only increase by the rate of inflation in the previous year, that means that spending on government programs like education, health care, pensions, infrastructure, and defense will, in real terms, remain paused at 2016 levels until the year 2037.

A few comments:

1.   Notice that no specific cuts are announced.

2.  A constitutional amendment in Brazil doesn’t have the same meaning as in the US.  It’s more like legislation.  When a government engages in Augustinian promises to do something virtuous, but only far out in the future, it’s a pretty good indication that they have absolutely no intention to fulfill their promise.  Many governments have long range promises to balance the budget, which no one seriously expects to be enacted.  I hope the Brazilians will hold real spending fixed for 20 years (to become a bit more like Chile), but it seems very unlikely that they will do so.

The Vox article is highly misleading in all sorts of ways.  For instance, did you know that Brazil is one of the most highly taxed countries in the developing world? If you did not, you probably would not acquire that information by reading this from the Vox article:

While the amendment does a great deal to limit the expenditure of government funds, it doesn’t do anything to directly address how to generate them directly: taxes.

“The major cause of our fiscal crisis is falling revenues,” Carvalho says, noting that the populist Rousseff, known for her support for government programs, cut taxes for the corporate sector during her time in office over the past few years in an attempt to avoid losing public support.

Carvalho says taking an ax to spending is coming at the expense of discussing “taxing the very rich, who do not pay very much in taxes, or eliminating tax cuts that have been given to big corporations.”

Brazil’s tax code is extraordinarily generous to corporations and the wealthy, and helps buttress its status as one of the world’s most unequal countries. Brazil’s highest income tax rate is just 27.5 percent — for comparison, US tax rates go up to about 40 percent, and in Scandinavia they can exceed 60 percent.

The Vox article doesn’t really provide much context.  Readers are not told that a decade of socialist misrule has driven Brazil into a painful recession. Perhaps Brazilians have noticed the fact that Chile and Mexico are not in depression, and do not have as bloated a government sector.  Maybe they don’t think it’s wise to have a government sector that is almost as large as in Venezuela.

PS.  Over at Econlog I discuss the peculiar views of Trump’s new economic advisor

Here’s an interesting news report:

President-elect Donald Trump’s administration is planning to nominate political commentator and economic analyst Larry Kudlow to chair the Council of Economic Advisers.

Stephen Moore, a conservative economist who advised Trump’s presidential campaign, said at a luncheon in Michigan that Trump was set to choose Kudlow to be next chair of the council, a source who was in attendance told Business Insider.

In a follow-up conversation with Business Insider, Moore clarified that Kudlow is the leading candidate for the job but was not selected yet. Moore also said the selection would come in “the next week or so.”

“He’s a fantastic pick for the role, a great pick,” Moore told Business Insider.

Kudos to Donald Trump for reaching out to someone who’s been willing to criticize Trump on occasion:

Kudlow was an early advocate for Trump, saying his proposals to lower taxes would benefit the US economy. Later in the campaign, Kudlow broke with Trump on his more protectionist trade policies — Kudlow has advocated the Trans-Pacific Partnership — and anti-immigration policies.

It will be interesting to see how influential Larry Kudlow will be.  Normally I might prefer a traditional academic in the Mankiw/Hubbard vein, but in this case I think Kudlow is a very good pick.  I see a looming fight between populism and supply-side economics, and Kudlow will ably defend the supply-side view.  Kudlow will speak Trump’s language more effectively than a pure academic would.  (Academics don’t like Trump, and I’m pretty sure the feeling is mutual.)

I view myself as a moderate supply-sider, sort of like Miles Kimball.  Even though I think some supply-siders are a bit too optimistic about the growth impact of tax cuts, at least Kudlow will be fighting for the right causes.

I know what you are all thinking; who will Kudlow recommend as Yellen’s replacement?  It just so happens that Kudlow mentioned 5 names a few years back:

Kevin Warsh, John Taylor, Steve Forbes, Paul Ryan and Richard Fisher.

I’d guess that Warsh and Taylor are the more likely choices.

PS.  Actually Kudlow mentioned 6 names, but the last person has spent the past 12 months using his blog to relentlessly attack Trump in a total unhinged manner.  At this point he has more chance of becoming the next Pope than the next Fed chair.

Amazing what you can do with Photoshop.

PPS.  Morgan Warstler mentioned that Kudlow is a fan of NGDPLT, and also Morgan’s proposed replacement of the welfare system

Since the election, there’s been a lot of speculation that we are transitioning to a more inflationary environment.  That’s certainly possible, but I’d encourage everyone to take a deep breath.  There are three arguments I’ve seen for this claim, and two are extremely weak, while the third is mixed. Let me start with the strongest of the three, rising TIPS spreads.

As a believe in the EMH, I am not going to discount the importance of TIPS spreads, I’ve cited them in the past.  Rather, I’d like to put that evidence in perspective with a few observations:

1.  As of today, 5 and 10 year T-bond yields are up 50 and 54 basis points from a month ago.  That’s pretty significant.  But that’s mostly real rates, which are up 32 and 33 basis points.  That means TIPS spreads are up 18 to 21 basis points.  That’s not trivial, but it’s also not a dramatic game changer.  We’ve seen similar moves at times over the past 5 years, and not much happened.

2.  In addition, the level of inflation expectations remains well under 2%, especially when you subtract 30 basis points to reflect the fact that PCE inflation (the Fed’s target) runs about that much below CPI inflation (reflected in TIPS.)  This is important, because TIPS spreads (as we’ll see) are basically the ONLY evidence we have for the inflation story.  And even they are not predicting that the Fed will abandon its 2% inflation target (or ceiling, as some of you would claim.)

3.  While I often cite TIPS spreads, I’ve also acknowledged in the past that experts believe these spreads are somewhat distorted by shifts in risk premia. They aren’t perfect.  The Cleveland Fed, among others, attempts to come up with adjusted spreads to better reflect true inflation expectations.  Of course these estimates are model based, and hence are not perfect either.  Please send me any recent ones you come across.

Update:  JP Koning directed me to the Cleveland Fed.  Their model adjusts TIPS spreads to account for risk premia.  Yesterday they updated their 10-year inflation expectations estiamtes to 1.75%.  Last month it was 1.69%, and two months ago it was 1.72%.

4.  With some uncertainty about the accuracy of small moves in the TIPS spreads, where else can we look for inflation signals?  Well, the big story since the election has been the dramatic appreciation of the US dollar.  If we are to believe that Trump plans to debase the dollar through higher inflation, would you expect the forex value of the dollar to be surging higher on that information?  That’s not the macroeconomics I studied in school.  Indeed doesn’t the recent upswing in the dollar suggest we might get a bit lower inflation, as import prices drop?

5.  In contrast, there is an alternative explanation for these events.  Maybe the markets expect a dose of supply-side Reaganomics, and this is driving up expected RGDP growth (modestly to be sure, as rates are still low in absolute terms) and also driving up real bond yields and the value of the dollar.  That makes more sense than the inflation story, although I’m also willing to accept a mixed claim of “0.3% more trend RGDP growth and 0.2% more inflation” as being consistent with the various markets.

The other two arguments cited for higher inflation are especially weak.  One claim is that fiscal stimulus will drive up inflation.  But Yellen recently shot that down—the Fed fully intends to do monetary offset, and is recommending that Trump not do fiscal stimulus.  I have a post on that at Econlog.  (BTW, people frustrated with my Trump derangement over here should keep in mind that I always try to put my most important posts at Econlog.)

The other reason cited is that Trump might pack the Fed with compliant pro-growth, low interest rates doves like Arthur Burns.  But there are many problems with that claim.  Trump would not be able to get a change in the Fed’s official mandate through the Senate.  It would be highly controversial, and there are more than enough GOP mavericks and inflation hawks in the Senate to stop it.  Ditto for a choice of an obvious lackey for chair of the Fed.  He needs to put up a respectable name.  The press has discussed two groups of possible Fed appointments.  One is traditional conservatives like John Taylor and Martin Feldstein.  And the other group is more heterodox thinkers like David Malpass and Judy Shelton.  Neither group includes a single person who can be described as a “dove”.  Does anyone seriously think that John Taylor would switch the Fed to a 4% inflation target just to please Trump?

For better or worse we are locked into a world of low inflation.  Get used to it, it’s not going away.  And that means that artificial attempts to generate higher wages will do nothing but slow growth and reduce employment.