Not from the Onion

In the 1990s, this sort of Bloomberg headline would be assumed to be a spoof from The Onion:

Taxing the Rich to Fund Welfare Is the Nobel Winner’s Growth Mantra

Just because it seems whacky doesn’t mean it’s wrong. My views on the Great Recession (tight money caused it) are also widely viewed as being whacky. But in this case, the Nobel Prize winner’s views are wrong for two reasons.

Abhijit Banerjee recommends higher taxes on investment, with the money redistributed to lower income people. The argument is that the rich have a lower propensity to spend and hence redistribution to the poor will boost aggregate demand.

One obvious problem is that the Fed will engage in monetary offset, either raising interest rates or cutting them less rapidly, and hence there will be no impact on aggregate demand. This is true even if the Fed is consistently undershooting its 2% inflation target by a few tenths of a percent, due to over-reliance on Phillips curve models.

But even if the Fed does not adjust interest rates in response, the policy is likely to fail. It’s a mistake to focus only on the different marginal propensities to spend. A tax on investment will depress the propensity to investment, and this will reduce the equilibrium interest rate. So even if the Fed keeps interest rates constant, money will become effectively tighter. Indeed we’ve seen something like this over the past 12 months, albeit due to the trade war, not higher taxes on investment. And the opposite occurred during 2017-18, when lower corporate taxes boosted business investment demand and raised the equilibrium interest rate.

Banerjee is relying on a model that Paul Krugman used to call “vulgar Keynesianism”. It’s just as wrong today as it was in the late 1990s.

PS. I’m not suggesting that redistribution is a bad idea; progressive consumption taxes and low wage subsidies have a lot of merit.

HT: Michael Darda



23 Responses to “Not from the Onion”

  1. Gravatar of Bob Bob
    30. October 2019 at 09:31

    All consumption is not equal, all investment is not equal. As an example: a transfer of $1 million from one trust fund to $1,000 across 1,000 low income households could nominally reduce the consumption of payday lending interest payments and increase the consumption of higher quality housing.

    From a short-term macroeconomic perspective this transfer might seem of zero value, but if the transfer reduces reliance on high-interest payday lending and improves access to better quality housing then it is providing a social good through health outcomes and better quality of life.

    Your post does address marginal propensity to spend, but it does not address marginal utility. A fatal flaw that I’ve seen all across economics.

  2. Gravatar of rayward rayward
    30. October 2019 at 09:32

    Sumner: “Abhijit Banerjee recommends higher taxes on investment, . . .” Sumner must have learned the meaning of a “transcript” from Trump. No, Banerjee does not recommend higher taxes on “investment”. Banerjee: “So we should start with raising the rates on top income and adding a wealth tax, as many have proposed.” We’ve been cutting taxes on capital for decades, and yet investment in productive capital has lagged, and as a result so has productivity and economic growth. Sumner, the good monetarist he is, believes economic growth and prosperity lies in monetary policy. My observation is that reliance on rising asset prices for prosperity will fail, and fail miserably and drastically.

  3. Gravatar of rayward rayward
    30. October 2019 at 09:45

    Orthodoxy is my doxy; heterodoxy is anybody else’s doxy who does not agree with me. I’ve always appreciated that expression. It’s mostly seen in the context of religion. Since economics is a form of religion, it applies to economics as well. Here is the link to a piece of my doxy:

  4. Gravatar of ssumner ssumner
    30. October 2019 at 09:49

    Bob, You said:

    “Your post does address marginal propensity to spend, but it does not address marginal utility. A fatal flaw that I’ve seen all across economics.”

    Actually it does, you must not have read it to the end:

    “I’m not suggesting that redistribution is a bad idea; progressive consumption taxes and low wage subsidies have a lot of merit.”

    I’m a utilitarian, so when I say “merit” I mean higher utility.

    In any case, there is no reason for me to “address marginal utility” in this post; I was responding to claims about RGDP growth, not utility. I also didn’t address gay rights or climate change.

    Rayward, A wealth tax is a tax on investment, unless it’s a lump sum once-and-for-all tax, and I don’t believe that’s what he’s proposing. (Correct me if I’m wrong.)

    Suppose Bill Gates saves $1 billion and invests in a new office building. The rents provide a 5% rate of return. Now impose a 3% annual wealth tax on the building. The rate of return falls to 2%. If Gates spends the money on consumption or charity, no wealth tax is imposed.

  5. Gravatar of rayward rayward
    30. October 2019 at 10:04

    I’m opposed to a wealth tax, although Gates’s investment in an office building isn’t the type of investment I might have used in a hypo if I were Sumner and wanted to justify low taxes on “investment”. What’s needed in America is greater investment in productive capital, which increases productivity, wages, and economic growth. Do we really need another high rise office building? Is America more productive because of more office buildings, hotels, mansions, WeWork, digital advertising web sites, etc. I hope the rate of return on office buildings falls. And the rate of return on productive capital increases.

  6. Gravatar of msgkings msgkings
    30. October 2019 at 10:23


    What do you have in mind when you say ‘productive capital’? Only factories? Farms? Anything else?

  7. Gravatar of Nick Nick
    30. October 2019 at 10:53


    if the office building generates rents of 5% then clearly it is productive capital. if it wasn’t people wouldn’t pay to rent the space.

    Is America more productive because of more office buildings, hotels, mansions, WeWork, digital advertising web sites, etc. yes, obviously it is.

  8. Gravatar of ssumner ssumner
    30. October 2019 at 11:02

    Rayward, I’d rather have the market determine what we “need” than some random commenter.

  9. Gravatar of Christian List Christian List
    30. October 2019 at 12:45


    Have you always believed that redistribution is a good idea?

    The idea somehow doesn’t suit you. Is the idea relatively new, say a few years old, or have you always believed in it?

    It seems to me that the zeitgeist hasn’t quite bypassed you either.

    Don’t tell me that you are a redistribution campaigner of the first hour.

    How much redistribution do you want? And what’s the point of redistribution anyhow?

    If I hear that monstrous word again, I drop down dead.

  10. Gravatar of Philo Philo
    30. October 2019 at 13:52

    I assume that ‘spending’ means *buying consumption goods or services*? Then why is the “propensity to spend” supposed to be important? A poor person might spend an extra dollar on consumption while a rich person would exchange it for a capital good (such as a financial asset—stock or bond). I am assuming that ‘spending’ is defined so as to exclude the latter action (which can be called, instead, “investment”). But the dollar is still being exchanged for something; why is it macroeconomically important *for what*?

    Or maybe the rich person will just sit on the extra dollar—add it to what he carries in his wallet or stuff it under his mattress. This is “currency-hoarding,” another possibility for dealing with an extra dollar. But the propensity of even rich people for such hoarding must be quite low; and the monetary authority can very easily offset any possible bad effects from it, inflating the money supply by a dollar.

    Or maybe the rich person will deposit the dollar in his bank account. But then, will not the bank have a very high propensity to increase its lending by at least a dollar? And what will the borrower do with the extra dollar that he borrows?

    I must be sorely in need of instruction in basic economics, for I do not at all understand the concern with “propensity to spend”!

  11. Gravatar of rayward rayward
    30. October 2019 at 14:24

    Yes, what we need. Sumner’s Austrian friends believe we need more markets, but Sumner denies having any Austrian friends, even though they were down the hall at Mercatus. Are we friends any more? What do we need? Rising asset prices? I’m more in favor of rising productivity and wages. Sumner and his monetarist friends seem to believe that rising asset prices are the path to prosperity. What do you believe?

  12. Gravatar of ssumner ssumner
    30. October 2019 at 15:07

    Christian, You asked:

    “The idea somehow doesn’t suit you.”

    LOL, a perfect example of how your mind works. How does one even converse with such a prejudiced person?

    Rayward, You said:

    “even though they were down the hall at Mercatus.”

    I live 2500 miles from “Mercatus”.

  13. Gravatar of Negation of Ideology Negation of Ideology
    30. October 2019 at 15:08

    Scott – you say

    “A tax on investment will depress the propensity to investment”

    “PS. I’m not suggesting that redistribution is a bad idea; progressive consumption taxes and low wage subsidies have a lot of merit.”

    Couldn’t you design a if tax policy that redistributes and offsets the reduction in propensity to investment?

    Assume you start with the imaginary country from your previous post, where everyone has an $80,0000 wage. Assume they have a consumption tax in the form of unlimited pretax 401ks and no mandatory withdrawals by age. And let’s assume they have a balanced budget.

    After an election of a new redistributionist Congress, they pass a reform limiting the contribution to $50,000 per year and requiring anyone, regardless of age, with over $2 million in their 401ks to withdraw 4% of the amount over that per year, i.e., someone with $3 million would have to withdraw $40,000.

    And assume all of the extra revenue raised is deposited as an equal dividend in each citizen’s 401k at the end of the year. Wouldn’t that meet the redistributionist goal in addition to not reducing investment?

  14. Gravatar of ssumner ssumner
    31. October 2019 at 08:19

    Negation, That will still discourage investment, as the redistribution to lower income savers will not encourage them to save more. A simpler solution is just to tax the rich at a higher rate.

  15. Gravatar of Arilando Arilando
    31. October 2019 at 12:58

    On the “vulgar Keynesianism” post by Krugman, on the page there is a link to a reply by a defender (James K. Galbraith) of “vulgar Keynesianism”, but the link doesn’t work. Does anyone know where i can see this reply by Galbraith, if possible?

  16. Gravatar of Matthias Görgens Matthias Görgens
    31. October 2019 at 17:07

    Navigation: well, if you are looking for shiny new tax that mostly falls on the rich, and doesn’t burden the economy, start with a land value tax. That tax also has good support from all kinds of different economists across the spectrum.

    If that’s still not enough to find your pet projects, you can look at consumption taxes and wealth taxesy CO2 taxes and income taxes etc in order of merit.

    (Though be advised that there are some theoretical results that suggest lowering eg income taxes will increase land rents, and thus the yield of land value taxes. So levying any other taxes might or might not give you an increase in yield over a pure land value tax.)

  17. Gravatar of gorge gorge
    1. November 2019 at 04:27

    Atlas Shrugged teaches you everything you need to know about redistribution. Innovators are not the enemy.

  18. Gravatar of gorge gorge
    1. November 2019 at 04:29

    Capitalism should not, and has not, ever been about equality of outcome. It was always about equality of opportunity. And to succeed, it must remain so.

  19. Gravatar of BB BB
    1. November 2019 at 05:56

    I went and read some of his interviews, and you are correct. He openly spouts the view that taxing the rich is good because poor people are more likely to spend the money. Unfortunate.
    I am personally in favor of more redistribution, which I know is not your point hear, and would like to hear more on your views on how to achieve it. I do wonder how the economy would benefit if more people had a basic level of wealth. I know that income levels can be misleading for a number of reasons (age), but my impression is that inequality has risen. The ability to buy a house or invest is very empowering. Many folks get their start because their parents have some level of wealth. On the other hand, having ridiculous amounts of wealth empower people to engage in some less-helpful things like super-pacs, vanity presidential campaigns, and wework. I know that’s not the focus of this post, but I think your views on redistribution would pair well with a post like this one.

  20. Gravatar of ssumner ssumner
    1. November 2019 at 11:37

    Arilando, I don’t know.

    BB, I have posts describing my support for progressive consumption taxes and subsidies for low wage workers. “Predistribution” would also help, doing regulatory changes that make it easier to earn money.

  21. Gravatar of bb bb
    1. November 2019 at 13:11

    “Equality of outcome” is a lazy straw-man argument. No serious people that I know of argue for equal outcomes. And it is absurd to think “equality of opportunity” is achievable. People clearly do not have the same opportunities in any system. And devising a model that made opportunities equal would require much greater central control than any model that I’m familiar with. Opportunity is also much harder to measure than outcome, so using it as a benchmark is a little silly. Outcomes can be measured, and many serious people argue for outcomes that are less uneven. Not equal outcomes, just less unequal.
    And there is is much to be learned about redistribution and many other topics beyond what’s offered in Atlas Shrugged, which is long winded and not all that clever- in my opinion.

  22. Gravatar of Negation of Ideology Negation of Ideology
    1. November 2019 at 14:11

    Matthias –

    I assume “Navigation” is me (auto-correct!), but if not I’ll respond anyway.

    I am familiar with Henry George’s arguments for a land value tax (Fun fact – the game “Landlord”, which Monopoly is based on, was created by a Georgist). I might support something like that as long as there is a homestead exception for primary residences.

    The type of tax system one supports should be dependent on what type of society one thinks we should have. My thinking on taxes is in line with GK Chesterton’s quote “The problem with Capitalism is too few Capitalists”. Along with Belloc, he promoted a theory that if steps weren’t taken to ensure a widespread distribution of ownership of productive property, you’d end up with a Servile State of either huge concentrations of capital owned by a tiny percentage of people, or the even more centralized system of socialism. Either way, the common man would be servile to someone else, rather than independent. Judging by this election campaign, I think we’re headed that way.

    I can’t prove that the best society is one where the vast majority of people own their own homes and have large stakes of capital, with little or no debt. Then large numbers of people are truly independent, rather than having to be ordered around by either billionaires, CEOs or government officials. But I believe it’s self-evident that this is the better society.

    So what kind of tax system promotes this type of society? I think having large universal pre-tax 401k’s (minimum 15% plus a dollar for dollar employer match), excise taxes on consumer credit, letting corporations deduct dividends (in practice, corporations would probably choose to return all profit as dividends and pay nothing), limiting the deductabilty of mortgages to 15 year loans, and raising the reserve ratio of banks to 100%. The Fed would offset any deflationary effects of these reforms. In total, these reforms would likely reduce revenue, so we might need to implement some kind of other tax, or raise the top rate on the progressive consumption tax much higher, as Scott Sumner suggests. Since elimination the tax on corporations would benefit the very rich the most, I’d rather the new tax fall on them.

    This would not create a Utopia, but the payoff would be immense, in my opinion. In a few decades, we could have a country where most people own their homes outright with no debt by their late thirties to early forties, and earn enough dividends to retire (if they want) by their late forties to early fifties. The benefits of labor-saving machinery would be widespread, going to more to voluntary leisure of early retirees (or partial retirees) than involuntary unemployment, or maybe even worse, to make-work jobs.

  23. Gravatar of Christian List Christian List
    13. November 2019 at 13:44


    You didn’t answer any of the (mostly) serious questions I raised; it was more like a crybaby answer.

    You may have used the word “redistribution“ in this blog 2-3 times so far. How old is this blog ? Ten years? It’s not prejudice when I say the word doesn’t suit you.

    A definition of redistribution is the correction of the market distribution of income and wealth through political measures. Again, why would you even want that?

    For economic reasons? For political reasons? For democratic reasons? For ethical reasons?

    Okay, one could partially answer these questions if you google the word “redistribution” in your blog, it seems to be utilitarian reasons. There’s one single post about it in ten years.

    To me “utilitarian” as used by you in this example looks like a filler word, a cover word, a word that has no content yet.

    What I also still don’t see is how you approach the wealth problem. You talk a lot about income, but at the moment it seems that the left is attacking wealth again. They want to gain power over wealth. That seems to be “des Pudels Kern”, the heart of the matter.

    Someone like Warren Buffett does not seem to consume much. Or in other word: the Left won’t be satisfied with consumption taxes.

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