Tax increases and AD (zero multiplier in action?)
Jim Geraghty of NRO sent me this:
Tax increases the fiscal cliff deal allowed:
1. Payroll Tax: increase in the Social Security portion of the payroll tax from 4.2 percent to 6.2 percent for workers. This hits all Americans earning a paycheck””not just the “wealthy.” For example, The Wall Street Journal calculated that the “typical U.S. family earning $50,000 a year” will lose “an annual income boost of $1,000.”
2. Top marginal tax rate: increase from 35 percent to 39.6 percent for taxable incomes over $450,000 ($400,000 for single filers).
3. Phase out of personal exemptions for adjusted gross income (AGI) over $300,000 ($250,000 for single filers).
4. Phase down of itemized deductions for AGI over $300,000 ($250,000 for single filers).
5. Tax rates on investment: increase in the rate on dividends and capital gains from 15 percent to 20 percent for taxable incomes over $450,000 ($400,000 for single filers).
6. Death tax: increase in the rate (on estates larger than $5 million) from 35 percent to 40 percent.
7. Taxes on business investment: expiration of full expensing””the immediate deduction of capital purchases by businesses.
Obamacare tax increases that took effect:
8. Another investment tax increase: 3.8 percent surtax on investment income for taxpayers with taxable income exceeding $250,000 ($200,000 for singles).
9. Another payroll tax hike: 0.9 percent increase in the Hospital Insurance portion of the payroll tax for incomes over $250,000 ($200,000 for single filers).
10. Medical device tax: 2.3 percent excise tax paid by medical device manufacturers and importers on all their sales.
11. Reducing the income tax deduction for individuals’ medical expenses.
12. Elimination of the corporate income tax deduction for expenses related to theMedicare Part D subsidy.
13. Limitation of the corporate income tax deduction for compensation that health insurance companies pay to their executives.
Some Republicans feel you should go, I don’t know, at least a couple of months between tax increases.
Here’s the conventional wisdom from the WaPo, back in January:
The good news: Many Americans saw their paychecks get fatter in 2012, as average weekly earnings rose 2.4 percent over the course of the year.
The bad news: The expiration of the payroll tax cut this January will basically wipe away all of last year’s gains.
Cardiff Garcia brings us the above chart from Credit Suisse, which notes:
We look at average weekly earnings of all employees on private non-farm payrolls: $818.69 in December. The 2% payroll tax increase clips $16.37 a week from take-home pay. … That’s the equivalent of losing all the 2012 gain in weekly earnings in one month.
And if you include inflation on top of that, then average weekly earnings actually went down1.4 percent compared to this time last year.
So how will Americans respond now that their paychecks are shrinking? A new study (pdf) from the Federal Reserve Bank of New York suggests one answer: They’ll spend a lot less this year. And that, in turn, could bruise the larger U.S. economy.
The New York Fed’s survey data found that the payroll tax cut has been a particularly efficient form of stimulus over the past two years “” Americans reported spending between 28 and 43 percent of the savings, far more than they have for previous tax cuts. (Much of the rest was used to pay down debt.)
And most workers expect to cut back on spending significantly now that the payroll tax cut is vanishing.
And this article indicated that most workers were shocked by the tax increase, as President Obama told them he was only going to raise taxes on “the rich.”
It would be nice to obsess on today’s big jobs number (236,000) and say “I told you so.” But jobs numbers are erratic, and are often revised. I’d focus instead on two other variables:
1. What have the markets been telling us about the economy?
2. What sort of jobs numbers have the consensus been forecasting in recent months? Has the consensus forecast called for a slowdown in the economy this year?
We don’t have a NGDP futures market, but my sense is that the markets are fairly bullish about the economy, expecting growth to keep plugging along, at least as fast as in recent years. And pundits seem to talk the same way, expecting steady growth, with jobs numbers in the 150,000 to 180,000 range, which is where we’ve been for years. People talk Keynesian but forecast market monetarist.
I actually do believe all those tax increases slowed growth a tiny bit, if only for supply-side reasons. But if they didn’t have a big impact on jobs, how can we explain why both John Maynard Keynes and Authur Laffer were wrong? Laffer may overestimate the impact of supply-side factors on the business cycle. And Keynes forgot about monetary offset. Indeed from a certain perspective the entire General Theory of Employment, Interest and Money is little more than an exercise in forgetting about monetary offset. I.e. fiscal stimulus, the paradox of thrift, the ineffectiveness of wage cuts, the revived arguments for mercantilism, all suffer from that fatal weakness. The Fed suggested that QE3 and the improved communication strategy were at least partly aimed at preventing the expected 2013 fiscal drag from pushing us back into recession. It’s too soon to know whether it will work, but I suspect it will.
Let’s hope this FT article is correct. If so, British market monetarists like Britmouse will soon be able to say: “Zero fiscal multiplier: It’s not just a good idea, it’s the law.”
Instead Mr Osborne will use his Budget on March 20 to reinforce his message of “fiscal conservatism and monetary activism” by clarifying how the government intends to use monetary policy to get the economy growing again.
Treasury officials are discussing proposals to change the remit of the bank to coincide with the arrival of Mr Carney as the governor in July, reflecting frustration at what was seen as previous BoE intransigence.
The government expects the BoE to think afresh about monetary policy under the leadership of the Canadian central banker at a time when Mr Osborne’s fiscal room for manoeuvre is highly constrained.
In the Budget, the chancellor renews the inflation-targeting remit of the BoE and this gives Mr Osborne an opportunity – already sanctioned by Sir Mervyn King, the outgoing governor of the BoE – to review the 2 per cent inflation target and the bank’s operations.
Options include giving the monetary policy committee greater time to bring inflation back to the 2 per cent target, giving the BoE a Federal Reserve-style dual mandate to target both employment and inflation, and even targeting cash spending in the economy rather than inflation.
PS. Obama should have gone with the Christy Romer/Germany approach, and cut the employer-side payroll tax back in 2009.
Update: Karl Smith has a post entitled “Middle and Lower Income Spending Looks Strong in Early 2013.”
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8. March 2013 at 06:32
We need to keep posting decent job numbers, so the fed will end QE and we can FINALLY find out what the real jobs numbers look like.
Until the govt. has to roll debt at higher interest rates, and that chews up tax revenue requiring less fiscal spending we are still in lalaland.
The only true path is productivity gains. Everything else is illusion.
8. March 2013 at 06:59
Note that Singapore is also one of those countries that cuts the employer share of payroll tax.
8. March 2013 at 07:37
Morgan,
Your logic implies that ending QE will somehow eliminate the effects of the Fed from the jobs market, which doesn’t really follow. Not doing QE is just as much monetary policy as doing QE is. Not to mention reserve requirements, interest on excess reserves, etc. which are also monetary policy.
The “starve the beast” outcome you posit (from rolling debt at higher interest rates) also does not seem realistic. At this point the only plausible way interest rates go up is in an improving economy, which means more tax revenues. Rising borrowing costs due to a debt crisis is not something the US is likely to face for a long while yet, even if we do nothing to restrain our fiscal spending.
8. March 2013 at 07:54
Uhhhh… we’re still running 7% fiscal deficits that are $1 trillion. We’ve been running these deficits since 2008. Yes, cuts have been made, but those cuts are small. Take the sequester as a simple example, the sequester has $85 billion of cuts this year, which is .5% of NGDP. On top of that, half of those cuts are in the most useless form of spending–military spending. Keynes would be proud of the way we’ve been running deficits since 2008 as the government has been injecting $1 trillion through deficits and the Fed is injecting another $1 trillion through asset purchases.
Not only that, but corporations and businesses in this country have been/are in fine shape, it’s the households and financial sectors that have been in poor shape. On top of this, those same businesses and corporations have been sitting on/accumulating a lot of cash since 2007-2008. As confidence starts to pick up, all that cash those same businesses were hoarding/sitting on will begin to be spent. A part of this has to do with the fear of sitting on the cash and getting killed by inflation. We’re starting to see the cash flow through more, this means that we can slowly start to cut the deficit and not see any sort of problems.
I never really realized this until recently, but a large part of economies are driven by things like confidence and faith. Markets are driven by psychology and financial markets behave just like we do: they get overoptimistic when things go well and they get extremely pessimistic when things go poorly. Our views and perceptions of the future affect what happens today, but our views of the future are liable to change in an instant. A huge part of having a recovering economy from what happened after the bursting of the massive credit bubble is changing those views and perceptions.
8. March 2013 at 08:00
Mmm I think the evidence looks as weak for the supply-siders as it does for the Keyenesians. Casey Mulligan projected massive declines in hours worked following the payroll tax increase, but average weekly hours are up along with employment!
Thank you Scott for showing me the light on market monetarism!! A logic that allows for deficient AD without the so-called “paradox of toil”
8. March 2013 at 08:12
Suvy,
Maybe it’s just me, but it’s not entirely clear what specifically you’re responding to.
8. March 2013 at 08:21
John, Good point.
Suvy, Many of the Keynesians I read have been telling us that the fiscal austerity will take 1.5% off GDP growth this year. And yet people are forecasting that GDP will grow at about the same rate as 2011 and 2012.
“Faith” has to be about something. It’s actually mostly about expectations of future monetary policy, future NGDP growth. So it’s not a random variable, but a reflection of government policy. People seem to expect the Fed to prevent a recession, despite the “austerity.” (Which I agree is not all that impressive.) Let’s hope they are right.
Thanks Bren.
8. March 2013 at 08:48
Bren,
There may be some of the Income Effect at work as well. When people get their pay cut, they’ve got to work more hours to maintain their lifestyles in the short run. In the long run, they might move to a smaller home or hold off on buying a new car but in the short run, their mortage and car payments are fixed.
8. March 2013 at 09:06
Speaking of Deutschland, they take sticky wages seriously (and work around them);
http://www.dw.de/temp-labor-modern-slaves-or-economic-heroes/a-16656289
———–quote———–
Temporary work is booming in Germany. Almost 2 percent of all employees are temps rented by agencies to other companies to meet peaks in demand without hiring new staff. But conditions are bad in some agencies.
900,000 temp workers are registered with German temporary work agencies. The agencies have the official permission to ‘allocate employees,’ or rent out their employees to other companies in temporary need of manpower.
The politicians who came up with the idea originally believed that the system would allow the German economy to better react to business fluctuations. At the same time, temporary work would help unemployed people get into permanent jobs. That’s how it works in theory, anyway.
———–endquote———–
If one reads further, it turns out that that is how it works in practice too;
‘Office clerk Sascha Eisenhut sees more advantages than disadvantages. “You can try out different firms and find out for yourself what it is that you like doing best.” And there is always the chance, he says, that the company that hired you temporarily will give you a permanent contract. The Economic Institute in Cologne (ZIW) confirms that in the last couple of years, some 25 percent of all employees received a permanent job via temporary employment.’
Das ist toll.
8. March 2013 at 09:31
“Many of the Keynesians I read have been telling us that the fiscal austerity will take 1.5% off GDP growth this year. And yet people are forecasting that GDP will grow at about the same rate as 2011 and 2012.”
It’s because these “Keynesians” use crappy models and try to predict the future by extrapolating past trends. The problem with extrapolating trends is that the payoffs are usually nonlinear. For example, in an effort to balance the budget, if we cut $600 billion out of the economy tomorrow, that will cause GDP to go down by 3-4%(probably more). If we cut $85 billion/year where 50% of the cuts are in the most useless area that returns the least while reducing our war spending overseas that also returns nothing and just sends money to people in other countries(for the most part), the drag on growth will be small. The problem with those models is that they can’t differentiate between those two kinds of cuts.
If we didn’t run up massive deficits in from 1980-2007(except for the small period under Clinton where we ran a surplus), we’d have a lot more room to continue the fiscal stimulus, but our government debt is over 100% of GDP and we just can’t continue to increase it. If our government balance was better, I’d also be asking for more fiscal stimulus. However we are not in that sitaution, thus, we have to slowly reduce our deficit as the economy begins to recover. We have $85 billion of “austerity”, but the Fed prints $85 billion every month.
I’d also like to add that the size of the austerity affects the national income in a nonlinear manner. In other words, small cuts in austerity do very little to decrease incomes, but as those cuts get larger, the rate of the income decline becomes larger along with the income decline itself. The nature of the cuts also make a difference. For example, raising taxes on the rich will impact the change in spending differently than raising taxes on the poor/middle class(who spend greater portions of their income). None of those factors go into the (garbage) models used by the “Keynesians”.
8. March 2013 at 09:45
“fiscal conservatism and monetary activism”
There are no sweeter words in economics.
8. March 2013 at 09:47
The only true path is productivity gains. Everything else is illusion.
I agree in principle, but one must then ask: how do we maximize productivity gains? And I think Scott and other MMs have made a very strong case that NGPDLT is the best answer right now.
8. March 2013 at 10:18
Until the govt. has to roll debt at higher interest rates
The worst part is that Treasury has apparently been buying a lot of the long-term debt, but very little short-term. So when interest rates go up, they will take a huge hit on the value of those bonds at the same time that borrowing costs for the federal government skyrocket.
Why does that matter? Well, if they owned all the short-term debt, the Fed could roll it over without changing their position, and the huge interest payments would just be returned to Treasury, making them a wash. Instead, the Fed will probably be forced to monetize a massive amount of debt at a time when monetary policy dictates they should be selling assets. It’s not hard to imagine NGDP spiraling and this ending in some painful devaluation.
I think is this the ultimate wages of being stuck in the so-called “liquidity trap” (which is really the Fed fighting the very expectations they have set, instead of targeting NGDP). It’s like revving your car faster and faster to get out of a muddy ditch, and suddenly flying off a bridge when you get traction.
8. March 2013 at 10:43
It seems to me that Monetarists and Keynesians both fall into the trap of completely disregarding the side which they do not favor. I.E. Monetarists declaring the fiscal multiplier is zero and Keynesians declaring fiscal policy is the answer to our current woes. I think the answer lies somewhere in between.
In my view both policy tools are so interlinked that you really can’t discuss one without the other. Monetary policies primary transmission mechanism is in the private sector credit markets. This is very effective in spurring growth but has its limits. Once the private sector reaches its debt service limit, we have a de-leveraging environment which has occurred since 2008. If the private sector can’t leverage than the government needs to fill that gap with deficit spending. It doesn’t matter if rates are 0 if no one wants a loan and the demand for credit is low.
What we have witnessed in Q4 2012 and so far in Q1 2013 is the private sector beginning to re-leverage as shown in the fed’s Q4 flow of funds data. This is making up for the reduction in government spending and tax increases. The question is how much can the consumer re-leverage? Are they now in a position to take on more debt? I think declaring the fiscal multiplier to be 0 based on not even a full quarters worth of data in 2013 to be premature. As we have seen multiple times since 2008 just when thing are looking up the rug gets pulled out.
8. March 2013 at 11:56
Scott,
I remember along time ago you argued that Obama fiscal stimulus did not work because the financial markets did not react to it like they do to monetary stimulus. But at the end of december last year when Congress was debating what to do about taxes every day I was reading about how the market were reacting to expectations about the tax deal. Doesn’t that mean it was important for AD?
8. March 2013 at 13:12
SilentKz, I have a radically different view of the monetary transmission mechanism—I don’t see it working through credit markets.
JoeMac, If you are talking about mostly demand-side fiscal policies, then I doubt the markets care very much. If the Congress had extended the payroll tax cut another 2 years, the Dow might have risen a couple points, but nothing significant. Markets do care about taxes on capital, which Obama agreed to compromise on. In this post I said the tax increases probably had a small effect. And I wasn’t trying to take a pro-austerity position here–I would have preferred smaller tax increases than what Obama favored, so in that sense I’m more pro-fiscal stimulus.
I’d add that I do think unexpected fiscal shocks can have some effect in the short run. Thus if QE3 was enacted to offset expected fiscal tightening, then a surprise move in fiscal policy (more or less than expected) might have a short run effect before the Fed offset it. I’ve never been a purist insisting that the fiscal multiplier is precisely zero, I simply take that as a working assumption, unless it can be shown otherwise.
8. March 2013 at 13:14
Patrick, The more I learn about the German labor market, the more I like it.
As I recall Hitler also promoted recovery through a flexible labor market—but of course that’s not to endorse any of Hitler’s other ideas. 🙂
8. March 2013 at 13:31
SilentKz,
You said:
“Once the private sector reaches its debt service limit, we have a de-leveraging environment which has occurred since 2008. If the private sector can’t leverage than the government needs to fill that gap with deficit spending. It doesn’t matter if rates are 0 if no one wants a loan and the demand for credit is low.”
Central banks have the power to influence people’s expectations about the future and therefore can influnence the amount of debt that the private sector is willing to take on. If the Fed annouced a new policy of doubling the general price level in ten years, the amount of debt that households a firms would want to take on today would be quite differnt than under current policy. “Deleveraging” is not an exogenous variable that is impervious to policy changes.
The orginal paper on “deleverging” was Irving Fisher’s “Debt-Deflation Theory of Great Depressions”. And it’s worth remembering his key conclusion:
“Those who imagine that Roosevelt’s avowed reflation is not the cause of the recovery but that we had “reached the bottom anyway” are very much mistaken…If reflation can now so easily reverse the deadly downswing of deflation after nearly four years, when it was gathering increased momentum, it would have been easier still, and at any time, to have stopped it earlier. It would have been still easier to have prevented the depression almost altogether.
If the debt-deflation theory is correct, the question of controlling the price level assumes a new importance”
8. March 2013 at 13:50
Scott, isn’t Bernanke calling for fiscal stimulus? Does one really need to be concerned about the Fed off-setting it, if Bernanke’s calling for it?
Why not try things like the cutting or elimination of payroll taxes, road and other infrastructure repair, grants to states to rehire teachers and other local government workers, etc.? You acknowledge we’re nowhere near a debt/inflation crisis, so why not give a nice big push?
I accept that it’s an inferior option to more monetary policy, but I don’t see why it isn’t worth a try. As bad as the Fed’s been, they aren’t the BOJ.
8. March 2013 at 13:51
Scott, isn’t Bernanke calling for fiscal stimulus? Does one really need to be concerned about the Fed off-setting it, if Bernanke’s calling for it?
Why not try things like the cutting or elimination of payroll taxes, road and other infrastructure repair, grants to states to rehire teachers and other local government workers, etc.? You acknowledge we’re nowhere near a debt/inflation crisis, so why not give a nice big push?
I accept that it’s an inferior option to more monetary policy, but I don’t see why it isn’t worth a try. As bad as the Fed’s been, they aren’t the BOJ, targeting inflation at around 0%.
8. March 2013 at 13:53
My point with the BOJ comparison is that I don’t expect that kind of offset, given their stated benchmarks for dialing down the monetary stimulus.
9. March 2013 at 07:01
Mike, I think you need to differentiate between the Fed and Bernanke. He had to work hard twisting arms to get QE3. If Congress does more, lots of people at the Fed will want to do less. And I think they’ll win out.
I’m not saying you are definitely wrong, I’m waiting for evidence that fiscal stimulus matters. And so far I’m not seeing it. But I’ll keep an open mind. I’ve always supported supply-side fiscal stimulus, such as cuts in the employer-side payroll tax, or cuts in taxes on capital. So I’m not anti-fiscal stimulus, just anti-demand side fiscal stimulus.
I expected the increased taxes to slow the economy slightly in 2013–for supply side reasons. I don’t see that yet. But the data is quite noisey, so who knows?
9. March 2013 at 08:29
Scott,
I’m guessing Bernanke is in a better position to know if there’s room for fiscal stimulus than I am, and I’m also guessing he accounts for the possibility of monetary policy offset. I’ve even read a few of his papers and he at least used to seem very aware of many of the nuances of conducting unconventional monetary policy.
Of course, if I were President, I may meet with the FOMC and very directly discuss the idea of fiscal stimulus with them. If I felt it necessary, I might also bully them to take more action on the monetary policy front. But, absent that, I’d go all in politically for more fiscal stimulus.
Ideally, the tax reform ideas you have along with a wage subsidy would provide a big boost to the economy, both in terms of demand and supply.
9. March 2013 at 08:44
I guess I should add that if you begin to think fiscal stimulus is worthwhile, why not start to really push your secular policy prescriptions now, including the tax reforms; expanded and increased wage subsidy to take the place of minimum wages and federal programs to help the poor, etc.? I bet you could get a lot of liberals on board, and perhaps even a fair number of half-way sane conservatives.
Personally, I would see these as liberal policies, given that it would represent increased help and freedom for the poor, a more progressive tax system, and yes, smart fiscal stimulus in the kind of situation we’re in now. I don’t think liberals are against supply-side friendly policies in principle, but just don’t understand them.
Conservatives might like the supply-side friendly elements, like the tax policies being less distortive, less social engineering, more incentives for the poor to work, etc.
I’m not a political analyst, but I think now’s the time to push for these policies. You have a voice now and it’d be an awful shame to let this ongoing crisis go to waste.
9. March 2013 at 11:56
Democrats wanted higher taxes on the rich. Republicans wanted higher taxes on the poor. They compromised on some of both but they failed to offset the net increase in taxes with additional spending to prevent a fall in the deficit.
10. March 2013 at 07:58
Mike, The fact that Bernanke would prefer more fiscal stimulus tells us very little about monetary offset. Many parents would prefer their kids work their way through college, but if they don’t the parents will support them financially. If a parent encouraged their son to work harder, would that mean they won’t offset any decision not to work?
You said;
Personally, I would see these as liberal policies,”
I consider all good policies to be liberal policies, as I define “liberalism” as utilitarianism.
I have been pushing lots of tax reform ideas, and will continue to do so. But monetary policy is the biggest issue right now.
10. March 2013 at 20:03
Scott,
Thanks for the reply. Do you have any papers that outline your view on the monetary transmission mechanism you mention?
11. March 2013 at 07:04
SilentKz,
You are a monetary realist. Go to monetaryrealism.com
Fiscal and monetary policy both have their strengths and weaknesses, they both work, they both can be used effectively. Demand side fiscal works, supply side fiscal works, they just have real world limits on their effectiveness.