"When the accumulation of wealth is no longer of high social importance, there will be great changes in the code of morals.
We shall be able to rid ourselves of many of the pseudo-moral principles which have hag-ridden us for two hundred years, by which we have exalted some of the most distasteful of human qualities into the position of the highest virtues"

( JM Keynes, "Economic Possibilities for our Granchildren" 1930 )

Wednesday, March 17, 2010

The case for higher taxes

The case for higher taxation

The last two years of a deep economy crisis became the heyday of public intervention aimed to support the whole economy and especially employment. Since the average citizen is interested to gain maximum efficiency from his taxes, we would like to see how to allocate the public spending toward the most efficient activities. In other words, public policy should seek for the policy which ensures the maximal return for the investment, which in our case is the GDP or expenditure increase on every public USD spent on the economy.

There are several methods to measure the impact of the public intervention on the economy and the figures presented in the following table are just one example . They detail the estimated impact on the economy given 1 USD of public expenditure or the “Bang for the Buck” in a more colloquial manner during the last 2 years ( each figure represents the activity gain by 1 USD public spending)

Fiscal Stimulus Bang for the Buck

Bang for the Buck

Tax Cuts
Nonrefundable Lump-Sum Tax Rebate 1.01
Refundable Lump-Sum Tax Rebate 1.22
Temporary Tax Cuts
Payroll Tax Holiday 1.24
Job Tax Credit 1.30
Across-the-Board Tax Cut 1.02
Accelerated Depreciation 0.25
Loss Carryback 0.22
Housing Tax Credit 0.90

Permanent Tax Cuts
Extend Alternative Minimum Tax Patch 0.51
Make Bush Income Tax Cuts Permanent 0.32
Make Dividend and Capital Gains Tax Cuts Permanent 0.37
Cut Corporate Tax Rate 0.32

Spending Increases
Extended Unemployment Insurance Benefits 1.61
Temporary Federal Financing of Work-Share Programs 1.69
Temporary Increase in Food Stamps 1.74
General Aid to State Governments 1.41
Increased Infrastructure Spending 1.57
Low-Income Home Energy Assistance Program (LIHEAP) 1.13

Note: The bang for the buck is estimated by the one-year dollar change in GDP for a given dollar reduction in federal tax revenue or increase in spending. Source: Moody's Economy.com

As can be noticed from the above figures, the impact of a public deficit coming from expenditure is much higher than the public support given to the economy through tax reduction. Such result is not surprising as the main benefactors of tax reductions are , generally speaking the high income citizens which tend to spend a smaller portion of their income .Any reduction of taxes to that stratus of society creates less consumption and less activity than any real and concrete spending. This is a major blow for right wing propaganda which tries to push for lower taxes as an answer for the crisis ( and an answer for almost any economic problem.... the tax reduction is practically a mantra).

What might be an interesting conclusion from that figures is an overwhelming response also to deficits hawks: Suppose that a massive infrastructure spending is funded by increasing taxation on capital incomes and corporations. The calculation would be that the spending itself would generate 1.57 USD per USD invested while the cost for the economy would be just app. 0,35 ( the loss from tax increase) which would generate a more than 1 USD net increase ( 1.57-0.35= 1.22) in the economy without having to appeal to additional public indebtedness.

The above observations fit with the basic analysis which considers the economic crisis as the result of defficient aggregate consumption as only a spending stimulus backed with heavy taxation on higher incomes is the best way to stimulate the economy. I wrote about it several times so I will not repeat the analysis in this post.