From xxxxxx <[email protected]>
Subject Analyses Claiming That Taxes on Millionaires and Billionaires Will Slow Economic Growth Are Fundamentally Flawed
Date November 25, 2019 6:07 AM
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[Highly stylized output of models that assume supply-constraints
on growth are the norm, and which are presented as effects on
“growth” and “jobs” with no further context are notably
unuseful, and often actively misleading in today’s policy debates.]
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ANALYSES CLAIMING THAT TAXES ON MILLIONAIRES AND BILLIONAIRES WILL
SLOW ECONOMIC GROWTH ARE FUNDAMENTALLY FLAWED  
[[link removed]]

 

Josh Bivens
November 21, 2019
Economic Policy Institute
[[link removed]]


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_ Highly stylized output of models that assume supply-constraints on
growth are the norm, and which are presented as effects on
“growth” and “jobs” with no further context are notably
unuseful, and often actively misleading in today’s policy debates. _


, Khalil Bendib

 

In recent weeks, a number of policy analyses of progressive economic
policies—a surtax 
[[link removed]]on high-incomes,
a wealth tax
[[link removed]],
and Social Security expansion
[[link removed]]—have
claimed these policies would damage economic growth. Policymakers
should give these analyses very little weight in debates about these
issues, for a number of reasons.

First, and most important, is the fact that all of these analyses are
grounded in an economic view of the world that sees growth as
constrained by the economy’s productive capacity (or the _supply
side _of the economy) and not by the spending of households,
businesses and government (the economy’s _demand side_). These
estimates have other problems too—they are not even particularly
convincing supply-side estimates and even if the economy’s growth
really was constrained by supply, these estimates would still be
misleading about the effects of these policies on welfare. But the
biggest reason why policymakers should give these analyses zero weight
is because they assume that growth is almost never demand-constrained.

Before the Great Recession, the assumption that growth was nearly
always supply constrained was almost universally held by economists
and macroeconomic policymakers. It was recognized that demand (or
aggregate spending) could occasionally be too weak to fully employ the
economy’s productive capacity and hence cause rising unemployment,
but it was generally thought that such periods were rare and would end
quickly after the Federal Reserve sensibly cut interest rates. Because
shortfalls of demand relative to supply were rare and short and easy
to fix, the reasoning went, any real constraint on the economy’s
growth over the long-run must be the pace of growth of supply. Growth
in supply is generally driven by growth in the quality of the
workforce, the productive stock of plants, equipment and research, and
growth in technological progress, which together lead to growing
productivity—or the amount of income or output generated in an
average hour of work.

The assumption that supply constraints are much more likely to bind
overall growth than demand constraints drove almost all macroeconomic
policymaking in the decades before the Great Recession. For example,
the Federal Reserve for decades feared lower unemployment far more
than lower inflation
[[link removed]].
Lower unemployment was a signal that demand was rising relative to
supply, and if one thinks growth was generally supply-constrained,
this meant that demand growth would quickly outstrip supply growth and
lead to rising inflation. Lower inflation, conversely, meant that
supply growth was outpacing demand growth—but that was always a
temporary and easy-to-fix condition. The decades-long
bipartisan overreaction to rising federal budget deficits 
[[link removed]]is
also a byproduct of assuming the economy’s growth is supply
constrained. Deficits boost demand growth. If one assumes that demand
is generally marching in lock-step with supply, then larger deficits
that boost demand imply that supply constraints will soon bind and
cause inflation (or interest rate increases). Smaller deficits,
conversely, reduce demand growth. But if the danger of demand growth
slowing too much is low and easy-to-fix, then that’s not a problem.

The experience of the last decade has done much to shake this belief
that demand-constrained growth is nothing to worry about and that
supply-constrained growth should be the default presumption for policy
analysis. For example, the Federal Reserve has cut interest rates to
spur demand growth three times in the past six months with
unemployment below 3.8 percent. They certainly seem to be acting
(correctly) as if demand-constrained growth is a real problem.
Prominent macroeconomists and former policymakers like Olivier
Blanchard
[[link removed]], Jason
Furman
[[link removed]],
and Lawrence Summers
[[link removed]] have
all written in recent months that efforts to close budget deficits
should not be a high policy priority, largely because there is no
evidence that supply constraints are binding. These reversals of
policy presumption are evidence-based and admirable. Yet the
decades-long inertia of policy evaluation done in a framework of
supply-constrained growth is hard to stop—and so we have the recent
parade of analyses claiming that a number of progressive initiatives
will slow the economy by dragging on supply side growth.

The Tax Foundation, for example, has estimated 
[[link removed]]that a ten percentage
point surcharge on incomes over $2 million—a change that would only
affect the highest-income 0.1 percent of households—will slow growth
enough to cost 118,000 jobs by the end of the decade. A
still-preliminary analysis 
[[link removed]]of
presidential candidate Elizabeth Warren’s wealth tax—a change that
would affect only the wealthiest 0.1 percent of households—was
estimated by the Penn-Wharton Budget Model team to slow growth by more
than 0.2 percentage points each year over the next decade. The
Penn-Wharton Budget Model project’s assessment of a plan by
Representative John Larson (D-Conn. ) to expand Social Security
benefits was analyzed 
[[link removed]]by
my colleague Monique Morrissey previously, so I will largely leave
that aside in this post.

Each of these results is driven entirely by the assumption that growth
is supply-constrained. In the case of both the high-income surcharge
and the wealth tax, the taxes are assumed to reduce labor supply and
savings (which raises the “user cost of capital” and hence leads
to reduced investment).

But over the past decade, there is no evidence
[[link removed]] that labor supply has
been a constraint on growth. Unemployment rates fell steadily
[[link removed]] in the years
between 2010 and 2018. Even as the decline in unemployment moderated
over the past year, labor force participation 
[[link removed]]rose smartly.
Additionally, the share of prime-age adults with jobs 
[[link removed]]remains below
its 2000 level—and there’s no particular reason to be sure that
2000 level is a hard upper bound. The clearest sign that availability
of labor has become a supply-side constraint would be rapid wage
growth— and that has certainly not happened.

There is even less evidence that insufficient savings or a high user
cost of capital have been constraints on growth of the capital stock
or will become constraints anytime soon. Interest rates—the simplest
proxy for the scarcity of savings and high user costs of capital
– have been severely depressed for years
[[link removed]], and interest
rate projections have overestimated their growth since the late 1990s
[[link removed]].
Corporate profitability has been extraordinarily high
[[link removed]] over the
2000s, even as investment has been weak
[[link removed]].

One rebuttal to the argument that we should severely discount policy
analyses based on supply-constrained assumptions is that we can’t
bank on too-low demand being the primary constraint on growth forever.
This is true—but hardly dispositive. The norm of conducting long-run
policy analysis premised on the assumption that supply is the primary
constraint on growth was never grounded in thinking that
demand _never_ constrained growth. Instead, it was assumed that
while demand could bind, it would only do so for very limited times so
could be largely ignored in the long-run. But, we just emerged from a
period where demand unambiguously constrained growth for a decade—an
entire budget forecasting window!

Worse, we know some of the primary reasons why demand has become a
tighter and tighter constraint
[[link removed]] on
growth over time. One of the most important is the rise in income
inequality  [[link removed]]that
has characterized recent decades. All else equal, a redistribution of
income from low and moderate-income households to richer households
will drag on demand growth, as richer households spend a smaller share
of their income. There are potential policy offsets to this demand
drag stemming from redistribution—most notably lower interest rates.
But interest rates have been extraordinarily low over the last decade
even as demand sagged. For a host of reasons, the strategy of fighting
the demand drag of the enormous upward redistribution of income with
lower interest rates seems to have lost any juice it may have ever
had [[link removed]]. Until
there has been a reversal of this upward redistribution, it seems odd
to think we should simply re-adopt the assumption that demand will
stop being the primary constraint on growth.

Another rebuttal to the argument that it is demand and not supply that
will be the more likely constraint on growth in coming years is that
productivity growth in the U.S. economy has been extremely slow of
late. With slow productivity growth, even historically sluggish demand
growth can exceed growth in the economy’s productive capacity and
cause the supply-side to bind much more often. But the productivity
slowdown is itself likely a function of slack demand 
[[link removed]]over
the past decade. Workers and capital have been so cheap and so
plentiful for businesses to hire over the past decade that incentives
to squeeze more from each unit of labor or capital have been severely
blunted. Tellingly, as labor became scarcer in recent
years, productivity growth has begun to 
[[link removed]]firm
up. Granted, productivity won’t rise _without bound _if demand
accelerates, but the larger point is that one cannot infer from the
past decade of data that low productivity growth is a permanent
condition that guarantees supply constraints will bind going forward.

Ironically, the three proposals recently dinged by supply-side
analyses as slowing growth are all aimed at pushing back against the
trend of rising inequality. As such, if adopted they would actually
make it more likely that such supply-side analyses could be useful
sometime in the future.

To be very clear about this, a world in which it is supply constraints
that bind is better in many ways. Involuntary unemployment would no
longer be a problem and both productivity and wages would be pushed
up. But even in a supply-constrained world, the recent analyses of the
high-income surcharge and the wealth tax would be deeply misleading in
terms of their effect on Americans’ welfare. Take the simplest case
of this: the decline in GDP and jobs allegedly caused by the
high-income surcharge. The first thing to note is how completely
trivial even the Tax Foundation’s estimated effects are: growth that
is slower by 0.01 percent for the next decade, with cumulative losses
reaching 0.1 percent by the end of that time. One way to think about
this is to compare how long it would take us _with _the surtax to
reach the level of GDP projected for December 31, 2029 _without _the
surtax. The answer is that we’d hit this same no-surtax level of GDP
a week or two later. Would anybody notice this? In the second quarter
of 2019, estimates of GDP growth were revised down by 0.1
percent—a _one-quarter _revision as large as the 10-year impact
estimated by the Tax Foundation for the surcharge. Did anybody notice
this 2nd quarter GDP revision in their lived economic experience or
actually feel poorer?

In regards to the job impacts, they are roughly equivalent to 900
fewer jobs per month created over the next decade. But the
statistical standard error 
[[link removed]]on the estimate of the
number of jobs created _each month _by the Bureau of Labor
Statistics is just under 70,000. Again, this is not a change anybody
would notice. Even more importantly for assessing the welfare impact
of these estimates, _none _of this job loss (assuming it happened
and was noticed) would be involuntary—that is, willing potential
workers who were unable to find a job because of the tax. Instead, the
job loss would occur because a miniscule decline in productivity
growth caused by reduced capital investment would reduce wages (by
something on the order of 0.01 percent each year on average). Due to
these lower wages (lower relative to a forecast baseline, mind you,
not lower wages than today), potential workers
would _voluntarily _decide to not work. Think of how little we
should worry about these welfare effects: a worker who chooses to work
when wages are $20 an hour, but chooses _not_ to work when wages are
$19.99 an hour was clearly on the knife-edge of this decision anyhow,
with work providing very little extra utility relative to not working.

Or take the case of the wealth tax. The GDP losses chalked up to its
effects come about because a decline in the after-tax return to
holding wealth reduces the incentive of households to save and hence
pushes up the “user cost of capital”, which in turn reduces
investment and productivity growth. But households’ after-tax return
to holding wealth is but one in a long list of inputs into the user
cost of capital, and even the _overall _user cost of capital has
been shown in empirical studies to have only weak effects
[[link removed]] on
investment. To get a sense of how unconvincing model-based estimates
of the effect of tax-based changes in the user cost of capital on
investment are, note that the Penn Wharton Business Model (PWBM)
actually predicted pro-growth effects 
[[link removed]]from
the 2017 tax cut—even though it was deficit-financed, which
suppresses growth in their supply-side driven model (all else equal).
The logic for how the 2017 tax law spurred growth in their model (even
as it boosted deficits) was again through the channel of lowering the
user cost of capital and spurring investment. And yet in the real
world, capital investment collapsed 
[[link removed]]shortly
after the law’s passage. Outside of highly stylized and opaque
models, efforts to empirically estimate the effect of taxes on capital
income on investment come to mixed results.

Finally, as many have pointed out, the effect of tax increases on
growth depends on what you do with the money collected. If the worry
is that tax increases might reduce private-sector investment, one can
allay that by using the revenue to finance public
investments. Research suggests
[[link removed]] that
because U.S. governments (both federal and sub-national) have been so
stingy with public investments in the recent past that the rates of
return to boosting these could be potentially higher than for private
investments. This seems especially true in regard to investments that
reduce the growth of greenhouse gas emissions or provide high-quality
early education for kids. Tax increases that help finance a larger
public role in providing health insurance which then bends the
long-run cost curve of health care by squeezing out inefficiencies
and rents [[link removed]] from
the American health system would also have strong effects in boosting
American living standards—yet this is obviously not any part of the
PWBM estimates.

Is any of this a call for economic nihilism—simply rejecting any
finding that progressive policies may have effects we’d want to
consider when debating them? Not at all. For example, the Earned
Income Tax Credit (EITC) is a very popular policy among progressive
policymakers. Yet high-quality research
[[link removed]] indicates
that some of its benefits may leak away from low-wage workers and to
their employers. Knowing this, pairing the EITC increase with a
minimum wage increase can help ensure that more of its gains are
captured by workers. Analogously, it is conceivable (but by no means
assured) that the wealth tax could indeed reduce savings by the very
wealthy. If direct empirical estimates confirmed that, this would be
valuable information. If further research indicated that reduced
national savings overall were a binding supply-side constraint on
growth (unlikely in the near-term or medium-term) then researchers
could next look at whether or not the wealth tax boosted savings by
the non-wealthy (it might). If the net effect of the wealth tax showed
that it reduced national savings and caused supply-side constraints to
bind, then complementary policies could be considered. For example,
some have put forward plans for universal Guaranteed Retirement
Accounts
[[link removed]],
financed by a combination of broad-based tax increases and mandatory
contributions from employers and employees. Such plans would increase
national savings.

Genuine information about economic policies is good and useful. But
the highly stylized output of models that assume supply-constraints on
growth are the norm, and which are presented as effects on
“growth” and “jobs” with no further context are notably
unuseful, and often actively misleading in today’s policy debates.

_JOSH BIVENS is the director of  research at the Economic Policy
Institute (EPI). His areas of research include macroeconomics, fiscal
and monetary policy, the economics of globalization, social insurance,
and public investment. He frequently appears as an economics expert on
news shows, including the Public Broadcasting Service’s
“NewsHour,” the “Melissa Harris-Perry” show on MSNBC, WAMU’s
“The Diane Rehm Show,” American Public Media’s
“Marketplace,” and programs of the BBC._

_Bivens is the author of Failure by Design: The Story behind
America’s Broken Economy (EPI and Cornell University Press)
and Everybody Wins Except for Most of Us: What Economics Really
Teaches About Globalization (EPI). He is the co-author of The State
of Working America, 12th Edition (EPI and Cornell University Press)
and a co-editor of Good Jobs, Bad Jobs, No Jobs: Labor Markets and
Informal Work in Egypt, El Salvador, India, Russia and South
Africa (EPI)._

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