Monday, March 31, 2014

Capital Gains Taxes, Paul Krugman, and the Lies of Scott Sumner

    If you think this is unfair to call him a liar, keep in mind that in his recent post has called Krugman either a liar or ignoramus. I know, Tom Brown will say it was nice of him to give us a choice LOL. You know I love you Tom. Here is Sumner:

    "this comment by Greg Mankiw intrigued me:
In this case, the issue is the reduction in capital taxes during the George W. Bush administration.  Paul [Krugman] says that the goal here was “defending the oligarchy’s interests.”
Really? As Paul well knows, there is a large literature in economics suggesting that an optimal tax system imposes much lower taxes on capital income than on wage income (or consumption).
     "Why should we assume that Paul Krugman is aware of that literature?  You would think he would be aware of the literature—other progressive bloggers like Matt Yglesias and Brad DeLong obviously are.  But I don’t recall reading a single Krugman column that showed any awareness of the need for replacing our current tax system with a progressive consumption tax.  I don’t recall a single post pointing out that taxes on capital should be much lower than taxes on labor income, if not zero."

     "I don’t recall a single post pointing out that nominal tax rates on capital income are meaningless, and that real tax rates on (for instance) Treasury bonds are now well over 100%.  Or that corporate income is triple taxed, making nominal corporate tax rates utterly meaningless as indicators of progressivity.  Or that Warren Buffet was spouting utter nonsense when he claimed his tax rate was lower than that of his secretary.  If such Krugman posts exist then please show them to me, I’d love to read them."

     "Either he is unaware of the literature, or he is aware of it and is knowingly spouting misinformation. I’d prefer to be charitable and assume that he’s not aware of the literature."

     This is a very strong statement by Sumner-way too strong. You're either have no idea what you're talking about or you're saying something you know is false. I came back at Sumner:
     "On Krugman are you suggesting that the idea that we should tax capital much lower than wage income is universally accepted among professional economists?"

      "There may be a literature with this argument but there is also a large literature arguing the opposite like Joseph Pechman for instance. He also argues against the consumption tax."

     "So there may be a large literature but its far from unanimous. My guess is Krugman is aware of this large literature but disagrees with it."

       It turns out my guess was right. I'm just waiting for Sumner to give me a snarky reply because I'm ready. Here is what Krugman wrote

     "Greg Mankiw is upset at my suggestion that the Bush administration was motivated by class interests in its determination to slash taxes on capital income and eliminate estate taxes. He wants us to know that it was all about optimal taxation, as dictated by economic theory."

     "Well, we could have a political discussion: How many people really, truly believe that George W. Bush chose to slash taxes on dividends and phase out the inheritance tax because Greg Mankiw and Glenn Hubbard told him that this was the conclusion from economic theory? Can we have a show of hands?"

     "But let me instead point out that the case for zero or low taxation of capital income rests on very strong, very unrealistic assumptions — basically perfectly rational intertemporally optimizing agents, with dynasties behaving as if they were infinitely lived individuals. Question those assumptions, and the whole case falls apart. Don’t take my word for it — read Peter Diamond and Emmanuel Saez (pdf), who also point out that the intertemporal optimizing model of saving is in fact rejected by lots of evidence."

    "And when it comes to bequests, read Irving Fisher (pdf):
The ordinary millionaire capitalist about to leave this world forever cares less about what becomes of the fortune he leaves behind than we have been accustomed to assume. Contrary to a common opinion, he did not lay it up, at least not beyond a certain point, because of any wish to leave it to others. His accumulating motives were rather those of power, of self-expression, of hunting big game.
     "The point here is that the economic case for not taxing capital rests on a stylized model that we know does a bad job of capturing real behavior; the case for taxing capital rests on considerations of equity and concerns about excessive concentration of wealth that are very much grounded in real-world observation. You don’t have to be a know-nothing to argue that the second case trumps the first."
    Ooooh! A few things become clear reading this. For one thing I was right-Krugman obviously is very well acquainted with this literature-he just doesn't buy it. This is a big distinction. It's also clear that someone is knowingly spouting misinformation and that person is, of course, Scott Sumner. He chose to pretend Krugman's reply to Mankiw here doesn't exist. So he's being dishonest-unless he published this on March 28 without having read Krugman's reply on March 27 so maybe he's ignorant.
    It's clear what bee was up Sumner's bonnet here. Krugman has really been kicking his hornet's nest the week or so. Listen to Krugman here:
    "Consider first one of the classic models in international macro, Dornbusch’s overshooting model (pdf) of the exchange rate, which is used to show how exchange rates can be as volatile as they are — basically it’s the combination of fast-moving asset markets where prices react quickly to news and slow-moving goods markets where prices can take years to adjust. To make his model as clean as possible (which is to say, very clean — Rudi was my role model), Dornbusch assumed rational expectations in asset markets, so that the exchange rate immediately reflects news about the money supply and other things. Was this assumption realistic? No — there is in fact a lot of evidence that the specific result that interest differentials are equal to expected future exchange rate changes isn’t right. But that really wasn’t crucial to Dornbusch’s point; he was using rational expectations as a simple way to get fast-moving asset prices, and his story wasn’t too sensitive to the precise correctness of the assumption."

    "Now compare this to people who say that because asset markets are efficient, there can’t be bubbles. They’re making the same assumption — but they’re putting much more weight on it, weight that it can’t actually bear." Main&contentCollection=Opinion&action=Click&pgtype=Blogs&region=Body
     That no doubt also tweaked Sumner-among other Righties-as this is exactly how he tries to claim there can't be bubbles-after all the market is efficient so how could there be a bubble?
      Anyway, good job Dr. Krugman. You have done God's Work here.


  1. Good job Mike!

    I want to comment on one small part of Sumners words that I hear from many places which has always bothered me; the idea that "corporate income is triple taxed".
    What the heck does that mean? Each individual who receives a share of income must pay taxes on it....... period! If the corporation takes in revenue and that revenue goes to wages of employees the employees pay taxes on it, the share which goes to stockholders..... they pay taxes on it and the share which corporations keep after all else is paid out..... they pay taxes on it.

    Here is a description I found from googling triple taxation;

    "Under U.S. tax law, corporations are taxed as an entity and then dividends paid to the company’s owners are taxed at the personal level. This double taxation would turn into triple taxation if the corporation were taxed for dividends received. The first taxation would be levied when the original corporation is taxed for earnings. The second taxation would occur when the corporation that owns stock in the first corporation pays dividends for the shares of stock that represent ownership. The third taxation occurs when dividends are paid to the stockholders and is taxed as personal income."

    These ideas seem to treat all income as if its in the form of a dollar with little corners on it that get torn off to pay a tax. Once the corner gets torn, you can't tax THAT dollar anymore seems to be the idea..... which of course is a totally flawed way of seeing dollar flows through the economy. I see many right wingers calling stuff double and triple taxation and I think this needs to be debunked.

    1. Good point Greg. I mean by this definition labor income is also 'triple taxed' at least. I never get it either as like you say there are different entities involved.

  2. "If you think this is unfair to call him a liar, keep in mind that in his recent post has called Krugman either a liar or ignoramus. I know, Tom Brown will say it was nice of him to give us a choice LOL."

    Funny! ... Well, choices are nice Mike... you have to admit.

    BTW, did you happen to catch Sadowski's recent comment?

    Sadowski lists the goodness and badness of various kinds of taxes:

    "In other words taxes can be ranked according to their effect on long run growth in the following fashion:
    1) Capital taxes (very bad)
    2) Labor Taxes (slightly bad)
    3) Consumption (moderately good)
    4) Property (very good)"

  3. Ok-I think Mark is dead wrong in his rankings. For why this is refer to the Krugman quote I pasted or this commentator on Money Illusion by the name of Philliphe:

    "“Really? As Paul well knows, there is a large literature in economics suggesting that an optimal tax system imposes much lower taxes on capital income than on wage income (or consumption).”

    "The paper linked to in the comment above makes no mention whatsoever of the real world. At no point in the paper do the authors analyse or describe the real world. What they do instead is construct artificial toy models, and then state that in these artificial toy models the optimal tax on capital income is zero. Astonishingly they then leap straight to the conclusion that therefore capital income taxes should be zero in the real world. They urge policy makers to reduce capital income taxes to zero immediately, or as soon as possible, and commit to keeping them at zero FOR EVER. They even imply that a law should be passed forcing all future governments to be bound by this commitment. All on the basis of their little toy models, and with no analysis whatsover of the real world. It’s absolutely extraordinary. Is this what passes for research and scholarship in economics?"

    Or for that matter read Greg's comments above.

    1. OK Mike, thanks. Yes, I know Philippe. He's left quite a few comments on my blog. Let me quote a little more from Sadowski's comment:

      "Generally speaking if we shifted from payroll and personal income taxes to a steeply progressive consumption tax (PCT) and dramatically boosted property (estate, gift and wealth) taxes we could not only create a system that is much more growth friendly, but also dramatically more progressive, and probably significantly increasing the amount of revenue as well. "

      Let me ask you specifically about the "property" tax as Sadowski explained it there. Where do you think that should be on his list (he currently has it at "very good")?


      Allow me to quote myself:

      "I clicked on the link [Mankiw] provided hoping to see something entirely different and instead I find a theoretical model showing capital taxes are bad (yawn). I share Krugman’s skepticism because I see such theoretical models presented all the time as “proof” even when the empirical evidence shows that the opposite is true...."

      "...Of course the theoretical model shows the opposite is true. The conclusion is built into the model by virtue of its very assumptions! But empirical reality is very different."

      So rather than refuting me, Philippe's comment only reinforces what I was saying.

      The ranking above is derived from *empirical* research, not theoretical.

  4. I don't have feelings that are very strong on the question of 'taxing property.' I've heard arguments for it-if memory serves me I think Morgan Warslter is a big proponent of it. I have also heard arguments that it may not raise so much revenue and that it's mostly just hype. I really haven't read enough about it firsthand to know for sure.

    What I don't like is Mark-and others- lauding a consumption tax and as far as I'm concerned a 'steeply progressive consumption tax' is a contradiction in terms.

    I tend to doubt that we would raise as much revenue through just the consumption of rich people as we would through taxes on capital gains, high income, and corporate income. My guess is it would hurt the nonrich by taxing their consumption and so would bring consumption down.

    I am all for taxing rich estates though, and would love to at least lower income taxes for the middle class and poor. I mean the worst taxes for the nonrich in reality are the payroll taxes. So some of these things could be good in theory but I don't like the idea of taxing consumption-where is this problem of too much consumption and no

    1. "I have also heard arguments that it may not raise so much revenue and that it's mostly just hype."

      The share of income that the top 0.01% paid in estate, gift and wealth taxes fell from 23.4% in 1970 to 2.5% in 2004. One of the main reasons why wealth inequality has gotten so much worse is that we no longer tax wealth.

      "What I don't like is Mark-and others- lauding a consumption tax and as far as I'm concerned a 'steeply progressive consumption tax' is a contradiction in terms."

      Then call it a luxury tax if you prefer. It's a myth that those with high incomes and/or high wealth don't consume profligately. A tax on mansions, yachts, personal jets, Rolls Royces and garage car elevators would bring in plenty of revenue.

      "My guess is it would hurt the nonrich by taxing their consumption and so would bring consumption down."

      Countries that rely heavily on consumption taxes such as the VAT tend to have much lower inequality than countries that rely more heavily on the taxation of personal income. VATs generally tax basic consumption items such as food at a lower rate. A PCT would go much further than this by exempting all consumption up to a basic level (e.g. $30,000 for a family of four).

      Robert Frank has written numerous articles on the benefits of a PCT:

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