TAX NEWS - June 2010

Jeffrey Sachs on the Post-Keynesian Era

Advocates of new stimulus efforts are deploying a number of arguments, one of which is that the first federal stimulus bill doesn't count because it didn't represent net stimulus.

My views have been heavily influenced, to my surprise, by Columbia economist Jeffrey Sachs, a scorched-earth critic of the Bush administration who has made a number of very temperate and persuasive arguments in recent months about how we need to pursue more stable macroeconomic policies. I don't agree with Sachs on all of the particulars, on which I'll elaborate further, but I was impressed by his latest intervention in the Financial Times.

Keynesian stimulus was premised on four dubious propositions: that it was needed to prevent a global depression; that a short-run fiscal boost would jump-start the economy; that "shovel-ready projects" could combine short-term cyclical and long-term structural agendas; and, last, that the rapid rise of public debt occasioned by stimulus need not be a concern. That these ideas were so widely accepted was a testament to the perennial political attractiveness of tax cuts and spending increases.

In fact, the ubiquitous references last year to the Great Depression were glib; the policymakers had panicked. Adroit central banking could and would prevent depression. The hastily assembled stimulus packages were a throwback to naive Keynesianism. The relevant fact was that the US, UK, Ireland, Spain, Greeceand others had over-borrowed for a decade, so a decline in consumption after 2007 was not an anomaly to be fought but an adjustment to be accepted.

In Sachs's view, the notion that "a temporary fiscal bridge would carry us back to consumption and housing-led growth" was always a mirage. And so we have to begin the painful process of adjusting to a new environment in which U.S. consumers will have to repair their balance sheets and the U.S. government will have to invest heavily, but efficiently, in education and infrastructure.

One place where Sachs and I disagree is on the extent to which we ought to impose higher taxes on the rich.

Governments and the public should insist that the rich pay more in income and wealth taxes – indeed, a lot more. The upward re-distribution of the past 25 years has made our economies into extravagant playgrounds for the super-wealthy.

Felix Salmon thinks that middle class U.S. voters will prove resistant to tax hikes on the rich. Like Matt Yglesias, I think he's wrong about that. The median voter seems entirely content to tax other people more heavily, as you might expect. Leaving aside Sachs's implicit mental model of the working rich — suffice it to say, I think I have a different mental model — taxing the rich is a strategy that yields diminishing returns, as Megan McArdle recently explained.

But the larger problem is that whether we feel for them or not, as noted in an essay one of my commenters pointed to, a 50% marginal rate seems to be where people get really, really serious about tax avoidance.  Paying more than half their income in taxes violates most people's sense of fairness.  More importantly, the higher the marginal rate, the bigger the payoff from tax avoidance–and the more you can afford to pay smart tax lawyers while still coming out ahead yourself.

Perhaps Sachs would advocate some form of tax harmonization to help mitigate this outcome. But my guess is that technology will make tax evasion less difficult rather than more difficult over time. This suggests that heavier consumption taxes are a far more likely revenue source. And when the alternative is taking a hard look at public spending in search of efficiencies or reducing net disposable income, my guess is that the politics of budget-trimming will gain potency in the decades to come.