Hypothetical Bias

If you cut tax rates to 0% will tax revenue explode?

From the NYTimes Economic Scene column (A bit of doodling ...):

One motivation for Mr. Reagan's tax cuts was a guess that the United States was on the right side of the curve - that is, that lowering rates would actually yield more tax revenue over all. Some recent statements by Joshua B. Bolten, President Bush's current budget director, seem to indicate that he still believes this to be true, though rates are much lower now than when Mr. Reagan took office in 1981.

The highest marginal tax rate in 1980 as 70+ percent. Mr. Reagan probably made a good guess. The highest rate in 2000 was about 40%. Maybe not so good a guess?

In July 2003, Mr. Bolten said this at a press conference: "All economists, I think, will agree very strongly that when you reduce taxes, put more money back into the economy, that has a feedback effect in the economy that causes growth" and in turn "increases receipts." He added that he wanted "to see how much better the government's fiscal situation is as a result of the tax cuts."

The problem with this statement is that it depends on the current rate of taxation. Consider the extremes. If the tax rate is 100%, no one will work and revenue will be zero. Reducing the tax rate will encourage some people to work and increase revenue. This is the impact that Mr. Bolten expects from tax cuts. At the other extreme, a 0% tax rate, no revenue is earned. Raising the tax rate will increase revenue. Both of these effects work themselves to the point where there is a tax rate that maximizes revenue. Increasing or decreasing the tax rate from this level will reduce tax revenue.

I think that only when the tax rate is 100% will ALL economists very strongly agree with Mr. Bolten. But, then, who am I to say what ALL economists think? In a paper published in the Journal of Economic Education in Fall 2003, 31% of surveyed AEA members disagreed with the following statement:

Lower marginal income tax rates reduce leisure and increase work effort.

In other words, tax cuts won't increase labor hours and won't increase revenue. Again, not ALL economists agree with Mr. Bolten.

Back to the NYT article:

The recent analysis by Mr. Page at the Congressional Budget Office dismisses the idea that tax cuts may actually improve the government's fiscal situation. Even in his most generous scenario, only 28 percent of lost tax revenue is recouped over a 10-year period. The United States, it seems, is firmly planted on the left side of the Laffer Curve.

Ooops!

The article goes on to describe the benefits and costs of reductions in government revenues. The benefits are the increased disposable household income and the inevitable shrinking government. The costs are the reductions in government services if government reduces spending and, if the government does not reduce spending, budget deficits. Budget deficits require borrowing and governments that increasingly borrow increasing amounts forever ultimately face some sort of crisis (higher interest rates and/or higher inflation and maybe some gremlins and goblins). These costs are nice because we don't suffer them until a long time from now. We can discount the future pain away.

Nice article, and I need to read the CBO paper.

WSJ: Debating Freakonomics

From the WSJ (Debating Freakonomics):

It's round two in the Freakonomics brawl.

Last week, two economists at the Federal Reserve Bank of Boston posted a working paper that took issue with a controversial chapter in the best-selling book Freakonomics. That chapter draws a link between the legalization of abortion in the 1970s and the decline in crime two decades later.

The Boston Fed economists found flaws in one of several statistical tests conducted by Freakonomics co-author Steven Levitt. Now, Mr. Levitt is firing back. He says he's rerun the numbers and found the Boston Fed researchers haven't measured abortion accurately enough to prove their point.

"No doubt there will be future research that attempts to overturn our evidence on legalized abortion. Perhaps they will even succeed," Mr. Levitt says on his Web site. "But this one does not."

Statistical debates like this never get settled overnight, if at all. Christopher Foote, the lead Boston Fed researcher in the debate, says he's studying Mr. Levitt's response, and should have a counter-punch ready within "a couple of days."

• Earlier: 'Freakonomics' Abortion Research Is Faulted

A side note: I’m always blown away by the sheer magnitude of the comments made at the Freakonomics blog by the abortion-cut-crime critic Steve Sailor. So far, his comments on this post amount to 22 double spaced pages (12 point, Times Roman font, 1” margins) and 5882 words.

That’s a lot of writing.

Music embiggens me

The top ten albums of the year according to John Whitehead as submitted to the WNCW listeners poll. In [brackets] is the overall ranking.

1. Wilco - Kicking Television: Live in Chicago [27]
2. Lynne, Shelby – Suit Yourself [NR]
3. Son Volt – Okemah and the Melody of Riot [14]
4. Cary, Caitlin & Thad Cockrell – Begonias [45]
5. Edwards, Kathleen – Back to Me [33]
6. Adams, Ryan and the Cardinals – Cold Roses [8]
7. Adams, Ryan and the Cardinals – Jacksonville City Nights [38]
8. Cowboy Junkies – Early 21st Century Blues [63]
9. Old 97’s, The – Alive & Wired [NR]
10.Crowell, Rodney – The Outsider [5]

As you can see, I have craptacular taste. So craptacular, in fact, that I was asked to read my list on air. The official request:

Thanks for submitting your Top 10 list at our website. We'll start counting down the Top 100 on the air December 29th. As part of the countdown, we'll be featuring select listeners reading their Top 10 on the air.

I'd like you to participate if you're interested.

By the way, I would have voted Wilco #1 if they had put out an album of Styx and/or Journey covers. And, how could Shelby Lynne [video] not make the top 100? Even ignoring her top 10 hotness (agreed, this juvenile comment deserves to be deleted from this cromulent blog but I can't bring myself to do it), the album "satisfies with the honesty and strength of the material" (from the Amazon.com review).

After they recorded my list, here is the message I received Thursday 12-29 at 7:24 am:

Anyway, your Top 10 will air Thursday 12-29 at 2:50am. This time is approximate. I'd allow about 10 minutes on either side.

Note the times and note that the countdown started Thursday morning at 8:00 am. Somehow, I don't think my list made the air. Could it be because I mentioned Shelby Lynne's top 10 hotness?

Update: I've heard that it played on Thursday at 2:50 pm! I've requested an electronic file which I'll be sure to post ASAP!

Ivan on Coldplay and global warming

I like this one from Ivan's (the Flemish Beerdrinker) weblog:

Beware for Progressives

Fine group Coldplay. And of course it’s leadsinger is a progessive who has his heart in the right place. He is for vastly increasing aid for poor countries, for "fair trade", and against global warming. There are two problems however: where his brain is situated is less clear, and he’s a hypocrite:

Coldplay singer Chris Martin is always going on about global warming. Fair enough - if listening to him hectoring us about scarce resources and carbon emissions is what it takes to conserve the planet then it’s a price worth paying. But what if he’s a big fat hypocrite? Coldplay frontman Chris Martin avoided serious injury when his BMW X5 hit another car in London yesterday December 19. Martin had a minor shunt on a busy road near Belsize Park. Nobody was hurt. Martin’s actress wife Gwyeth Paltrow is also thought to have been in the vehicle. These things do between 12 (city) and 21 (motorway) miles to the gallon.

Aah. Progressives. They are such easy targets sometimes.

My bet is that Jeff Tweedy drives a hybrid.

1 in 4 chance of a recession within 12 months

Since I didn't pay much attention in school I've never seen one of these ... (Thrown for a yield curve):

Many standard economics textbooks report that an inverted curve is a leading indicator of an imminent economic slowdown. The traditional reasoning goes something like this: when short-term rates are relatively high, demand for loans slackens, weakening the economy. And bond traders, collectively seeing so many signs of an impending economic slowdown, have already driven down longer-term rates in anticipation of an eventual loosening of short-term credit.

The statistical support for this indicator looks impressive. Arturo Estrella, an economist at the Federal Reserve Bank of New York, contends that an inverted yield curve "has predicted essentially every U.S. recession since 1950 with only one 'false' signal."

At first blush, there is no evidence that the indicator is losing its touch. It worked like a charm, for example, in forecasting the economy's most recent recession. According to the National Bureau of Economic Research, the widely recognized arbiter of when recessions begin and end, that recession began in March 2001. The yield curve went negative the previous summer.

Mr. Estrella and Frederic S. Mishkin, a professor of banking and financial institutions at Columbia University, have built an econometric model that relates various levels of the yield curve with the probability of a recession within 12 months. With the rate on 10-year Treasury notes now just about half a percentage point higher than that for three-month Treasury bills, for example, the researchers' model calculates a 10 to 15 percent probability of a recession within the next year. That probability would grow to about 25 percent if the difference in rates disappeared, and would grow even further if the curve inverted, meaning that the short-term rate was higher than the longer-term one.

The difference between the 2-year and 10-year notes is about zero, so we have about a 1 in 4 chance of a recession within 12 months. I'll begin hoarding money (M1) and/or gasoline on January 1.

Here is another Economist's View from Mark Thoma.