Asymmetrical Information

Thanks for the Robert Heinlein reference - I remember being very young, and trying to look up TANSTAAFL in a Russian dictionary...

The problem with last year's tax bill (or, more accurately, one of the major problems) was the tax cut was phased in over several years. This created an incentive to defer income (and income producing activity) into future years. By moving the remaining scheduled cuts into the current year, the President's proposal removes this disincentive to growth.

And of course, incentives are what its all about. Yes, it is the combination of capital and labor that determine the size (and growth or contraction) of our economy. But it is very easy to divert capital and labor from productive to unproductive uses. By exempting dividends from taxation, the real (expected) return on an investment in stock just went up. By cutting the marginal tax rate, the value of working a few more hours just became greater.

Are these differences large enough to cause wholesale changes in the way our society works and invests? Probably not. With an economy as large as ours, a few extra dollars (or hours per month) diverted to more productive uses on a per capita basis can add up to a material difference in the economy. A positive difference in growth that does not require a corresponding contraction. TITSATAAFL!

Drum has two points to make. One is the surprise at no free lunches. The other is that the stimulus seems to be politically motivated, yielding its bad effects after the election is safely over.

In other words, he is shocked! that Bush and his cronies might be playing politics. Oh my! The president play politics? Who would even think it?

TANSTAAFL? FUBAR.

Speaking of productivity, Clinton, halfway through his tenure, saw only 0.3% annual gains while Reagan and Bush saw 1.5% and 1.4%, respectively. Kennedy saw 4.1%; Carter saw 0.6%. This is from the Economic Report of the President, 1996.

Talking about stimulus.

Old question: What did you do in the war, Daddy?

New answer: I pocketed a large tax cut, honey.

Pause.

And then I passed the bill for the war onto you.

Read more.

I wrote a post the other day questioning whether we really needed any economic plan right now. I'm still wondering about that.

I probably agree with your trendline argument (although my grasp of economics is not strong enough to say for sure). Also, it's not clear what those White House figures meant: 1.4% stimulus compared to nothing? Compared to some estimate of what growth would be anyway? Or what?

But if stimulus is the order of the day, wouldn't it be better to try and have it this year, not next? Why wait? The answer is obvious, of course, and I am indeed shocked! But then, I'm easily shocked.

Ah, but the real question: why did they remove those estimates from their Web site? To keep people like me from mocking them, of course!

Most macroeconomic changes take between eighteen and twenty-four months to work their way through the economy; for example, that's the lag between the Volcker interest rate increases and the end of the Reagan recession, and between the Keynsian stimuli of the 60's and their inflationary endpoints. It's going to contract in 2005 because by the time the tax cuts are enacted, that will be the macroeconomic lag.

New to the blog. Interesting debate.

Whether the Bush plan stimulates the economy or not matters little to me, though it's legit since he introducing it as such. I'm more concerned with: is it the right thing to do long term?

The answer has to be yes. Investors in stock should see a return from their investment in terms of cash while holding the investment that they are not seeing because of the double tax hit. Stocks are now like art work -- you only make money on them when you sell them. Stocks are not designed this way for good reason.

Simply put, more money in more people's hands (the hands that made it possible to make money in the first place) is better than having it the hands of a mucher smaller number of execs.

The basic idea of a stimulus plan is to borrow prosperity from the future.

Tsk tsk - what makes you think that future prosperity would be there in the first place? A stimulus is an insurance policy, in case we fall into a liquidity trap that the Fed can't get us out of. If we don't end up in one, the Fed can raise rates to counteract the effect, so there's no downside.

That's an interesting idea, Jason, but that's not the way that anyone's talking about the stimulus, and if we do fall into a liquidity trap, it's probably going to be more important to create inflationary expectations than to tax or spend, seeing how little effect Keynsian stimulus has had on the two liquidity trap recessions it was supposed to cure.

Jane,
"Most macroeconomic changes take between eighteen and twenty-four months to work their way through the economy; for example, that's the lag between the Volcker interest rate increases and the end of the Reagan recession"

a> the lag is only 6 months; about 1 yr for fiscal policy; and there's no need to go to Volcker's Fed- look at 1991-2 recession recovery curve steepness (GDP growth of ~3%)
b> Speaking of Fed actions: what do you mean by RATE INCREASE VS. END OF RECESSION? Is it a typo?
---
". If you believe in stimulus, all stimulus plans are eventually contractionary...

"Stimulus plans do not grow the economy, everyone from Paul Krugman rightward generally agrees that the only way to grow the economy is either to increase the labor or capital input, or increase productivity. "

a> contraction is a cyclical phenomena. Happens every 10 yrs or so and will happen regardless of fiscal stimulus or whehter u believe that there WILL BE an expansion.
b> Productivity can actually be increased when companies have cash to invest in CapEx and hire more people. And since div.tax cut could boost sharevalue through hogher valuations of paid in/out capital rather then "retained earnings"- it could boost the asset values of the market.
c> Consumer spending is a moot point, of course, The resilienace is astounding: we spend, borrow and spend, then refinance and spend some more.

Having said all of that- I am not a big supporter of tax cuts, ans especially the div.tax - which in this package is a political move to gain votes, oh well...BUT if there's a good time to slash taxes, NOW is the best.

Sorry, also a comment of your last comment ;-)

"if we do fall into a liquidity trap, it's probably going to be more important to create inflationary expectations than to tax or spend,"

Why is it important to have inflationary expectations?

Because the liquidity trap is based on inadequate money supply/collapse of aggregage demand (depending on whther you're a Keynsian or Monetarist/Neo-Classicist; the distinction for our purposes is trivial). The contraction generally stems from people holding money (often combined with a banking crisis) and therefore decreasing their consumption. As they've found in Japan, Keynsian stimulus doesn't help; it may stave off disaster, but won't end the recession. (and I've heard a very credible Japan economist argue that it actually causes problems, because the debt overhang causes people to worry and save more). The only way to get people to spend is to make them fear that their money will be worth less tomorrow than today -- so get rid of it quickly! Or so goes the theory; it hasn't been put into practice because the Japanese are afraid, and because their banking system is so screwed up that it would take a major run of the presses to alter it; the primary vehicle for money creation is broken.

What makes you think this is a stimulus policy at all? The fact that they say so? More likely calling it that is a political tactic to avoid the Bush I "we were suffering and he did nothing" criticism.

If they wanted to stimulate the economy while cutting taxes, they should raise the personal exemption as high as need be. After all your salary has already been taxed once on the corporate side, right?

No, no, no, no, no, no, no, no NO! Raising the personal deduction is absolutely the worst kind of tax cut; it makes consumers feel wealthier (and thus want to work less), while giving them no incentive to work more. To the extent that it works at all, it shrinks the labor input and thus total production.

JG,

"Contraction" or "contractionary"? Is there good reason to expect that the after-effect of stimulus is outright contraction? If we look at this process as around trend (which you also suggest) rather than around zero, what good design and a lot of luck could come down to is a smoothing of economic performance around trend, less strength in the period of inflationary risk, more strength in the period of deflationary risk.

Dima,

Before JG comes back from coffee (and her answer may be different), the notion is that a deflationary episode is driven at least partly by expectations. Consumers anticipate lower prices in future periods, so delay purchases. That delay of purchases makes expectations self-fulfilling, as producers compete for consumer demand by lowering prices. The way out is to convince consumers that prices will begin to rise, so the smart thing to do is go out and buy before they do. Inflationary expectations.

JG,

Do you drink coffee?

What makes you think this is a stimulus policy at all? The fact that they say so? More likely calling it that is a political tactic to avoid the Bush I "we were suffering and he did nothing" criticism.

You say this like it's a bad thing. Wasn't the reason we all pumelled Bush I for doing nothing during a rough economy so that future presidents would take a different action? Or were we just doing it because it's fun to bash the president?

Sometimes politics makes politicians do the wrong thing for selfish reasons. When that happens, have at 'em. But sometimes, politics forces politicians to do what the people want (or think they want). This is exactly what politics is for.

Yeah - he's doing it because it will help him get elected again. But it'll help him get elected again because a lot of people think it's a good thing. That doesn't sound so bad to me...

>> After all your salary has already been taxed once on the corporate side, right?

Absolutely wrong, xian. Compensation paid to employees is deducted from revenues, thus lowering the corporation's taxable income. Just as interest expense is deducted. And unlike dividends.

Economists get so wrapped up in the effects of different policies, when in the end, you just need to know one for our country: more money kept by those that earn it means greater economic prosperity. It only gets complicated when there are claims to money by those that didn't earn it, thus resulting in endless variations and fine-tuning on what is a pretty basic formula.

K.Harris,
I am not sure who is drinking which beverage, but none of my comments were addressed yet. ;-)
I am sure it is very personally rewarding to throw out various textbook economic terminalogy, however, it does NOT answer real life situations.
There is no liquidity concern today, nor there was one last year and there will probably not be one this year.
Fed is pumping liquidity employing EVERYTHING from lowering rates (by the way- still no answer to my question of how RAISING rates helped the RECESSION???) to buying UST. They even considered buying back AAA Agencies, if needed.
The question of Japan is ludicrous- their banking and financial system is inherently different from Amercian; as is their consumer mentality. On this topic, please refer to June 2002 Fed paper outlining difference between USA and Japan, particularly with respect to possibility of deflation (I will be more than happy to discuss DISINFLATION with interested "real-world" practitioners, if interested).

Speaking of productivity, Clinton, halfway through his tenure, saw only 0.3% annual gains while Reagan and Bush saw 1.5% and 1.4%, respectively. Kennedy saw 4.1%; Carter saw 0.6%.

Maybe you should look at productivity only on Wednesdays. I'm sure it'd be just as fascinating.

That's an interesting idea, Jason, but that's not the way that anyone's talking about the stimulus, and if we do fall into a liquidity trap, it's probably going to be more important to create inflationary expectations than to tax or spend, seeing how little effect Keynsian stimulus has had on the two liquidity trap recessions it was supposed to cure.

That's not the way the GOP is talking about "stimulus" because they don't give a crap about stimulus; it's just a veneer of social good on top of a political plan. Unless you can somehow convince me that a dividend tax cut isn't dead last on the list of things that'll stimulate demand. And what were these two liquidity trap recessions Keynesian fiscal policies didn't cure?

As they've found in Japan, Keynesian stimulus doesn't help; it may stave off disaster, but won't end the recession. (and I've heard a very credible Japan economist argue that it actually causes problems, because the debt overhang causes people to worry and save more).

They haven't fallen into a depression, either, so it "didn't push growth positive" isn't particularly helpful either. Do you have any evidence it's made things worse or had no effect?

No, no, no, no, no, no, no, no NO! Raising the personal deduction is absolutely the worst kind of tax cut; it makes consumers feel wealthier (and thus want to work less), while giving them no incentive to work more. To the extent that it works at all, it shrinks the labor input and thus total production.

So you think the population is fooled into "feeling wealthier" by a deficit-financed increase in the personal deduction, they aren't fooled into reducing total investment by an increase in the deficit?

And isn't the net effect on aggregate demand what's important, not the 1st-order effect on hours worked?

That's right, Jason. Republican stimulus evil. Democrat stimulus good. Make sure you keep them straight. Above all, be sure and avoid any explanation of what makes them that way. It makes for better demagoguery.

Dima,

“I’m sure it is very personally rewarding …” Come again? I’m not sure what I did to step on you sensitivities, but you asked what could be mistaken for a straightforward question in search of a straightforward answer. I’ll be sure not to mistake any of your future posts in similar manner.

K Harris,
I actually didn't intend that phrase to come off like that...no sensitivities, nothing personal.
I think its just an internet mixup, where there's no tone or emotion coming through...sorry ;-)

p.s. I guess thats why they have "emoticons".

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