Commentary On the Tax Bill Is Atrocious

I'll start by saying I have no idea if the tax bill is good or bad on net, but I will freely point out deficiencies in some of the opinion pieces I've read. Bad as those are, the garbage that gets scrawled across my Facebook feed is worse. I see even really smart people fall victim to sloppy thinking.

Tax Incidence

What bothers me most about the commentary on the tax bill is the utter lack of economic understanding, with full bore inequality-mongering and class-baiting in its place. Much of the commentary is of the variety "Corporation X will see its corporate taxes decline by $Y billion dollars! Therefore the tax bill is a giveaway of $Y billion to Corporation X. Naturally this comes at the expense of the rest of society." When I see this kind of unserious comment, I think, "Really? So you've never heard of tax incidence?" People supplying this kind of comment are doing mere accounting without any thought about how the world adjusts. You can't calculate the distributional effects of a tax bill just by recalculating everyone's tax liability under the new tax structure, assuming everything else stays fixed. Things adjust. Prices adjust, such that a tax increase on a business will tend to raise prices and a tax cut on business will lower them. No fair objecting to one and not the other; this is a perfectly symmetric statement. Scott Sumner had an excellent post on tax incidence just the other day that perfectly captures the naive view and contrasts it with how economist think about these things.

Current Rates Must Be Justified

No, you can't simply dismiss any reduction in tax rates as a "giveaway to the rich." The existing tax structure is highly progressive. (Try looking up shares of income and comparing them to shares of taxes paid. Good analysis here.) Maybe it's not progressive enough, or maybe it's too progressive, or maybe it's just the right amount of progressive. I'll play agnostic on this question, but it is a question that needs to be answered. We can't just take what exists as a given, as if the status quo government policy were automatically justified, and berate any movement in the "wrong" direction. If you think that current levels of progressivity are about right or too low, that requires some sort of argument. Perhaps the outcome of some kind of optimization problem. Even if it's an imprecise and back-of-the-envelope optimization, that would at least be a great place to start.

Given the US's very high level of progressivity, almost any kind of tax cut is likely to reduce the taxes paid by rich people more so than middle-class and poor people. That doesn't mean it's the wrong thing to do. Suppose we are in a regime where even Bernie Sanders-level progressives think the tax regime is too progressive, and we mostly all agree we should scale back top marginal rates. A dishonest demagogue could cast this change to the tax code as a "giveaway to the rich." Just so. Fixing a tax structure that's too progressive is a thing.

Taxes on Capital Should be Close to Zero

I am disappointed by some parts of the tax bill, but the reduction in the corporate tax rate is badly needed. A bit of (now)-standard macro shows that it is impossible to tax the capitalists and use the proceeds to enrich labor. Do read the full piece by Garett Jones. Here's an excerpt:

First, let me sum up a key implication of Chamley-Judd:

Under standard, pretty flexible assumptions, it's impossible to tax capitalists, give the money to workers, and raise the total long-run income of workers.   

Not, hard, not inefficient, not socially wasteful, not immoral: Impossible.

If you tax capital income and hand all of the tax revenue to workers, then in the long run (or the "steady state") you'll wind up with a smaller capital stock. And since workers use the capital stock to earn their wages, the capital tax pushes down their wages.  

Also see this excellent post by Casey Mulligan. Here's an excerpt, but you'll need to see the supply and demand diagrams to understand them:

The red area (R) is the revenue from a capital income tax.  The red and green areas (R + G) are the losses from that tax suffered by owners of the factors of production, combined for capital and all other factors.  The revenue is a LOWER BOUND on the factor owners' loss.

In the long run, all of the factor owners' loss from a capital income tax is a loss to labor (the area below the horizontal dashed line is negligible; see A below).  Therefore, in the long run, capital-income tax revenue is a LOWER BOUND on labor’s loss.

Emphasis mine. There are ways of extracting taxes from rich people, it's just that capital taxes are a particularly inefficient way of doing it. (Corporate taxes, taxes on dividends and capital gains, inheritance taxes, and other taxes that hit savings and investments.)

This also falls under the header "tax incidence". When you tax corporate profits, the corporation doesn't just keep doing everything it was doing before and shell out the money. It raises prices to offset the tax. (I literally do this calculation as an actuary so that my company has an indicated profit margin. It's a standard piece of actuarial methodology, and there is certainly a non-insurance version of this in other industries.) It is less likely to undertake a project with a marginal rate of return. It will fail to invest in the kinds of "capital goods" that make its workers more productive, thus raising their workers' marginal product of labor and thus their wages. So "capital taxes" actually come out of the pockets of workers in the form of lower wages and higher prices. If you imagine that "corporate taxes" fall on a faceless, inhuman monstrosity, as if you were simply taxing a robot, get real. It's flesh and blood humans who ultimately pay those taxes. All those price increases and wage reductions happen in reverse if we cut an existing corporate tax. (Again, if you can easily see it happening in one direction but not in the other, the onus is on you to tell us what breaks the symmetry.)

Declining to Tax is Not a Cost

I have seen that the estimated "cost" of the tax bill is $100 billion a year. This is actually the reduction in government revenue, which is very different from the cost of the bill. A tax is merely a transfer. If you take $100 billion from some people and give it to others, or decline to do so, you can't simply say that the cost of this transfer/non-transfer is $100 billion. You need more information. How much does it cost to collect $100 billion? When you collect taxes, people adjust their behavior to avoid the taxes. They do things they otherwise wouldn't do, they hire tax accountants to minimize their bills, they decline services they would otherwise have paid for, and they decline to work as often or as diligently as they otherwise would have. (Extreme example that I am pulling entirely from memory: In some Scandinavian country you have to earn $19 in pre-tax dollars to pay one after-tax dollar to a laborer who remodels your home. People thus do a lot of home handy work that they'd otherwise simply hire someone to do. Some of the value of division of labor is thus lost. Even if I'm misremembering the example, this is the kind of thing that happens with very high tax rates.) These costs are called "deadweight losses." The money transferred isn't the loss. We've taxed Peter but paid Paul. That is a wash. The loss is the labor that Peter declines to give us, the foregone sandwich because of our tax code's quirky sandwich tax, the tax accountant who should have been an engineer if minimizing people's tax liabilities weren't so lucrative, etc.  Those are deadweight losses. That is the true social cost. Economists think that the social cost of taxing a proportion X of the national income scales up like X squared. So that $100 billion transfer may be more or less costly depending on how much your tax code is currently collecting and how large the total economy is. Under our current tax structure, collecting a dollar of revenue costs about $0.33 in deadweight loss (citation needed; this is a rough figure I have seen in multiple places so I am using it, as a placeholder anyway). So, unless that $100 billion is buying something worth at least $133 billion, it's probably a good idea not to collect it.

Now if we perpetually run budget deficits such that the government can't pay off the debts when they come due, that could lead to some kind of serious financial crisis with very high social costs. It's worth estimating those. But once again, the "$100 billion" figure tells us nothing about the magnitude of that cost.

Trickle-Down Economics Isn't a Thing

Some may read the section above on capital taxes and say, "That's just trickle-down! Which we all know is wrong and doesn't work!" And indeed, "trickle-down" as it's so often depicted is silly as a basis for tax policy. The idea isn't that you give money to really rich people and big companies and hope that maybe, if they're feeling generous enough, they'll give some of it back to the rest of us. If your model for this is to follow a dollar (as if you've put a radioactive tracer on it) from the government, to the rich guy, to the rich guy's tailor/grocer/driver in the hopes that it ends up in the hands of poor people, then your model is wrong. The benefit of tax cuts comes from getting rid of the high levels of distortion and deadweight losses, not from giving lots of money to rich people and hoping they will spend it on our services. If economists are right about the magnitude of deadweight loss from taxation, it should be easy enough to cut some spending to justify some tax cuts and net out a social gain. This holds even if you think some government programs are strictly cost-justified in terms of their dollar price tag, because you have to justify the social cost of collecting the tax revenue, too. Nothing "trickles down" here, we're just eliminating wasteful spending and the destructive effects of the associated taxes.

The Burden of Government is the Spending, Not the Taxes Paid

A dollar spent is a dollar taxed. You can finance that dollar of spending with a dollar of taxes collected this year, a dollar from budget surplus from a prior year, or a dollar from a future year (plus the interest on the dollar you borrowed this year). This tax bill may make the collection of taxes mildly more or less efficient, but it won't fundamentally solve our problem unless the spending problem gets fixed. I don't know if this impugns or justifies the tax bill. If the lower tax revenue induces a future congress to cut federal spending ("starve the beast"), then the budget deficits could be good for us. If the lower tax revenues simply mean that future tax rates will need to be higher and thus even less efficient (remember the X^2 scaling mentioned above?), then the budget deficits will be bad for us. The tax bill should be connected at the hip to a spending bill. There is plenty to cut. Very few federal programs would pass a serious, honest cost-benefit test. Just start ranking programs on their cost-benefit balance, set a threshold, and start cutting. At any rate, I wish people would stop taking their eye off the spending ball to obsess over tax rates.


I wanted to write this post after Scott Alexander wrote three bad posts in a row, repeatedly doubling down on his initial claim. Some very good commenters corrected his errors, and I hope that he's digesting them. (Re-reading his second and third posts just now, I see he is conceding some important points to defenders of the tax bill.) But I worry that the good comments will be drowned out by the flood of noise-comments. Not to pick on Scott, because he is a very intelligent, honest, and thoughtful commentator. I just think he got this one very wrong, and for fairly obvious reasons. In the third post (which he opens by explaining what he's learned from his commenters, a good start!), he says, "[Y]our job isn’t to explain Economics 101 theories to me even louder, it’s to explain how the country’s best economists are getting it wrong." And he links to the IGM forum, a survey of professional economists, specifically regarding a question about the tax bill. Great, we have a poll of experts and some of their commentary, so let's see what they said.

The exact wording of the question is:

Question A: If the US enacts a tax bill similar to those currently moving through the House and Senate — and assuming no other changes in tax or spending policy — US GDP will be substantially higher a decade from now than under the status quo.

Daron Acemoglu says:   

The simplification of the tax code could be beneficial, but it is more than offset by its highly regressive nature.

David Autor says:         

Tax policy appears to have little effect at the margin on GDP growth in OECD countries.

Markus Brunnermeier says:             

It is more likely that GDP will be somewhat higher

Darrell Duffie says:

A reduced corporate tax reduction is likely to grow GDP. Whether the overall tax plan is distributionally fair is another matter.

Austan Goolsbee says:

Of course not. Does anyone care about actual evidence anymore?

Robert Hall says:

Though there is merit in cutting the corp tax and other capital taxes, with no other changes in policy, the fed gov will collapse.

Oliver Hart says:

The incentive effects are unclear to me. Some of the simplifications make sense but many of the changes look like hand-outs to the rich.

Anil Kashyap says:

doubt it will substantially change things either way

Pete Klenow says:

Expensing of investment would provide a bigger boost to the capital stock and GDP 10 years from now, per dollar of revenue lost.

William Nordhaus says:

Keynesian effect will have disappeared. Higher debt will probably outweigh lower corporate tax rates. Unlikely that nothing else will change

Larry Samuelson says:

Other factors swamp the importance of details of the tax code in determining GDP.

Richard Thaler says:

Aside from the redistribution of wealth, hard to see this changing much.

I'd summarize this by saying there are a few basic themes. 1) There's always lots of stuff going on, so with many causal factors it's hard to know the effect of a tax bill. 2) Naive empiricism. (See Goolsbee's comment, also Autor's.) As if theory tells us nothing at all. If you can't tell, I don't care for this kind of thinking. 3) Economic theory on capital taxation is probably correct, but given theme 1) the size of the effect is swamped by noise. 4) Distributional effects matter. (But these guys should have answered the question about GDP independent of their feelings on justice of distribution). BTW, I don't really get the feeling that these guys carefully read the tax bill, entered its provisions into a big simulation, and gave a considered reply after seeing the results. Dare I say some of these folks might be influenced by politics and mood affiliation? Bryan Caplan suggested once that the panel has a left-leaning political bias, though he was careful to say that doesn't mean we should dismiss their consensus (when there is one). I take this survey seriously. I'm certainly not dismissing it. But some of the comments seem flippant and reveal a shallow consideration of the question. And I don't assume the non-commenting members necessarily had a more thorough justification for their responses.

So, in short, there is no safe "Gee, I just agree with the experts" position here because the experts are all saying very different things. That's when it's time to dive into the details, or admit your ignorance and just be agnostic. Indeed, I was surprised by the number of people responding to Scott in the comments who said something along the lines of, "I don't know if the tax bill is good on net, but your argument is wrong here..." Such a comment is perfectly in tune with the IGM respondents, based on their comments.

(I'm sure the Congressional Budget Office does a better job of this thorough ins-and-outs analysis, but my impression is that they are mostly concerned with budgeting, not cost-benefit analyzing the bill? Is that impression wrong? As in, a bill under consideration can be a net loser from a government budgeting standpoint but pass a cost-benefits analysis from the point of view of society as a whole, conceivably. )

BTW, there is a second question on debt-to-GDP, and economists understandably agree that the tax bill will raise the debt. Sheer accounting is probably good enough here, save some ultra-supply-side argument.