Must-Read: Larry Summers: One last time on who benefits from corporate tax cuts

Must-Read: I confess that I, at least, never heard Larry Summers say: “A-list people do not directly criticize A-list people: doing so is a way to become a B-list person”. I doubt he has ever said it that way.

I have, however, heard Larry say—many times—that it is in general not wise to presume bad faith or incompetence on the part of, say, present or former fellows at places like, say, the American Enterprise Institute.

First of all, people think differently and disagree. Economics ain’t rocket science. As John Stuart Mill said, in economics:

What was affirmed by Cicero of… philosophy… may be asserted without scruple… that there is no opinion so absurd as not to have been maintained by some person of reputation. There even appears to be on this subject a peculiar tenacity of error—a perpetual principle of resuscitation in slain absurdity…

You might be the one maintaining the absurd position. You should keep an open mind, and mark your beliefs to market.

Second, strident criticism of error according to a hermeneutics of bad faith or a hermeneutics of incompetence may be effective at rallying one’s own troops to the cause, but it is not effective in winning converts from the other side, or even at persuading the rational middle of good-hearted and public-spirited people fresh to the issue.

Thus, the view was, we should invite Kevin Hassett to present his view of the “Tax Reform” framework to the Tax Policy Center, and name him a Distinguished Speaker. We should presume that Charles Murray’s rantings are not at base motivated by whatever made him burn a cross in imitation of the KKK. We should presume that there is competence at some level behind Casey Mulligan’s claim that 4% of the American labor force quit their jobs and began happily playing video games in the basement as a result of the passage of ObamaCare and similar policies. We should take it for granted that John Cochrane has done his math correctly when he claims that a 20% VAT could provide a progressive replacement to America’s tax system. We should keep a open mind to Nick Eberstadt’s argument that Americans have been unmanned by their receipt of unemployment insurance, Medicaid, Medicare, and Social Security—never mind the fact that such programs neither greatly alter incentives nor are perceived as “welfare” by beneficiaries—and turned into a nation of “takers”, in the phrase coined by right-wing goldbug loon Edmund Contoski. And we should spend our time and energy going the extra mile to presume that their positions are advanced in competence and good faith, and arguing earnestly against the positions they advance with evidence and logic, in one gigantic interminable game of whack-a-mole.

I have long thought that Larry was wrong here.

I have long thought that the best working rule is: everybody gets three strikes—three mistakes that are highly unlikely to have been made by someone working competently and in good faith, with plenty of opportunities to recant, correct error, and mark beliefs to market.

After three strikes, they are out. After they have struck out, then it is not irresponsible to work according to a hermeneutics of bad faith or incompetence. Rather, it is irresponsible not to.

Not to do so—to assume good faith and competence where it is absent—is, IMHO, very destructive of the public sphere in the long run. It sets in motion a downward Gresham’s Law spiral. Those who are willing to argue in bad faith are not constrained in the degree to which their doctrines can please their political masters and their think-tank donors. Those who are not competent are, similarly, unconstrained by reality—and pure fantasy can, also, often be very pleasing to political masters and think-tank donors. And so bad economists will drive out good ones: in the esteem of their political masters, in their positions in think tanks, in the financial support that they can elicit.

Larry might have thought—he has never argued this way to me, but it is a plausible argument—that it is the business of economists on each political “side” to police their own, and require quality analysis. And in the center and on the center-left there is indeed such a tendency. Charlie Schultze in the 1980s had no tolerance for the arguments of Bob Reich, who he thought dangerously overestimated the administrative and planning competence on the one hand and the relative autonomy from industry-specific rent-seeking on the other of the American government. When the smart and well-intentioned Gerry Friedman put forth a series of arguments that my faction thought greatly overstated the good that could be done by a not too massive public investment and spending program, the smackdown was intense. The view is that analyses that are not in the range of those made by politically-disinterested analysts and forecasters who do not have a career-making or -breaking dog in the fight are not analyses that should be used for policy planning or policy advocacy.

But there is no much less policing of intellectual quality on the right than on the center and the center-left. And so the downward Gresham’s Law quality-of-economic-analysis spiral continues.

It gives me no pleasure to watch the evenhanded, hermaneutics-of-good-faith-and-competence Larry vanish. But he has. And now we have a different Summers: one who is downright shrill:

Larry Summers: One last time on who benefits from corporate tax cuts: “I recently asserted that Kevin Hassett deserved a failing grade for his ‘analysis’ projecting that the Trump administration proposal to reduce the corporate tax rate from 35 to 20 percent would raise the wages of an average American family between $4,000 to $9,000…

Larry states that in his view it is Kevin Hassett who crossed the ultimate line in terms of tone and respect, and that that line-crossing deserves universal condemnation:

Hassett had, for what seemed like political reasons, impugned the integrity of people like Len Burman and Gene Steuerle who have devoted their lives to honest rigorous evaluation of tax measures by calling their work “scientifically indefensible” and “fiction”…

And this line-crossing imposes on analysts a duty to call Hassett’s garbage analysis what it is, rather than to presume it is both competently done and made in good faith:

The analysis from Hassett, chief of the White House Council of Economic Advisers (CEA), relies heavily on correlations between corporate tax rates and wages in other countries to argue that a cut in the corporate tax rate would boost returns to labor very substantially…. The CEA ignores our own historical experience…. The corporate tax cuts of the late 1980s did not result in increased real wages…. The same is true in the United Kingdom…. These examples feel far more relevant to the corporate tax issue analysis than comparisons to small economies and tax havens like Ireland and Switzerland upon which the CEA relies…. No one has defended the 4,000 dollar[/year wage boost] claim [of Hassett’s] as a “very conservatively estimated lower bound,” let alone endorsed the plausibility of the $9,000 claim…. The Wall Street Journal… published two very optimistic versions of what the wage increase could be… below CEA’s lower bound…

Then Larry turns to those who have… not defended Hassett, but not criticized Hassett either: who have, while not endorsing his numbers, tip-toed up to the line of what they think they can do in terms of providing half-hearted support for Hassett:

Casey Mulligan and Greg Mankiw… make use of simple academic abstract models that do not capture the complexities of a policy situation to argue that wage increases could be larger than the tax cut…

Let me skip over Mankiw for the moment, and go to Summers on Mulligan and company:

Mulligan accuses me of rejecting the results of my 1981 paper on Q Theory which he claims to like and teach. I’m flattered that he appreciates my paper, but am fairly confident he draws the wrong conclusions…. One central aspect… was the recognition that the corporate tax rate is… not a sufficient statistic for assessing the impact of the corporate tax system…. It is necessary to build in assumptions about depreciation allowances, debt finance and so forth…. The main point… which Mulligan entirely ignores, was that because of slow adjustment costs, the impact of tax changes was felt primarily on asset prices for a long time…. The primary impact of a corporate tax cut would be to raise after-tax profits and the stock market. This in turn, as I noted, primarily benefits wealthy individuals….

It is worth noting that Larry Kotlikoff and Jack Mintz’s response to criticisms of the Trump tax plan suffers from the same deficiencies as Mulligan’s. The authors include no corporate tax detail, no recognition of the impact of the tax proposal on asset prices, and no treatment of the budget consequences of tax cuts. The newest, boldest bit of claim inflation regarding the tax bill comes from the Business Roundtable: “a competitive 20 percent corporate tax rate could increase wages sufficient to support two million new jobs.” This would, coupled with job growth projected even in the absence of a corporate rate cut, take the unemployment rate well below 3 percent! I would be very interested to see the underlying analysis.  I would be surprised if it is convincing…

Mulligan has long seemed to me to be far past his three strikes:

And Summers on Mankiw:

Mankiw’s blog is a fine bit of economic pedagogy. It asks students to gauge the impact of a corporate rate reduction on wages in a so called “Ramsey” model or equivalently in a small fully open economy, with perfect capital mobility. Even with these assumptions, he does not get answers in the range of the CEA’s estimates. As a device for motivating students to learn how to manipulate oversimplified academic models, Mankiw’s blog is terrific as one would expect from an outstanding economist and one of the leading textbook authors of his generation…

I would not have used the word “terrific” (or “gorgeous”). I think that the Greg we have here is not primarily (1) Greg-teaching-students-about-public-finance-issues but rather (2) Greg-going-as-far-as-he-believes-he-can-to-be-helpful to the Republican Party. And I wish we had (1) Greg instead.

Why do I think this? First of all, as John Maynard Keynes wrote in his obituary for Alfred Marshall:

The study of economics does not seem to require any specialised gifts of an unusually high order…. Yet good, or even competent, economists are the rarest of birds. An easy subject, at which very few excel! The paradox finds its explanation, perhaps, in that the master-economist must… reach a high standard in several different directions… be mathematician, historian, statesman, philosopher… understand symbols and speak in words… contemplate the particular in terms of the general, and touch abstract and concrete in the same flight of thought…

And the most important element of this combination needed to be a good economist is to choose the right model for one’s analysis.

Greg begins his analysis of the effects of a corporate tax cut on the U.S. with “an open economy…”. In so beginning he has already served his readers ill. The U.S. is not a small open economy. You choose a model that applies, not a model that does not apply.

The second most important element of this combination is that one chooses a complete model and does a complete analysis. Corporate tax cuts are cut, yes. But then what? There is a government budget constraint there somewhere—or if there isn’t, that is a very important element of the situation. Is government spending cut? Is it cut now or in the future? Are other taxes raised? Which taxes? And when? Kevin Hassett called the Tax Policy Center’s analysis “scientifically indefensible” and “fiction” in large part because they had done a complete analysis, filling in the parts of the tax cut framework that were missing with what seemed to them to be reasonable assumptions. But Mankiw doesn’t do a complete analysis. The corporate tax rate is cut. Full stop.

Third, there is a math error in Greg’s presentation. When in a small open economy you cut the corporate tax rate t by an infinitesimal amount dt, that tax rate cut has three first-order effects on tax revenue. It (a) reduces how much revenue is collected from each dollar of tax base, (b) reduces production and the tax base by reducing the pre-tax rate of profit, and (c) raises the tax base by encouraging more investment. The “static” revenue-loss calculation ignores term (c). The first-order “static” revenue loss is then:

Monday Smackdown Larry Summers on Kevin Hassett and Company

But Greg misses term (b), and so he calculates the revenue loss as:

Monday Smackdown Larry Summers on Kevin Hassett and Company

This error inflates Mankiw’s calculations by a factor of 1/(1-t).

He thinks that he is demonstrating that the gain in wages is greater than the “static” revenue loss because the cut in taxes calls forth extra investment and higher productivity. But you can recognize that this interpretation is wrong by considering the case in which more capital is useless and unproductive. In that case, note that Mankiw’s math still claims that wages grow by a factor 1/(1-t) bigger than the corporate revenue loss even when the tax cut does not induce any extra investment at all.

This is the kind of math error that can happen to anyone—and does happen to me, especially in a blog post. We are all bears of very little brain, and none of us as smart individually as we are smart collectively, especially in that for of thinking that is manipulating systems of symbols.

More serious are the other two flaws. One models the behavior one wants to see students adopt. (1) Choosing an appropriate model, and (2) performing an analysis with a complete model are both very important things to, well, model.
Larry reaches more or less the same assessment about Mankiw’s choosing the wrong and an incomplete model—and then piles on still more complications:

…As a guide to the effects of the Trump administration’s tax cut, I do not think it is very helpful…. A cut in the corporate tax rate… in the presence of expensing… has very little impact on the incentive to invest…. The United States is not a small open economy…. A big cut in the corporate rate does not happen in isolation as a break for new investment… monopoly profits… other ways… benefit[ing] shareholders without encouraging investment… increases in other taxes or enlarged deficits… capital moves out of the noncorporate sector…

And I should also note Larry wishing for the public sphere debate on tax policy he wants to see. One in which due attention is paid to the true authorities:

the highest quality assessment… has been provided by Jane Gravelle,… of the Congressional Research Service. It looks at all the literature… recognizes that the issues are complex… does not start with a point of view… provides little support for claims that corporate rate cuts will raise revenue, help the middle class or spur rapid wage growth…

One in which all recognize the win-win importance of building up technocratic gatekeepers like CBO, GAO, CRS, and TPC, not tearing them down:

The inadequacy of their analyses illustrate why well-resourced, team-based institutions with a strong culture of attention to detail like the Congressional Budget Office, the GAO, the Joint Tax Committee Staff or the Tax Policy Center are so important…

One in which CEA Chairs regard themselves primarily as custodians of the intellectual quality of the public discourse rather than regarding themselves primarily as servants of their political masters:

I served with 7 CEA chairs — Martin Feldstein, Laura Tyson, Joe Stiglitz, Janet L. Yellen, Martin Baily, Christy Romer and Austan Goolsbee… all of them fighting with political figures… insist[ing] that CEA analysis had to be… respected and validated by outside economists… refus[ing] to cheerlead for Administration policies at the expense of their professional credibility. I cannot imagine any of them releasing an estimate as far from the professional mainstream as $4000 to $9000 wage increase from a corporate rate cut claim. Chairman Hassett should for the sake of his own credibility, that of the Administration he serves and the institution he leads, back off.

I started with Mill citing Cicero on philosophy. Let me end by citing Cicero on politics: how the problem with his ally Marcus Porcius Cato was that Cato acted as though he was living in the Republic of Plato rather than the Sewer of Romulus. At this stage I would be happy with the Sewer of Romulus. I would like to see some pushback from the right: people saying that, just as Kevin Hassett two decades went way too far with his claims that (a) the equity premium return was disappearing and that (b) that disappearance would carry the Dow to 36000 by 2004, Kevin Hassett has gone way too far with his claims of a 4000-9000 dollar/year average wage gain.

I am not holding my breath.

AUTHORS:

Brad DeLong
Connect with us!

Explore the Equitable Growth network of experts around the country and get answers to today's most pressing questions!

Get in Touch