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Silent Cal

June 10, 2013 4 comments

I just finished reading the book Coolidge by Amity Shlaes. I highly recommend the book if only because it is refreshing to read about a man serving as President who was modest, unassuming, and did not think himself to be so important that the country could not survive without him. From the perspective of an economist, I was struck by several economic policy positions that Coolidge and his Treasury Secretary, Andrew Mellon, espoused that are actually quite sophisticated and discussed today in economic policy discussions.

Coolidge and Mellon both believed in the Laffer Curve before Laffer told us about it! They engineered a tax cut in 1926 and argued that reducing tax rates would raise the government’s tax revenue because lower tax rates would stimulate economic activity. Most economists take the position that while it may be possible for a cut in a tax rate to increase tax revenue, there is no serious evidence indicating that this is the case. But it is a bit of a shock to see this position taken so long ago.

Coolidge and especially Mellon argued that policy uncertainty was damaging to the business environment and so government policies should be as predictable as they could be so the business community could make better business decisions. Policy uncertainty, Mellon argued, would damage and reduce economic activity. Critics of Obamacare have made this point many times in claiming that the law would reduce economic activity.

Coolidge and Mellon believed that economic activity would change in advance of changes in economic policy. So a tax cut a year from now would stimulate economic activity today. This is a very sophisticated position, one proven by economists many years later using what were, at the time, advanced mathematical methods. It is remarkable to see Coolidge make this claim so long before the economics profession discovered it.

Finally, during Coolidge’s tenure in office, there was the inevitable battling over how much the rich should pay to finance government activities and so critics of the tax cut advocated by Coolidge claimed that it was a subsidy to the rich. Coolidge argued that a tax cut would cause the rich to pay a higher fraction of the government’s tax revenue because lower tax rates would cause the rich to do less legal tax avoidance. After the tax cut occurred, Mellon was quick to point out the next year that those earning over $50,000, an enormous income at the time, paid a bigger share of the personal income tax revenue.

Some things never change and much of the battling over economic policy is the same today as it was in Coolidge’s time. But Calvin Coolidge and Andrew Mellon had remarkable economic insight into the effects of economic policy. They understood many sophisticated economic policy issues without needing the fancy math used by economists today.

The Lesson from the IRS Scandal

June 3, 2013 1 comment

The IRS scandal that has been dominating the media’s political coverage contains a lesson about economic policy that has not received much attention. That lesson is this; the scandal is the best argument that I know supporting an overhaul of the tax code to simplify it and make the tax rules as clear as they can be.

Most economists subscribe to the notion that households and firms can best maintain their self-interest when the policy environment is clear. This is a point emphasized in the rational expectations literature but it is a very intuitive notion. When the public knows the tax rules of the game, they can make better economic decisions because the public will know how its decisions will impact their tax liabilities. The less clear are the rules, the more resources we must devote to hiring attorneys and accountants who help us navigate a complex regulatory and tax environment. This complexity does not help us create wealth and improve living standards.

The tax code that we now have is riddled with situations that require interpretation by the IRS and, the more situations that require interpretation, the greater the potential for abuse. I suspect that this ambiguity is just fine for many politicians who are willing to manipulate the IRS for political advantage (here is a link to a news story describing the letters sent to the IRS by eight Democrats). But I think the public realizes what a nightmare it can be to deal with an IRS audit (a Romney supporter spent $80,000 defending himself in an IRS audit and ultimately paid no additional tax) so it is not surprising that polls show widespread public disapproval of this manipulation of the IRS.

If the IRS scandal has any long-run benefit, it will give us a better chance for a tax code overhaul which will vastly simplify it. I am not optimistic but hope springs eternal.

Categories: Fiscal Policy, Taxation
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