Camp Keynes and Camp Classical

by Don Boudreaux on January 23, 2008

in Economics

Today’s New York Times has this op-ed by Len Burman.  I sent the following letter in response:

To the Editor:

Len
Burman argues that repealing the Bush tax cuts two years early, in
2009, will stave off recession ("Make the Tax Cuts Work," January 23).
He reasons that "If people knew that their tax rates were going up next
year, they’d work to make sure that more of their income is taxed at
this year’s lower rates."  And investors would "cash out their capital
gains now to avoid paying higher taxes later."

If Mr. Burman’s
economics are correct, his proposals are far too modest.  Why not
propose that Uncle Sam announce that in 2009 he will raise income-tax
rates to 100 percent and confiscate all investment property?  Think of
the enormous outpouring of work that will result in 2008!  And because
looming confiscation in 2009 will cause the cashing out of ALL
investments in 2008, the resulting economic stimulus would dwarf that
which would follow from merely raising capital-gains taxes next year.

Sincerely,
Donald J. Boudreaux

One of the fundamental problems with Mr. Burman’s argument is his inappropriate obsession with the short-run (namely, 2008).  People might well work harder during 2008  if they expect higher rates of personal-income taxation in 2009.  Mr. Burman clearly focuses on the additional spending that he supposes will emerge from this extra income earned in 2008.  But if Milton Friedman’s permanent-income hypothesis is correct, people are unlikely to spend much of this income today, knowing that their income-earning profiles haven’t risen permanently (and, because of higher taxes starting in 2009, likely have fallen).  (Of course, the promised higher capital-gains taxes in 2009 will do their part to discourage the productive investment of this income.)

It’s not excessively over-simplified to divide pundits on this "stimulus" issue into two camps:.

Denizens of the first camp — call it Camp Keynes –  believe that willingness of consumers to spend money lavishly is the chief fuel of economic progress.  Even the prospect of lower after-tax returns to investments won’t much discourage investors from running their factories and stores at a fast clip if consumers will spend, spend, spend.

Residents of second camp — call in Camp Classical — understand that taxes discourage investments, and that investing for the long-run is crucial for economic progress.  These campers know that spending power is the reward, and not the fuel, of economic growth.

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{ 14 comments }

Wojtek January 23, 2008 at 9:27 am

You're not alone, we in Ontario, Canada have the same camp in power in our province:

"Premier Dalton McGuinty tried to bolster Ontarians’ confidence, telling reporters that experts advising his government believe the economy will continue to grow. And he offered a word of advice to consumers: “If you want to be helpful to the economy, then go ahead and buy that fridge, buy that new house, buy that car. That’s good for our economy and that’s good for our jobs.”" — The Star (daily)

shawn January 23, 2008 at 9:45 am

wojtek….I didn't realize that if canadians didn't purchase that fridge/house/car(ibou?), you'd all have the money stashed in your mattresses.

MT January 23, 2008 at 9:50 am

I love it when people tell others to spend money on consumption "for the good of the economy." The altruism brings a tear to my eye.

pylorus January 23, 2008 at 10:07 am

My wife and I fall into the top quintile for household income. So the "stimulus" consists – for us – of generating several thousand dollars of debt in our names, and having (mostly) other people spend it. No-one has to think too hard to see what the effect will be upon our perception of our permanent income, and consequently the effect upon our spending habits.

We live in New York City, and have a child on the way. A top-quintile income in NYC goes mainly on housing and associated taxes. So this is hardly a case of shaking dollars out from under the mattresses of the rich.

Mark N. January 23, 2008 at 10:59 am

"spending power is the reward, and not the fuel, of economic growth."
Amen

Bret January 23, 2008 at 11:48 am

Personally, I'm in camp half-way-between Kamp Keynes and Camp Classical. It's best to find the optimal balance between demand and supply-side.

Brad Hutchings January 23, 2008 at 11:50 am

I especially liked Burman's suggestion that focussing the stimulus on food stamps would generate the most bang for the buck. Yeah, why don't we just write a check for $5K to every person who qualifies for federal food assistance and see how that works. I don't mean to sound elitist, but I have a feeling that those people are less well equipped to make good financial decisions than your typical income earner who is actually in a tax bracket.

Wojtek January 23, 2008 at 2:08 pm

Personally, our beloved premier makes me want to max-out my credit cards to help my fellow man. Truly benevolent act I think, and I can be sure that my fellow man will help pay them off when creditors come calling.

Question January 23, 2008 at 3:44 pm

I'm confused.

1) Why does it matter how people use their money? If they spend it, that increases aggregate demand. If they save it, it gets invested, which increases aggregate demand. What difference does it make?

2) These studies, implying that rebate checks were saved and not spent, don't seem to be looking at how consumers used the rest of their income. I would use a rebate check to bring down my credit card balance, and then go on to use my credit card more than I otherwise would have – ie, I would increase spending, though perhaps not by the full amount of the check.

M. Hodak January 23, 2008 at 5:08 pm

It's funny how most people have become acutely concerned about recession because of the tanking stock market. That's a pretty visible indicator of future trouble. So a genius like Burman thinks that repealing the Bush "tax breaks" will help? A big part of those so-called tax breaks is their relatively low rate of double-taxation on capital gains and dividends. What does Burman or his ilk think will happen to the stock market (and investment in general) if the government were to announce an early end to that double taxation?

Nick January 23, 2008 at 6:46 pm

I noticed the Burman article and wonder how he can write that kind of crap with a straight face. For whatever its worth I don't think it matters whether people spend the rebate check or not. My thinking goes like this: (1) I get an $800 check from the government. This is good because that is $800 I can spend intelligently instead of having the government "redistribute" it to more worthy projects. Right? (2) Oh wait. The government isn't going to stop redistributing. They're just going to continue to waste resources while running a bigger deficit and taxing me later (I can say "me" since I'm still in my twenties). Wonderful. I get the burden not just of the wasteful and corrupt redistribution, I get to pay interest on it to. Hooray!

And I think the happiest people on the planet right now have to be the politicians. A pending recession gives them a perfect excuse to "do something bipartisan" while still not dealing with the deficit ("we'd really like to cut spending this year, but with the economy as fragile as it is").

The WSJ had a pretty good piece today on how even Keynes wasn't a Keynesian. Maybe somebody can comment on whether that piece is accurate in its assertions about him?

The Albatross January 24, 2008 at 1:15 am

Hey Nick I hope you have not already familiar with this (so I am not telling you something you already know), but I find that the best insight into Keynes comes from his personal friendship with Freidrich von Hayek. I think the best example can be found from Commanding Heights, although I would recommend a shortcut by ordering the DVD set from PBS and looking at the first one—rather than the book. Although I find the book/DVD a little dismissive of Keynes, I was persuaded that Hayek always thought that Keynes was an-old-school British Whig, and I take the latter at his word. Hayek thought that Keynes was an honest man, who may have just been grasping at straws in a very difficult period (and turned out being right half of the time—kinda like Adam Smith). I tend to think that this was Hayek’s thoughts, but I would be happy to be proved wrong. Anyway, Keynes died in 1946 from overwork and smoking too much, so we may never know, but, with this in mind I think the Journal article saw in Keynes what Hayek thought he did so long ago. I know a deep question, but as much as the legacies disagree the two men rspected and liked each other.

vidyohs January 24, 2008 at 9:28 pm

Brad Hutchings,
Careful with the tongue in cheek suggestions, we have participants on this blog stupid enough to believe you are serious and take your suggestion and run with it.

I especially liked Burman's suggestion that focussing the stimulus on food stamps would generate the most bang for the buck. Yeah, why don't we just write a check for $5K to every person who qualifies for federal food assistance and see how that works. I don't mean to sound elitist, but I have a feeling that those people are less well equipped to make good financial decisions than your typical income earner who is actually in a tax bracket.

Posted by: Brad Hutchings | Jan 23, 2008 11:50:07 AM

BTW, Brad, Hillary already beat you to the 5K thing.

Mesa Econoguy January 25, 2008 at 9:52 pm

Wasn’t Len Burman a sportscaster for WNBC, New York?

Ohhh, wait, that was Len Berman….

My bad.

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