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:

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.

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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