Tuesday, January 1, 2013

A brief perspective on the cliff deal

So it seems that a deal on the fiscal cliff has been reached, and was approved by a large margin, 89 to 8, in the Senate. The deal basically raises income taxes to pre-Bush tax cuts levels on families making more than $450,000 a year and individuals making $400,000, and raises the estate tax on the biggest inheritances too. Estates of more than $5 million would be taxed at 40%, up from the current 35%. It also does not include any cuts in Social Security or Medicare (the main tactics used for cuts were changing the price index for Social Security adjustments and increasing the age limit for Medicare).

More importantly no spending cuts really, which means the long term unemployed will continue to receive a check every week, and we will not add another drag on a very mild recovery. If no concessions are made on the debt limit in the next two months, a double dip recession this year might be averted. So progressives should be really happy.

The NYTimes editorial is unhappy because "this deal is a weak brew that remains far too generous to the rich and fails to bring in enough revenue to deal with the nation’s deep need for public investments." In all fairness, that's silly. It is true that Dems could have gotten more revenue from tax increases on the wealthy, but the US has no long term deficit problem other than rising costs of health, and no problem to finance public investment at all. To deal with the first a public option is the solution, and the limits to public investment are purely political.

The agreement actually makes the US political system look less dysfunctional than the European, which continues to be tangled in their austerity policies. All in all, a pretty decent start for 2013.

PS: Not sure why Krugman thinks that the agreement has left "a bad taste in progressive's mouths." Seems that he is afraid that the insufficient increase in taxes will let welfare programs vulnerable to the starve the beast argument. Again I think that risk is purely political, and a bit more revenue from the wealthy would have done little to eliminate it.


  1. Thanks for writing this, clears things up.

    I am an MMT guy. For me the deal is bad because the taxes are raised at all, although they won't (hopefully) bring that much in. But it is mildly contractionary. What do you think?

  2. Hi Peter:
    MMT is a new label for an old thing. So if you consider endogenous money and, more to the point to your question, functional finance to be MMT, I would also be an MMT guy so to speak. A few things before I get to the question. Note that endogenous money is not central to define heterodoxy, since some mainstream authors from Wicksell to modern followers of the New Consensus model (that have an exogenous interest rate rule) also accepted endogenous money. Note that functional finance is an application of Keynes' Principle of Effective Demand to the government sector, suggesting that government spending determines the revenue and that it is the use (its function) of spending that matters. In this respect, note that functional finance (and MMT) does not necessarily mean that higher taxes per se are bad or contractionary. In fact, in the case in question higher taxes on the very wealthy has almost no effect on their spending patterns. You think Bill Gates or Mitt Romney will be forced to contract their consumption because their marginal tax above $450,000 is 39% not 35%? The higher marginal tax means that with higher government spending (we're not getting another stimulus and that is a problem) now you get more additional revenue than before, and can use to redistribute to people with higher spending propensities, and that is potentially expansionary. Further, note that the period between the late 1930s and the early 1980s, in which marginal taxes were high, you had better income distribution, which again by giving people at the bottom more money implied higher propensities to spend. In addition, as Jamie Galbraith and others noted, worse income distribution leads to financial instability, since the poor are forced to get indebted to spend. So if anything I would have increased the marginal income tax at the very top (say those beyond $1,000,000) to something like 70% (below the 90% or so that we had at the time of that Communist Eisenhower). And would also eliminate the cap for payroll taxes, and increased for the very wealthy while reducing it significantly for those at the bottom. Other than that this bill saves lots of long term unemployed workers and for that it is worthwhile.

  3. Thank you for your comment. I totally agree on what MMT is: an amalgam if various strands, some dating back to 19th century. I think the sum is larger than the parts here, it all comes together and starts making sense, like the theory of evolution in biology which ties all organisms into one family.

    But what you say later is not really MMT, I would argue. Tax increases are not revenue that pay for spending directed to the lower income people. The govt can spend more without taxing one cent. Taxing is to dampen aggregate demand at full employment. Since you argue that taxes on the rich won't alter their spending, they seem useles even for that purpose. So the point is redistribution, which I would argue is a separate issue entirely. It is true that low income groups can then fund their spending with debt and this leads to bubbles and crashes. But this could be fixed by ending bailouts or setting interest rates higher - banks would be tighter with credit to low income folks. But you want them to afford more and the rich to afford less. This is a political statement. I think economics cannot prove that it is "correct", it is a value statement. Therefore a statement that something is a "better income distribution" is a belief statement in my opinion. I think there is a lot of wishful thinking involved in arguing that we need flatter income distribution. I am a lefty myself, I am inclined to *want* to believe in them, but I think these statements simply cannot be proved using economics. No?

    1. On that we'll disagree. Income distribution can be measured. It is an objective variable. Real wages have stagnated since the early 1970s, and the wage share has decreased since the 1980s. You may have a debate on the causes, but it is clear that tax policies did play a role. And yes governments can spend in national currency (if that does not lead to unsustainable balance of payments problems; the US is a special case since its foreign debt is also in domestic currency) without raising taxes. But as I noted taxes do have an impact on income distribution.

    2. This is where I think there is a possible conflict with Keynesianism and MMT. Sure, they both agree that in a downturn, tax cuts and increases in spending are generally the best approach, the Keynesians are also concerned about other problems, such as the paradox of thrift, in which implies that savings is a bad thing in a downturn since this is in itself decreasing aggregate demand because it lowers consumption.

      Another conflict would be on the issue of value statements and economics... If I understand the commentors comment correctly, he is essentially stating that MMT is value free and that Vernengo (along with 99% of Keynesians) claim value judgements into their economics. But it is well known that most Keynesians (especially the non-mainstream thinking ones) claim that economics cannot be done without value judgements, this is to say, economics is not just value free.


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