[N.B. I try to keep that pesky "real life" thing to a minimum on this blog. I particularly try to keep anything remotely political out of it because I have a sense that, as Victorian understatement might put it, not all of my readers necessarily agree with my views 100% of the time. However, I couldn't resist this one and, for what it's worth, I'd like to think this is less a matter of right- versus left-wing and more a matter of decent economics and common sense. - RJ]
It must be difficult to come up with topics for two columns per week. Some weeks the ideas may not be there; other weeks the ideas may flow freely but the writing does not. On the other hand, the columnist doesn't have to pound the beat the way a reporter does, and the columnist can fire away with her opinions, so many reporters think having a column is a good gig. Consequently, I don't have much sympathy for the howler of a column that Washington Post business columnist Steven Pearlstein put to paper on July 28.
His premise is that the U.S. economy needs a tax increase. He never really explains why, other than to mention in passing "an investment agenda to match the global challenges we face." Unless he takes as given that all the government spending that's done is necessary, it's not clear why he doesn't consider the possibility of redirecting spending toward this "investment agenda," whatever that is. But that's neither here nor there. Pearlstein could certainly make a reasonable argument that the current political climate, in which the idea of any tax increase is anathema, is unhealthy. The 2010 top marginal tax rate for personal income is 35%, scheduled to increase to 39.6% next year. I have no idea whether 35% is "better" than 39.6%, or even how to define "better" in this context, because much of tax policy is a matter of opinion. Sure, higher marginal rates discourage employment decisions on the margin, but tax revenue is needed to run a government, and reasonable people can disagree about the right size of government and the best way to raise the required revenue.
Here are the real howelers in the Pearlstein column: first, "raising marginal tax rates on the rich wouldn't be a huge deal." He cites economist Douglas Holtz-Eakin to say that "excluding upper-bracket households [which Pearlstein doesn't define] from a one-year tax-cut extension would only reduce employment by 300,000 in 2012." I guess whether one thinks an addition 300,000 people out of work is worthy of the "only" in that sentence is a matter of opinion, but when the unemployment rate is pushing 10% it's hard to see an increase in that number to be a good thing.
Second, Pearlstein cites with approval testimony from Len Burman of the Tax Policy Center, a creation of the Urban Institute and the Brookings Institution. "Burman's point was that spending by rich people wouldn't change much even after a modest tax increase because so much of their income is saved rather than spent." Ow! I got whiplash from that sentence! True, consumption spending as a percentage of income falls with income. But "rich" people don't put the money under the mattress, they invest it. The money ends up in the form of mortgage loans, or corporate stock or bond purchases, or venture capital funding. A tax increase, modest or not, takes some of this money out of the hands of the "rich" and puts it in the hands of Uncle Sam. Whether that's good or bad depends, in part, on what private investments the government spending crowds out.
Third, to support the proposition that government spending is better for the economy than an equivalent tax cut, he cites a January 2010 Congressional Budget Office report to say that a million dollars in increased unemployment assistance would lead to between six and fifteen additional jobs.* It's a jobs-creation machine! (True, it's not a very efficient one, if each job created costs roughly $100,000 per year, in perpetuity.) This is the kind of number that should make even the laziest columnist go dig into the document to find out what magic is behind the calculation, but Pearlstein takes it as gospel.
Finally, "it's hard to understand why a profitable company, seeing an opportunity to expand, would forgo hiring because the profits generated by new workers would be taxed at 40 percent rather than 35 percent." Sadly, this guy has a Pulitzer Prize for his business column. It's pretty obvious that after-tax profits of 65 percent are higher than those of 60 percent, so any venture that's close to break-even won't be made at the higher tax rate. As an example, suppose a small business making iPad apps thought of a new product. To get it to market, the firm would need to hire an additional programmer at $100,000 per year, and it would take a year to get the product to market, with no additional costs. Expected sales are $180,000. At a 35% tax rate, the expected gain is $117,000, while at a 40% tax rate the expected gain is $108,000. If the firm's opportunity cost of capital is more than 8% (accountants like to use the term "hurdle rate," which reflects the fact that the firm needs to be compensated for the risk of the venture), the tax increase will mean that the firm will not hire the programmer. Again, I'm not making a value judgment about whether the benefits of the additional tax revenue outweigh the costs to businesses and individuals, but to say that there is no tradeoff to be made is indefensible.
Again, this doesn't mean that Pearlstein is wrong to believe that modest tax increases on wealthy people will have modest adverse effects, and that the benefit to the economy outweighs those adverse effects. But Pearlstein hasn't made that case and, really, his readers deserve better analysis.
* See Table 1, p. 18, and the text on the subsequent pages. Pearlstein uses the last column, which is the cumulative effect on employment between 2010 and 2015. The methodology is opaque, but the CBO seems to be assuming that the effect on employment comes because the unemployed will spend the additional money on goods and services, thereby stimulating demand for those goods and services, thereby increasing hiring. This can only be true if the CBO also assumes the money borrowed for such spending is never repaid (or is repaid after 2015; note that "repayment" can take the form of higher taxes in future years); otherwise, the increased spending by the unemployed merely crowds out private consumption and investment, a point which the CBO studiously ignores.