Wednesday, February 8, 2012

Institute of Fiscal Studies thinks tax increases reduce the deficit. LOL.

95% or so of the population who haven’t grasped the difference between macro and micro economics. As a result they tend to think that governments (macroeconomics) can be viewed the same way as households or firms (microeconomics). For example, cut the expenditure of a household or firm by $X a year, and all else equal, its deficit will decline by $X a year.

The same does NOT APPLY to government deficits (or surpluses). Indeed a paper by Victoria Chick and Ann Pettifor claims that alterations to tax or government spending have the OPPOSITE of the expected effect. That is for example, raise taxes, and (all else equal) far from the deficit declining, it actually RISES. That’s because (amongst other reasons) the automatic stabilisers kick in, which tends to nullify the effect of the tax increase.

The above “Chick” claim might be a bit extreme. But certainly the effect of tax and government expenditure changes are counter-intuitive: or at least counter-intuitive for those who have not studied economics.

The Institute of Fiscal Studies’s 2012 Green Budget.

Section 3 of this recent publication by the Institute of Fiscal Studies (IFS) makes all the above sorts of errors – and more.

The IFS, as its name implies, has concentrated since its foundation mainly on matters connected with tax. Many matters in connection with tax are essentially microeconomic, and I would not challenge their expertise there. But in section three of the above publication they have strayed well and truly into macroeconomics and tripped up as a result.

Section three of this publication starts with the sort of emotive language on the deficit that you’d expect from a Republican member of Congress. But then as Bill Mitchell has pointed out time and again, the political left has fallen hook line and sinker for the anti-deficit rhetoric of the political right. Section 3 of the IFS work reads very much like the “Citizens Guide” to the deficit produced by the right wing Peterson Institute in the US, or the equally ridiculous Peterson publication “A Path to Balance”.

The Peterson “Path to Balance” starts with the archaic assumption that the budget needs to balance. That’s the main objective. Anything more sophisticated, like trying to maximise GDP is way beyond the Peterson Institute or the authors of the IFS work.

The first paragraph of section three of the IFS work refers to the fact that the “financial crisis” has “punched a permanent hole in the public finances”. Oooh. Shock horror. Punching holes in things: that’s bad bad bad. Very emotive.

The fashionable word “sustainable”.

Next, the IFS makes frequent use of the fashionable word “sustainable”. Frequent use of fashionable words is always a good evidence of B.S.

The first problem with the “sustainable” point is this. The IFS claims that British national debt as a proportion of GDP is around 75% and rising (see their figure 3.14). And that, so they argue is not “sustainable”. But they don’t mention that the relevant percentage for Britain just after WWII was over 200% without any catastrophic problems. And the same goes for Japan, where the percentage is currently also around 200%. The sky is not falling in in Japan, far as I know. Now if 200% is sustainable, it’s hard to see why 100% or 150% should not be sustainable.

Next, the fact that a current trend is not sustainable in the long run is not an argument against letting the trend continue for the time being. When a typical family car is doing 10mph and is accelerating at 5mph/sec, that trend is not “sustainable” in the long run because after 14 seconds the car will be doing 80mph. And that’s about the maximum speed for a typical family car.

But that would be a ridiculous argument against limiting car speeds to 10mph.

Next, what is the merit in “sustainability”? Obviously a government does not want to get into the position where its debt becomes so large that creditors begin doubting its ability of pay interest or repay capital. And for those who do not understand macroeconomics there seems to be a feed-back mechanism there: doubts about ability of a debtor to pay result in the interest charged to the debtor rising, which puts the debtor in an even worse position. The latter idea certainly applies to a microeconomic entity.

However, the government of a monetarily sovereign country like Britain is in a totally different position: if creditors do not want to lend to it, it can simply print money.

For more detailed explanation of the latter point, see here. You don’t need much of a brain to understand this explanation – though you’ll need far more brain that is possessed by Peterson Institute authors. And in contrast to the IFS publication and Peterson Institute publications, you won’t find the word sustainable there. In contrast, the prime consideration is the question as to what level of debt maximises GDP.

And finally, the fact that debt IS SUSTAINABLE does not prove that that debt makes sense. To illustrate, if someone with a healthy income, plenty of money in the bank and no debts actually goes into debt to buy a PC for example, that is highly unlikely to make sense (assuming the person has more than enough cash to buy the PC). Unless the PC vendors are shooting themselves in the foot by offering a ridiculously low rate of interest, it purchaser will not benefit from buying the PC on credit. But given that the purchaser has a healthy income, the debt will certainly be “sustainable”.

Conclusion. The word “sustainable” is a great word for dedicated followers of fashionable phraseology. So far as anyone with a grasp of economics goes, the word is near irrelevant.


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