Romer & Romer on Taxes

by
Robert Waldmann
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Given the debate about returning to 60s level top marginal tax rate of 70% amazingly re-opened by Alexandria Ocasio-Cortez, I decided to actually read the Romer and Romer paper (pdf warning) which includes evidence suggesting an even higher rate is optimal. It is a masterpiece, which I won’t try to summarize. Read it.

I do however, want to grind a very old ax related to “Schlock Economics”. I am thinking of the time that Robert Lucas totally humiliated himself while accuding Christine Romer of Schlock Economics. He demonstrated that he had managed to forget the IS-LM model (honestly he might actually have failed my undergraduate intro-macro course which is a major major accomplishment few have achieved).

Old ax grinding after the jump

OK so Lucas demonstrated that he had managed to erase IS-LM by asserting that Hicks found one and only one multiplier, therefore the balanced budget multiplier had to be zero. He made is amazing ignorance perfectly clear and undeniable.

[update]

This is interesting. I have had some difficulty getting a link to the proof that Lucas is amazingly ignorant. Here is another link to a very clear post by Krugman with a link to Lucas. But Krugman’s link to Lucas (like Brad’s link to Lucas) sends me to “The page you’ve requested does not exist”. It sure seems to me that the Council on Foreign Relations has decided to destroy the evidence. I’m not sure why this isn’t a scandal.

Lucas made a fools of himself
[end update]

while slandering Christina Romer asserting that she must be intellectually dishonest, because, as a highly reputed academic economist, she couldn’t take her work as chair of the Council of Economic advisors seriously. This shows he had ignored her extremely similar scholarly work. He knew she was a respected economist and clearly doesn’t know how she won that respect (he would consider her scholarly work schlock just as I am sure she considers his scholarly work schlock).

But wait. Romer does from time to time pitch the exact same schlock Lucas pitched. She too sometimes assumes that the multiplier on G and on T are identical, so the full employment deficit is a reasonable rough measurement of fiscal stance. In fact, Keynesians (other than Paul Krugman) often make as much of a hash of Hicks as Lucas did.

In the brilliant paper I find the following appalling nonsense

The implication of these two key facts—that the revenue effects of interwar tax changes were
typically small, and that tax changes were usually accompanied by spending changes in the same
direction—is that interwar tax changes are unlikely to have had much effect on aggregate demand. The
budget surplus simply did not move much in response to tax changes. Thus, to the extent that tax changes
mattered, it was probably not through effects on disposable income and spending. Hence, we focus on the
incentive effects of changes in marginal rates.

Notice the equivocation of “spending”. They know that spending doesn’t always depend on disposable because they know that during WWII and since 1980 US Federal Government spending has become completely detached from US Federal Government income. In fact, their point is exactly that this is a post Pearl Harbor development. But they use “spending” to refer to private consumption and suggest that there isn’t other spending which might be affected by fiscal policy and which might affect income through aggregate demand. You know public consumption and investment.

In fact paleo Keynesian analysis suggests that a balanced budget increase in taxes and spending causes increased aggregate demand and fancy DSGE new Keynesian models suggest that the timing of taxes doesn’t affect aggregate demand at all so balanced budget spending increases have the same effect as deficit financed spending increases. Also, even if one isn’t more Ricardian than Ricardo, one might guess that the spending of the very rich has little to do with their after tax income (which they don’t have time to spend even if most of their pre-tax income were taken by the IRS).

This is actually important, because a non schlock consideration of the effect of fiscal policy on aggregate demand implies that the policy shifts which included increased taxes caused higher aggregate demand, because the increased G matters more (or vastly more) than the increased T. This is a problem for Romer and Romer. They must both know this and know that the convention of the profession (not just Lucas but economists in general) implies that they can ignore it.

This brings me back to my most ground old ax — unconventional monetary policy. C Romer asserts that it can have dramatic effects as is proven by data from 1933 in which the depresssion troughed even though the huge spending increases were balanced by huge tax increases (huge enough that the full employment deficit changed litle).

This argument is schlock just as Lucas’s critique of Romer is schlock.

There is no theoretical rationale for Romer’s assumption in the past or the Romers’ assumption now (not that I care about theory). There is overwhelming evidence against it (including the anomaly which C Romer ascribes to effective monetary policy at the zero lower bound).