February 19, 2021 - 11:53am
There’s nothing quite so dangerous as a counter-intuitive idea that is sometimes true — especially if it promises the seemingly impossible.
For instance, what if you could cut taxes and as a result raise tax revenues? It’s a theory that’s tantalised the free market Right for decades — as depicted by the famous Laffer curve (and contained within the wider theory of supply-side economics).
The theory isn’t always wrong. Onerous tax burdens act as disincentive to productive activity. So when rates are very high, cutting taxes can increase revenues by making hard work and bold investment worth the effort.
So here we have a concept that promises a substantial reward, that is demonstrably true in some circumstances and which is sufficiently hard to grasp that getting your head around it provides an ego boost.
When you’ve got a cool weapon like that in your ideological armoury, it’s likely to be overused. Which it has been — especially in the United States.
However, it’s not just the free market Right that’s prone to this sort of magical thinking. Lately, the Left — and not just the hard Left — has had its head turned by Modern Monetary Theory. This is the idea that most limits to what governments can spend are illusory because a state in charge of its own currency can simply create the money it needs. The only real limit is the build up of inflationary pressure, but this can be dealt with using taxation to manage the level of demand in the economy.
So again, there’s the mind-blowing concept; again, there’s the tantalising offer of a seemingly impossible benefit; and again, there is some evidence that there is such a thing as a free lunch (after all, we’ve had a decade or more of rampant money printing by the central banks and we’ve got away with it so far).
In a brilliantly provocative thread, Ricardo Reis of the London School of Economics argues that the pet economic theories of Left and Right have a lot more in common than either side would care to admit. Both are based on a valid insight, but then used as an indiscriminate political battering ram:
“I learned from political scientists that the far left and the far right are closer to each other than to the centre, united by a disregard for moderation. In economic policy, so are left-wing MMT and right-wing old supply-side econ. United by a disregard for fiscal prudence.”
- Ricardo Reis, Twitter
Reis hopes that Modern Monetary Theory will follow the path of supply-side economics and eventually calm down:
“Today, supply side economics is respectable, because it is no longer used in its extreme (wrong) 1980s form. Maybe the same will happen with MMT. Hopefully under a more accurate name.”
- Ricardo Reis, Twitter
Of course, this is an academic perspective. In the political world the tax cutting mantra continues to corrupt conservatives — and I fear that MMT, in its crudest form, is likely to addle Left-wing brains for many years to come.
Finally, while we’re poking fun at the extremes, we shouldn’t forget that mainstream economics is itself built on concepts which are valid only in some circumstances. I’m talking about really basic stuff like efficient markets, rational agents and perfect information.
Increasingly, we’re realising just how rarely these assumptions apply to reality. The fact is that markets are often inefficient, that people are frequently irrational and that we live in a world of radical uncertainty.
Any economic theory — whether of Right, Left or Centre — that doesn’t start from a position of epistemic humility has a lot of growing up to do.
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SubscribeThe Laffer curve isn’t always wrong, because it is obviously right. There isn’t a question of whether or not higher taxes can result in lower tax yields, because plainly at some point they will. If you set income tax at 100% you will begin to lose revenue. The only question is at what tax rate will a government receive optimal revenues.
The concept is always wilfully misrepresented as a belief that a lower tax will necessarily generate higher revenues.
It is similar in that regard to ‘trickle-down theory’ and ‘greed is good’ as examples of strawman arguments.
MMT on the other hand is an inflationary printing press covered by a smokescreen of babble.
As a non-economist, I understand MMT as analogous to Perpetual Motion Machine = Modern Mechanical Theory.
Ah! So it’s the darling theories of the right that are misrepresented, whilst those of the left are just rubbish!
So how would you explain the fact that there is 14% more money in the economy than a year ago (ie: the ‘printing presses’ have been going full-tilt), yet the inflation rate is only 0.7%?
That’s easy, it has gone into global financial markets, where inflation is rampant.
Indeed. So the ‘printing press’ need not be inflationary. It depends on where the money goes. For example – if both consumption and production increase in step you have more money and more goods, so no necessary inflation. This is part of the MMT analysis.
MMT stands for Magic Money Tree but it will not work unless you say hocus pocus alakazam first.
Try ‘asset purchase facility’.
I see BitCoin is back up to about $50,000 today haha!!
No, just those ones.
I’m not an expert on MMT, Diarmid, but I will have a go anyway. First, if we are talking about a proper macroeconomic measure of inflation, the UK CPI doesn’t qualify, and at the current time it likely understates inflation. A proper measure would include an owner-occupied housing (OOH) component based on a net acquisitions approach, ideally a gross weight-gross price variant of the same, while the CPI excludes virtually all OOH costs. The RPI ex mortgage interest ex council tax adjusted for the formula effect (I use a 0.6 percentage points adjustment since the ONS stopped publishing monthly updates for it) suggests that the inflation rate was 0.9% in January, rather than the 0.7% shown by the CPI, and that 0.9% is likely an underestimate.
Another thing is that the lags for monetary policy are both long and variable, and usually substantially longer than a year. So we will likely see more inflation later on, and the February MPR actually forecast a 2.1% inflation rate for 2022Q1.Also, market participants hear the Bank of England saying it doesn’t believe in MMT and they may believe it. So they will operate on the assumption that monetary stimulus will be reined in whenever the inflation rate (an inappropriate rate since it is quite insensitive to housing price changes) rises steeply. If they thought the Bank of England was being run by MMT types, the inflation rate might be higher already.
All no doubt true. But we ain’t going to see 14% goods inflation any time soon, are we? So there’s a lot of other stuff going on that renders the ‘inflationary printing press’ narrative as simplistic nonsense.
I wouldn’t count your chickens quite yet…
Anyone paying attention and keeping scrupulous track of expenses and prices can see that inflation rate is certainly not .7%. The inflation statistics simply cherry-pick which real life goods get factored into the equation. Look at automobile and housing prices, look at food prices. Track these over the last 3-4 years, and notice a pattern.
You can argue with the methodology, but I think ‘cherry-picking’ is a bit unfair on the ONS.
https://www.ons.gov.uk/economy/inflationandpriceindices/articles/ukconsumerpriceinflationbasketofgoodsandservices/2020
Ahhh, I was speaking on US Fed’s CPI.
They’ll be using similar methodology – at least would have been pre-Trump!
That official inflation figure is such obvious propaganda and nonsense – anyone can work out that what £10 would buy 5 years ago has changed.
We are just about to see the final effect of MMT, debt bubbles and the failed concept of fiat money as the trillions of $ printed cause the collapse of the reserve currency, inflation, a domino collapse of other currencies including the £ and € resulting in a new global financial system.
Probably heading for devaluation of currencies and a return to some form of gold backed international currency SDR (Special Drawing Rights) Which is why central banks are buying gold. Good luck with living off photocopied paper then!
My bets are on economic insights from sound money experts such as Alasdair Mcleod
https://www.goldmoney.com/research/goldmoney-insights/economic-and-monetary-outlook-for-2021
In my experience this is done by those arguing for tax cuts, or against increasing taxes to fund public services.
Absolutely agree that it gets wheeled out by both sides of the argument in bad faith.
What exactly was the point of this piece? Whatever economists might think or say, they’re not the ones holding elected office. That’s usually lawyers, elected by people who too often think that every issue requires a govt solution. It doesn’t; govt often makes existing situations worse because those lawyers who run it are something less than experts in the various fields where they want govt to intervene.
“For instance, what if you could cut taxes and as a result raise tax revenues? It’s a theory that’s tantalised the free market Right for decades — as depicted by the famous Laffer curve (and contained within the wider theory of supply-side economics).
The theory isn’t always wrong. Onerous tax burdens act as disincentive to productive activity. So when rates are very high, cutting taxes can increase revenues by making hard work and bold investment worth the effort.”
That’s actually not the correct explanation of the Laffer Principle. The more accurate statement about the value of the Laffer Effect is to say that even if cutting tax rates does not increase tax revenues, it is still worth doing if the only effect is to boost economic activity anyway, and as a consequence to raise GDP and reduce the debt/GDP burden through the denominator effect.
Secondly, the “incentive” in this argument is never properly explained in my experience, and it isn’t here either. What’s missing is the essential idea that it is not people’s inclinations, desires or tolerances we talking about changing here; it’s the nature and value of the opportunities we are all faced with in living life in general. Specifically when it comes to tax, this boils down to a simple matter of numbers: if a tax rate on a particular enterprise is so high that it makes the risk involved unacceptable, then rational people won’t waste their time and money on it.
This point is important here because very often, the Laffer principle is presented as something related to the selfish character of the individual, with the silliest examples coming from the extreme ends of the popular debate, when rich people are called selfish for not wanting to pay more tax to support public services etc. That’s not what’s happening at all: what’s happening is that when you change the tax rate on a specific activity, you are changing the risk/return equation itself. There is a point, as you raise tax rates, that the return falls below what is required to cover risk, and that is something that commercially competent people simply do not do, no matter what their politics.
‘it is still worth doing if the only effect is to boost economic activity anyway, and as a consequence to raise GDP and reduce the debt/GDP burden through the denominator effect.’
I’m not sure Laffer’s thinking ever reached that level of sophistication, did it? My understanding was that his ‘curve’ was drawn on a table-napkin!
But of course, raising GDP is not necessarily all, and taxation’s incentives and disincentives should be used to guide behaviour. So less taxation on employment and general consumption, more on wealth accumulation and carbon-intensive activities.
When you say “wealth accumulation” do you mean saving/investment?
Saving and investment are flows, so it would make no sense to equate them to accumulation.
Deficits are a flow – debt is its accumulation. They are linked concepts. Unfortunately we have too much of both.
The basic principles can be shown as a curve on any surface. To suggest that reveals a lack of knowledge on Laffer’s part reveals bias. The concept of diminishing marginal returns is fundamental in economics. The fact that eventually the next unit can DECREASE benefit is critical to understanding the Laffer Curve. Laffer’ understood fundamentals. If more did we would have better policy.
Can you say Austrian Economics? I find it to be a very humble approach as it’s axioms—not the least of which is that predicting future economic states is well nigh impossible—keeps the practitioner pretty firmly grounded in realistic assumptions of human behavior.
Are you actually suggesting that devotees of the Austrian School of economics are noted for the tentative nature of their prescriptions on taxation or government policy and spending?
The Cato Institute, to pick one example, never struck me as particularly humble.
Is economics important? Before it can be used it has to be translated into politics and then anything can happen.
Actually there are examples of lowering tax rates and increasing revenue. In the 20’s tax rates were very high for those earning 6 figures. I believe 74%, the problem was high income people stuffing their money in to tax areas like municipals. I think it was the Sec. of Treasury Mellon was begging Congress to get rid of tax free investments…but they did not. Taxes got lowered somewhere around 24% and the government got a huge increase in revenue. Kennedy did the same thing I believe and it happened as did Reagan. Where this all get screwed up is when Democrats call it “Trickle Down” economics. An article I read stated that there is no such economic theory. It has never been codified or proposed as an actual theory. Recently Trump did the same thing. It spurs economic growth and revenues increased. Of course we spend to much and revenues never seem to cover the spending.
Government spending in the 21st century has always increased to exceed revenue. Any cut in spending is characterised as “an attack” .
We seem to be stuck in that paradigm now.
You’re right, Earl. Amity Shlaes writes a lot about Mellon’s policies in her biography “Coolidge”, since Mellon was Calvin Coolidge’s Treasury Secretary. As you say the Democrats called it “trickle down economics” although it wasn’t, and for some reason, President Obama started calling it “top down economics” in his debates with Romney in 2012. Romney actually said that Obama must have meant “trickle down”, not “top down”, during one of the debates, but it didn’t get much notice.
All money is a debt in labour – each person gives some work in exchange for someone else’s work. Money tokenises this. Changing the token (MMT) affects all the historical set of debts – it’s been tried and failed lots and lots in history. So while governments have printed money for the crisis and at the moment there is low inflation, there are tantilizing signs that inflation will follow. I hope not, because inflation is massively destructive.
On taxation, the right amount isn’t just about the government optimising its revenue, but also about ensuring the economy grows and full employment is achieved (real jobs exchanging real valuable work). A faster growing economy (that exports) will generate more reserves for expenditure long term than a slow or stagnant economy, and by growing employment is kept buoyant, leading to reduced welfare expenditure, better wages while also allowing for investment-type spending – eg on education – rather than paying subsistence for people out of work.
‘Changing the token (MMT) affects all the historical set of debts – it’s been tried and failed lots and lots in history.’
By ‘changing the token’ I assume you mean devaluing the currency through inflation? This is not the aim of MMT – MMT argues that inflation need not follow from greater government expenditure, and to the extent that it does this can be controlled by measures that have additional benefits – eg: an employer of last resort (ELR) mechanism.
In fact, as Nick Faulks points out above – there is plenty of inflation around, but it is in asset markets (bubbles), not goods markets. This has already wreaked massive destruction through inequality of income, wealth and power, but seems to be easy to ignore.
It may not be the aim, but it is the outcome. Though MMT argues “inflation need not follow”, historical economic analysis suggests that it will, as it nearly always has.
We’re currently in a time of panic with individuals curbing expenditure and economic activity, but large amounts of debt being created. As the economy comes back into process, that debt has to be repaid. That adds cost to everything and prices will rise as a result. Inflation being a result, and a way of diminishing the debt pile, but it also takes down savers and pensioners and greatly destroys value.
The bubbles in asset markets can be seen as traders anticipating a coming inflation surge, and so moving into areas as hedges against inflation. As the debt percolates through the system and inflation comes, asset prices will rise in response. Goods suppliers then have to follow, or go bust. MMT and printing money just changes the tokens, it doesn’t change the underlying economic exchanges of value – just gives them new numbers.
In the US purchase of government debt by the Fed has kept rates low by artificially shifting the debt demand curve out. This has a limit and rates will RISE. Simultaneously there have been significant checks on price increases – cheap Chinese labor, US expansion of fossil fuel supply and lower regulation. The trend in all these factors is toward HIGH prices. Look for ‘stagflations’ return.
I am all for lowering taxes to increase tax revenues which can be spent on public services and other good things that we like. However, as with everything, there comes a point where there is an inverse result as well. If public services and welfare benefits disincentivise working to such a degree that tax revenues fall and public services and social harmony suffer to unacceptable degrees then however unpopular it is there has to be a rebalancing. The trick is to know how much and when to re-balance. There should be no shame in changing course when the theory you once espoused has reached its limits. Extremes of any kind are usually bad. Dogmatic thinking is the enemy of reason.
‘If public services and welfare benefits disincentivise working…’
A big ‘if’!
Quite – the right services (eg more efficient and lower cost public transport) and the right welfare benefits (that taper fairly and gradually) can incentivise work and improve working peoples’ quality of life
Interesting to bring these points together.
If MMT is predicated on printing money and then soaking it up via taxation, the problem is that once taxation gets too high not only does the motivation to produce decrease, but also the most productive members of society up sticks and emigrate, and the wealthy who stay resort to outright tax evasion.
That was pretty much the situation in late-Apartheid SA. The Mandela government reduced tax rates, eliminated most of the loopholes, and ended up collecting a lot more money.
It wasn’t that taxation was stripped to the bone, just lowered enough that the system became efficient.
In fact ‘printing money and then soaking it up via taxation’ is what MMT largely rejects. The argument is in fact that there need be no simple relationship between government expenditure and taxation, and so the idea that national budgets should be ‘balanced’ like household or corporate budgets is wrong.
Whenever I see a government policy that won’t work at the household level I know disaster will follow. Eventually accounts must be balanced.
There are also questions like, is a more efficient market actually better? Because it may well be less resilient.
Hence the saying, “You’re ‘aving a Laff, ain’t yer?”
The difficulty with the Laffer curve is that it cannot be measured, except in retrospect. Most economics is like this. Economists make pronouncements about human behaviour (and human nature in general) which have no basis in fact, and then wonder why their predictions are so wrong.
Economics is a subject which ought to be a behavioural science, but isn’t. Start with the facts; theorise only in small, testable ways, which will yield more facts. Repeat.