Free Exchange rightly notes that the demand side effect of an increase in the tax level is negative. Though the simulative effect of a future tax on consumption might be positive.

The total equilibrium effect is perhaps more subtle. On one level this seems like a pretty basic point but it is one that is ignored / glossed over in the macro debate: The supply side effect of a tax increase is to reduce unemployment.

Why? Well a tax increase reduces the return to working. Or, put another way it reduces the relative price of not working. This is relevant for students, primary care givers, the elderly – people who don’t really need to work, but might if the reward was great enough.

As those people exit the labor market unemployment goes down. AND, the reduction in unemployment is, in the context of a recession, a good thing. Right now you have people who desperately need to work competing against people who kind of, sort of want to work.

The long lines will drive out some of the people who are only casually seeking employment but asking a friend of friend to put in a word for you or posting a resume online are essentially free. There is no reason not to keep up this behavior.

Indeed, I would argue that the uncertainty caused by the recession might increase it. This is certainly the case in my household. We dramatically expanded our labor supply in response to the crisis because we were not sure about our future earnings stream. We wanted to store away as much as possible, now. Higher future consumption taxes would discourage that.

And when, households who can afford to drop out of the labor force drop out it becomes more likely that more desperate households will be able to find work. This in turn makes them less desperate and more likely to spend. To some extent this counteracts the negative income effect of the tax.

Income is lower, but it is more stable. Whether, this produces a net increase or decrease in spending is not a straight foward question. Combine this with the stimulative effect of a delayed increase and it doesn’t seem crazy to me that the right kind of consumption tax could boost the economy. Its not likely, but its possible.

However, it doesn’t seem too unlikely at all that such a combination could reduce unemployment and that is a worthwhile goal in and of itself.

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