When borrowing is cheaper than free?
So what happens if we simply suspend taxation for a few years and then pay it back later?
I know, I know there are issues about market freak out and the signals that such a move would create. Some will also object that such a move would alter interest rates based on sheer volume but I doubt that actually.
Even still lets put all that aside for the moment.
If the government suspends taxation and then tries to raise the money later to repay what it borrows it will actually be extracting less real resources from the economy.
Okay but there is the issue with rates. Won’t they have to double and doesn’t that mean the deadweight loss will quadruple you say.
I’m glad you asked.
Because even though negative real interests rate make the point obvious what really matters are real interest rates relative to real economic growth. Here are real interest rates over 30 years.
Now do you believe that the real US economy will grow faster than 1.1 percent per year over the next 30 years? We should hope so, because if it doesn’t then lots of our forecasts are going to be waaay off.
Well that means that if we suspend taxation, borrow to fund the government and then keep rolling in the interest payments into the debt, our total obligation as a fraction of the economy will keep falling every year over the 30 year horizon.
Suppose real growth is 3 percent per year. Then this years obligation as a fraction of GDP falls by 1.9 percent per year, every year for 30 years. This means that in 30 years this obligation as a fraction of GDP will be only 56% as large.
Even if we then pay it all off in one lump payment we will only have to increase taxes by 56%. That increases deadweight loss by 146%. However, we saved 100% of deadweight loss in the current period. So our net increase in deadweight loss is only 46%.
And that’s paying it all back in one year. Stretch it out over a number of years and you can actually reduce the deadweight loss.
Fundamentally that is because the US government is earning a positive spread on its borrowing. The US tax base is growing at a faster rate than is the cost of delaying taxes. In such an environment you make money by pushing taxes into the future.
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Saturday ~ September 10th, 2011 at 2:06 am
An Outside the Box Stimulus Package: Stop Collecting Federal Taxes For Awhile. Period.
[...] Karl Smith wonders why the U.S. Government is even bothering to collect taxes right now, since interest rates are negative, which makes borrowing cheaper than cash right now. Now do you believe that the real US economy will grow faster than 1.1 percent per year over the next 30 years? We should hope so, because if it doesn’t then lots of our forecasts are going to be waaay off. [...]
Saturday ~ September 10th, 2011 at 3:37 am
Anon
Karl:
The multiplier would be awful: a majority of the work-force does not pay any federal income tax. Much of the tax comes from high earners, which in the current environment would save a significant portion of it.
My estimation is that for every 1 dollar of new demand created there would be about 6 dollars in general tax cuts. (this comes from the current 3% desired savings rate and from the vast number of households that do not pay any or much federal tax.)
So what you want to do is to cut taxes there where it’s most likely to be spent. Take a look at the awful HABSHNO numbers to see where most of the prospective US spenders are trapped today …
But those trapped households do not pay taxes – except payroll tax.
Thus purely from an economic point of view the best policy would be a payroll tax cut with a ceiling for the cut. This spreads most of the cuts towards the median household (where most of the potential demand is) instead of the average household skewed by one hundred bubble billionaires.
Yet another risk of cutting taxes for high earners is that funds will simply flow out of the country and be invested in China and elsewhere – boosting their economies, not the US economy.
So to maximize the multiplier for the recovery of the US economy you want to target households roughly along these lines:
– target households which are balance sheet constrained
– target households which are median earners (exclude high earners)
– target households which are more likely to spend domestically than abroad
If you look at the Obama plan you will see elements of this: veterans are a politically correct way of targeting “non-billionaire median households that are more inclined to spend in the US than elsewhere”.
The simplest solution would be to cut all payroll taxes but require those funds to be spent domestically: but that would likely be seen as a protectionist and capital controlling move. So you want policy that does something similar via targeting not via limits.
Saturday ~ September 10th, 2011 at 11:25 am
teageegeepea
I don’t think it be the case, but a long period of lousy growth sounds like a real possibility to be considered. What has Japan’s growth rate been since the start of the “lost decade”? I know they have population decline, which is why we’re less likely to experience it, but there’s no law that says that’s the only way to have long periods of anemic growth.
Saturday ~ September 10th, 2011 at 3:29 pm
Dave Milovich
A more prudent version: On Oct. 3, Treasury auctions as many 30-year TIPS bonds as it takes to get rates to hit some ceiling (2%?). Treasury repeats this on Nov 1., and Dec. 1. On Dec. 5, lower payroll tax rates are announced for 2012. If you are right and Treasury raises sufficient debt, rates will be zero or negative. Merry Christmas!
Sunday ~ September 11th, 2011 at 12:22 am
arraja
Suppose real growth is 3 percent per year.
Well now, there’s the flaw in your argument right there.
Sunday ~ September 11th, 2011 at 6:41 pm
Rick
Just to clarify: The 56% number is if the decision to zero taxes this year has no impact on future economic growth. If it has a positive impact, then the number will be lower than 56%.
Sunday ~ September 11th, 2011 at 8:37 pm
obama’s “jobs” plan, et al | r.j.'s space
[...] people looking for work, and another 20 million idle…we dont have to pay for it now; in fact, economist karl smith shows that with interest rates as low as they are now, we could eliminate all federal taxes today & borrow 30 years out, & make a profit on that [...]
Monday ~ September 12th, 2011 at 9:51 am
IVV
What about state and local taxes? Let’s say we reduce federal taxes to zero. Reducing payroll taxes to zero will remove a regressive tax paid by all employees. However, if you really want to reduce lower/middle class tax burdens, you should find a way to get sales tax and state excise taxes repealed, as well.
In theory, the federal government could tell the states that if they would reduce their sales taxes to zero, the federal government will pay the individual states the difference in revenue, and fund that through borrowing as well. But is that politically possible?
Tuesday ~ October 18th, 2011 at 1:21 pm
What does Green Mean? » The Language Problem
[...] why the government is bothering to collect revenues at all, when the cost of borrowing is hitting zero. By now, everyone who cares has realized that fear-mongering about the debt and the deficit is a [...]
Friday ~ October 21st, 2011 at 4:36 pm
No deficit problem? « Jonathan R. Walton
[...] are questioning whether we really ought to be concerned with the government’s budget deficit. Read a post by Karl Smith. Interest rates on federal debt are currently negative, which means that it makes more economic [...]
Tuesday ~ November 8th, 2011 at 8:06 pm
It Isn’t Brinkmanship
[...] you’re not standing on the brink. Karl Smith has published a very thought-provoking post in which he proposes a complete, temporary tax holiday: So what [...]