J. Bradford DeLong's Blog, page 425

On the Negative Information Revealed by Marvin Goodfriend's "I Don't Teach IS-LM": Hoisted from the Archives

The smart and snarky Sam Bell wants to taunt me into rising to his bait by twittering https://twitter.com/sam_a_bell/status/872116967070732288 a quote from likely Fed nominee Marvin Goodfriend: "I don't teach IS-LM". He succeeds. Here is the quote:

TOM KEENE: But, Marvin, with, you know, basic IS-LM and theory and all that stuff you teach in Economics 101, aren't we going to see a dampening of GDP if we see a restrictive Fed?

MARVIN GOODFRIEND: By the way, I don't teach IS-LM. But what I would say is this...

And here is the tape:

March 23, 2012: https://www.youtube.com/watch?v=emvSYwUnWyI&ab_channel=Bloomberg

Let me start by analyzing "I don't teach IS-LM". And let me preface this by saying that Marvin Goodfried is a very sharp and honest economist. But I believe that whenever anybody says "I don't teach IS-LM" they are one of:

Making completely implausible and wrong claims about how the economy works.
Being lazy and/or stupid.
Declaring a tribal affiliation to a particular Carnegie-Mellon tradition of macroeconomic analysis that the late Rudi Dornbusch described to me and others as "Jim Tobin with original errors", and that I think has shed a lot more heat than light on real issues.

Let us start with (1), and let us start with Irving Fisher's monetarism: the quantity of money demanded in the economy is given by the equation:

Md = PY/V

where M is the quantity of money demanded, P is the price level, Y is the level of production, and V is the velocity of money���the value of transactions that having $1 in the bank or in cash as money can support, in the sense of manufacturing the needed trust so that the transactions will go through.

If you believe that that velocity of money is fixed by the institutions of the banking system and the technology supporting transactions, then you do not have to teach IS-LM. You have reached a full stop, and have the monetarist conclusion that the total nominal spending in the economy���prices times quantities produced���is equal to a constant times the economy's money stock, with the constant of proportionality chaining slowly over time as the institutions of the banking system and the technology supporting transactions slowly changes.

That is meaning (1) of "I don't teach IS-LM": I do not need to teach it because it is not important in determining how much spending there is the economy. That is implausible and wrong. Here is the graph of velocity since 1960���the thing that is supposed to be on a smooth and steady time trend if "I don't teach IS-LM" is a sensible thing to say:

Even before the 1990s any model assuming an unproblematic relationship between the money stock and total spending was badly awry, although not as badly awry as it has been since.

Now let's move on to (2)���lazy and/or stupid. The graph above tells you that if you want to forecast���or even retrospectively explain���the relationship between the money stock and the level of spending, you need a model of what the determinants of the fluctuations of velocity we see are. If we draw a graph with the level of spending on the horizontal axis and some sufficient statistics for the determinants of velocity on the vertical axis, the path traced out by our equation:

Md = PY/V

is conventionally called "the LM curve". But you then need to know where on the LM curve the economy will be���you need another curve. And that other curve is conventionally called "the IS curve".

To claim that you do not teach IS-LM is to implicitly claim that you do not need to figure out where on the LM curve the economy will be. That is something it is only possible to say if you are being lazy, or stupid.

The third meaning of "I don't teach IS-LM" is that it is a CMU-school tribal indentification marker, and has no purpose beyond that���no intellectual purpose.

So, yes, the fact that Marvin Goodfriend would go on Tom Keene's surveillance and say "I don't teach IS-LM" makes me think a good deal less of him. I do, however, interpret that claim as a declaration of tribal allegiance to CMU-school macro. I do not interpret it as a claim that you don't need a model of the determinants of fluctuations in velocity. I do not interpret it as a claim that there are no fluctuations in velocity large enough to worry about.

What worries me more, however, is what comes next:

GOODFRIEND: There is no way that this recovery can proceed with any degree of confidence unless the Fed makes sure that inflation does not move up. So I think the risks are exactly reversed from the way the Fed chairman discusses this. He has to make the public understand that any whiff of doubt about the Fed's ability and willingness to stabilize inflation is going to put a crimp into the public's willingness to take positions and commitments over the next two or three years that would produce genuine growth. And so I would just take it, and turn it on its head, and not put the question as you did to me, but reverse it.

The risks of allowing any latitude in inflation expectations to build dup, or any doubt about the Fed's willingness to do what it takes to keep inflation down, is to me the most likely risk in preventing this recovery from getting any traction...

Do notice that Marvin Goodfriend is, here, thinking in terms of an IS-LM model. When he says "any whiff of doubt about the Fed's ability and willingness to stabilize inflation is going to put a crimp into the public's willingness to take positions and commitments... is to me the most likely risk in preventing this recovery from getting any traction...", he is saying: "any whiff of doubt about the Fed's ability and willingness to keep inflation low will cause a large leftward shift in the IS curve that will prevent this recovery from getting any traction..." He does not do more than gesture at an expectational mechanism for this leftward shift in the IS curve that he wants the Federal Reserve to take action to head off. But it is what he fears.

And, of course, Goodfriend was wrong: a continuation of Bernanke's extraordinary easing policies was not going raise "any whiff of doubt about the Fed's ability and willingness to stabilize inflation".

Here we have a market-based measure of inflation expectations���the ten-year breakeven inflation rate since 2010: that inflation rate over the forthcoming ten years that would, at each date, have made investments in conventional Ten-Year U.S. Treasury bonds and investments in Ten-Year Inflation-Protected Securities (TIPS) equally profitable. The vertical blue line marks March 23, 2012: the date of Marvin Goodfriend's interview. The point that Marvin was hammering home again and again on March 23, 2012 was that the Federal Reserve needed to rapidly start shrinking its balance sheet and raising interest rates lest inflation expectations break out to the upside.

The Federal Reserve ignored Marvin Goodfriend.

And Marvin Goodfriend was wrong. The shift to a tighter, more restrictive policy he demanded then was not necessary to prevent an upside breakout of inflation expectations.

In fact, the Federal Reserve's persistent problem since has been that expectations of���and actual outcomes for���inflation have been well below rather than above the Federal Reserve's targets.

I would very much like to hear Marvin Goodfriend explain why he misjudged the situation in the spring of 2012, and how he has updated his view of the economy and of optimal monetary policy since.

Must-Read: The Nine Unprofessional Republican Economists ...

Must-Read: The Nine Unprofessional Republican Economists have become even more unprofessional. I would also note that such transparent self-contradiction is incompetent. Do they even read what they wrote four days before?: Robert J. Barro, Michael J. Boskin, John Cogan, Douglas Holtz-Eakin, Glenn Hubbard, Lawrence B. Lindsey, Harvey S. Rosen, George P. Shultz and John. B. Taylor (Wednesday, November 29, 2017): Economists respond to Summers, Furman over Mnuchin letter: "First Point You Raised: Our letter addresses the impact of corporate tax reform on GDP; we did not offer claims about the speed of adjustment to a long-run result (though official revenue estimators will obviously need to do so for short-run analysis)..."

Robert J. Barro, Michael J. Boskin, John Cogan, Douglas Holtz-Eakin, Glenn Hubbard, Lawrence B. Lindsey, Harvey S. Rosen, George P. Shultz and John. B. Taylor (Saturday, November 25, 2017): How Tax Reform Will Lift the Economy: "A conventional approach to economic modeling suggests that such an increase in the capital stock would **raise the level of GDP in the long run by just over 4%. If achieved over a decade, the associated increase in the annual rate of GDP growth would be about 0.4% per year..."

The "If" at the start of the second sentence in the second quote is an assertion that the long run could well be as short as a decade. That is a claim about the lower bound of the speed of adjustment to a long-run result if I have ever seen one.

They have reputations: blowing them up for the whole world���or even for Wales���would be one thing. This is another:

Should-Read: Scott Aaronson (2013): Quantum Computing sin...

Should-Read: Scott Aaronson (2013): Quantum Computing since Democritus: "[Alan Turing's] main idea... as I read it... is a plea against meat chauvinism...

...Sure, Turing makes some scientific arguments, some mathematical arguments, some epistemological arguments. But beneath everything else is a moral argument. Namely: if a computer interacted with us in a way that was indistinguishable from a human, then of course we could say the computer wasn't ���really��� thinking, that it was just a simulation. But on the same grounds, we could also say that other people aren't really thinking, that they merely act as if they're thinking. So what entitles us to go through such intellectual acrobatics in the one case but not the other?

If you'll allow me to editorialize (as if I ever do otherwise...), this moral question, this question of double standards, is really where Searle, Penrose, and every other ���strong AI skeptic��� comes up empty for me. One can indeed give weighty and compelling arguments against the possibility of thinking machines. The only problem with these arguments is that they're also arguments against the possibility of thinking brains!... One popular argument is that, if a computer appears to be intelligent, that's merely a reflection of the intelligence of the humans who programmed it. But what if humans��� intelligence is just a reflection of the billion-year evolutionary process that gave rise to it? What frustrates me every time I read the AI skeptics is their failure to consider these parallels honestly. The ���qualia��� and ���aboutness��� of other people is simply taken for granted. It's only the qualia of machines that's in question....

There's another thing we appreciate now that people in Turing's time didn't really appreciate. This is that, in trying to write programs to simulate human intelligence, we're competing against a billion years of evolution. And that's damn hard. One counterintuitive consequence is that it's much easier to program a computer to beat Garry Kasparov at chess than to program a computer to recognize faces under varied lighting conditions. Often the hardest tasks for AI are the ones that are trivial for a five-year-old����� since those are the ones that are so hardwired by evolution that we don't even think about them.

In the last 60 years, have there been any new insights about the Turing Test itself?... There has... been a famous ���attempted��� insight, which is called Searle's Chinese Room.... You... answer... questions... in Chinese just by consulting a rule book... carrying out an intelligent Chinese conversation, yet by assumption, you don't understand a word of Chinese! Therefore, symbol-manipulation can't produce understanding.... Considered as an argument... several aspects... have always annoyed me.... The unselfconscious appeal to intuition������it's just a rule book, for crying out loud!������on precisely the sort of question where we should expect our intuitions to be least reliable.... The double standard: the idea that a bundle of nerve cells can understand Chinese is taken as, not merely obvious, but so unproblematic that it doesn't even raise the question of why a rule book couldn't understand Chinese as well....

The way it gets so much mileage from... trying to sidestep... computational complexity purely through clever framing. We're invited to imagine someone pushing around slips of paper with zero understanding or insight... But how many slips of paper are we talking about? How big would the rule book have to be, and how quickly would you have to consult it, to carry out an intelligent Chinese conversation in anything resembling real time?

If each page of the rule book corresponded to one neuron of a native speaker's brain, then probably we'd be talking about a ���rule book��� at least the size of the Earth, its pages searchable by a swarm of robots traveling at close to the speed of light. When you put it that way, maybe it's not so hard to imagine that this enormous Chinese-speaking entity that we've brought into being might have something we'd be prepared to call understanding or insight...

Should-Read: This is nuts! When's the crash? Charlie Stro...

Should-Read: This is nuts! When's the crash? Charlie Stross: Unforeseen Consequences and that 1929: "The mining process in combination with the hard upper limit...

...Per this article, Bitcoin mining is now consuming 30.23 TWh of electricity per year, or rather more electricity than Ireland; it's outrageously... energy-intensive.... BTC is a libertarian shibboleth.... I tweeted... that we need to ban Bitcoin because it's fucking our carbon emissions. It's up to 0.12% of global energy consumption and rising rapidly: the implication is that it has the potential to outstrip more useful and productive computational uses of energy (like, oh, kitten jpegs) and to rival other major power-hogging industries without providing anything we actually need. And boy did I get some interesting random replies!... What I wasn't expecting was the alt-right/neo-Nazi connection. Bitcoin isn't just popular among libertarians, it's popular among folks with green frog/Kek user icons and anti-semitic views. ("Are you a Jew?" asked one egg.)

One possible explanation, which looks quite reasonable as a first approximation, is that the US libertarian fringe has been assimilated by the neo-Nazis.... Weaponized media (both social media and mass media owned by the oligarchs) is used to channel the sense of grievance felt by the immiserated population into acceptable directions, via slogans like "taking back control" or "make America Great again". Directions such as resentment towards immigrants, get-rich-quick schemes such as cryptocurrency bubbles or goldbuggery, and ritualized abusive denunciation of anyone who questions these attempts to divert attention away from the real problem���the way we're being conditioned for exploitation by our self-proclaimed masters. So I now have two follow-on questions about BTC....

If BTC delivers what its supporters promise, then how will the oligarchs react? A working distributed cryptocurrency model is inimical to the interests of billionaire monopolists who want to get rich by imposing rent-seeking practices on the immobilized peasantry (ahem: I mean us ordinary folks). They won't go quietly, there will be a crack-down, and we may be seeing the first signs of the shape it will take in China (which is banning bitcoin exchanges). Distributed systems, contra received wisdom, can be banned: you just have to be sufficiently ruthless....

If, as I think, BTC doesn't deliver, then the bubble will eventually burst.... We're going to run out of new BTC to mine.... The incentive for mining (a process essential for reconciling the public ledgers) will disappear and the currency will... what? The people most heavily invested in it will do their best to patch it up and keep it going, because what BTC most resembles (to my eye, and that of Jamie Dimon, CEO of JP Morgan Chase) is a distributed Ponzi scheme. But when a Ponzi scheme blows out, it's the people at the bottom who lose.

The longer BTC persists, the worse the eventual blowout���and the more angry people there are going to be. Angry people who are currently being recruited and radicalized by neo-Nazis.

Should-Read: Alan Simpson and Erskine Bowles: Unfortunate...

Should-Read: Alan Simpson and Erskine Bowles: Unfortunately, the tax plan currently under discussion... ignores nearly all the hard choices... incorporating only the 'goodies'...

...It reads as if it were developed for a country whose debt problems have been solved, when in reality debt is the highest it has ever been other than around World War II. When this tax reform discussion started, House Speaker Paul D. Ryan (R-Wis.) and Senate Majority Leader Mitch McConnell (R-Ky.) called for revenue-neutral tax reform. While ultimately more revenue is needed, deficit neutrality is likely the best that can be expected in the current political environment. Yet Congress abandoned even this minimum standard of fiscal responsibility...

Comment of the Day: So Many Years: @korybing: "Sometimes ...

Comment of the Day: So Many Years: @korybing: "Sometimes I sit around and think about how mammoths went extinct AFTER the pyramids were built...

...We lived closer to Tyrannosaurus than tyrannosaurus lives to stegosaurus. Betty White is older than factory-sliced bread. Oxford University is older than the founding of the Aztec Capitol of Tenochtitl��n....

Minivet: When you use a celebrity's name as metonym for a point in history, it feels like a cheat to be referring to their birthdate when the career they're known for started much later. Technically true, but that's all....

Moby Hick: oth Oxford and Tenochtitl��n produced many people who didn't like Spaniards.

Peep: But Chomper and Spike were friends.

Robert Halford: The Mammoth thing is kind of nonsense. I think he's talking about the tiny survivor populations of mammoths that lived on Wrangel Island or St. Paul Island. Feels like cheating. Sure there were a few mammoths existing in the world but it's not like there were herds moving down La Brea Ave when the pyramids were being built. I tell my kid the stegosaurus/T.Rex thing all the time, to the point where my daughter pulled an "everyone KNOWS that ALREADY" the last time we were at the natural history museum....

Peep: "But it's not like there were herds moving down La Brea Ave when the pyramids were being built" Even then there were traffic jams in LA....

Pee;: My stepdaughter is making me correct 10. Chomper did not appear in the original Land Before Time movie. His first appearance was in the sequel The Land Before Time II: The Great Valley Adventure....

Peep: Anyway, 6 is wrong. The Egyptians used the mammoths to carry the stones for the pyramids. When the Hebrews escaped they rode on the mammoths across the Red Sea. But then the mammoths died during the 40 years in the desert, and that's why they are extinct....

Moby Hick: "Blanche dates an Oxford don"?

Robert Halford: "Blanche dates a Stegosaurus"

Academic Lurker: Can anyone name the last dinosaur to get an Oxford degree?....

Essear Niall Ferguson?

Should-Read: Well, we have 100 more unprofessional Republ...

Should-Read: Well, we have 100 more unprofessional Republican economists today... We saw 4.5% real GDP growth in the second half of the 1990s and 5% in the half-decades before and after the 1979-1982 Volcker Disinflation Recession. "Levels of growth not seen in generations" is a high bar indeed. Appealing to Kevin "Dow 36000" Hassett rather than doing any modeling is perhaps the most unprofessional thing I have ever seen, save for insisting that sophisticated economic models show... macroeconomic feedback... more than enough to compensate for the static revenue loss" without, somehow, naming the models, plural���let alone grappling with the fact that of us who have tried hard to look for an elastic supply response of domestic savings to the after-tax rate of return have failed to find anything. I am, I have to admit it, greatly embarrassed by the fact that (some of these) clowns have Ph.D.s in economics...

Most of them know they are lying. And it is not as though many of them think that a devil's bargain is worth making they will thereby gain high federal office and be able to rein in crazy nut jobs. A little affinity fraud. A lot of partisanship. Zero commitment to telling it like it is:

One Hundred Unprofessional Republican Economists: Trump tax reform opinion: Why Congress should pass: "The enactment of a comprehensive overhaul���complete with a lower corporate tax rate���will ignite our economy with levels of growth not seen in generations...

...A twenty percent statutory rate on a permanent basis would, per the Council of Economic Advisers, help produce a GDP boost 'by between 3 and 5 percent'. As the debate delves into deficit implications, it is critical to consider that $1 trillion in new revenue for the federal government can be generated by four-tenths of a percentage in GDP growth. Sophisticated economic models show the macroeconomic feedback generated by the TCJA will exceed that amount���more than enough to compensate for the static revenue loss.... Your vote throughout the weeks ahead will therefore put more money in the pockets of more workers. Supporting the Tax Cuts and Jobs Act will ensure that those workers���those beneficiaries���are American...

Sincerely, James C. Miller III, Douglas Holtz-Eakin... Barry W. Poulson... Charles W. Calomiris... Donald Luskin... [and 95 others]

Should-Read: Since Sam Brownback planted his behind behin...

Should-Read: Since Sam Brownback planted his behind behind the Kansas governor's desk at the end of 2012, Kansas has lost 6%-points of employment relative to the U.S. average. And there is nothing special about Kansas that would make such a huge swing happen in such a short period���nothing but the presence of a tax-cuts-for-the-rich nut in the governor's chair and a complaisant legislature implementing his policies. I would not in a hundred years have dared speculate that Brownbackism in Brownbackistan could be so destructive. And yet I cannot think of any alternative explanation for what has gone on:

Kansas City Star: Jerry Moran: Don't take failed Kansas tax plan nationwide: "Moran... could be the deciding vote.... He has already seen, first-hand, during a very painful five years, what will happen...

...At a forum Moran held at the Tasty Pastry in Clay Center last weekend, one of his constituents, Robynn Andracsek, of Olathe, neatly summed up the apparent thinking behind the bill: ���Let���s cut taxes for millionaires and billionaires, and then let���s figure out how to pay for it.��� Instead, she pleaded with him, ���Let���s do a sensible tax cut. This is Kansas. We know the trickle-down experiment doesn���t work. All of our members of Congress from Kansas should know that.��� Should but do not. Or if they do, betray no sign of it.

Every Kansan knows what happened after Gov. Sam Brownback���s 2012 cuts did away with the state income tax for some 330,000 business owners. The governor kept insisting���and in fact, still does���that robust growth and woohoo, jobs galore would result. When that didn���t happen, elected officials kept having to dip into funds set aside for highways and schools just to balance the budget. Finally, this year, lawmakers overrode a Brownback veto and at last repealed the LLC tax break and raised income tax rates.

That had to happen, as Andracsek reminded Moran, ���because we decided we want schools and we want roads.��� Knowing all that history, she asked him, ���Why would you take this failed experiment nationwide? Our members of Congress should be the ones leading the way for tax reform that actually affects normal people, not just millionaires and billionaires.���... Moran assured voters in Clay Center that ���I���m also cognizant of what people saw happen in Kansas.��� And even if that weren���t the case, he said, ���there is plenty of conversation about Kansas in Washington, D.C.���

Senator, we understand that you want to get something accomplished. But you don���t have the luxury of the ignorance that the president could plausibly claim when just days after his election he went around promising applauding, whistling patrons in one of New York���s best restaurants, ���We���ll get your taxes down, don���t worry about it.��� We want to believe you, Senator, when you say, ���My goal is to find out which taxes you cut can actually help create more jobs, better jobs, higher-paying jobs ��� and which ones don���t do that. Not all of them do that.��� ���There are still a lot of conversations to be had,��� you say. But please have the toughest one of all with that small-town banker who insists that his top priority is to stay connected to Kansans....

You know what���s wrong with this bill.... So all you have to do now is vote accordingly.

Should-Read: Economist: Jean Tirole: Standing up for econ...

Should-Read: Economist: Jean Tirole: Standing up for economists: "Review of Economics for the Common Good. By Jean Tirole. Translated by Steven Rendall. Princeton University Press; 576 pages; $29.95 and ��24.95...

...Economics is perfectly capable of incorporating questions of morality, says Mr Tirole. It simply imposes structure on debate where otherwise indignation would rule. It might make sense to ban some markets, like dwarf-tossing, he says: its existence diminishes the dignity of an entire group. But a market in organs or blood, for example, should not be rejected on the basis of instinctive moral repugnance alone. Policymakers should consider whether payment would raise the supply of donated blood or kidneys, improving or even saving lives. (It might not, if the motivation of money makes generous people afraid of looking greedy.) Whatever the answer, policymakers should make decisions from ���behind the veil of ignorance���: without knowing whether any one person, including the policymakers themselves, would be a winner or loser from a particular policy, which society would they choose?

Mr Tirole applies this type of reasoning to topics ranging from carbon taxes to industrial policy, from competition to the digital economy. He presents economists as detectives, sniffing out abuse of market power and identifying trade-offs where populists make empty promises. His analysis is laden with French examples of ill-advised attempts to defy the constraints that those in his discipline delight in pointing out. When in 1996 the French government blocked new large stores in an effort to restrain the power of supermarket chains, share prices of existing ones rose. The new laws inadvertently worsened the problem by restricting competition.

He also depicts economists as ill-equipped to deal with the dirty reality of politics. To those who might be catapulted into sudden stardom as he was, he warns that academic economists will be quickly put into political pigeonholes, and their arguments celebrated or dismissed according to whether the recipient favours that pigeonhole. Though populists revel in simplicity, his aim is to make economics context-specific and point out its complexities. This is his strength, but his discipline���s limitation. He is economists��� defender, but not their saviour.

Must-Read: Jason and Larry bring plenty of refreshments t...

Must-Read: Jason and Larry bring plenty of refreshments to the debate over tax "reform". They are really unhappy with the Nine Unprofessional Republican Economists. Shrill, even. And so they provide great detail on how these nine economists are being unprofessional. This is good to see:

Jason Furman and Larry Summers: A modest proposal: time to rethink the impact of US tax reform: "You recently wrote an open letter to Treasury Secretary Mnuchin quantifying the economic impact of tax reform...

...We are interested in and surprised by your analysis. We share your commitment to the idea that well-designed tax reform can make the economy stronger and that careful economic analysis is essential. And we know that you all share our belief that such careful analysis is well served by discussion and debate of these issues that is at least as frank and vigorous as what we are all accustomed to in the average economics seminar. To that end, we think it would be useful to lay out some of the questions we have about your analysis:

Many members of Congress are citing growth estimates consistent with your letter to claim that the tax cuts would pay for themselves and that the legislation currently being considered by Congress would not add to the deficit or debt over the next decade. Your letter, however, does not say that tax cuts would pay for themselves. Would it be fair to say that you agree with Martin Feldstein (who did not sign the letter) that these tax cuts will not pay for themselves and, in fact, would add more than $1tn to the debt over the next decade?

Can you explain how the studies you cite justify the conclusions you reach? You cite three studies to justify your conclusion that the annual growth rate would rise by 0.3-0.4 percentage points over the next decade. But two of these studies actually appear to have estimated substantially lower growth rates ��� potentially as low as a 0.01 percentage point increase in the annual growth rate.

 

You cite a Treasury study of the Bush tax reform commission���s growth and investment tax plan that you asserted found a 4.8 per cent increase in long-run GDP. But the study you refer to provides estimates from three different models ranging from 1.4 per cent to 4.8 per cent increases in national income and does not express any views on which model is preferred.

 

What was your reason for citing only the upper end of the range of Treasury���s estimates, from one model and ignoring its other calculations? Also, why did you not mention that the middle of the range of Treasury���s 10-year estimates was 1 per cent, a figure that would corroborate the views of critics of the tax bills since there would be only a 0.1 percentage point increase in the growth rate? (Moreover, the Bush Commission���s growth and investment tax plan differed in important ways from the one before Congress: it included permanent expensing, applied expensing to structures, raised taxes on investments that are already in place and was fully paid for. Do these differences affect the validity of your use of this plan as a model for the current Congressional bills?)

 

You also cite an OECD study that you say justifies the conclusion that long-run GDP would go up by 2 per cent. But since you are explicitly talking about 10-year growth rates in your letter, would it not be better to use estimates from this same study that show that the effect in the 10th year is less than one-third of the long-run effect, translating into an annual growth rate of less than 0.1 percentage point? Moreover, how did you come up with the 2 per cent long-run GDP number since the OECD study says that a 1 per cent of GDP reduction in corporate taxes adds 1.25 per cent to long-run GDP? Applying that estimate to corporate rate reductions in the Congressional bills would yield only a 0.8 per cent increase in long-run GDP, translating into a growth rate increase of 0.02 percentage point per year (and if you factored in the base broadeners, the magnitude would be half as large). Either way, the OECD study you cite also corroborates the critics of the tax bill.

Did you give thought to the impact of the corporate rate cut, assuming that expensing as proposed in the bill was enacted? We suspect that much of the projected growth benefit from corporate tax reform comes from enacting expensing of equipment, which reduces the entity-level effective tax rate to zero on equity-financed investment and makes it negative if financed in part with debt. In the presence of debt finance, textbook analysis would suggest that a cut in the corporate tax rate would raise the cost of capital because interest deductions would no longer be as valuable and thus discourage investment.

 

Have you considered this important possibility, since most of the budget cost of the reform comes from the corporate rate reduction? Moreover, even with the lower statutory tax rates in the bills if expensing ended after five years, as it does in the bill, effective marginal tax rates on equipment investment would actually be higher than they are today with bonus depreciation in effect. It would be ironic if lower corporate rates and an expiration of bonus depreciation actually discouraged investment at the margin relative to continuing current policy but we believe this is likely.

The pass-through provisions in the House and Senate bills would appear to create new sources of complexity in the tax code and violate the basic principle of tax policy that similar sources of income should be taxed at similar rates. A number of you have expressed concerns about the pass-through provisions in the past. Did you model the impact that these provisions would have on macroeconomic impact of the tax cuts?

President Donald Trump has expressed concern about the magnitude of the trade deficit. As his chairman of the Council of Economic Advisers said, ���A corporate tax cut to 20 per cent would dramatically reduce the trade deficit.��� In your analysis, you reject concerns about the macroeconomic impact of budget deficits because, you argue, the United States will be able to attract capital from the global capital market. As a matter of logic, won���t increased capital inflows require an increase in the trade deficit, totaling hundreds of billions of dollars annually if they are to finance your projected 15 per cent increase in the capital stock?

Apart from the question of global financing of the budget deficit, do you worry about the impact of enlarged deficits given projections of rising spending on entitlements and national security? Do you think that it is realistic that Congress will actually sunset provisions like the expanded child credit or corporate expensing, or do you think that the true cost of this bill is likely to significantly exceed $1.5tn? One of the authors of your letter wrote that the Bowles-Simpson fiscal commission ���was very good���, and several other signatories wrote that it should be the ���starting point��� for fiscal negotiations. Do you think that cutting revenue to less than 18 per cent of GDP, as would happen under the Congressional legislation, is consistent with the 21 per cent of GDP in revenue that the Bowles-Simpson commission recommended for long-run fiscal sustainability?

 

Moreover, we understand that you support entitlement reform, but do you believe that it is politically realistic for the Republicans to actually achieve your goal when it would entail asking seniors to sacrifice by cutting social security and Medicare shortly after Republicans argued that we could afford to add more than $1tn to the deficit for tax cuts that largely benefit corporations and high-income households?

 

Finally, one of you [Douglas Holtz-Eakin] signed a previous letter stating that because outside estimates are often ���not objective and not as well informed as the Congressional Budget Office���s analysts��� that relying on CBO���s estimates in the legislative process has served the Congress���������and the American people���������very well during the past four decades.

As the House and Senate consider potential policy changes this year and in the years ahead, we urge you to maintain and respect the Congress���s decades-long reliance on CBO���s estimates in developing and scoring bills.

Your recent letter ignores many specific features of the legislation ��� to give just three of many examples that you did not incorporate into your analysis: the legislation would increase the after-tax cost of research and development, would increase asymmetric penalties on corporate risk-taking and would raise effective marginal tax rates for many individuals through the repeal of the state and local tax deduction. Do you think your analysis of a highly simplified hypothetical plan that is different from the actual legislation before Congress should serve as a substitute for the Joint Committee on Taxation (JCT) and the CBO producing analysis? Do you think it is responsible for Congress to vote on technically complex legislation in the absence of hearings or complete analysis?

Thank you for your attention to these questions. We may disagree on the merits of particular proposals but as professional economists we can all agree on the importance of critical discussion and debate to advance the improved understanding that is the basis of better public policies.