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  • Tax Rebates Are No Laughing Matter

    Brian Riedl’s paper on economic growth and tax rebates has caused quite a stir. Over at OMB Watch, blogger Craig Jennings calls it “breathtakingly moronic” and resorts to name calling, claiming Riedl would “fail tenth-grade economics” for his analysis. (Jennings mustn’t have known Riedl studied economic policy while earning his master’s degree in public affairs from Princeton.)

    Unfortunately for Jennings, he diminishes his organization with language more fitting a middle school playground than a serious think tank. Meanwhile, the economic points he sneaks in between insults are simply wrong. We felt the need to rebut some of them. (Jennings made a second blog post shortly after lodging his first attack.)

    1) Riedl’s statement that wealth creation is based on capital, labor and technology (all assuming basic rule of law) is simply the Solow growth model. By oddly criticizing Riedl’s omission of consumption from this list, Jennings confuses the Solow growth model of how wealth is initially created with the old Keynesian formula for how existing wealth is eventually spent (consumption + investment + government + net exports). If Jennings feels Solow was incorrect, and that producing a good or service somehow requires consumption, that’s a criticism to take up with the Nobel laureate himself.

    2) This confusion between how wealth is created and how wealth is spent leads to Jennings’ next error: asserting that tax rebates increase consumption and therefore GDP. Jennings never stops to ask where Congress gets the money it mails out. Every dollar that rebates “inject” into the economy must first be taxed or borrowed out of the economy. In 2001, the money for rebates was borrowed from capital/markets, so the resulting consumption increase was matched by an investment decrease. Total spending was unchanged, and the economy remained sluggish.

    3) Finally, Jennings mocks Riedl’s basic point that “reducing marginal income tax rates has been shown to motivate workers to work more.” Although economists debate the size of the impact, Riedl’s point that some link exists is widely accepted. Does Jennings believe the same people would work the same jobs at the same hours, regardless of whether their tax rate is 0, 50 or 100 percent? It would be worth reviewing Nobel Prize-winning economist Ed Prescott’s groundbreaking research specifying how higher income tax rates reduce labor supply in Europe and the United States.

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