By Gabriela Cugat and Futoshi Narita Emerging markets and developing economies grew consistently in the two decades before the COVID-19 pandemic hit, allowing for much-needed gains in poverty reduction and life expectancy. The crisis now puts much of that progress at risk while further widening the gap between rich and poor. Despite the pre-pandemic gains in […]
. . . then you are not taxing who you think you are taxing. I was reminded of this point by a recent tweet I saw:
Progressives tend to favor higher income tax rates on the rich. I prefer a progressive consumption tax. It might be worth noting that if the top rate of income tax were increased, President Trump still would have paid roughly $750 in income taxes in 2016. In contrast, he probably would have paid much more in taxes with a progressive consumption tax, at least if his lifestyle is as lavish as has been reported.
Just to be clear, I don’t believe that tax policy decisions should depend on how it impacts Trump—that would be absurd. My point is that when people get outraged about what they see as a gross inequity, it’s important not to just lash out blindly, rather one should think clearly about who actually bears the burden of different types of taxes. In general, it’s NOT the person (or company) that writes the check.
There are technical problems with taxing consumption. But there are often even bigger technical problems in taxing income, wealth and other alternatives. For instance, there is the question, “Is X a consumer or an investment good?” But the exact same dilemma crops up with income taxes.
By Jihad Azour and Joyce Wong Countries in the Middle East and Central Asia face with COVID-19 a public health emergency unlike any seen in our lifetime, along with an unprecedented economic downturn. The pandemic is exacerbating existing economic and social challenges, calling for urgent action to mitigate the threat of long-term damage to incomes […]
By Niels-Jakob Hansen, Alessandro Lin, and Rui C. Mano Inequality in both advanced economies and emerging markets has been on the rise in recent decades. The COVID-19 pandemic has exacerbated and raised awareness of disparities between the rich and poor. Fiscal policies and structural reforms are long known to be powerful mitigators of inequality. But […]
By IMFBlog The pandemic has altered people’s lives in both enormous and small ways. Our editors have picked the top recent blogs that dig into the details of what COVID-19 means for people: the impact on women and the young, what it means for the food supply, and how it can increase already growing inequality, […]
Within the economics community, thrift was very fashionable during the neoliberal era (roughly 1980-2007). During the 2010s, economists opened a three front war on thrift. Thrift was blamed for rising inequality, stagnating aggregate demand, and debt problems associated with “currency manipulation”. In each case, the charges were false. Let’s consider them one at a time.
The most famous recent critique of inequality was Thomas Piketty’s book Capital in the Twenty-First Century. Piketty claimed that the forces of capitalism inevitably led to greater wealth inequality unless restrained in some fashion. He focused on the following inequality:
r > g
This means that the annual rate of return on capital assets usually exceeds the growth rate in the economy. You might argue that the recent risk free interest rate is lower than the trend rate of economic growth, but Piketty pointed out that returns on assets such as stocks and real estate have often exceeded the growth rate of the economy. As a result, wealth will accumulate at a pace that exceeds the growth in GDP, producing increasing wealth inequality.
For this theory to work, one needs to assume that the wealthy do not consume the returns on their capital. This is where thrift becomes the villain in the story. The greater the degree of thrift, the greater the growth in wealth inequality.
In my view, what matters is not wealth inequality, rather it is economic inequality; i.e. inequality in consumption. To the extent that I worry about economic inequality, I worry more about wealthy people with high levels of consumption (such as Larry Ellison) and less about wealthy individuals with low levels of consumption (such as Warren Buffett.) Saving by the ultra-wealthy might make wealth more unequal, but it makes consumption more equal.
The second front on the war on thrift opened in the 2010s, when a long period of near zero interest rates led to worry about monetary policy impotence. The root cause of the problem was believed to be the “paradox of thrift”—attempts to save more led to near zero interest rates and falling aggregate demand. Economists such as Krugman, Woodford, Eggertsson, and Summers worried that monetary policy would be ineffective at zero interest rates. Saving is contractionary in that sort of world, and fiscal deficits are needed in order to provide an adequate level of aggregate demand.
Long time readers know that I don’t buy this claim; monetary policy remains highly effective at near zero interest rates. If the world’s major central banks don’t know how to boost nominal spending, I’d be glad to show them.
The third front in the war on thrift emerged in the arena of international economics. Thrift in places like East Asia (especially China) and Northern Europe (especially Germany) were seen as leading to large current account surpluses, which somehow imposed harm on deficit countries.
One claim is that the current account surpluses had the effect of depressing global aggregate demand. But in that case, deficit countries could easily offset the effects with more expansionary monetary policies. Indeed this is exactly what the US did from 1985-2007. By 2007, our trade deficit had reached extremely high levels, but appropriate monetary policy kept unemployment low.
Another complaint was that these surpluses forced excessive borrowing on deficit countries such as Greece. But no one is forced to borrow. For instance, Australia kept its budget deficits at very low levels for decades, despite large and persistent current account deficits. Greece’s excessive public borrowing was an unfortunate policy decision, not something forced on Greece by German surpluses. Not all countries can have current account surpluses at the same time, but it’s possible for all countries to have budget surpluses at the same time.
I am a big fan of thrift, but at the moment my side is losing the battle. The US government is running up debts like a drunken sailor. All the energy in the economics profession is with the anti-thrift factions.
Someday the tide will turn and thrift will come back in style. Practices that are virtuous at the individual level are rarely harmful at the country level. Eventually it will be recognized that the thriftier nations tend to be the more successful nations.
By Mariya Brussevich, Era Dabla-Norris, and Salma Khalid The COVID-19 pandemic is devastating labor markets across the world. Tens of millions of workers lost their jobs, millions more out of the labor force altogether, and many occupations face an uncertain future. Social distancing measures threaten jobs requiring physical presence at the workplace or face-to-face interactions. […]
By Ulric Eriksson von Allmen, Purva Khera, Sumiko Ogawa, and Ratna Sahay The COVID-19 pandemic could be a game changer for digital financial services. Low-income households and small firms can benefit greatly from advances in mobile money, fintech services, and online banking. Financial inclusion as a result of digital financial services can also boost economic […]
by Chang Yong Rhee For the first time in living memory, Asia’s growth is expected to contract by 1.6 percent—a downgrade to the April projection of zero growth. While Asia’s economic growth in the first quarter of 2020 was better than projected in the April World Economic Outlook—partly owing to early stabilization of the virus […]
At a recent press conference, I was dismayed to see a number of reporters asking Jay Powell about inequality—an issue far beyond the scope of monetary policy—while asking few questions about the highly questionable current stance of monetary policy.
A recent Yahoo Finance article illustrates the confusion:
Federal Reserve Chairman Jerome Powell on Wednesday acknowledged economic inequality in the United States but said monetary policy tools can only do so much to narrow the income gap.
Research from within the Fed itself, however, suggests that the central bank may be more effective when policymakers pay mind to income inequality while designing policy tools.
Actually, inequality is a long run issue and the Fed cannot do anything to address the problem. Money is neutral in the long run.
Pointing to previous economic research, Cairó and Sim note that higher-income groups tend to save more than lower-income groups (or in economic terms, have a lower marginal propensity to consume). The authors argue that higher-income earners can “overaccumulate” financial wealth and sustain high savings rates; lower-income earners are more likely to spend larger shares of their income just to make ends meet.
This presents a dilemma for the Fed, which broadly wants to discourage saving and spur consumption (or in economic terms, drive aggregate demand) to fuel an economic recovery.
This is a common mistake, conflating “consumption” with “aggregate demand”. Most textbooks say the opposite, that monetary stimulus is aimed at boosting investment. Because saving equals investment, this implies monetary policy is expected to boost saving as well. Indeed both saving and investment are procyclical, even as a share of GDP. They both rise faster than GDP during booms and fall faster than GDP during recessions. (Note that I am responding to the Yahoo article and not the scientific paper, which I have not read.)
I also disagree with the standard textbook description of the transmission mechanism. Aggregate demand equals consumption plus investment plus government output plus net experts, and hence you can think of monetary policy as being intended to boost the sum of those four categories, measured in nominal terms. Or more simply, boost NGDP. Thus Zimbabwe monetary policy sharply boosted nominal spending in 2008, even as real consumption and real investment plunged. (Try explaining this to an MMTer.)
The suggestion: an “optimal” monetary policy prioritizing the reduction in unemployment to improve the welfare of lower-income wage earners – even at the expense of welfare losses to higher-income earners holding onto financial assets.
The monetary policy that boosts employment in the short run is the same policy that boosts real equity prices in the short run—expansionary policy. In the long run, the optimal monetary policy keeps employment close to the natural rate, and that’s also the monetary policy that’s best for equity prices.
Readers of this blog know that I currently favor a more expansionary monetary policy. But not because of its effects on inequality. In the short run, a more stimulative policy would help low wage workers and it would help stockholders. And in the long run, money is neutral. If you want to do something about inequality, look elsewhere.
Meanwhile reporters need to ask the Fed why they don’t intend to hit their inflation target in 2022. And keep asking the question over and over again until Jay Powell provides an intelligible answer.