Thursday, November 27, 2008

John Taylor insists that Permanent Tax Cuts are the answer

In doing do, he leans on the permanent income and life-cycle hypotheses. While these are totems of economic theory, they do not stand up particularly well when tested against data.

As George Akerloff emphasized in his magnificent AEA Presidential address, the five famous neutrality results in macroeconomics don't hold up especially well when tested against data. Akerloff notes:

"Each of the neutralities is based on the assumption that the respective decision makers are utility maximizers. But in each case the utility functions of the decision makers have been very narrowly described. They depend only on real outcomes. For example, in the consumption- neutrality models, utility depends on consumption and leisure; in Modigliani-Miller it depends only on the discounted real return to shareholders.

But as early as the beginning of the Twentieth Century, Vilfredo Pareto pointed out that
such characterizations of utility missed important aspects of motivation. According to Pareto people typically have opinions as to how they should, or how they should not, behave. They also have views regarding how others should, or should not, behave. Such views are called norms, and they may be individual as well as social."

[I am having difficulty figuring out how to do block quotes in Safari].

The events of the past 18 months suggest to me that we should regard the neutrality results with more suspicion than ever--and that we should be most suspicious of policies whose foundation is in the neutrality results. (Paul Krugman and Mark Thoma have their own criticisms of Taylor's policy recommendations).


Anonymous said...

Permanently eliminate all taxes on any income less than 50k. Permanently eliminate all regressive taxes (sales, property, inflation, etc...)

That's the way to stimulate the economy.

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