. . . is that it will raise unemployment. Allow me to channel Paul Krugman:
Before the 1936 publication of Keynes' The General Theory of Employment, Interest, and Money, economists had developed a rich and insightful theory of microeconomics, of the behavior of individual markets and the allocation of resources among them. But macroeconomics--the study of economy-wide events like inflation and deflation, booms and slumps--was in a state of arrested development that left it utterly incapable of making sense of the Great Depression.So-called "classical" macroeconomics asserted that the economy had a long-run tendency to return to full employment, and focused only on that long run. Its two main tenets were the quantity theory of money--the assertion that the overall level of prices was proportional to the quantity of money in circulation--and the "loanable funds" theory of interest, which asserted that interest rates would rise or fall to equate total savings with total investment.
Keynes was willing to concede that in some sufficiently long run, these theories might indeed be valid; but, as he memorably pointed out, "In the long run we are all dead." In the short run, he asserted, interest rates were determined not by the balance between savings and investment at full employment but by "liquidity preference"--the public's desire to hold cash unless offered a sufficient incentive to invest in less safe and convenient assets. Savings and investment were still necessarily equal; but if desired savings at full employment turned out to exceed desired investment, what would fall would be not interest rates but the level of employment and output. In particular, if investment demand should fall for whatever reason--such as, say, a stock-market crash--the result would be an economy-wide slump.
It was a brilliant re-imagining of the way the economy worked, one that received quick acceptance from the brightest young economists of the time. True, some realized very early that Keynes' picture was oversimplified; in particular, that the level of employment and output would normally feed back to interest rates, and that this might make a lot of difference. Still, for a number of years after the publication of The General Theory, many economic theorists were fascinated by the implications of that picture, which seemed to take us into a looking-glass world in which virtue was punished and self-indulgence rewarded.
Consider, for example, the "paradox of thrift." Suppose that for some reason the savings rate--the fraction of income not spent--goes up. According to the early Keynesian models, this will actually lead to a decline in total savings and investment. Why? Because higher desired savings will lead to an economic slump, which will reduce income and also reduce investment demand; since in the end savings and investment are always equal, the total volume of savings must actually fall!
Or consider the "widow's cruse" theory of wages and employment (named after an old folk tale). You might think that raising wages would reduce the demand for labor; but some early Keynesians argued that redistributing income from profits to wages would raise consumption demand, because workers save less than capitalists (actually they don't, but that's another story), and therefore increase output and employment.
Such paradoxes are still fun to contemplate; they still appear in some freshman textbooks. Nonetheless, few economists take them seriously these days. There are a number of reasons, but the most important can be stated in two words: Alan Greenspan.After all, the simple Keynesian story is one in which interest rates are independent of the level of employment and output. But in reality the Federal Reserve Board actively manages interest rates, pushing them down when it thinks employment is too low and raising them when it thinks the economy is overheating. You may quarrel with the Fed chairman's judgment--you may think that he should keep the economy on a looser rein--but you can hardly dispute his power. Indeed, if you want a simple model for predicting the unemployment rate in the United States over the next few years, here it is: It will be what Greenspan wants it to be, plus or minus a random error reflecting the fact that he is not quite God.
MM, seriously, could you add a few general phrases for clarification purposes?
Who are the high priests of the complexities of the 67,500 page income tax code?
Are they revered for understanding what cannot be understood?
Are they sought after for their access to the inner circles of complexity and power?
Do they enjoy a specialized language that only the initiated speak?
Have they become essential to the functioning of government because of their specialized knowledge?
Are they well compensated for their pronouncements, theories and musings?
Are they, by virtue of their knowledge of their own creation, elevated above others?
Will they do or say anything to protect the temple?
So why didn't they index the AMT?
And another thing--
Why does Megan write earlier that the FairTax is regresive (ish) and that in her view the poor should pay a lower percentage of taxes than the rich?
I guess the fact that the FairTax prebate wipes out all federal taxes paid by the poor kinda slipped past her.
Or how about FICA taxes? Does Megan know that low and moderate income Americans pay far more in FICA taxes than income taxes? Maybe she also missed that the FairTax also eliminates FICA taxes.
How about taxation of existing wealth? Will Warren Buffet pay more taxes when he spends more than his secretary under the FairTax? Oops, I guess she missed that one, too.
The national saving rate is at a lower point than in the Great Depression. It's gone negative. Hmmm. I guess it must make more sense to have a tax system that rebates part of the interst payments on debt but taxes the growth of wealth and savings. How very curious.
The income tax system primarily benefits those who work in around the tax writing process. The FairTax may not be the best solution to $365 billion of compliance costs a year and $350 billion that goes uncollected but I sure have not heard Bruce (it just needs a little tweaking) Bartlett, Megan, Rich Lowry or the rest of the income tax crowd, who are howling with indignation that anyone would tamper with their rice bowls, suggest something better.
Could it be that although the current system is universally despised by taxpayers, independent economists and every business leader that the-- what? 50,000-60,000 people making a good living off the tax code just don't care? Nice gig for them but a nightmare, damaging the economy, for the rest of us.
Got something better? Let's see you put it out there. No? We thought not.
I do not believe that you can be a moral and ethical human being and not believe in Alan Greenspan.
Megan Channeling Krugman Channeling Keynes. This is the Escher painting mentality that undermines the intelligent discussions of the day.
The savings rate in our culture is incredibly low Megan, is the cost of a small increase in unemployment rate in the 'short term' (say 5-15 years), worth an offset in increase in savings, investment, and reduce consumerism and materialism in the long run? What about the benefits of a reduce tax bureaucracy?
The fact that the so-called "Fair Tax" tries to make up for its lousiness by having a kickback to all Americans embedded it in does not, in fact, keep it from being a regressive tax. Which it simply does is throw some money at the problem in an attempt to cover up how awful it is.
For a real understanding of the business cycle and how central banks induce it, Ludwig von Mises' book Human Action is a good place to start: http://www.mises.org/Books/HumanActionScholars.pdf
As for the Fair Tax, I much prefer Ron Paul's idea of eliminating the income tax and replacing it with nothing. This could be accomplished by reducing government spending to year 2000 levels.