Mainstream economists believe that if government increases spending and injects new money into the economy, then productive wealth will follow. Austrian economists would like to differ.

Jeff Bezos tweeted:

Yes, the United States has the most progressive tax system in the world. The top 1% pay 40% of taxes, the bottom 50% pay 3% of taxes. We can make it even more progressive by zeroing out taxes on the bottom half. It’s a small amount of the total tax revenue but very meaningful to people in this group.

Strangely, a chorus of liberal economists rushed to attack Bezos. Gabriel Zucman replied:

Contrary to what you claim, working-class people contribute significantly to funding American society today. Payroll taxes and consumption taxes absorb a high fraction of their income.

Justin Wolfers piled on:

If you only count the progressive taxes the U.S. levies, then the U.S. system is quite progressive. But if you also count regressive taxes (payroll taxes, sales taxes, etc), it’s not very progressive.

Bezos called for cutting taxes on the bottom half to make the tax system more progressive and the redistributionists came out swinging–to argue he was wrong about how progressive the current system already is. Own goal. Heretics are worse than unbelievers.

But there’s a second, more interesting thing going on. To make the regressivity case, Zucman and Wolfers have to count payroll payments as taxes. That cuts directly against eighty years of liberal doctrine. Beginning with FDR, the argument on the liberal side has always been that payroll taxes are not taxes but contributions or premiums entitling the payer to benefits as an “earned right.” Here’s FDR to Luther Gulick in 1941:

We put those payroll contributions there so as to give the contributors a legal, moral, and political right to collect their pensions and their unemployment benefits. With those taxes in there, no damn politician can ever scrap my social security program.

That framing isn’t a historical curiosity. It runs straight through liberal social security stalwarts like Arthur Altmeyer, Wilbur Cohen, and Robert Ball, and it’s alive today in Nancy Altman and Eric Kingson’s Social Security Works!, which attacks billionaires and insists Social Security benefits are “earned compensation.” The whole political durability of the program–the third rail–rests on this framing.

So the modern left wants it both ways. When the question is whether to cut Social Security, FICA is a premium and benefits are earned compensation. When the question is whether the tax system is progressive, FICA is suddenly a regressive tax. Pick a lane.

Is there a principled way to resolve this? Yes, and it follows Jim Buchanan (see my earlier post here) and Larry Summers who laid out the economics in his classic paper Some Simple Economics of Mandated Benefits. The principled test is whether a payment reduces labor supply. The wedge between marginal product and the worker’s reservation wage isn’t the statutory rate–it’s the gap between the mandated payment and the worker’s marginal benefit. Sylvain Catherine made exactly this point in reply to Wolfers:

Payroll taxes are not regressive! They are mandatory contributions to a retirement system that offers higher rates of returns at the bottom than at the top.

Consider a forced savings program: everyone must pay 12.4% of income into a 401(k). Is this a tax? For someone who was going to save 15% anyway, not at all. For someone who was going to save 10%, only the extra 2.4% bites. Mandatory does not mean tax. The marginal valuation of the mandated benefit is the key.

Now apply this to the two payroll taxes.

Medicare (HI): Every marginal dollar buys zero marginal benefit. Thus, it’s a tax. Part A eligibility is binary–40 quarters gets you in–and once in, your benefit is whatever Medicare spends on your care. No relationship on the margin. (Moreover, the raw HI schedule is unambiguously progressive: 2.9% flat, rising to 3.8% above $200K/$250K thresholds, plus the NIIT.)

Social Security (OASDI): The 90/32/15 Primary Insurance Amount bend points mean a low earner gets a much better return than a high earner. So the gross statutory rate is flat-then-regressive; but the net rate is progressive. In short, OASDI isn’t a tax for low earners but it is a tax for higher earners, thus the tax is progressive.

So: HI is a progressive tax. OASDI is a contribution at the bottom and a tax at the top. Either way, the Zucman-Wolfers framing—payroll payments as straightforward regressive taxes—is wrong and rhetorically it abandons the framing the left has spent eighty years building to protect these programs.

Personally, I’d prefer a system truer to the old rhetoric–a forced savings program with a closer connection between marginal payments and benefits. But if the left wants to reframe Social Security contributions as taxes, and thus make Social Security all about redistribution to the poor, rather than a wise savings program, roll the dice. Just remember that Altmeyer, Cohen, and Ball spent decades building the “earned right” framing precisely because they understood it was the program’s structural defense against means-testing and privatization. Drop the framing and you drop the defense. I suspect the privatizers at AEI and Cato will happily take that trade but the left may come to regret making it for them.

The post Liberal Economists Score an Own Goal Against Bezos appeared first on Marginal REVOLUTION.

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Here’s a letter to the Wall Street Journal.

Editor:

Greg Ip’s argument that cryptocurrencies, being privately issued, will fail as money relies heavily on his historical claim that privately issued bank notes in the 19^th-century United States failed as money (“Stablecoins Are Private Money. That’s Why They’re a Risk to the Economy.” May 25). Mr. Ip’s history is incomplete.

It’s true that problems plagued privately issued bank notes in 19^th-century America. But research by Hugh Rockoff, George Selgin, Lawrence H. White and others reveals that these troubles were caused not by the bank-notes’ privateness but, instead, by government restrictions. Most notably, but not only, legislation restricted branch banking and required privately issued bank notes to be collateralized by state-government and railroad securities that sometimes proved to be junk.*

In contrast, where banking was less encumbered by government restrictions – places such as Scotland in the 18^th and 19^th centuries, and Canada in the 19^th century – privately issued bank notes served very well as money.

Nor is history kind to Mr. Ip’s suggestion that government money serves well as a store of value. In the 124 years from 1790 through 1913 (the year the Federal Reserve was created), the dollar lost approximately eight percent of its value, yet in the 114 years since the Fed’s creation (1913-2026), the dollar lost a whopping 97 percent of its value.**

If cryptocurrencies fail to serve as good money, the reason won’t be that private issuers of money are destined to perform more poorly than government issuers.

Sincerely,
Donald J. Boudreaux
Professor of Economics
and
Martha and Nelson Getchell Chair for the Study of Free Market Capitalism at the Mercatus Center
George Mason University
Fairfax, VA 22030

* George A. Selgin and Lawrence H. White, “How Would the Invisible Hand Handle Money?” Journal of Economic Literature, December 1994, Vol. 32, pages 1718-1749.

** George Selgin, William D. Lastrapes, and Lawrence H. White, “Has the Fed Been a Failure?” Cato Policy Report, November/December 2012, and “Consumer Price Index, 1800- ” Federal Reserve Bank of Minneapolis.

The post On Private Money appeared first on Cafe Hayek.

The first Star Wars feature film in seven years should have been a grand event. But from the moment the opening text rolled, it was clear something was amiss. Yes, the story is classic pulp adventure, in the beloved style of Star Wars and Indiana Jones, but it was glaringly obvious that something was missing right away: not a single mention of the genocide in Palestine.

The United States, like most other countries, use a method of double-entry accounting to track certain aggregate statistics known as National Income Accounting. One of the statistics tracked is the balance of trade. The balance of trade reports the difference between imports and exports. When imports exceed exports, we are said to have a trade deficit. When exports exceed imports, we are said to have a trade surplus. When the two equal, trade is said to balance. Technically, the balance of trade refers to imports and exports of both goods and services, but so much attention tends to fall just on the trade of goods, or what is called the “Merchandise Balance of Trade.”

Confusion abounds over what the balance of trade is. Even David Hume and Adam Smith note that the concept does far more harm than good. Hume discusses how those “ignorant of the nature of commerce” misinterpret the balance of trade (see his essay “On the Balance of Trade”). In the Wealth of Nations, Smith goes even farther, calling the whole concept “absurd” multiple times (see pages 377 and 488 in the Liberty Fund edition). Much of his case against protectionism and mercantilism in Book IV is aimed against the balance of trade as a whole.

With the inclusion of the balance of trade into National Income Accounting, the confusion has persisted. The connotations of the words “surplus” and “deficit” (coupled with the accounting conventions of pluses and minus) give the impression to those who do not understand the balance of trade that deficits are bad while surpluses are good. But, digging a little into the accounting shows that 1) “deficits” and “surpluses” are value-free and 2) referring to these as “trade deficits/surpluses” is something of a misnomer.

What is important to note here is that the balance of trade has surprisingly little to do with merchandise trade at all. It is actually the result of the relationship between national Savings and national Investment. Given the accounting identity

GDP = Consumption + Investment + Government Spending + Net Exports,

we can do a little algebra and show that

Net Exports = Savings – Investment

In other words, if the quantity demanded of Investment funds exceeds the quantity supplied of saved funds (Savings), the nation must import savings from abroad. That, in turn leads to foreigners buying fewer material exports, preferring to buy assets.

Both Saving and Investment are determined by factors far divorced from how many goods cross borders. Things like real interest rates, growth expectations, confidence, institutions, and other macroeconomic factors matter much more. Indeed, as noted in his textbook International Economics, Robert Carbaugh shows us that some 98% of transactions in the foreign exchange markets deal with people swapping currencies for investment purchases, not goods/services purchases. Given that the foreign exchange market handles some $6 trillion in trades every day, that’s a lot of dollars (and pounds, yen, francs, euros, etc) being swapped to align savers and investment opportunities.

Consequently, the balance of trade is a result of macroeconomic factors. Which means that, at best, the balance of trade is a symptom, not a cause, of macroeconomic phenomena. Furthermore, since nations do not trade, but rather individuals do, to properly understand any trade deficit, we must understand why there is a difference between Savings and Investment. Investment will come from firms (note: it can be financed by borrowing, but doesn’t have to be) and individuals making large capital purchases, like a house. If these individuals are using Investment to create long term productivity enhancements, then a trade deficit is a signal of good things. But, if borrowing is going on where there are no such productivity advancements, then the trade deficit can be a signal of bad things. Regardless, and this is the big takeaway here, the balance of trade has little to do with trade at all. It is determined by much larger macroeconomic factors.

Thus why I titled this post as I did. It probably would have been better to call the balance of trade the “balance of savings” or something like that—although there still would have been much confusion. No nation, government, or entity is legally responsible for the balance of trade. A trade surplus does not indicate profit, nor a deficit indicate loss. A trade balance doesn’t need to be “financed” in the colloquial sense, nor does the deficit imply increased indebtedness. These terms are used for no other reason than accounting convention. They’re a historical accident of including trade in a system of accounting, nothing more.

The post The “Trade Deficit” is a Misnomer appeared first on Econlib.