Republican economics and other fanciful thoughts

Republicans are signaling they could agree to closing tax loopholes. That would raise revenues.

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    In this file photo June 14, 2011, House Majority Leader Eric Cantor (R) of Virginia (right) joins Speaker of the House John Boehner (R) of Ohio in criticizing President Obama on jobs creation, on Capitol Hill in Washington. Mr. Cantor, who has been participating in bipartisan budget talks headed by Vice President Joe Biden, has pulled out citing an impasse over taxes. But the GOP has signaled it would be amenable to close tax loopholes, which would raise government revenues.
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Rep Cantor’s irresponsible canter notwithstanding, it’s worth clarifying a point he and other Republicans have recently raised. They’ve signaled that they could actually live with raising more revenue through closing loopholes associated with tax expenditures, that $1 trillion or so we forego every year by giving tax breaks for things like mortgage interest and ethanol production.

So what’s the big difference between tax expenditures and “raising taxes” such that the former might be OK and the latter is the stuff of hissy fits?

Well, put aside for a second the strategic posturing and political theater and imagine, just for fun, that there’s actually some economics in play here.

Economists generally believe that higher marginal tax rates “distort” economic behavior. They lower after-tax earnings, for example, and thus lower the price of an hour of leisure (non-work) relative to an hour of work, so the thinking is that if you raise taxes, people will work less.

At least that’s what you mostly hear these days. Even in the theory, there’s an offsetting effect: if you lower my after-tax hourly wage, I might just want to work more hours to make up for the loss. But that’s a less convenient argument to the anti-tax crowd so you don’t hear it a lot.

Put aside for another second whether these effects are even real. My read is that the empirical literature doesn’t support either effect from small changes in the code of the type we’re contemplating, like raising the top marginal rate back to where it was in the Clinton years—35% to 39.6%–when working people apparently ignored the memo re “substitution effects” (the labor/leisure trade off noted above) and did all kinds of work.

My only point here is that we can have a budget plan that taps both spending cuts and more revenue without raising tax rates. It would take the closing of some loopholes, not unlike the ethanol one that a bunch of R’s supported the closure of just last week!

To do so would actually be consistent with Republican economics, if there actually were such a thing.

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