Always Ask Yourself, Compared to What?

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Responding to my piece about capital gains tax rates this morning, Matt Yglesias makes a couple of useful points. The first is that there’s a big difference between a capital gains tax cut that simply raises the deficit (almost certainly worthless) and a cut that remains deficit neutral because it’s offset with something else (possibly modestly worthwhile). His second point is that even if your capital gains cut is deficit neutral, the offset matters:

The politically and theoretically sound alternative is to offset your cut in taxation of investment income with new taxes on either high-end consumption or environmental degradation or both. It’s striking, however, that the political entrepreneurs promoting low levels of taxation of investment income never propose these options and seem generally unconcerned with the entire question of offsets. It’s enough to make you question their sincerity! A path to an increased national savings rate over the long-term that opens with a gigantic increase in public sector debt doesn’t make any sense, and the fact that this is the strategy they keep promoting is surely on the list of reasons that their claims are so hard to verify in the data.

Without writing a humongous post about this, it’s worth keeping in mind that this is an example of the public policy question you should always ask yourself whenever anything is proposed: compared to what? A capital gains tax cut, like any other policy proposal, doesn’t happen in a vacuum. So even if you’re convinced that it might have a positive effect, that’s not enough. How big an effect? And how does that effect compare to, say, a cut in the payroll tax? Or the personal income tax? Likewise, if you want to be deficit neutral, how does a cap gains cut paired with spending cuts compare to a cap gains cut paired with a carbon tax to make up the revenue?

Hauling out an Economics 101 argument is almost never enough to shed much light on any public policy problem that’s controversial enough to be interesting. Will a tax cut incentivize certain behavior? Sure, probably. But how much? If the effect is small, does it get swamped by other things? And how does it compare to alternate proposals? Unless you can get halfway plausible answers to those things, you’re just being sold snake oil.

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