Tuesday, July 13, 2010

Time Horizons For The Gazillionth Time

Matt writes:
What I take Mankiw et al to be saying is that taxes are really, really, really bad. And taxes on high-income people are really, really, really, really, really, really, really bad. They think that the electorate is joined by leftwing economists in massively underestimating the scale of the badness. And they look at population aging and growing health care costs and see that it’s likely that taxes will go up in the future. And they think this is an incredibly bad outcome, with massive negative long-term consequences. Consequences that are far more dire than any transient, years-long period of unemployment. Ergo, it’s really important to do the best one can to weather the 111th Congress—the most leftwing congress in decades, and the most leftwing congress we’re likely to see in quite some time—while minimizing increases in the spending level. Really, really, really important.

I can’t prove this is wrong, and Mankiw can’t prove it’s right, but as he notes this—the level of tax-aversion and related disagreements about the key drivers of the political process—is really at the root of the disagreement.

The disagreement on these economic issues really is about the discount rate or time horizons. Mankiw, a conservative, is very concerned about the distortionary effects of future taxation, both on the present through Ricardian effects (which means that people see current government spending and anticipate future taxes), but also the distortion of future taxes themselves on subsequent economic activity. As Matt correctly writes, conservatives see deficit spending and project deficits as future tax increases with "massive negative long-term consequences" as opposed to "transient" unemployment issues.

More progressive voices, Krugman, DeLong, and Yglesias, have a higher discount rate on future economic activity, and by comparison the cost of current unemployment weighs much heavier.

As Matt states:
I can’t prove this is wrong, and Mankiw can’t prove it’s right

Thus, we've arrived at my long-held belief that liberal versus conservative, at least on economic questions, is determined by one's personal discount rate. And since reasonable people can disagree about the appropriate discount rate, then neither side is evil or stupid. Although, it often seems that way to both sides.

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