Matt Nolan

Points on optimal taxation

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There has been a lot of talk about tax (eg here).

When thinking about tax systems it is useful to run the following train of thought for optimal design:

  1. Start with a target level of government spending.  Goal is to raise this revenue at the lowest cost to society.
  2. First start with taxes which improve the allocation of resources by correcting a market failure (externality taxes).
  3. Then design a nice flat tax (either on all income or consumption) which treats everything equally.
  4. Then shift relative taxes in broad areas based on the long-run elasticity of supply and demand, and constrained by the potential for tax avoidance (Ramsey principle).

Once this initial tax system has been designed, and government spending has been sorted we face a clear “equality-efficiency” trade-off.

In a final step we then adjust the progressivity of the tax system, or the type of government welfare spending, in order to achieve the type of trade-off between these factors that society desires.

Now this doesn’t tell us what the scheme should be, but it allows us to directly look at the trade-offs we are making and make a clear decision.  If the goal is to make fiscal policy that represent the preferences of society at the lowest cost this is the way we need to think about it – instead of saying “more growth”, “more redistribution”, “more tax on land/capital/houses/consumption” etc etc without thinking about it in general terms.

Furthermore, even when we come up with a scheme based on this train of thought we only get told what would be optimal “in the long run”.  The required transition path for the tax system from now until then is still far from clear.

Matt Nolan

What happened to the term monetarism?

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Given the sudden rapid attack on New Zealand monetary policy from various segments I’ve begun to notice a few more things crawling around in political language that confuse me.

For example, the term monetarist.  In a discussion with my sister and on this post from the DimPost the term “monetarist” was used to describe a relatively right wing outlook about political issues and policy in general.  However, this confuses me.  My impression was that monetarists at their most narrow are people that believe money supply growth = inflation completely.  While more generally a monetarist is someone that believes money supply growth is in some way related to higher long run inflation.

In this sense, even some of the most left-wing economists have a touch of monetarist in them.  Monetarism is a set of beliefs about how changes in the money supply influence inflation – not a set of beliefs regarding the appropriateness of “economic freedom” or “government intervention”.

When replying to my sister I said:

Monetarism is simply people saying, if we print a whole bunch of money it will end up increasing prices. Evidence and logic add some credence to this view, and so even very left wing economists are in some sense monetarists.

However, an early monetarist was Friedman. He also wrote heaps on “economic freedom”, which is viewed as quite right wing a lot of the time. As a result, people have said Friedman=monetarist and have associated that word with political views that have nothing to do with it.

I think what they mean is “capitalism based on the idea that individual freedom almost always leads to the best outcomes for society” instead of “capitalism based on monetarist theory” – as the second statement doesn’t actually make any sense to me.

Update:  Paul Walker blogs Milton Friedman’s own views on what monetarism is.

Matt Nolan

More good news for NZ!!

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Guess what.  The EU subsidies on dairy products, introduced at the start of this year, are GONE.

Now US, step up to the plate and dump yours.  Or are we going to move into a situation where the United States is more protectionism than Europe …

Matt Nolan

Questions on NZ stimulus

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Bill English says it is now time for New Zealand to begin pulling back from its stimulus measures.  The RBNZ also says that they won’t lift rates because they expect fiscal stimulus to be withdrawn.

However, I have a question.  Other then the cycle way (which will still be constructed) and permanent tax cuts (which won’t go away) what stimulus did we actually take on?

If this is the only stimulus we did, and we are not withdrawing it, then isn’t the statement that we will withdraw unnecessary stimulus absolutely meaningless.

So, what DISCRETIONARY spending did the government add solely because of the recession?  [automatic stabilisers do not count – as the economic cycle deals with them itself]

Matt Nolan

Falling wage rates: Should we be concerned?

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According to the Employers and Manufacturers Association’s 22% of job types are being done for a lower wage in 2009 then they were in 2008.  Furthermore, according to recent labour market data 1% of actual employees have received a pay cut in the past year.

At first this seems like a bad thing.  Falling wages mean falling labour income.  If other prices are unchanged such movement implies that people will be falling below the poverty line.  Furthermore, it implies greater levels of government spending – as income rebates are negatively related to income.

However, the pain the economy is experiencing is because of the recent recession, and the large shock to activity New Zealand (and the rest of the world) has experienced.  One of the reasons why we often urgently run to government stimulus during a recession is because wages and prices do not adjust to a change in the economic situation.

Specificially, nominal wages are said to be sticky.  If the nominal wage is stuck and we have a recesssion (which reduces the demand for labour) then we end up with a “surplus of labour” – or unemployment.  The less sticky wages are, the less unemployment the economy faces.

As a result, the fact that wage rates have been able to move downwards is a good thing – it suggests that the economy has been able to adjust and keep more people in work (and as a result, keep activity rolling at a higher level) then would have been the case if wage rates hadn’t been adjustable.