Reply to Mike Sax's Question "But What About the Demand Side, as a Source of Revenue and of Jobs?"

Mike Sax writes about my exchange with Karl Smith, starting with my post “Why Taxes are Bad,” Karl Smith’s reply “Miles Kimball on Taxing the Rich” and finally my post “Rich, Poor and Middle-Class.” He has at least three different lines of questions. In this post I want to answer two that might be summarized as “But what about the demand side, as a source of revenue and a source of jobs?” Here is what Mike says:

One more point: Implicit is the idea that rich are the "job creators.“ It’s not wholly true that the Occupy Wall Street presumed that most wealthy people are rich through personal chicanery. Much of their indignation is directed to what they see as systemic injustice-I for one do believe that capitalism is the most efficient and potentially most just allocator of resources, though I’m skeptical of too much laissez-faire.  What I see in Supply Side analysis is no recognition that 70% of GDP is consumer demand. So who is exactly the job creators?


If there’s no money in people’s pockets there’s no demand and no job creation. Again, my position is a "Demand Sider” I’d like to find ways to reduce the demand side taxes-the taxes that the poor and middle income have to pay, from high payroll taxes, to the litany of state sales taxes, and fees-traffic fees, meters, indeed, insurance. As I suggested in my first reply to Miles nothing gets my goat more than this Cato canard that’s repeated ad nauseum that “45% of Americans pay no tax.”

Even the wino on a park bench pays tax every time he gets his hands on demon rum.


Does Miles recognize the distortions that come from the demand side of income-the taxes that the nonrich pay? Again, I poise these questions to Miles as I appreciate his contributions to the debate. Hopefully he understands the spirit that I poise these questions. I’ve certainly changed my opinion some on the “progressive consumption tax”-not enough to take the scare quotes away yet, of course!-and am willing to be persuaded on supply side issues.

Mike is absolutely right that the poor and middle class pay substantial amounts of sales taxes and taxes on earnings such as Social Security taxes. When people want to argue that the tax system is unfair to the rich, they often skew things by only talking about the income tax. But a key point to make here is that almost all countries that devote a higher fraction of GDP to government spending than the U.S. tax the middle-class a lot through a national sales tax or a value added tax (VAT) which is a lot like a sales tax except that it is harder to evade because much of the tax is collected from companies long before the good gets to the final consumer. The European model, in particular, is to tax the middle-class heavily in order to give benefits to the middle class. I believe that the resultant tax distortions are why so many Europeans work many fewer hours per year than Americans. They used to work roughly the same amount as Americans when they had lower tax rates. (These are facts that Ed Prescott has made much of.)   

Why not just tax the rich to pay for benefits for the middle class? The basic problem is that there aren’t enough rich people. I found this video by Tyler Durden etertaining and revealing on this topic. I can’t verify what he says exactly, though I think the basic point is right. You have to include at least the upper middle class in your tax in a big way, or you can’t get enough extra revenue to do a big expansion of social programs. 

So the “demand side” is a big source of potential revenue, if by that you mean some kind of sales tax of VAT tax. But to get a lot of revenue, you have to include people who don’t think of themselves as rich, and whose acquaintances might not even think of them as rich. Maybe we should do it anyway, but it won’t feel like what people imagine a tax on the rich would feel.  Here I remember Senator Russell B. Long’s parody:

“Don’t tax you, don’t tax me, tax that man behind the tree.”

There just aren’t enough “men behind the tree” who don’t seem like you or me.

What about the demand side as a source of jobs?  (This is a more typical meaning of “demand-side.”) Here, my answer is that, despite the floundering of policy makers lately, it is fundamentally easy to get enough aggregate demand. On this, just click the sidebar link on the June+ 2012 table of contents and look at all the posts on monetary policy and short-run fiscal policy, together with the recent post on evidence that Federal Lines of Credit should work: “Brad DeLong and Joshua Hausman on Federal Lines of Credit.” (My post “Dissertation Topic 1: Federal Lines of Credit (FLOC’s)” is also useful, but is pretty heavy.)  The bottom line is that monetary policy can provide plenty of aggregate demand, and if the Fed won’t do what it takes, we can use Federal Lines of Credit and the change in the timing of Federal payments to the states for Medicare that I talk about in “Leading States in the Fiscal Two-Step” to get enough aggregate demand without adding too much to the national debt. So, you wouldn’t know it from the news or from big chunks of discussion in the blogosphere, but getting enough aggregate demand is the easy problem. Raising aggregate supply while getting the revenue we need is the hard problem.