Higher Taxes, Lower Unemployment?

I recently received a letter from my congressman, Mr. Jim Sensenbrenner. It was a response to the e-mail I sent him, begging him to cooperate with Our Trophy President and let tax cuts on the wealthiest 2% expire. His reply cited a very interesting paper. He writes:

“The independent firm Ernst & Young has stated that allowing tax rates to expire for the top two income brackets will cost our economy 700,000 jobs.”

He then goes on to argue that closing loopholes is the better approach. But just how is closing loopholes not raising taxes on the rich using a different method? That question has been bugging me all during this past election. But the more pressing point he’d made was in regard to this Ernst & Young study. I was intrigued.

So I downloaded a copy and read it.

It’s not a very comprehensive report. It leaves off the exact formulae used in the calculation. This is perhaps understandable, as they don’t want their proprietary model stolen by competing interests. But even then, it is not very quantitative in any respect. In other words, they just don’t give any solid, damned numbers! Here’s the key paragraph from the actual report:

"This report finds that the increase in the top tax rates would reduce long-run output by 1.3% when the resulting revenue is used to finance additional government spending. Employment is found to fall by 0.5%. In today’s economy, these results would translate into a reduction of gross domestic product (GDP) of $200 billion and employment by 710,000 jobs. Investment and the capital stock (net worth) would fall in the long-run by 2.4% and 1.4%, respectively. Real (non-inflationary) after-tax wages would fall by 1.8%, indicative of the decline in living standards relative to what would have occurred otherwise.”

Sounds dire. But how did they get these numbers? Ernst & Young gives us one, and only one, piece of information. They used the “Ernst & Young General Equilibrium Model of the US Economy.” Just what is that, exactly?

Well, General Equilibrium economic models have been around since the late 70’s. They have been quite cumbersome at times, but advancements in computer technology have made them much easier to use. As such, many Chicago-school and neo-conservative economists love using them, because they think that the fancy mathematical formulae makes them irrefutable.

That having been said, they have a history of failure.

Not only Ernst & Young’s General Equilibrium model, but everybody else’s as well, failed to predict and respond to the housing bubble which led to the crisis in 2008. In fact, part of the very reason that professional economists failed to sound the alarm was because their General Equilibrium models kept indicating that there was no problem! You see, such models have to assume that businesses and consumers will behave perfectly rationally – or else their behavior would be impossible to compute with accurate numbers. Fine in theory, but in practice, people do not behave rationally with money! Hence, General Equilibrium models do not work, and their record proves it.

These General Equilibrium models have such a spotty track record that neo-Keynsian economists find them laughable. I’m forced to agree. When such economic models failed us so spectacularly in 2008, should we really give them any credence in 2012, four years later? Even if they say they’ve worked out all the bugs, would you trust their product?

Let’s face it: General Equilibrium models might work someday. But for now, they are the Yugo of economics, and the Sylvia Browne of economic prediction.

The report repeatedly states that the impact is “long term.” But just what is meant by that? Five years? Ten years? Fifteen? The report fails to say, and that’s so unforgivably sloppy that it should tell any critical reader how jokingly unreliable the conclusion must be.  After all, $710,000 jobs over 20 years is about 2,960 jobs each month. Since job growth has been taking place at an average of 140,000 jobs each month over the last three years, that means that this “dire consequence” would be a mere 137,000 additional jobs each month. Big deal! If the model predicted a loss of 710,000 jobs out of four million potential jobs added, that’s a 3.29 million job gain. It would therefore be irresponsible to report the 710,000 “job loss” number by itself. A slight decrease in future job growth is not a loss! Is that what this report did? Again, they failed to specify. I wonder why that is?

A criticism of this report by the White House and the Huffington Post points out that it assumes that the additional tax revenue would be used for additional spending. Not so, says the Obama administration, because that money instead will be used to pay down the deficit, lower interest rates, and create economic growth over the long run that way. Fine, but conservative economists do not take this gripe seriously, and neither do I. The neocons argue that the additional spending will be there because it all goes into the same federal reserve where there is no specific account labeled “deficit reduction.” I, on the other hand, argue that the additional spending could be on bullet trains, roads and infrastructure, thus providing more than enough jobs to offset the proposed job losses. It’s all a matter of where that money gets spent.  The Post also criticizes those who paid to develop their report, arguing vested interest. This is rightly rejected as an ad hominem argument, but I also add that such an argument is not even necessary.

The Ernst & Young report fails on its own lack of merit.


Eric