Among commentators on Korean politics, there is a renowned saying that “the conservatives are ruined by corruption, yet the progressives are ruined by dissolution.” While this usually applies to politics, endless clashes between egos seem to be the fate of every path towards progress; moral judgment of either side has become pointless. As every bird must have two wings to fly, both conservatives and progressives are vital in the improvement of the status quo. Viewing complex issues through both ends of the spectrum might be the easiest way to understand them. The right-wing, central, and left-wing thinkers’ collaboration through heated debates is therefore the manifestation of a viable intellectual community. This is now happening in one of the most challenging yet controversial issues in the modern world: economics.
Gregory Mankiw once noted that the world is only looking at the tennis court of Alan Greenspan to check whether he is wounded during the game. The person who was a rising intellectual in macroeconomics at the time of writing now became a superstar professor at Harvard whom the world is only looking at his personal blog posts. To say the conclusion first, he recently suggested that a worker’s wage will increase by the ratio of 1.5 as a result of the static tax cut to capital gains if the tax rate is one-third. This essentially means that every dollar of capital gains tax cut raises wages by $1.50. Mathematically, this result can be expressed as dw⁄dx= 1⁄((1-t)). In addition, if positive externalities exist to capital accumulation, the tax cut will increase the wage greater than the level this equation predicts. Also, considering the dynamic, not static, revenue loss, the result becomes higher.
A more detailed process of derivation is the following: in an open economy with the production function of y=f(k), wages are determined by the equation w=f(k)-f^’ (k)k in which f^’ (k)k equals the tax base for capital gains. Because cutting the tax rate results in a reduction in the government revenue, the static cost of the tax cut per worker dx will become -f^’ (k)kdt. Keeping in mind that f(k) does not change in the static model, dw is the total differential of the previous equation w=f(k)-f^’ (k)k, which is -f^” (k)kdk. However, current version of dw function is still inconsistent with the dx function as it does not include dt. This can be addressed by substituting dk in the dw function into (f^’ (k))⁄(((1-t) f^” (k) ))dt as dr is zero because of a fixed return to capital. Dividing its result -((kf^’ (k))⁄((1-t) ))dt by the dx function will bring the answer 1⁄((1-t)).
Many other economists including Alan Auerbach, an economics professor at U.C. Berkeley, focused on providing a more intuitive implication of this finding. He added that the result is a combination of “the standard result that in a small open economy, labor bears 100% of a small capital income tax” and “the fact that starting at a positive tax rate, the burden of a tax increase exceeds revenue collection due to the first-order deadweight loss.” If this theoretical point is the case in reality, President Trump’s historic tax cut will be beneficial to the U.S. economy and its workers unlike what most experts suspect. Mankiw also advocated this part of the tax reform in a sense that “lower corporate taxes would attract more investment in the corporate sector, increasing workers’ productivity and thus their wages.” Fallen revenues can be recovered by other methods such as value-added taxes.
However, Paul Krugman, another giant who received a 2008 Nobel Prize in economics, argued Mankiw’s mathematical error on the above analysis when harshly criticizing the behaviours of conservative economists. This is not the end of the story. The title of his blog post shows the bottom line of his opinion ever more conspicuously: La Trahison des Clercs, Economics Edition.
Gregory Mankiw’s response was equally polemical; he suggested that he and many other economists from a variety of political spectrum such as Casey Mulligan from the University of Chicago share the accuracy of the solution and that he never defended the Trump Administration and their policies inconsistently with his own economic beliefs. Specifically, Mankiw shows that he has openly been worried about a new tax bill as it is not revenue-neutral and that, despite all those flaws, he still appreciates some features in the reform. The point here seems to be found in Mankiw’s conclusion: “in the world as I see it, reasonable people can disagree, and progress is best made when people do not question the moral rectitude of others simply because they hold different opinions.” Krugman believed that virtually all aspects of the tax reform are the results of either wrong analyses or corruption, while Mankiw did not share this perspective.
Nevertheless, making a mathematical mistake in deriving the equation is unjustifiable by the difference in political philosophy. As both economists are in a group of people who are least likely to do such thing, it remains unclear who made the error. According to Bradford Delong, an economics professor at U.C. Berkeley who shares Krugman’s perspective, a static revenue loss of the government caused by tax cut consists of two parts: -f^’ (k)kdt+((f^’ (k)t)⁄((1-t) ))kdt.
Choosing whether to add ((f^’ (k)t)⁄((1-t) ))kdt or not comes from the notion of what static means in this model. A decrease in a firm’s pre-tax rate of profit may not be seen as an immediate reaction to tax cut, for it takes some time for the firm to accumulate capital and face a declining marginal product of capital. This is why Mankiw assumed dr, a factor related to corporate income and the marginal product of capital, to be zero. On the other hand, it is also imaginable that more capital by lower tax rate becomes useless in improving productivity. Also, “Mankiw’s math still claims that wages grow by a factor 1/(1-t) bigger than the corporate revenue loss even when the tax cut does not induce any extra investment at all”. What these essentially imply is that no one in the discussion made a mistake and that one’s political stance influences the interpretation of mathematical factors.
Notwithstanding, even the economists who support a low corporate tax rate do not fully advocate President Trump’s tax reform for several reasons. As previously mentioned, Gregory Mankiw himself thinks that a new tax code is problematic in a sense that it is not revenue-neutral, that it taxes on large university endowments, and that there is still a considerable difference between the tax rate for pass-through entities and personal income tax rate for high-income wage earners. Jason Furman, an economic policy professor at Harvard University who contributed heavily to Mankiw’s derivation in case of dynamic revenue loss, also firmly believes that the tax reform will “increase government debt and hurt economic growth.” The Trump Administration and the Republican Party might have initiated a bold way to reform, yet its direction and effectiveness should be reconsidered.
Designing and implementing a better tax system for the United States will benefit both U.S. and the global economy and should therefore be the central task of the White House. Under these circumstances, the role of the intellectuals and their active discussions independent of external pressures becomes more imperative than ever before. Scholars with enough capability and will can illuminate the hidden aspects of convoluted issues and suggest at least a brief guideline to policymakers when they are confused among the possible alternatives. Democratic justice and efficiency are sustained only by smart policies coming from the collective thinking of intelligent citizens.