Former Treasury Secretary Larry Summers visits FOX Business Network at FOX Studios on January 30, 2015 in New York City.
(Photo by Rob Kim/Getty Images)
Originally posted at Forbes, October 2017.
Former Treasury Secretary Lawrence Summers wrote an op ed for the Washington Post on October 8 calling the Trump Administration’s tax plan “an atrocity.” He also called Kevin Hassett, who is a highly distinguished economist and chair of the President’s Council of Economic Advisers, some combination of “ignorant, disingenuous, dishonest.” Several sentences later, Summers indirectly, but obviously called Hassett “absurd and dishonest.”
On October 22, Summers wrote another article in the Washington Post giving Hassett “failing grades” and accusing Hassett, in his recent address to the Tax Policy Center and Tax Foundation, of impugning the integrity of two top economists, Len Burman and Gene Steuerle, who work at the Tax Policy Center. In his more recent column, Summers dismisses my own co-authored work on the potential impact of the Republican tax plan (discussed in a recent Wall Street Journal op ed with University of Calgary economist, Jack Mintz) on three grounds. Only one of these concerns is valid and even that is of dubious import.
Summers’ language concerning Chairman Hassettt is simply awful. It’s unprofessional, ad hominem and politically charged. He should be ashamed. Kevin Hassett has done very careful and very important work over many years on corporate tax reform and many other key economic issues. I’ve known Kevin most of my professional life — almost as long as I’ve known Larry Summers. Kevin Hassett is brilliant, transparent and entirely honest. Summers has absolutely no grounds, besides politics, for such calumny.
Hassett’s address cited many articles in the literature by equally careful, well respected economists — work that supports his view that reducing marginal effective corporate tax rates will lead to an inflow of foreign capital and raise real wages of U.S. workers. Nowhere in his address does Hassett mention the names “Len Burman” or “Gene Steuerle.” Hassett refers to the The Tax Policy Center’s (TPC) instant analysis of the Unified Framework tax plan (the current Republican tax plan), with no consideration of economic impact effects, as “scientifically indefensible” and “a fiction.” The TPC study indicates it was authored by “staff.” Nowhere do the names Burman or Steuerle appear on the title page or in the analysis. Hence, Summers is connecting two people to Hassett’s address who may have had nothing to do with the study that Hassett, in my view, rightfully criticizes — two people who Hassett never even mentions in his address!
Like Hassett, I consider the TPC’s instant release of a study of the Unified Framework plan, as inappropriate absent any analysis of the plans’ dynamic economic feedback effects. And yes, I would describe this as “scientifically indefensible.” This is not to denigrate the outstanding economists at the TPC, including my old friends, Len and Gene, from whom I’ve learned so much over the years. But if Summers thinks that 37 years of economic research (some his own) on dynamic feedback effects to tax changes can be blithely ignored, he’s dis-serving our profession. And, yes, I understand that the TPC is engaging in dynamic feedback analysis of the new plan. But no one will likely pay any attention to the revised study since the TPC’s instant analysis has already received so much media attention.
My concern about the TPC’s failure to incorporate dynamic feedback in its preliminary analysis is heightened due to new simulations I and my colleagues have run using The Global Gaidar Model (GGM). The GGM is described in this tax reform study, which I co-authored with MIT’s Seth Benzell and The Inter-American Development Bank’s, Guillermo Lagarde. The simulations incorporate estimates of the effective marginal corporate income tax rate (EMTR) under the new Republican tax plan. These estimates were developed by Jack Mintz. Jack has been calculating EMTRs for the U.S. and other countries for over 30 years. His work has been published in leading journals. Unlike virtually all measures of the EMTR being produced in federal agencies and D.C. think tanks, Jack’s EMTR incorporates all taxation of corporations, including at the state and local levels. The GGM, based on Jack’s EMTR estimates, is, I believe, the best available model when it comes to analyzing the dynamic feedback effects of U.S. tax reform, particularly corporate tax reform. The main reason is that the model incorporates all regions of the world. And all regions of the world will be increasing their investment in the U.S. if the reform is implemented.
Summers, in his first op ed, states, “We know enough to say that a tax-reform plan along the lines of the administration’s sketch would not substantially increase economic growth, would blow out the budget deficit and would make the United States an even more unequal place.” Summers is not yet king and should avoid the royal “We.” In fact, Summers, let alone everyone else on the planet, does not know enough about the impact of this tax reform plan.
According to the GGM, the Unified Framework tax reform produces a significant economic response, which would translate into roughly $3,500 in higher wages for the average American household. And it does so with no rise, let alone “blow out” in the budget deficit. As for economic inequality, Summers is correct as I’ll show in a forthcoming column. The Unified Framework does exacerbate inequality, but by less than Summers and the TPC suggest. This said, we do need a 4th bracket, which the Unified Plan envisions, as well as some other tweaks to maintain our current system’s progressivity.
To be clear, the revised Unified Way Republican plan is, according to the GGM, far worse than the Better Way plan, whose reform of business taxation is very close to the Modern Corporate Tax Plan advanced by Alan Auerbach in 2010. The revised Unified Framework plan only includes expensing of equipment. It also maintains deductibility of interest to a degree not yet fully determined. My assumption is that it will retain full deductibility of interest, which will continue to encourage over leveraging among U.S. companies, leading them to operate at far greater risk of bankruptcy. The latest plan also eliminates the Border Adjustment Tax, which is needed to fully eliminate incentives for foreign companies to operate abroad. The plan also appears to be less progressive than the Better Way version because full expensing of all investment represents an implicit tax on existing capital (a large component of wealth) since only new investment (new capital) can be expensed. This lowers the price of existing capital and represents a subtle, but real tax on wealth.
Let me turn to Summers’ very brief analysis of my co-authored simulation studies. Here’s what he says. “It is worth noting that Larry Kotlikoff and Jack Mintz’s response to criticisms of the Trump tax plan suffers from the same deficiencies as Mulligan’s. The authors include no corporate tax detail, no recognition of the impact of the tax proposal on asset prices, and no treatment of the budget consequences of tax cuts.”
The deficiencies in University of Chicago economist, Casey Mulligan’s, analysis to which Summers refers is a failure to consider adjustment costs, which can delay the arrival of capital from abroad and raise the initial market price of existing (already invested) capital. The GGM model does not yet incorporate adjustment costs (They will be added shortly.), but inclusion of such costs will, at most, slow down for a few years the output, capital inflows and wage increase impacts predicted by the GGM model. I base this on prior OLG CGE models with adjustment costs, which I’ve built and simulated with Alan Auerbach.
Summers also states, “Mulligan also fails to recognize that a corporate rate cut benefits capital and hurts labor outside the corporate sector because it draws capital out of the non-corporate sector, raising its marginal productivity and reducing that of labor. It is true that if the corporate sector is small, this effect is small in terms of return, but by assumption it is large in total because it applies to a large quantity of capital and labor.” This point is badly off base. The Unified Framework will provide additional capital for both sectors given that the taxation of pass-through entities is also being reduced.
Summers next assertion is that we “include no corporate tax detail.” Not true. The key corporate details he’s referencing are the global interest rate, which the GGM calculates, the depreciation rate, which the model includes, the effective marginal tax rate, whose pre- and post-reform values are provided by Mintz, and the treatment of old versus new capital, which was important in our modeling of the Better Way plan and is included in that study. It’s not particularly important to the modeling of the Unified Framework plan, but will be included in a revision of the study. Taken as a whole, Summers’ statement that we “include no corporate tax detail” is another falsehood.
Next comes Summers’ statement about the impact on asset prices. This issue is surely overstated if he’s talking about the impact of the treatment of old versus new capital. This is because the Unified Framework should not have much of an impact on their relative valuations. (Again, our next update of the paper will include this issue.) As for adjustment costs, he’s correct that they are not yet in the GGM and they can matter to the distributional effects of the reform. But, in our open economy, such asset price changes won’t matter much, if at all, with regards to the flow, after a few years, of capital to the U.S. or the impact, over time, of the reform on U.S. output and wages.
Finally, Summers says we don’t consider the “budget consequences of tax reform.” That’s completely wrong. Our model keeps debt to GDP constant using personal income and consumption tax-rate increases to achieve that end. The fact that personal tax rates (income and consumption) don’t rise in our debt-to-GDP-constant simulation is testimony to the fact that the Unified Framework is essentially revenue neutral. I.e., it raises essentially the same revenue as it loses. This is not surprising given the large elastic supply of global capital and the inefficiency of the U.S. corporate tax rate, which is marked by a very high marginal, but very low average corporate tax rate.
When my Wall Street Journal op ed with Jack came out, I received emails from TPC and former Obama Administration economists asking for clarifications of details of the GGM. I would have happily responded to emails or a call from Larry. But Larry, because he despises President Trump (for many good reasons), has decided that any analysis that provides support for the tax plan must be a lie perpetrated by liars. That’s not the case. Larry owes Kevin an apology — in print! And he owes it to himself to consider the economics of the proposed tax reform far more closely. The plan is not what he or I or Kevin would prefer. But with some tweaks, it will be much better than the status quo.