Supply side economics and tax policy

[Qfwfq]

I can't say much about why the media should or shouldn't be of this opinion, but certainly tax needn't be the only way for a country to raise public money and income tax isn't the only form of taxation. I don't know the details but reducing one tax might end up bringing more money in some other way. Or, maybe, Bush reduced those taxes but he also sold lots of cherries by the roadside and made lots of dough that way.

 

Exactly how did the federal revenue increase?

 

I am not sure what you meant when you said "they" held the US currency low.

I'm not concerned with the details of how "they" caused devaluation but I'm damn sure it was "they" that caused it. Thatcher was also fond of this type of thing. Many other countries have done it too. In this case there was the need to reduce the foreign debt. Being denominated in US$, as you also said, the lower dollar also made the debt lower. If, for instance, you export at prices not denominated in US$ but instead get more dollars because the dollar is lower, you're paying the debt easier. It's obvious that there are pros and cons, they wouldn't want to put the dollar arbitrarily low and keep it there, but they do decide when it's an advantage to devalue to a certain measure and for how long. I was talking about foreign debt, not foreign reserves, nor about inflation so much.

 

The exchange rate of the US dollar is established in the foreign exchange markets.

Does that mean they have no influence on it? You must be joking!

[Biochemist]

Exactly how did the federal revenue increase?

Decreasing top income tax rates increases income tax revenue. This phenomenon is often referred to as the "Laffer Curve", named after the economist Art Laffer. There is a tax rate where governmental income is maximized. At rates above or below that, it decreases. The optimal rate is thougt to be somewhere in the mid 30% range in the US. Raising rates above that decreases revenue from the higher brackets. If we decrease rates on the higher brackets, revenue goes up from the higher brackets.

I'm not concerned with the details of how "they" caused devaluation but I'm damn sure it was "they" that caused it.

I still have no idea who you are talking about. What"'they"?

...Being denominated in US$, as you also said, the lower dollar also made the debt lower.

Not for the US. It would make it lower for foreign bondholders

If, for instance, you export at prices not denominated in US$ but instead get more dollars because the dollar is lower, you're paying the debt easier.

Sorry, Q. I am confued. I don't understand your connection between foreign exchange pricing and US debt.

Does that mean they have no influence on it? You must be joking!

Not much. Broad policiy issues (like money supply and interest rate decisions made by the US Federal Reserve) probably are 95% of the influence. But those decision are primarily focused on controlling dollar inflation. Typically, when the US economy slows, the feds drop rates to encourage investment and revitalize the economy. When rates drop, the dollar is less attractive for foreign investgors, and the foreign exchange rate falls. It pops back up when the fed raises rates again in a stronger economy. I am not sure what point you were making.

 

The Fed does occasionally directly intervene in foreign exchange markets (buying or selling dollars) but the effect seldom last for more than a day or two. This is mostly for looks, not for any real policy or economic gain.

[Qfwfq]

When rates drop, the dollar is less attractive for foreign investgors, and the foreign exchange rate falls.

Isn't this what Greenspan did? I did not mean direct intervention.

[Biochemist]

Isn't this what Greenspan did? I did not mean direct intervention.

Sure. But the reason for interest rate management is not related to the foreign exhange rate. You can even read the Fed board minutes after they are released to see it. The Fed sets monetary policy (i.e., rate targets and money supply decisions) based on dollar inflation. Their objective is dollar price stability. They expect other countries to manage their own currencies. If rates are high in Europe (because of European central bank action) and low in the US, the dollar falls. But the Federal Reserve manages dollar inflation, not the exchange rate.

[Qfwfq]

I'm not here to argue about it Bio, but I've often heard about many a US gov't using devaluation. Slightly more than a year ago a young Californian snot-nosed brat even treated me as if I were an idiot that doesn't know these things, when saying that the dollar is low because that's the way they like it.

 

I had also, much previously, had a few talks with a gal that was a great fan of Reagan and Thatcher, she had written her grad thesis in economics on Reaganomics. She sure didn't place money supply issues as being unrelated to currency exchange rate. I'm surprised at some of the things you say. ;) ;)

[lindagarrette]

Decreasing top income tax rates increases income tax revenue. This phenomenon is often referred to as the "Laffer Curve", named after the economist Art Laffer.

The Laffer Curve is an obsolete notion concocted over lunch one day in the early 70s by Laffer and Don Rumsfeld when economic incentives for the rich would supposedly result in the "trickel down" effect. In a global economy it is not even a valid theory.

[lindagarrette]

Sure. But the reason for interest rate management is not related to the foreign exhange rate. You can even read the Fed board minutes after they are released to see it. The Fed sets monetary policy (i.e., rate targets and money supply decisions) based on dollar inflation. Their objective is dollar price stability. They expect other countries to manage their own currencies. If rates are high in Europe (because of European central bank action) and low in the US, the dollar falls. But the Federal Reserve manages dollar inflation, not the exchange rate.

There are no simple solutions to the current economic downturn for the US. Although the interest rate is not directly related to the exchange rate, they affect each other. That's primarily because of the way exchange rates are handled by various governments. Some peg their currency to the dollar, some recognize that the dollar is shrinking quickly relative to the real value of other currencies. Interest rates don't have much to do with willingness of foreign investors to fund our debt. If the Chinese decided to float the yuan, they could dump their vast amount of dollars on the market and create a massive inflation.

[Qfwfq]

VERRRRRRRRRy interesting, Linda!!!!

 

;)

 

BTW, is... is it... is that the very same Don Rumsfeld?

[Biochemist]

I'm not here to argue about it Bio, but I've often heard about many a US gov't using devaluation.

I was not aware that we were arguing. I was asking you what you thought the US government does to affect current exchange rates, other than the actions of the Fed. The Fed's actions certainly affect exchange reates, but the intent of the Fed is to manage inflation, not exchange rates.

 

I do not know what you are suggesting yet. Are you suggesting something that is different that me? If so, what is it?

...She sure didn't place money supply issues as being unrelated to currency exchange rate. I'm surprised at some of the things you say.

Huh? I described above exactly how I think they are related. My point was not that they are not related, but that the intent of the Fed is to manage dollar inflation, not exchange rates. The market value of the dollar against other currencies is a by product of the relative policies of the various central banks.

 

I dont' think we can be arguing if I don't know what your position is.

[Biochemist]

The Laffer Curve is an obsolete notion concocted over lunch one day in the early 70s by Laffer and Don Rumsfeld when economic incentives for the rich would supposedly result in the "trickel down" effect. In a global economy it is not even a valid theory.

What? I was talking about the empirical experience in the US since 1960. Every time we have reduced the maximum tax rate brackets, the revenue from those income brackets has increased. It happenned under Kennedy, Reagan and Bush II. Tell me exactly how this is obsolete???

[Biochemist]

... Interest rates don't have much to do with willingness of foreign investors to fund our debt.

You are correct that the relationship is complicated, but the impact of interest rates on US bonds is probably a primary driver. At a slightly more granular level, if the real interest rate return (that is, nominal rates net of domestic inflation) on dollars is higher than the real interest rate of return of other currencies, foreign investment in US bonds rises.

...If the Chinese decided to float the yuan, they could dump their vast amount of dollars on the market and create a massive inflation.

Maybe. But I suspect the Fed would buy back most of the extra cash (by selling bonds at the open market desk) and neutralize most of the monetary expansion. The resultant exchange rate (presumably a higher yuan) would probably cause US trade with China to plummet. That is why I expect they will not do it.

[Biochemist]

... is that the very same Don Rumsfeld?

It is the same Rumsfeld. Reportedly, Cheney was at that lunch as well. But I am not exactly clear why anyone would bring up this association, other than to bring out boogie men. The topic is tax policy and federal revenue.

[Qfwfq]

I was not aware that we were arguing.

And I don't think we should. I think we have kept misunderstanding each other.

 

Huh? I described above exactly how I think they are related. My point was not that they are not related, but that the intent of the Fed is to manage dollar inflation, not exchange rates.

I can't remember you saying they are related and you don't prove the devaluation wasn't deliberate, but I won't go looking upstream. One thing I do remember is saying that the lower dollar makes the debt lower and you replying "No, it makes it lower." but I think we should just call it off.

 

Surely you're not afraid of the boogie man?

[lindagarrette]

What? I was talking about the empirical experience in the US since 1960. Every time we have reduced the maximum tax rate brackets, the revenue from those income brackets has increased. It happenned under Kennedy, Reagan and Bush II. Tell me exactly how this is obsolete???

The revenue from some of the upper brackets may have increased in the 50s and 60s when tax rates were readjusted, but the total tax revenue has always dropped significantly when rates are reduced. The Laffer curve describes a theoretical situation based on carefully selected data. Reagan's voodoo economics was so misguided, there is no telling what the real causes and effects of verious pressures were. You surely can't claim that Dubya's fiscal policies make any sense whatsoever, can you?

 

In a global economy, the tax benefits to the rich go overseas.

[lindagarrette]

You are correct that the relationship is complicated, but the impact of interest rates on US bonds is probably a primary driver. At a slightly more granular level, if the real interest rate return (that is, nominal rates net of domestic inflation) on dollars is higher than the real interest rate of return of other currencies, foreign investment in US bonds rises.Maybe. But I suspect the Fed would buy back most of the extra cash (by selling bonds at the open market desk) and neutralize most of the monetary expansion. The resultant exchange rate (presumably a higher yuan) would probably cause US trade with China to plummet. That is why I expect they will not do it.

I don't think revaluing the yuan is imminent but it would hurt us more than it would them. China has a booming trade with plenty of other nations. For the fed to buy back debt, it would have to run a surplus budget. Now, how is that going to happen, with such a huge military and low tax revenue? Or maybe it could reduce the value of bonds to near zero to attract buyers which would only make it more attractive for the foreign investors. Buy Euros.

[Biochemist]

The revenue from some of the upper brackets may have increased in the 50s and 60s when tax rates were readjusted, but the total tax revenue has always dropped significantly when rates are reduced. ...

LindaG, this is absolutely untrue. I have no idea where you got this.

 

Natiional income statistics cleary show that revenue increased every time the higher marginal rates are reduced. It often takes more than 18 months for effect to mature, but in both the Kennedy and Reagan tax cuts, not only di revenue go up, but the fraction of revenue from the folks in the highest brackets rose as well. If you decrease the rates in the lower tax brackets, revenue goes down fomr those taxpayers.

 

This data pretty much supports the Laffer curve (that you called obsloete).

[Qfwfq]

Anyone for ping-pong? ;)