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Author: LorenCobb Big gold star, 5000 posts Top Favorite Fools Top Recommended Fools Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 441245  
Subject: Re: Read this Date: 11/3/2012 12:57 PM
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Joel: Read the report (not just the Yahoo summary) and respond to it if you know anything about economics or math - I want to know if it has a strong, moderate or weak factual basis.

Okay, I will try. There appear to be two problems perceived by Republicans:

1. The one-year time lag in the analysis between a change in top marginal tax rate (or in the capital gains rate) and the subsequent change in per capita income is too short. Policy changes like this generally take multiple years to reach their full effect.

2. The analysis failed to take into account the actions of the Federal Reserve to change interest rates.

Before I comment on these specific objections, I want to make some general remarks.

First, the regression method employed is the method recommended by most econometric textbooks and research articles, but it is not (in my opinion) error-free. In my experience, it is always necessary to check the results by simulations which employ the fitted equations. The fact that their coefficients are the best in some statistical sense (e.g. least squared error, or maximum likelihood) does NOT guarantee that the estimated equations will produce realistic results. I have learned never to accept such statistical estimates without thorough checking for plausible consequences -- and there is no sign in this report that such a check was ever made.

Second, I am not sure exactly how each of the variables was measured, and then transformed prior to its use in the regression equation. This too makes a difference. Economists try hard, but they are often are less than fully aware of the effect their transformations have on the analysis.

Third, it appears from the Yahoo news story that the Republicans did not object to the inequality portion of the analysis, i.e. the finding that lowering the top marginal tax rate increases income inequality. I wonder whether this aspect was simply ignored by the reporter -- if I were a wealthy Republican, then I would question *all* parts of the study.

Fourth, the literature on inequality mentions other influences that ought to have been included: age structure, outsourcing of jobs, and immigration come to mind. They should have been included.

Fifth, what ever happened to international statistics? Why not do a cross-national study, thus multiplying the available data by many times?

Now, to the specific objections of Senate Republicans (or, perhaps more accurately, of certain Republican think-tanks).

1. The time lag objection is not serious. If it takes, say, five years for a policy change to have its full effect, then the one-year lag is sufficient to detect a statistically significant rate of change. The important thing here is the rate of change! On the other hand, one could easily change the time lag to five years -- this is not in any way difficult. If only for the sake of convincing Republican doubters, the analysis should be reworked with a longer time lag. Why not?

2. The influence of Fed policy is a more serious objection. Personally, I think they should redo the regression analysis with change in Fed interest rates as an independent variable. I agree that this is an obvious thing that should have been done in the first place. I predict it will not change the conclusions of the study, but it needs to be done in order to make a stronger and more defensible analysis.

Overall, I think it is clear that this study is merely one small step in a long conversation about the effect of tax rates on economic growth and inequality. The key in such conversations is to exhaustively and quantitatively answer each and every objection, no matter how minor. Eventually a consensus will emerge, even in American politics.

The important thing is that the conversation has turned to detailed quantitative analysis, rather than ideological rantings. This is a very positive development.

Loren
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