1. “I find that almost anything having to do with taxation is better than a sleeping pill”. Krugman (1993)
2. “But let me cut to the chase: the real answer is that we don’t know.” (1994b, p5, his italics)
3. “The key objective of the supply-side tax reduction was to lower marginal rates, that is, the rates that people pay on any additional income they make. That makes economic sense: marginal rather than average rates determine the incentive to work and invest.” (1994b, p155) Comment: I have shown this to be false.
4. “I’m not an expert on taxes.” (Said in a public exchange following his Tinbergen Lecture 1996, to be published by the Dutch “Koninklijke Vereniging voor Staathuishoudkunde” - Royal Dutch Association for Political Economy)
These points are relevant for understanding:
1. See my analysis on taxes.
2. Krugman (1994a) makes a big issue of productivity.
Comment: Quite correct.
Note that I am rather sure about the explanation of and cure for the productivity slowdown, but that my certainty derives from mathematical proof and trained intuition, and not from an econometric model exercise on the (world) economy. My analysis does not invalidate what others have said on the shift to the service economy - and the difficulties of measurement - etcetera, while I also present relatively new insights.
One of the ideas that I would have liked to look into, but have had no time for, is, that the return on consumer investments (like home improvement for the elderly) may be larger than that on financial stock (“savings”), and that this return is not adequately accounted for (also as a tax base).
Another idea, also emphasised by Phelps, is that real rates of interest are high (anyway). A major cause is that Central Banks have to be tough, given the reduced competition on the labour market. Another cause is that government doesn’t dare to raise marginal rates given the current misconception about taxes; so governments borrow (at a higher rate) what actually should have been taxes. Subsequently, investors buy government bonds and grow lazy and spoiled about taking risk (that otherwise would have spurred productivity). [123]
3. Krugman (1994b) p186 onward discusses East Germany and its relation to the downfall of the European Monetary System. The story is familiar: the then-existing policy paradigms of the EMS forcing a recession in Europe when Germany raised its interest rates. Krugman suggests that exchange parities should have been adjusted before the markets forced this. He suggested that preoccupation with fixed rates seduced policy makers to adopt the Maastricht Treaty on the EMU: “(...) by early 1993 political and economic stresses had made the solemnity of Maastricht seem almost comic. If there is a lesson here, it is that serious and dignified men and women in impressive international meetings may have absolutely no idea what they are talking about.” (p192).
Comment:
This is too quick. When Germany decided that wage earnings in the East should be equal to those of the West (to reduce migration), it should also have decided to let wage costs reflect productivity. This is a better approach than parity adjustment; and known at the time, see my work and the Financial Times editorial “Time for Mr Kohl to act”, July 26 1991.
In the same way, EMU can still aspire at monetary stability, and this can be done when countries use their tax structures (thus, structure as opposed to level only) to balance wage costs with productivity. Even though EMU is not a logical beauty, and East Germany still suffers from a wrong policy mix, the gut feeling of EMU - one economy, one means of payment - was admirably correct. This is even clearer given my work on taxes and their influence on wage costs.
Note that many top economists make fun of EMU instead of providing answers of how to deal with the policy challenge. This is not so professional.
One possible answer is the following. With one rate of interest for the EMU territory, and rates of inflation differing by regions (countries), real rates will tend to differ. Some markets will be interested in the real rate instead of the nominal rate. So loans indexed to the local inflation rate might suit many, for example Dutch government and Dutch pension funds, for part of the portfolio.
The following points are only interesting:
1. Krugman makes a point that income developments are fractal. Laywers get much more than cleaners, but top lawyers get much more than average lawyers.
Comment: Ditch ‘fractal’. It still is a lognormal distribution.