Keynes’s General Theory can be generalised even further by the inclusion of endogenous government in the model, and in particular economic policy making itself as that is guided by economic theory. Keynes clearly anticipated this line of thinking, where he wrote: “Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back.” (GT:383) The new point now is that this does not only concern “practical men” but economists themselves too, and the whole institutional framework for economic advice. When economic policy making itself is part of the model, economic stagnation can be explained as stagnation in that realm, and the solution for economic stagnation can be found there too.
OECD nations had full employment in the 1950-1970 period, and Japan and Sweden had it much longer. So it would seem that full employment at least is feasible. However, after the period of full employment, all nations showed the phenomenon of stagflation, which is a worsening trade-off between inflation and unemployment (represented as the shift of the Phillipscurve), frequently associated with stagnating growth. Instead of full employment and a steady growth of welfare, OECD nations suffered a long period of insecurity from 1970-2005.
This volume analyses the different periods and finds the likely cause. The fundamental cause is the common Trias Politica structure of economic decision making that all OECD nations share over time and space. At an operational level, stagflation can be explained by the tax policy that OECD nations have in common as well.
The common tax policy is based upon a particular economic theory that has become the conventional economic view of our time. This conventional theory sees tax as a penalty on work effort and holds that statutory marginal rates have major disincentive effects. Marginal tax rates are a useful penalty on (inflationary) wage claims in wage-bargaining, but the conventional view is that the disincentive effect dominates. Following this theory, policy has been to reduce marginal rates at the cost of lower exemption. Another measure was to switch from the income tax to a Value Added Tax (VAT) that has no exemption at all.
The common tax policy has static and dynamic components. Statically, exemption is low. Dynamically, there is the tendency of reducing exemption even further. The low and ever lower exemption causes rising tax levels and hence either poverty or higher labour costs in the lower wage brackets, causing unemployment, and causing higher taxes to pay for the benefits. What is crucially wrong about current policies is the phenomenon of differential indexation. Exemption is indexed on inflation, while subsistence, by social psychological causes, rises with inflation and real income. This differential indexation causes ever increasing problems with poverty and unemployment.
The OECD countries have been pursueing this policy now for more than three decades, and rather little is being achieved. It is time to seriously wonder whether policy is on the right track. This book shows where the conventional theory goes wrong.
A first feature is the tax void. The tax void is the region of productivity and income between the net minimum wage and the gross minimum wage. The difference between net and gross is normally called a ‘tax wedge’, but this term is inadequate since a wedge is commonly thought to apply at a particular level while the void is a range. The income range between the net and gross minimum wage is a void since there are official tax statutes for that range but no true revenues. People are not allowed to work below the gross minimum and thus cannot pay taxes there (that is, for full timers). Ideally, as in the 1950s, the net minimum should be equal to the gross minimum so that the void is zero, and so that such workers can start earning their own living without paying taxes. Because of the current practices for tax indexation, the tax void has grown over time so that the gross minimum wage has risen much more than the net minimum wage. By result, more and more low wage workers are subject to that excessively high gross minimum and are effectively removed from the labour market. The shift of the Phillipscurve can be explained partly by this growing component of minimum wage unemployment. This analysis also points to a solution. For the tax void, no taxes are collected (on full timers), thus abolishing such void taxes will not cost anything. The argument is not quite that lowering the minimum wage will create new job opportunities, but rather that not raising the gross wage costs so excesssively would not have destroyed the opportunities that already existed. This argument designs an experiment at no cost.
The tax void causes needless unemployment for millions of people all over the world and its plain bureaucratic stupidity is a blow to naive ideas about democracy (that the current democratic structure would be adequate and provide adequate information).
The second feature in the new analysis concerns the dynamic marginal tax rate. Marginal tax rates are important - since economic theory indeed assumes optimising economic agents - but these marginal rates should be properly computed. This analysis not only considers the partial effect, assuming other things constant, but rather considers the total effect that includes all simultaneous changes. A change in a marginal tax rate is usually accompanied by a change in exemption, and both generally happen at the same time, either annually or in computer policy simulations. Private and national income change at the same time too. Individuals are frequently aware that their own fortunes are linked to the fortunes of the national economy and they will be sensitive to their relative position in the distribution of income. Work incentives may be more guided by the average tax rate rather than the statutory marginal tax rate. Hence, ‘incentives’ may not be a convincing argument against higher marginal tax rates, even though policy makers have been advancing that argument forcefully. That, in fact, the converse is true, fits perfectly with the experience of the last decades. The reduction of the statutory marginal rates, as the policy was, appears to have had little incentive effects, since the true incentive effect depends more on the average tax over time, and this average has remained high due to the problems of unemployment, poverty and lower growth.
This book concludes that macro-economic policies in OECD nations have not countered stagflation but have actually increased it. Current policies add to labour costs, reduce incentives, fuel forward shifting of the tax burden, and worsen the trade-off between inflation and unemployment.