Policy Implications of the Jim/Stephen Debate

In terms of pure economics, Jim’s most interesting comparison may have been of investment to GDP, which has sparked a discussion about how to properly measure investment.

For public policy, I think that Jim’s most interesting comparison was of investment to business finance/profits.

If one accepts Stephen’s interpretation, then falling capital prices have allowed firms to make adequate or appropriate additions to the capital stock without greatly increasing nominal investment spending. In that case, the huge increase in profits is an unneeded windfall that should be taxed away and used for public purposes, as Andrew suggests.

If one accepts Jim’s interpretation, then capital prices have not fallen in any meaningful sense and business investment has been sluggish. In that case, governments should seek to ensure that the huge increase in profits is reinvested.

Either way, it seems that an appropriate policy would be to raise corporate tax rates (say, up to American levels) and provide a corporate tax credit for new investment. To the extent that firms do not invest more, they would pay more tax. The tax credit would be justified if one believes that investment has social benefits above and beyond its private benefit to the firm.

3 comments

  • If one accepts Stephen’s interpretation, then falling capital prices have allowed firms to make adequate or appropriate additions to the capital stock without greatly increasing nominal investment spending. In that case, the huge increase in profits is an unneeded windfall that should be taxed away and used for public purposes, as Andrew suggests.

    That’s not exactly how I’d put it. If investment demand is inelastic, then you could use taxes to increase its price with a relatively small effect. (What we’re seeing is the reverse scenario: a price decrease accompanied by an increase in investment that some might view as too small).

    But another thing to remember here is the important difference between the short and long run in investment. Adjustment costs are an important factor at work here*, so the long-run elasticity is generally much larger than it is in the short run.

    *This was actually my thesis topic. Now the nightmares are going to come back, curse you! 😉

  • I like the idea of raising corporate taxes and then stimulating invetment spending with an ITC. But good luck to anyone who wants to have an intelligent discussion of this in broader progressive circles. I have proposed approaches like this at various tables (including past incarnations of the AFB), and was always beaten back by the notion that providing an investment tax credit was somehow pro-business (even when accompanied by an increase in the base rates). This is not to say that the idea shouldn’t be pursued — only that we’ll have a formidable task of education ahead of us before we can get our own troops on side.

  • The irony is that if you suggested that the tax revenue go to direct government investment (ie some form of public ownership) you would be labelled as hopelessly idealistic. Between what is too pro business and what is too utopic the debate is very narrow indeed.

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