By: Leandra Lederman
On April 5, Indiana University Maurer School of Law’s Tax Policy Colloquium welcomed Andrew Hayashi from the University of Virginia School of Law. Andrew presented his fascinating new paper, “Countercyclical Tax Bases.” (The paper isn’t publicly available yet, but Andrew offered to share it by email with interested readers.)
The paper argues that the choice of tax base should take into account what tax base is most helpful to the economy in recessions. It points out that recessions are not rare; between 1980 and 2010, there were 5 recessions, covering 16% of that period. The paper does two main things. First, it provides interesting stylized examples showing how, following an economic shock that reduces income or housing value, three types of tax bases (income, sales, and property) each interact with household credit constraints and adjustment costs (committed consumption of housing) to either stabilize or aggravate the negative economic shock. These examples illustrate quantitatively how different tax bases can affect taxpayer behavior in a recession, and thus the local economy.
Second, the paper contains an original empirical study of county tax bases for 2007-2014, to see the effect of tax bases on the recessions of 2001 and the Great Recession of 2008-2009. Andrew combined data from the Government Finance Database, Zillow, the FBI’s Uniform Crime Reports, and the IRS’s Statistics of Income, among other places. Although the results for the two recessions were not identical, Andrew generally found in his OLS regressions that counties that relied more on property taxes had smaller increases in unemployment during the two recessions and may have recovered from the recession more quickly. Sales taxes generally had countercyclical effects, as well, particularly in stabilizing government revenues during the Great Recession. In general, counties that were most reliant on income taxes suffered the most in the two recessions (though the results for income taxes generally were not statistically significant).
Andrew was up-front in the talk that tax might be a second-best tool to manage recessions. It might nonetheless be a very important one. I found the paper very interesting and the empirical study (which Andrew plans to further refine) very informative.
Andrew points out in the set-up to the stylized examples that, following an adverse economic shock, expenditures on more goods that are more heavily taxed (by a consumption tax) decline by less than expenditures on less heavily taxed goods. This reminded me of the Domar-Musgrave idea that, in effect, a tax makes the government into a partner who not only taxes the upside but who also absorbs some of the downside loss. In effect, the government is providing a type of insurance.
The results of Andrew’s analysis suggest that counties that rely more on property taxes, and perhaps sales taxes, do better in recessions than counties that rely on income taxes. Of course, not all taxes of the same type have the same features, but I wondered what the effect would be if counties moved away from income taxes. Would there be negative effects during the 84% of the time the country is not in recession? If income taxes tend to be more progressive, would such a move exacerbate income inequality, for example? The dynamic effects of such changes in tax base are difficult to address but highlight the importance and complexity of the topic the paper is wrestling with.
I highly recommend this paper to anyone interested in fiscal policy. Thank you again to Andrew for sharing his fascinating paper with us, and for a terrific talk!
Maurer’s Tax Policy Colloquium series will continue on January 31, with Prof. Lily Batchelder from NYU Law School presenting “Optimal Tax Theory As a Theory of Distributive Justice.”