Note on the tax discourse

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By FERNANDO NOGUEIRA DA COSTA*

Those fearful of progressive tax burdens revert to the confidence fairytale narrative designed to thwart any further fiscal stimulus.

The fiscalist-conservative discourse on the budget deficit is always delivered by “bond watchers”, believers in the “fairy of confidence”. If the government does not cut its spending, to avoid the deficit, the watchdogs of public debt threaten to flee to the dollar, forcing the rise of interest rates. But if you cut all spending (except the finance burden), the “confidence fairy” will reward you by spurring private spending to fill the public spending vacuum.

The classic Sleeping Beauty fairy tale is full of meaning. The figure of the father, for example, is linked to the image of the daughter's protector from all evil, even if this task turns out to be impossible. They are the “title watchers” protecting the Nation…

The sorceress, on the other hand, personifies revenge and the desire to return the harm done to her. It represents speculators fleeing to the dollar, even though this exchange rate risk is much higher than the sovereign risk of public debt securities – and paying less.

The princess, that is, the nation, is the greatest victim of the spell, it is only saved thanks to a brave prince, naturally, the market. This omnipresent, omniscient and omnipotent being warns us: we must be resilient and seek everything desired, individually, despite the fact that many others have tried and failed in this greedy ambition.

The protagonist – public debt – bears the characteristics of a passive woman, always waiting to be freed by a male figure: the market. This cliché is repeated in the various versions of the fairy tale, generating some criticism from supporters of the contemporary identity agenda.

However, critical observers say: cutting a public deficit, in a recessive crisis, can never bring about a recovery. Conservative-fiscalist rhetoric can prevent a good developmentalist policy from being adopted, but cannot prevent it from succeeding if its preaching is contradicted. Above all, neoliberals cannot make bad politics work, as demonstrated from 2019 to 2022.

An old argument, recurrently used by vigilant bond watchdogs, is: adverse expectations would affect the outcomes of a policy, not just the chances of its adoption. If people think of government debt as simply tax-deferred, they would save more to pay expected future taxes.

This neoclassical reinterpretation with rational expectation is known as “Ricardian equivalence”: if the government raises taxes, taxpayers pay them immediately; if the government issues government bonds, taxpayers anticipate having to pay more taxes in the future to redeem that debt. Soon, there will be an immediate drop in disposable income, as there will be a cut in private spending to increase savings and be able to pay taxes later. Can you believe it...

The mistake of this line of thought is to project all economic agents to reason, mistakenly, like the neoclassical economists… Confidence in the balance of public finances would guide all economic-financial decisions!

Does the trust factor affect all decision-making? Then, does it affect the outcome of decisions? Rationally, confidence cannot make a bad economic policy have good results, and the lack of it cannot make a good policy have bad results…

The economy of trust is not an economic theory, but rather an assumed process of social bonding. This notion of Economics is a kind of compulsory communication, collectively imposing certain ways of producing and consuming goods and services through the sharing of uniform expectations. It presupposes (without proof) this change in the regulation of social ties in the current way of life.

Turns economics into collective psychology. A good state of confidence does not encourage economic agents to be on guard against the unforeseen. When a period of distrust ensues, investors become insecure and skittish, accentuating early buying and selling. They would uniformly act in herd behavior.

The “state of confidence in the independence of the Central Bank” refers to its ability to provoke a brutal punitive recession to those who doubt its credibility in delivering the inflation target. If the Central Bank withdraws lender support as a last resort, then it generates a breakdown in confidence in banks – and bank runs.

Confidence in asset prices requires the absence of volatility in interest rates and general credit conditions. After all, credit is the confidence to get back borrowed money. This magic word qualifies the confidence fairy!

Novoclassical theoretical literature sums it all up in credibility. It would be the degree of public confidence that a given change in policy has taken place when, in fact, such a change has actually taken place. 'did you? Idealism would reign against materialism!

In great depression, government, your kingdom come! On monetary easing, government, for confidence in its reputation, embrace austerity: accelerated liquidation of budget deficits by cuts in social – not financial – spending.

Those fearful of increasing the progressive tax burden revert to the fairytale narrative of confidence, designed to prevent any further fiscal stimulus. The crisis was created by fiscal extravagance, market-god-fearers insist, and therefore could only be cured by fiscal austerity.

It's not about any austerity, it's about spending on the poor, not interest on the rich. Those must be cut, because they are the real cause of the problem.

The Keynesian beabá prays: cutting the public deficit in a crisis is bad policy. Increased tax collection with resumption of income growth is better.

But bond watchdogs maintain their preaching of healing on the basis of fiscal austerity. Just the belief that the confidence fairy with her magic wand is able to work magic will guarantee your success!

The confidence fairy promises to reward fiscal frugality by making the economy more productive. When this cure fails to produce a recovery, there is a pervasive excuse: it has not been applied with enough conviction to be "credible."

The moral of the fairy tale is: if austerity in a crisis doesn't work, then bloodletting-based healing never worked. It weakens the patient instead of strengthening.

There is a distinction between policies. A time-inconsistent policy may make the public confident in the short term, but will ultimately fail to produce the long-term policy objective. A time-consistent policy, in contrast, achieves the policy objective in the long run but does not make people confident in the short run.

Hence the market-god fearers preach: rules produce consistent results over time because they make the pronouncements of policymakers credible. With rules, policy responses must follow a pre-specified blueprint.

The rule can force policy makers to follow the same course of action in any circumstances of the economic cycle phases. Rather, the plan may be activist in nature with the rule directing policymakers to respond to different circumstances in different predetermined ways.

The common denominator is that the rules must constrain the actions of economic policymakers, in a democratically elected government, in advance. In discretionary decisions, policymakers have ample freedom to design the best policy response for each circumstance that arises in the future.

This discretionary policy flexibility allows policymakers to respond to unforeseen scenarios. Rules are valuable, according to market god-fearers, because the public watches policymakers and forms expectations about their likely actions. Policymakers with discretion may renege on today's pronouncements tomorrow; thus, the public may dismiss such pronouncements as idle talk. The confidence fairy fades away...

Only a mandatory rule, capable of preventing policymakers from reneging on what was previously announced, will convince the suspicious public. Such a rule could be made mandatory – and therefore credible – by passing a constitutional amendment! Only…

The suspicious argue: policy makers have asymmetric information and use tools with lagged implementation. Thus, even the most well-intentioned attempts to combat cyclical fluctuations can end up destabilizing the economy.

However, discretion allows policymakers to respond innovatively to unforeseen problems. Who do you trust: human intelligence adequate to the circumstances or the fairy of trust with a rule?

*Fernando Nogueira da Costa He is a full professor at the Institute of Economics at Unicamp. Author, among other books, of Support and enrichment network. Available in https://fernandonogueiracosta.wordpress.com/2022/09/20/rede-de-apoio-e-enriquecimento-baixe-o-livro/

 

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