Betting the Farm on Bad Economic Theory

Posted: September 25, 2010 in Politics
Tags: , , , , ,

This quote is from a 9/25/10 AP story on the GOP “Pledge to America”, PBO’s predictable response and the philosophical differences between the Dems and the Repubs:

“Perhaps the biggest difference was on taxes, where Republicans want to extend all of George W. Bush’s income tax cuts permanently — at a cost of some $4 trillion over 10 years.”

“Cost.” Says who? Keeping taxes where they are will cost $4 trillion? Partisan bull.

There is an element of our population that does not understand the simple economics of this discussion, but I hope most Americans get it. The left does – at least those who don’t have their heads so far up their ideology that they can’t hear the howls of outrage of the electorate. The rest of them will stick their fingers in their ears and remain willfully ignorant when this is explained because they know it undoes their agenda.

Imagine a produce stand. It makes enough in sales that Farmer Brown can support his family. His wife gets the idea that she’d like to add a swimming pool to the old homestead, so she convinces him to raise his prices – tomatoes, for example, are now $15 each. He is surprised to find that his sales have dropped off to nearly nothing, even though he’s the only produce stand for miles around. In one week, he sold only 2 tomatoes, so he’s made $30 on his tomato sales. He’s experiencing a seriously sluggish micro-economy, and now he can barely afford to keep the lights on at the farm.

He wants to lower the price of his tomatoes from $15 each to $1 each. Still outrageous, but not as hopelessly overpriced. Based on last week’s sales figures, his wife calculates that when they sell the 2 tomatoes this week that his low price plan will “cost” them $28 in lost revenue.

But an amazing thing happens – sales go up, and he sells 50 tomatoes (still a far cry from the glory days, but an improvement nonetheless). He can now happily put $50 toward his electric bill and keep the lights on. His sales went up $20 in just one week. But his angry wife points out that if he’d left the price alone like she wanted, they’d have made $750 on those 50 tomatoes! She’s so preoccupied about the $700 he “let get away” that she can’t get her brain around the simple cause-and-effect scenario – that lowering the price caused the higher sales, and that charging too much chased the sales away. Her $750 sales day could never have happened.

Will lowering taxes (prices) cost the government (farmer) $4 trillion ($750)? Or will it generate more income, like it has in every credible example ever recorded?

Watch out for AP statistics that use “static accounting”, which is a fancy way of saying that they assume a change in one variable will not trigger change in anything else. A change in price will affect sales at the produce stand, and a change in our tax rates (or even uncertainty in future tax rates) will affect our GDP.

The real question is whether the “Tax! Tax! Tax!” ideologues will give up on this failed and faulty path we’re on before the bank forecloses on the farm.

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