I am losing posts or something. I clearly recall an exchange with Warren about his concept of deflationary stimulus that still makes no sense to me. I made a post and never got a response. I can't find it now, so I wonder if it got lost and never appeared. The idea was if you cut a plumbers tax rate he would be incented to cut his rates which would drum up more business expanding his output.
The example was say the tax is 35% and he currently charges $100 an hour--after tax $65. He gets a tax cut to 20%. So he cuts his rate to $90 an hour, which increases his business by 5%. He takes home $72, more than the $65 before. So his weekly income increases from $2600 (40*65) to $3024 (42*72) demand stimulus of $424. His old customers who were paying $4000 for a week of his labor are now paying $3600 for the same, freeing up $400 that can be spent elsewhere for a total demand stimulus of $824. This comes at a cost of a $600 loss in government revenue for a net stimulatory impact of $224. Looks great right?
The problem is the incentive calculation is not correct. After the tax cut, if the plumber would not cut his rates, he will take home $80/hr. If he then continues to work the same 40 hours a week he will take home $3200, MORE than the $3024 in the example above and do this by working LESS hours. Why would be cut his rates and take a pay cut? In this case the gain to the plumber is $600, exactly equal to the loss in revenue and there is no stimulus, simply a transfer of money from the state to a private individual. And unless the private individual spends all of it is will be contractionary.
I don't see how this "deflationary stimulus" is supposed to work.
The example was say the tax is 35% and he currently charges $100 an hour--after tax $65. He gets a tax cut to 20%. So he cuts his rate to $90 an hour, which increases his business by 5%. He takes home $72, more than the $65 before. So his weekly income increases from $2600 (40*65) to $3024 (42*72) demand stimulus of $424. His old customers who were paying $4000 for a week of his labor are now paying $3600 for the same, freeing up $400 that can be spent elsewhere for a total demand stimulus of $824. This comes at a cost of a $600 loss in government revenue for a net stimulatory impact of $224. Looks great right?
The problem is the incentive calculation is not correct. After the tax cut, if the plumber would not cut his rates, he will take home $80/hr. If he then continues to work the same 40 hours a week he will take home $3200, MORE than the $3024 in the example above and do this by working LESS hours. Why would be cut his rates and take a pay cut? In this case the gain to the plumber is $600, exactly equal to the loss in revenue and there is no stimulus, simply a transfer of money from the state to a private individual. And unless the private individual spends all of it is will be contractionary.
I don't see how this "deflationary stimulus" is supposed to work.