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The Economics of Tax Policy

David Stewart: Welcome to the podcast. I’m David Stewart, editor in chief of Worldwide Tax Daily. This week, getting your macros. In this episode, we’re taking a look at the economics of tax policy with Yair Listokin. He’s a professor at the Yale Law School, and is the author of the new book, Law and Macroeconomics, Legal Remedies to Recessions. We talked about the ways that tax policy has affected past recessions and how it may help or hurt in the next one. I’m joined in the studio now by Professor Yair Listokin. Yair, welcome to the podcast.

Yair Listokin: Great to be here. Thanks so much for having me.

David Stewart: Why don’t we start off with — as a macro economist — how do you look at and how do you review tax policy?

Yair Listokin: I think that tax policy is an instrument, or can be an instrument, of macro policy in general, even though we’ve come close to forgetting that. And the idea — it’s not the only goal, but coming from tax law, I’d say that we typically think about tax in terms of its micro-efficiency, micro-economic efficiency, as well as administrability, and justice, and things like that. And I would like to add — not to replace anything — but to add macro into that set of things we’re looking for in good tax policy.

David Stewart: What sort of policy levers should we be focusing on from a macro perspective?

Yair Listokin: So when we’re thinking about macro, we’re thinking about, in bad recessions, trying to boost spending, and in booms, trying to reduce it. And tax, naturally enough, is good at doing either or both. So in busts, in a bad recession, like we had in 2009 to whenever it ended, we want to have lower taxes, increasing discretionary disposable income and spending. And we did that a bit, I think we can do it more and I think we could make the whole system more robust to the business cycle.

David Stewart: All right, so you brought up the great recession and how did tax policy play out during the great recession? What sort of stabilizers or destabilizers came into place?

Yair Listokin: Great question. So first I wanna distinguish between automatic stabilizers and discretionary stabilizers. So automatic stabilizers are parts of the tax code that automatically collect more revenue when things are good, when incomes are high, and less revenue when incomes are low and people are struggling. And that automatically stabilizes the economy by kind of buffering the effects of increase or decrease in income. So a big increase in income has less of an impact on people’s disposable income because a lot of that big increase gets taken away in taxes, and, similarly, a big decrease is also buffered by a reduction in tax revenue. And all that happens automatically, at least with the typical income tax. No laws have to change in order to get that buffering effect, so that’s automatic. Then there’s also discretionary. Discretionary requires Congress to pass a law. So in 2008, and in 2009, Congress was busy passing laws, sort of reducing tax rates and providing all sorts of tax credits to kinda get spending going. And to do that, they actually had to truly pass a law rather than just kind of letting the system work on autopilot.

David Stewart: Did these policies have a noticeable effect on mitigating the recession?

Yair Listokin: I think yes. And one of my favorite examples is what happened with corporate taxes. So corporate income tax payments plunged between 2008 and 2009. They went down by a few hundred billion dollars, and this was at a time when corporations were really short of capital. So this reduction in their tax obligations, I think, was really important to whatever investment spending they continued to make, or perhaps even just staying in business. So I think that alone was a relatively effective automatic stabilizer, right then and there, and particularly with respect to corporate income tax carrybacks. So NOL carrybacks, which means that when a company has a loss in a given year the government doesn’t simply write a check. But if they paid income tax in previous years, they can carry today’s loss back to previous years and get a refund of their previous income tax payments. The policy of carrybacks, which was extended in the 2009 Obama stimulus to be even more years going backwards, meant that a lot of corporations received the check from Uncle Sam in 2009, exactly when they needed it, and I think that that was an important piece of government stimulus.

David Stewart: Okay, well then following that recession, many years later we’ve had uninterrupted growth over the last several years. And into that world of uninterrupted growth we have the Tax Cuts and Jobs Act. So overall a stimulus type of tax plan into an already firing on all cylinders economy. What sort of effects does the TCJA have from a macroeconomic tax perspective?

Yair Listokin: So a few things. First of all, I think TCJA tells us something about macro in general. It turns out that we had a lot more slack in the economy, certainly in the labor force than we realized. And TCJA, however ill-timed, passing a stimulus in good times is generally not a good idea. But it turns out that our economy had a lot more slack than we realized, in part because so many people had left the labor force during the recession. And it’s only by running the economy particularly hot, that we’re actually learning that. That’s one thing, but TCJA has…so that’s its broader effect, but I think you’re asking more specifically about some of its provisions with respect to automatic stimulus?

David Stewart: Mm-hm, yes.

Yair Listokin: Okay, so there are few provisions of TCJA that I think are a bad idea from a macro perspective. Number one, and I wrote about this with Bill Gale of Brookings in a recent op-ed in The Hill, but we point out a few things. First of all, we point out that it lowered taxes on corporate income, and corporate income is a particularly cyclical component of the economy. In boom times, corporations do very, very well. And they’re the residual claimant on the boom. And then in bust, they do quite poorly. And they do quite poorly because a lot of their claims are fixed. Their rent claims are fixed, a lot of their interest payments are fixed. So they only get what’s left over and when revenues go down, what’s left over isn’t very much. So it’s a highly sensitive component of income with the business cycle. TCJA lowered rates on that component of income. And so that’s a bad idea from an automatic stabilization perspective for the simple reason that we want things that are gonna go down a lot in busts, and up a lot in booms. We want taxes that go down a lot in busts and up a lot in booms, and corporate income taxes were exactly that. So that’s A on the TCJA is bad from a macro perspective points. But secondly, TCJA repealed carrybacks. And I was just saying before, that in the great recession, carrybacks turned out to be a really important part of the automatic government response to the bad business cycle. In the next really bad recession, corporations that make losses in the current year will not be getting a check from Uncle Sam that will help tide them through a lack of financing. So I think that that’s a second really big absence that is something to worry about. And then third, I am really worried about the limitations on interest deductability and this is why: Let’s take a company that…let’s say their income is 100 and, in a good year, and they pay $25 in interest. So if they can deduct all of that interest from their taxes because the restrictions on deductibility of interest from TCJA only kick in at roughly 30 percent of income. So the restrictions do not apply. But now how about in the next recession, what’s going to happen? What’s going to happen is that the corporation’s net income is going to go down. Let’s say it goes down to 50. All of a sudden they’re paying interest of 25 and they only have income of 50. Meaning that interest payments make up 50 percent of their income. And now, all of a sudden, the TCJA’s interest deduction limitations are going to kick in, giving the corporation an unexpected tax increase precisely when they did not expect it. So while in the great recession, the corporate income tax was a macro hero I think TCJA took a hammer to that. And in the future the corporate income tax will do a much worse job of stabilizing the economy.

David Stewart: So would it be expected that in the next recession, since there are fewer automatic stabilizers, that it would become incumbent on lawmakers to put in discretionary stabilizers?

Yair Listokin: Yes, so goes the theory. I am extremely skeptical about Congress’s ability to turn on a dime and tailor tax policy to the business cycle in a discretionary way. I think they can do it in an automatic way, they can get it right once but I think it’s very hard to get it right repeatedly. And even in 2009, it was really hard to pass the 2009 stimulus. And the 2009 stimulus was weaker than most economists would have liked. And then after 2009, there were lots of calls for further stimulus, that did not get passed, further discretionary stimulus. So the people who are afraid about discretionary stimulus, because they worry about Congress’s ability to get the timing right? Well, I think they’ve been vindicated, those are very legitimate worries. So TCJA making automatic stimulus weaker, and sort of putting more of a burden on discretionary stimulus, seems like a policy loser.

David Stewart: All right, so I guess that brings us to the other major factor in tax policy and that would be IRS regulations and rulemaking. What role do they have to play from a macroeconomic perspective?

Yair Listokin: I just wanna emphasize that the IRS, when it makes rules and regulations, is implicitly making fiscal policy. When it writes a rule that collects more revenue, it is implicitly running tighter fiscal policy. If it relaxes some sort of a burden, then it’s running looser fiscal policy. And I argue in my book that the IRS should use the discretion that it already has to recognize that it is functionally making fiscal policy, and use its discretion in a macroeconomically sensitive way. So the idea being that: Try to run functionally looser revenue policy in busts and tighter policy in booms. And I can give examples.

David Stewart: Why don’t you just give an example? Yeah, that would be great.

Yair Listokin: So one example has to do with income tax withholding. Income tax withholding, especially after TCJA, is highly sensitive to IRS regulations. So basically, the tax withholding statutes now instructs Treasury to figure out how much to withhold. And we saw this become an issue when people were surprised with how little they received in refund checks in this year, even though taxes went down. So there’s a lot of discretion vested in the IRS now. I would argue that they should use that discretion about withholding in a business cycle sensitive way, along the following lines. Next time that we’re in a recession, I would argue that they, the IRS, should lower their withholding. What would that do? That would put more money into everyone’s weekly paycheck, which would raise spending, and mitigate the business cycle, reduce unemployment. Of course, that would lead to a lower refund, but a refund comes later. So lower withholding would move spending earlier, which is something you wanna do in recessions. And on top of that, refund checks, because they’re one big lump sum payment, are more likely to be partially or largely saved than ordinary paycheck income. So lowering withholding during busts would be the IRS’s way of stimulating spending when spending is needed. And then by going the other way, by increasing withholding during booms, would be the IRS way of promoting savings when the business cycle is running hot.

David Stewart: I’m just foreseeing some pushback on that, where you have people maybe getting a surprise at the end of the year when they go to file their taxes. Is there a way of mitigating that, or is that just more of a feature than a bug?

Yair Listokin: Well, I’m normally not a fan of surprising people. It would be best to let people know that this is what is going on. And I think this would cause the most harm when people are surprised by the size of a refund check. I don’t think that when it’s bigger than expected, I don’t think that that’s a big problem. I think the concern is when it is too low. But I think that if it’s explained well, that it can at least be, “Well, it’s for a good reason. You already got the money.” And I’d like to point out that Bush 1, during the recession in the early 90s, his IRS, so far as I know, did this. So it’s been done. I’m not aware of any sort of cries of protest. I’m sure there were some surprises, but it seemed to have gone off, not without a hitch, but at least reasonably successfully.

David Stewart: All right, well, you mentioned earlier that you have a book. Why don’t you tell the listeners about your book?

Yair Listokin: Sure, so the title of the book is “Law and Macroeconomics, Legal Responses to Recessions,” and it goes through different possible responses to recessions. About a quarter of the book is about monetary policy, and it broadly argues that we’ve maxed out on monetary policy as a response to a recession. That having central banks buy more and more and more assets, when interest rates hit zero…we’re running into diminishing returns. That we’re having central banks buy trillions of dollars worth of assets for only a marginal improvement in economic conditions, and we haven’t even figured out exactly when the central banks can unwind their asset purchases. So I argue that I’m a fan of monetary policy, but I just think it’s highly constrained, especially when interest rates are zero. So I argue we need to look for other macro policy tools. One of them, which we’ve just spent the last however many minutes discussing, is tax policy, and spending policy more generally. Tax and spend. And unfortunately, and I speak as someone who teaches tax law, while macro, I think, 30-plus years ago was regularly mentioned as a goal of tax policy — and I’m thinking here of Richard Musgrave, who wrote in his public finance book, when he lists what are the goals of tax — I think maybe the first thing he mentions is business cycle stability. Well, nowadays, no one mentions it. I teach from a tax law casebook that spends a lot of time on microeconomic efficiency and the dead weight losses of taxes. Spends a decent amount of time on administrability, never once mentions macro. I think that’s a big loss because tax policy is such an important lever of macro policy in general. And I argue that we should reinvigorate that tax policy as a macroeconomic policy lever. And then I go through the tax code and find lots of kind of perverse consequences of relatively new tax and spending instruments. And I’ll give you an example, if-

David Stewart: Sure.

Yair Listokin: So, tax expenditures, for example, have unintended destabilizing macro consequences. And the argument goes as follows. Tax expenditures tend to be substitutes for government spending that happen in the income tax code, rather than through direct spending. So for example, if the government wants to subsidize healthcare, it could just buy people healthcare. Or it could make their healthcare spending tax-exempt or tax-deductible. And in fact, as you well know, we make healthcare spending tax-exempt or deductible. Section 105 and 106 of the Internal Revenue Code basically say that employer-provided healthcare is — even though it’s functionally compensation — it is exempt from income tax. That’s a big subsidy to the taxpayer. But unfortunately, while direct government spending, we would expect the subsidy to go up in bad times, tax expenditure subsidies tend to go down in bad times. And the argument goes as follows: The exemption for employer-provided healthcare is tied into employment. You need to be employed in order to get tax-exempt employer-provided healthcare. In bust, 2009 and 10, employment goes down, fewer people are eligible for employer-provided healthcare. So the implicit government spending associated with subsidizing employer-provided healthcare goes down. Meaning that government spending, at least in this regard, goes down exactly when we would normally want it to go up. And this is going to be true about most tax expenditures. And because tax expenditures are such a big deal, they’re well over a trillion dollars, this is introducing a really large, unintended destabilizer. Again, which is gonna amplify business cycles. We’re gonna spend less subsidizing in the bad times and more subsidizing in the good times when we want to do the opposite. So very bad macro policy, and it turns out there are lots of examples of it in our tax regimes, and in our spending regimes as well.

David Stewart: All right, well, if listeners wanna read more about this, where can they find your book?

Yair Listokin: It’s available on Amazon. Just “Law and Macroeconomics, Legal Remedies to Recessions,” and my name is Yair Listokin.

David Stewart: Yeah, we will link to that in the show notes. Thank you very much to being here.

Yair Listokin: Thanks so much for having me. It’s been a pleasure.

David Stewart: And now, Coming Attractions. Each week we preview commentary that will be appearing in the next issue of the Tax Notes magazines. We are joined by Executive Editor for Commentary Jasper Smith. Jasper, what will you have for us?

Jasper Smith: In Tax Notes, Michael Cannon explains why tax-year-end rules matter in M&A transactions. Also, Daniel Mayo examines how the gain recognition principles that are highlighted by the TCJA’s Opportunity Zone regime affect the application of the Foreign Investment in Real Property Tax Act of 1980.

In State Tax Notes, Richard Pomp discusses the implications and missed opportunities of Wayfair. Also, Martin Eisenstein and David Swetnam-Burland discuss various state responses to Wayfair and potential corrections in the future.

And in Tax Notes International, a group of practitioners from KPMG discuss the mutual agreement procedure, focusing on the workings between the U.S. competent authority and its counterparts in China. While Jeremy Cape considers current and proposed taxes on air travel in the U.K. and whether taxation can effectively lessen the environmental impact of flight.

We also want to remind listeners of the June 30th deadline for our student writing competition. For more information, visit

David Stewart: You can read all that and a lot more in the June 10th editions of Tax Notes, State Tax Notes, and Tax Notes International.

That’s it for this week. You can follow me on Twitter @TaxStew, that’s S-T-E-W. If you have any comments, questions, or suggestions for a future episode, you can email us at And as always, if you like what we’re doing here, please leave a rating or review wherever you download this podcast. We’ll be back next week with another episode of “Tax Notes Talk.”

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