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Static Assumptions Undermine Economic Policy Analysis


Over 50 years ago, Schumpeter emphasized that static models of capitalism miss what is most important in capitalism.  Yet static analysis still dominates most policy discussions.  But there is hope:


(p. A14) A bit of background:  Most official analysis of tax policy is based on what economists call "static assumptions."  While many microeconomic behavioral responses are included, the future path of macroeconomic variables such as the capital stock and GNP are assumed to stay the same, regardless of tax policy.  This approach is not realistic, but it has been the tradition in tax analysis mainly because it is simple and convenient.

In his 2007 budget, President Bush directed the Treasury staff to develop a dynamic analysis of tax policy, and we are now reaping the fruits of those efforts.  The staff uses a model that does not consider the short-run effects of tax policy on the business cycle, but instead focuses on its longer run effects on economic growth through the incentives to work, save and invest, and to allocate capital among competing uses.

 

For the full story, see:

ROBERT CARROLL and N. GREGORY MANKIW.  "Dynamic Analysis."  The Wall Street Journal  (Weds., July 26, 2006):  A14.





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