Monday, May 26, 2008

conservatives, liberals, and dynamic analysis of both Iraq and tax rates

OK, that's a mouthful of a blog entry title, but I couldn't think of anything clever.

An observation:

Conservatives are (correctly) quick to criticize a static analysis of tax cuts. For example, if taxable activity is $100 billion and the tax rate drops from 15% to 10%, a static analysis would predict a decrease in govt revenues from $15 billion to $10 billion.

But any budding young economist (or anyone with a lick of sense) knows that the incentives have changed. Since the activity is being taxed at a lower rate, the incentive to engage in the activity increases. Depending on the activity's "elasticity", behavior will increase modestly, moderately, or quite a bit. So, decent analysis would take the dynamic reaction into account-- and if possible, provide a solid estimate of the behavioral changes one would expect from a change in policy.

But when it comes to Iraq, some conservatives are loathe to do dynamic analysis-- particularly with respect to the probability that opposition in general and suicide terrorism in particular will increase in response to our on-going efforts in Iraq. They assume a (largely) fixed number of terrorists who we happen to be fighting in Iraq-- with little or no concern about our ability to create new terrorists.

Robert Pape explores this theory-- and in studying the data, finds a significant dynamic impact.

Ignoring dynamics is bad analysis and can easily lead to bad policy-- whether in our tax code or our foreign policy.


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