Wednesday, August 1, 2007

See what you like...


One of the topics I touch on in The Social Atom is the embarrassingly loose relationship between observations and beliefs in social science, especially among those driven by ideology. I've always thought it odd that there are "conservative" and "liberal" economists, when economists are supposed to be scientists approaching the workings of economic systems with the same dispassionate methods as physical scientists do nature (or so I thought). Nothing can send you toward ridiculous conclusions more rapidly than a conviction that you already know the truth.

Here's a most amusing example that I came across at Cosmicvariance (linking to Mark Thoma and Brad Delong). A while back, apparently, the Wall Street Journal, soon to be Rupert Murdoch's prize possession, published the figure above to illustrate the relationship between corporate tax rates and GDP. The Laffer curve is a theoretical construct (held in great respect by "conservative" economists) which purports to depict how the amount of overall tax revenue a nation collects first rises with increasing tax rates, and then ultimately falls -- showing how too-high taxes can be bad for the economy.

The Journal published this figure, fitting the Laffer Curve to the data for a number of real countries, apparently with a straight face. Or were they laffing? It doesn't take immense mathematical intuition to doubt whether the curve really matches the data very well; it certainly doesn't look like it.


Here, in contrast, is Mark Thoma's rather more realistic attempt at fitting the data with a relatively simple curve. I think most physical scientists would look at this and say that this curve too is rather hard to take seriously; what the data really seems to show is an awful lot of scatter, suggesting that the tax rate alone just doesn't account for much of the variation in tax collected. Other factors must be more important.

But Thoma's curve (and he offered only as an illustration of how easy it is to do better than the WSJ's completely ludicrous fitting) at least isn't a purposeful distortion of reality. Oh, but perhaps we shouldn't be surprised. Apparently the "original" research quoted in the WSJ editorial was carried out by economist Kevin Hassett at the American Enterprise Institute, self-proclaimed to be "a private, nonpartisan, not-for-profit institution dedicated to research and education on issues of government, politics, economics, and social welfare."

I'm not sure what Dr Hassett learned about curve fitting during his education, and experience, which certainly seems impressive. From the AEI website:

Before joining AEI, Hassett was a senior economist at the Board of Governors of the Federal Reserve System and an associate professor of economics and finance at the Graduate School of Business of Columbia University. He was an economic adviser to the George W. Bush campaign in the 2004 presidential election and the chief economic adviser to Senator McCain during the 2000 presidential primaries. He has also served as a policy consultant to the Treasury Department during the former Bush and Clinton administrations.


Worrying, eh?

7 comments:

Len said...

If anyone is interested, I've posted my own version of the chart on my blog at http://nextintheseries.blogspot.com/2007/08/wholeflaffer-curve.html

And Mark, I couldn't agree with you more.

Len said...

Let me try this differently.

My blog

MaryKaye said...

Mark, It's actually a little more complicated than that. There are any number of things wrong with the first graph - not the least of which is they got the axes wrong - and the WSJ has taken a first class drubbing for putting it out there the way they did. Part of the problem with the whole issue is reasonable economists will confront a theory with the data to confirm or disconfirm the theory. In the case of the Laffer Curve it seems folks are willing to torture the data until it confesses; a violation of first principles. That said, it's not unusual for an economic model to leave much of the variation unexplained. Ergo, the endless ceteris paribus declaration.

Jason said...

As I heard it, the fabled Laffer curve was originally drawn on a napkin at a dinner shared by Laffer and the chief editor of the Wall Street Journal sometime in the early 1980s on the basis of no data; looks like they took the original, added units arbitrarily, and then put in data points accordingly. I'm no expert, but I think drawing the curve is fine so long as you don't give units on your axes. Certainly if I were taxed at 100% of my income, I wouldn't work very hard/report much income; the curve is there. It's just that we don't know much of the details beyond 0% and 100% tax rates. Well, aside from having learned that we're probably to the left of the peak if we judge by our experiences during the Reagan and second Bush Administrations.

But you're being a little unfair to economists--think of who your example is. You might analogously point to the Discovery Institute and say, "Hey, aren't biologists supposed to use evidence and Occam's Razor as physicists do?" (See also the tobacco controversy, the greenhouse gas controversy, the sulfur dioxide controversy...)

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