It’s unlikely that the Royal Swedish Academy of Sciences was thinking about the taxpayers of New York when it announced yesterday that it was giving the Nobel Prize in economics to Edward Prescott and Finn Kydland. But the work of the Nobel laureates turns out to have some interesting implications for the city and state government.

One of the things for which they won the prize was research in respect of something known as the “time consistency problem.” While it is largely applied to the monetary economic policy controlled in America by the Federal Reserve, its implications can be felt in every area of government policy – including the tax rates set by the politicians in here and Albany.

Messrs. Prescott and Kydland explained this phenomenon in a famous piece published in 1977 in the Journal of Political Economy. They used the analogy of persons constructing homes on a floodplain. Policy-makers announce that anyone constructing a home on a floodplain will receive no government aid if his home is destroyed. People build anyway, and their homes are destroyed when the floods inevitably come.

The government then changes its mind when compassion trumps reason, and bails out the flood victims. Taxpayers are stuck with the damage bill, and the policy that was intended to discourage building on the floodplain is rendered ineffective, because people learn that the government is unwilling to follow through on its warnings. If the government had acted consistently, taxpayer money would be saved, and the disaster could be avoided in the future, because people would heed government warnings.

As the Swedish Academy pointed out yesterday, the economists noted that this “time consistency problem” also applies to tax cuts.” A government can pledge tax cuts for certain kinds of activity (such as investments) – but once the investments have been made, it can nevertheless withdraw the tax cut in order to increase tax revenue,” the Academy explains.

Sound familiar? Here in New York, taxpayers have also learned to take government promises with a healthy does of skepticism. Rent control, adopted as an emergency measure during World War II, is still with us today. The sales tax on clothing costing less than $110, which was supposed to expire in May 2004, was extended for another 12 months. What can taxpayers expect to happen to the quarter point increase in state sales tax, which is set to expire on June 1, 2005, or to an income tax surcharge on those earning more than $100,000 a year, which expires at the end of 2005? Or to the parallel increases in the city sales tax and the city income tax, which are supposed to expire on the same schedule?

Even at the federal level, tax rates fluctuate – the death tax is gone entirely in 2010, but returns in 2011, under current law. It doesn’t take a Nobel laureate to notice that Senator Kerry has his own problems with consistency when it comes to the Iraq war.

Messrs. Prescott and Kydland’s research suggests that the expectations of higher taxes lead taxpayers to save less. Those expectations will be developed based on what lawmakers actually do, not what they promise. Something for politicians to ponder, whether they are making promises or breaking them.