More Inequality
Josh Bivens correctly notes that the extent to which public policy plays a role in pre-tax income inequality is probably going to have something to do with which sort of inequality we're talking about -- the top ten percent diverging from the bottom ninety, or the top 0.1 percent diverging from the bottom 99.9 percent. Meanwhile, I was sad to read this comment from Andrew Samwick on my theory that tax policy affects pre-tax income distribution:
I hadn't fully appreciated that a progressive tax system might be used to give lower-income workers a leg up in competing for the marginal unit of production. It remains an empirical question as to how important this might be over the last 25 years. I would have thought the effect to be small, compared to things like increasing global competition in product markets.I would have thought that lots of people would have thought of that already. It doesn't seem like it should be too hard to model, right? Indeed, at first I thought I should be able to model it myself but actually I can't. Some of what I'm thinking, though, goes below.
If you look at, say, this chart you'll see that overall federal tax revenue hasn't changed all that much since 1962 -- bouncing up and down between about 16 percent of GDP and about 20 percent of GDP. The top marginal income tax rate, by contrast, has changed a great deal, veering from 91 percent to all the way down to 28 percent. In particular, there was a large structural shift during the Reagan years when the top rate started at 70 percent and has never since gone above 39.6 percent.
This new era of low top marginal rates coincides fairly directly with the great inequality explosion. We also saw during the Clinton years that it was possible to raise actual revenue levels on a par with the historical high notwithstanding much lower top rates than had prevailed in the past. Which seems to me to lead to the conclusion that dramatic shifts in the top tax rates don't quite have the dramatic impact on tax revenues that one might believe.
The simplest explanation of this would seem to be that the supply-side crowd is at least partially correct. Lowering the tax rates on the richest Americans reduces federal revenue by less than you might think, because it causes the rich to get richer and you wind up pulling in a lower percentage of a bigger pool of money. In other words, tax rates impact pre-tax revenues.
I mean, at some adequately extreme level, the "Laffer curve" idea has to be correct, right? If you taxed all dollars earned above $250,000 per year at a rate of 100 percent this wouldn't lead to a revenue bonanza -- nobody would earn a salary over $250,000. It would be pointless. The resulting situation would have various consequences, but one of them would be less inequality.
Right wing tax theory possibly isn't so much incorrect as it is out of date. Extremely high top marginal tax rates do produce a break on economic growth. On the other hand, that theory has gone far beyond the level of diminishing returns. Even assuming that the right wing is correct, there comes a point where each tiny bit of economic growth costs too much in reduced tax revenues and/or social inequality.
Right wing friends of mine like to use JFK in defense of the Laffer curve. After all, he lowered taxes and gained revenue. Nevermind that the Shrub's tax cuts came on top of Reagan's tax cuts that came on top of JFK's. They see this idea as an absolute when it is so obviously absurd.
Perhaps the right wing's supposed distaste for moral relativism prevents some of them from seeing any nuance. To them, there is no difference between lowering the top rate from 90% to 70% and from 35% to 0.
John
For more go to my online journal.
August 22, 2006 11:21 AM | Reply | Permalink
Is that the same guy who did the Chronicles of Narnia rap?
August 22, 2006 11:38 AM | Reply | Permalink
The claim that higher marginal tax rates discourage earning additional income, and hence discourage higher-income earners from working, is standard econ 101 textbook supply of labor stuff. The validity of Laffer and supply-side economics hinges on the trade off between increasing the tax base by lowering marginal rates (removing the discouragement to work) and the increase in tax revenues. This rate is determined by the elasticity of supply of labor – the change in the quantity of labor supplied divided by the price of labor. If this number is greater than 1, we can say that for each reduction in tax rates, there is a greater increase in the quantity of labor supplied. Empirical studies actually put this number at about 0.2.
So, for each dollar of reduction in marginal tax rates, we can expect to see an additional 0.2 units of labor in the economy. Do the math, and it’s obvious Laffer and supply-side economics – the idea that “tax cuts pay for themselves - has been proven demonstrably false.
August 22, 2006 2:20 PM | Reply | Permalink
Matt: If you look at, say, this chart you'll see that overall federal tax revenue hasn't changed all that much since 1962 -- bouncing up and down between about 16 percent of GDP and about 20 percent of GDP. The top marginal income tax rate, by contrast, has changed a great deal, veering from 91 percent to all the way down to 28 percent.
There is a missing bit to this. This assumes that high-income earners actually paid the full amount of the taxes they were supposed to pay. The AMT was introduced because there were so many high-income earners that paid zero income taxes because of tricksyness. It also assumes that the number of people paying this top marginal rate that they could have a substantial effect on tax receipts as measured by percent of GDP.
It makes sense then that the reduction of the top marginal rate from 91 to 28 percent would have but a tiny effect on gross tax receipts if it turns out that very little tax revenues come from the top marginal income tax rate.
August 22, 2006 2:31 PM | Reply | Permalink
The "problem", I suppose, is that the right,
1. Doesn't particularly value the left's version of "social equality". Equality of rights, yes, but not of outcomes.
and,
2. Doesn't really think that the government should be extracting every last cent possible from the economy.
So the right, naturally, wants the tax rate to be set substantially below the revenue maximizing point, not at it.
While the left,
1. Doesn't particularly value the right's version of property rights.
and,
2. Views reducing the wealth of the richest segment of society as a positive good, even if doing so doesn't make anybody else one iota better off.
So the left wants the tax rate set above the revenue maximizing point.
Of course, the key point is that the government is controlled by neither right nor left, but incumbant politicians. Who set the combination of taxtion and borrowing at the vote maximizing point, not revenue maximizing point.
Which is at a different point for politicians sucking up to the left or to the right, but in neither case motivated by our sort of ideological concerns.
August 22, 2006 2:59 PM | Reply | Permalink
No, that doesn't prove Laffer and supply side economics wrong. It simply puts us at a particular point on the Laffer curve.
After all, Laffer never claimed that lowering tax rates would raise revenues at ALL tax rates. Where we were on the curve was always an empirical question.
Also, I'll point out that the instantaneous and long term elasticity don't have to be the same. To use a farming analogy, saving more seed corn lets you plant a larger field the next year, and so have a larger harvest, even if it does reduce what you can consume THIS year. Lowering the tax rate below the point of maximum revenue yield may cause the economy to grow faster, and thus yield higher revenues down the line, even if the elasticity IS 0.2.
August 22, 2006 3:14 PM | Reply | Permalink
While this is a tempting idea, it is also rather wrong on two levels.
First, on logical grounds. If supply-siders are correct, then a declining top rate would keep tax revenues constant (or increasing) in dollar terms, but they would be decreasing as a share of GDP. The point of supply-siders is that you cut taxes, the economy grows, and so you can collect the same amount of revenue but from a larger economy. This would in most cases imply that revenue falls as a share of GDP.
Second, on factual grounds. Revenue has stayed constant as a share of GDP not because of a supply-side effect but because the base has broadened: that is, more kinds of income are now taxable and not because of increases in income. In particular, the 1986 tax reform (for the right-wing take on it, see here).
August 22, 2006 3:34 PM | Reply | Permalink
A rather scary thought that the Right is now damning the crowning tax policy act of Ronald Reagan and a GOP-dominated Congress.
August 22, 2006 4:10 PM | Reply | Permalink
Re: Equality of rights, yes
I donklt knwo I can agree with even that much. With significant and honorable exceptions the American Right has had to be dragged kicking and screaming into accepting ever major advancement of human rights in this country, all the way back to the abolition of slavery. Their current howling and moaning over gay rights issues is but the latest chapter of their long intransigence which in the past also opposed equal rights for Blacks, native Americans, Catholics, women and even non-real estate owners.
August 22, 2006 4:14 PM | Reply | Permalink
I was thinking very similarly over at DeLong's a while back (at least about that last paragraph).
Samwick sounds so embarassing here that either he, I or both are not understanding Samwick and or Krugman. It reminds me of the old Dawkins/Gould fueds, actually, and not unlike the nature/nurture battles - a false dichotomy.
August 22, 2006 6:53 PM | Reply | Permalink
Reagan never increased taxes?
August 22, 2006 8:44 PM | Reply | Permalink
“This new era of low top marginal rates coincides fairly directly with the great inequality explosion. We also saw during the Clinton years that it was possible to raise actual revenue levels on a par with the historical high notwithstanding much lower top rates than had prevailed in the past. Which seems to me to lead to the conclusion that dramatic shifts in the top tax rates don't quite have the dramatic impact on tax revenues that one might believe.”
“Lowering the tax rates on the richest Americans reduces federal revenue by less than you might think, because it causes the rich to get richer and you wind up pulling in a lower percentage of a bigger pool of money. In other words, tax rates impact pre-tax revenues.”
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You seem to forget the Saving and Loan scandals of the Regan years and the Internet bubble of Clinton.
I believe that the Regan years were supported by the money thrown off by the S&L scandals. The total cost of the government money put into the failed institutions do not include the loans and projects that should not have been built, but the institution loaning did not fail.
The amount was 150 Billion dollars cost to us the taxpayers for those that did fail. Clinton had the Internet bubble in his time to help the tax income.
All this really covers over the fact that the largest amount of value increases actually happens in assets held over time that increases in value. That is what the estate tax fight is all about.
If you go to the nonprofit web sites to see the discussions as they talk about the transfer of assets of the wealth and the opportunity for charity receiving some of this transfer.
"Although the report documented a low-, a medium- and a high-growth scenario, the most cited figure is the low-growth minimum estimate of $41 trillion in 1998 dollars)
during the 55-year period from 1998 through 2052.2" http://www.bc.edu/research/swri/meta-elements/pdf/41trillionreview.pdf#search=%22nonprofit%20value%20of%20transfer%20of%20assets%20predicted%20%22
Also think about the cost to society of the low taxes on the high income tax payer. Could the inflation of housing values beyond the average earner be because of this money chasing new construction? Most of these communities are outside of the
infrastructure of exiting facilities of the cities they are built near so there is a large cost for existing citizens to extend services, roads and schools.
“This new era of low top marginal rates coincides fairly directly with the great inequality explosion.”
You do comment on this in a way that is looked at as a social cost, but there are read distortions of the economy, real costs, and inflation caused by this phenomenon!
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Top US Marginal Income Tax Rates, 1913--2003
http://www.truthandpolitics.org/top-rates.php
Presented here are five series for making such comparisons in US dollars between any two years from 1790 to 2005. They are the CPI, the GDP Deflator, the unskilled wage rate, the GDP per capita, and the GDP.
http://eh.net/hmit/compare/
In 1964 the top rate was 77% and I do not know the % that paid, but remember there were all kind of deductions for investment and other real ways to save on taxes.
In 2005, $400,000.00 from 1964 is worth:
http://eh.net/hmit/compare/
$2,518,598.38 using the Consumer Price Index
$2,037,776.77 using the GDP deflator
$2,800,890.87 using the unskilled wage
$4,848,208.14 using the nominal GDP per capita
$7,508,016.88 using the relative share of GDP
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Today, are we searching for I deals or Ideals?
-Thinking
August 22, 2006 9:02 PM | Reply | Permalink
Matt: Why are you showing a chart of "federal tax revenues" and then, discussing changes in individual income tax rates, solely?
Where are FICA receipts? Especially after the Greenspan Commission increases? Corporate income taxes? Excise taxes?
Before we discuss supply-side theory wouldn't we need a chart showing individual income tax receipts for the period under discussion?
August 22, 2006 9:17 PM | Reply | Permalink
I now think of economists the same way I think of lawyers. They're highly skilled advocates who have, in the best cases, a high degree of mastery of their material. But they work in the interests of their own political principles and those of their employers and grantors.
The range of economic opinion is from the Ayn Rand far right to the center-left (and more center than left). Perhaps a third of Americans are to the left of Krugman and DeLong, and well over half of Europeans. (Of course, few of those who hire economists are left of center.)
Besides the economists' biases, the science of economics itself has a skew. Labor, for example, is a cost. The lower costs are, the better. (There are countervailing factors, of course -- the buying power of labor, for example. But these hardly supersede the need to keep labor cost low).
There are lots of ways of skewing results -- selecting a dataset to study, selecting a kind of statistical analysis, selecting variables to study . The gross skews get caught, but the little tweaks don't. Skewing is not done consciously, I suppose, but results that "don't look right" get a second look, whereas results that look right get passed on.
The best way of getting a good skew, of course, is just not to study a question at all. For decades economists have been condemning the minimum wage on basic economic principles, without bothering to look for empirical backing. When a study was finally done, it was found that the backing wasn't there.
On the other hand, basic economic principles tell us that, **of course**, both outsourcing and high immigration will reduce wages -- supply and demand. But economists, including Krugman and DeLong, don't want this result, so they do an empirical study (!) which proves that -- hold your breath -- either there's no effect on wages, or the effect on wages is very small.
There's always a subtext in this proof, too: only the lowest-paid, lowest-skilled workers are impacted. People we wouldn't care to know.
Economists don't like Stiglitz's book on his experiences with the World Bank / IMF etc. I haven't read it (it's on my list) but my guess it's because it isn't written in economic terms, because the kinds of things Stiglitz wants to say can't be expressed in economic terminology. Economics as such has enormous blindspots, and just be working professionally economists effectively adopt a rightward bias.
August 23, 2006 6:58 AM | Reply | Permalink
What about Max Sawicky and Sandwich Man? Max posts here on TPMCafe as well as his own site. I'd bet he'd be on the left of more than two thirds of Europeans.
There are plenty of lefty economists. They may not have the cachet of DeLong and Krugman but they are out there.
Also, Krugman does agree that outsourcing and immigration reduce domestic wage.
http://economistsview.typepad.com/economistsview/2006/03/krugmans_notes_.html
http://economistsview.typepad.com/economistsview/2006/03/paul_krugman_no.html
He may not be the leftiest of the lefties, but I think this post distorts his positions.
August 23, 2006 9:32 AM | Reply | Permalink
I may be wrong about DeLong and Krugman's present positions, but during the Nafta debates they were pretty adamantly pro. Perhaps they've moved left, or perhaps I'm wrong about them.
My reading of the tea leaves is that DeLong, Krugman, and Stiglitz all changed their ideas once they got involved in actual hands-on real-world stuff and its concrete effects. A lot of econ is either academic or strictly business / finance -oriented
I could have mentioned Sawicky, but he's really an outlier, and as far as I know doesn't have much heft within the profession (no discredit to him in that, in my opinion). He also does work for a labor-oriented group, which is very rare.
Often left economists are from stigmatized "heterodox" branches such as the institutionalists, etc. I think that the center of gravity of the profession is about what I've said, with far more hard-rightists than even moderate liberals.
August 23, 2006 10:04 AM | Reply | Permalink
To repeat the tired, old metaphor, if all you have is a hammer . . . .
The very fact that, in this controversy, economists who have watched the 99/1 breakaway for twenty years and now, must admit that their formulas and methodologies don't explain what's going on is strong support for the idea that economists have constructed and are manipulating (and are benefiting economically from) a reified, artificial model of human getting and spending.
A pox on their house!
August 23, 2006 10:23 AM | Reply | Permalink
The "breakaway" as you describe is simply the normal and natural functioning of an economy in an enviornment that lacks massive upheavals and calamities. Money is like mass in phyics: it "gravitates", and hence tends to attract itself into larger and larger (and fewer and fewer) clumps, absent perturbations which disrupt this process. The first half of the 20th century was full of such perurbations, more than so any epoch since the disastrous 14th century (with its Plague, etc.): two world wars, the Great Depression, Russian Revolution, Chinese collapse and Maoist tyranny, the fall of European imperialism in the Third World. All those upheavals disrupted the tendency of wealth to acumulate into a few hands, and they tended to distribute what they did not outright destroy (and the destruction was immense). If you want an egalitarian world you need a world of disasters-- and I don't know if it's worth it. Otherwise we just muddle along with the usual gang of oligarchs growing richer and richer until they screw up so bad they produce their own collapse. At best we can ameliorate the worst of the immiseration of society in the meantime, as the Euroepans and Japanese have.
August 23, 2006 4:17 PM | Reply | Permalink
When physically young, I believed that economics told what should be done and political science told what was really done and why.
I now understand economics is about profits
and profits are maximized when others pay your expenses
which is accomplished though politics!
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Today, are we searching for I deals or Ideals?
-Thinking
August 23, 2006 7:18 PM | Reply | Permalink
If all the books in a library were filed in one long shelf
beginning on the left with subjects that men of good will
could agree on going on to those subjects with less agreement onward to the right.
Staring on the left would be math, going on and on to philosophy and religion in the center and to the far right side, pressed and squeezed hard against the wood of the casing, would be economics, where only those with the same assumptions
could agree on anything.
-----------------------------------------------------------------------
Today, are we searching for I deals or Ideals?
-Thinking
August 23, 2006 7:26 PM | Reply | Permalink
Part of the problem in trying to tie tax policy to the massive shift of wealth to the very wealthy is that tax policy is only a part of the cause of the shift. Other causes include governmental collusion in the fantasy that stock prices always go up, governmental approval of bookkeeping standards that define income, expenses, etc. so as to persuade stock investors that red is black, and part is governmental tolerance for the misleading language used to persuade stock investors that a company that never makes a penny is a good investment. And, of course there are other factors, such as anti-labor actions by the government, artificially holding down income by refusing to raise the minimum wage, governmental collusion with the insurance, pharmaceuticals, and medical supply industries. The economic model that can account for all of those causes would be quite a wonder to see. Frankly, I prefer to just vote for Democrats.
Hoppy in Sacramento
August 23, 2006 8:56 PM | Reply | Permalink
Krugman is pro free trade, in general, despite the fact that it can lower wages in the US. He sees it as a net positive overall.
http://web.mit.edu/krugman/www/smokey.html
I do believe that economists underestimated the wage impact it would have in the US.
Nothing like ignoring and referring to them as "stigmatized" to help mainstream the arguments of scare quoted heterodox economists.
August 24, 2006 10:07 AM | Reply | Permalink
I sound like a one man Krugman cheering squad, but he's been writing about the breakway for well over a decade. Just because something has been known and studied for a long time doesn't mean its going to be solved, otherwise we'd have licked cancer.
http://www.prospect.org/web/page.ww?section=root&name=ViewPrint&articleId=5232
August 24, 2006 10:10 AM | Reply | Permalink
I am pro-heterodox economics. What I'm saying is that mainstream, orthodox economics has multiple serious problems, among which is the marginalizing of heterodox economists. It's not me who's doing this, believe me.
Krugman, DeLong, and Stiglitz to me are interesting hybrid cases -- they're orthodox, as far as I know, but they have a reality sense and political committment that most economists don't. There's a big tension there. Krugman and DeLong are the best of the bunch. Nonetheless, I think that their performance on NAFTA and freetrade (which they unreservedly supported) was harmful. Clinton won some quick victories, but with a long-term cost.
August 25, 2006 6:03 AM | Reply | Permalink