Tuesday, April 17, 2012

Giving Guidance to the Angels means never having to say you are sorry

Yesterday, the NYT, in its news pages, presented a glowing article about a pair of French economists, Emmanual Saez and Thomas Piketty, whose seminal ground breaking research shows that income inequality is a very bad thing indeed, and that, therefore, we need a 90% marginal tax rate on top earners. Their main points:
  • Income inequality has become morally offensive
  • This inequality is correlated with a steep reduction in marginal labor tax rates for high earners
  • The increase in inequality is particularly pronounced in the Anglosphere
  • The so-called Buffet rule, which would invoke a 30% tax rate on incomes above $1 million, "... would do little to reverse the rich's gains."

Therefore, according to Mr. Saez, "Absent drastic policy changes, I doubt that income inequality will decline on its own."

Previous income inequality studies had a fairly short timeline: direct data had only been collected since 1970. Saez and Piketty extended that horizon by researching income tax archives all the way back to 1913. According to their research, inequality dropped after WWII, and remained relatively low until the 1970s, when it started to increase. "From 2000 to 2007, incomes for the bottom 90% of earners rose only about 4%, once adjusted for inflation. For the top 0.1%, incomes climbed about 94%. ... In 2010, the top 10% of earners took about half of overall income."

That has led the two economists to renew their calls for higher rates on the rich. Along with Peter Diamond, an emeritus professor at MIT and a Nobel laureate, Mr. Saez has estimated the "optimal" tax rates for the wealthy -- getting the most revenue from those most able to surrender it -- to be between 45% and 70%."

According to Mr. Diamond, "... whom [President] Obama nominated to the Federal reserve and Republicans blocked[,] 'Our finding is that the debate should be between the pre-1986 Reagan tax rate, which was 50%, and the rates that existed from Johnson to Reagan, which were higher." [Note: by "higher" the reporter, whose job description apparently excludes even superficial research, meant to say 91%.]

Since I am not a reporter, I am not at risk of betraying the profession by, well, reading the actual study. Also, as merely a glorified heavy equipment operator, and not an intellectual, I am not in the business of providing guidance to the angels, and therefore perhaps less willing to mistake my policy preferences for objective truth.

So, despite my lack of reportorial professionalism and academic credentials, I am going to take on the anointed elite to see if Saez and Piketty's argument is vulnerable to the predations of the hoi polloi.

From the introduction (citations omitted; edited slightly for wordiness; emphasis mine):

While there have been many discussions both in the academic literature and the public debate about the causes of the surge in top incomes, there is not a fully compelling explanation. Most explanations can be classified into market driven changes vs. institution driven changes. The market driven stories posit that technological progress has been skilled-biased and has favored top earners relative to average earners for CEOs as well as Winner-Take-All theories for superstars. [These] pure market explanations ... cannot account for the fact that top income shares have only increased modestly in advanced countries such as Japan or Germany or France which are also subject to the same technological forces. The institution driven stories posit that changes in institutions, defined to include labor and financial market regulations, Union policies, tax policy, and also more broadly social norms regarding pay disparity and in particular tolerance for executive pay, have played a key role in the evolution of inequality. Simply put, under that view, the Reagan and Thatcher revolutions ushered new eras in the United States and United Kingdom that favored the rich and significantly increased their bargaining power while other countries were less affected.

Whether you call it "reason", "science", or "rational inquiry", analytical thinking is abundantly effective at organizing systematic observations into an overarching schema. However, there are two significant limitations to that approach. First, and most obvious, not all phenomena are amenable to systematic observation: art, for instance. That doesn't mean art doesn't exist; rather, it means that definitive statements about art, which is primarily subjective, are essentially impossible.

Second, and less readily apparent, all analytical thinking aims to create a model of reality. Since the model is not reality itself, analysis must make decisions about which phenomena to include, and which to exclude. We all do this whenever trying to solve any problem: if I am trying to discover the source of a noise in the front end of my car, I am not going to spend much time observing the seat belts. Consequently, the challenge of useful analytical thinking is to include all phenomena that can have a "significant" impact on the analyses.

Now, one would think that such esteemed intellectuals as Saez and Picketty would understand this and, furthermore, that they would provide some indication that they had considered, and excluded, certain phenomena that might, just might, have some impact on their findings.

In the highlighted sentence above, the market explanation is seemingly shown as inadequate because of the contrasting inequality between the US and England on one hand, and the obviously more enlightened European-socialist economies on the other. Since they are alike in all other respects, then the explanation for greater income inequality within the Anglosphere must be down to that one area: tax rates and other policies which put Progressives on the side of the angels.

Not so fast. Even before flipping to the second page, they have not considered two factors which probably go well beyond the realm of the merely salient.

There is one thing, besides a hatred of the poor that only Satan could love, that the US and England share, which the other advanced economies do not: English. So What? S&P might ask. As it happens, English happens to be the language for the vast majority of the world's various entertainment offerings. Best selling books, blockbuster movies, popular music, are all far more likely to come from the Anglosphere than the rest of the world, combined. I think the fancy economics term for this is "network effect", and it is non-trivial: think Microsoft.

And by ignoring, whether blithely or otherwise, network effect, S&P then compound the problem by confusing a group characteristic for its composition. The characteristic is wealth. Upon that characteristic, they impose a presumed composition of the group sharing that characteristic, and it is that composition upon which their analysis rests: the wealthy are CEO-ish. Their whole notion of economic responses to confiscatory taxation presumes that essentially everyone who is wealthy is someone who is paid for some sort of executive position.

But thanks to the network effect, that is nonsense. Confining ourselves to that voracious beast, the top 1%, at any given moment, a substantial number of them are athletes and entertainers (which is really two words for the same thing). There are at least as many of those as there are Fortune Top 500 CEOs. Moreover, even understanding that the composition of that top 1% is far from monolithic doesn't go far enough. Most entertainers lucky enough to hit it big don't do so for long. The subset of the category "wealthy" that is composed of entertainers is fairly constant over time, but the members of that subset do not.

Speaking of time. While I am not going to quibble over whether top executives take home a higher multiple of average wage earner pay than they once did, homogenizing the category "wealthy" into one easily demonized group ensures that S&P, as well as all other Progressives, ignore the certainty that no small amount of that multiple is due to the far higher compensation of entertainers now than, say, the 1970s.

So, even before getting to the meat of this seminal groundbreaking study, there are two good reasons to suspect that, through ignoring what very much needs attention, S&P have produced a result that, regardless of the mathematical ornamentation, should be rejected out of hand.

Similarly missing, or, perhaps more accurately, waved away is the notion of opportunity cost. S&P insist that a uniform tax system (i.e., all income treated the same, regardless of source or nature) sufficiently ruthlessly imposed, will so reduce the gains from high salaries or elaborate fringe benefits that people will not go to the bother of bargaining for higher pay. VOILA! equality.

Glaring in its absence is what must happen instead. The wealthy, just like the rest of us, can do only two things with money: spend or save it. By engaging in ruthless taxation, the economic value of the talents of high wage earners accrues to the government, rather than the individuals themselves. That, in turn, must mean that essentially all of the spending and investing that the wealthy would have done instead becomes government spending. All of those employed as a direct consequence of the rich spending their ill-gotten gains must lose their jobs, never mind the knock-on effects.

I could go on, but this has already long gotten past the cut-to-the-comments point. In a recent Thought Mesh thread, I suggested that the sine qua non of Progressivism (the presumption of sufficient knowledge to conclude that their policy preferences are equivalent to how the world should and will work) means that Progressives must more frequently, and thoroughly, purvey ideas that are either divorced from reality, as here, or completely fraudulent (Gleick, Rather, Group of 88, et al).

But to everyone who is not a Progressive, that presumption of knowledge is the disease of self-appointed intellectuals who might have extensive and well founded knowledge within their own specialty, and from that conclude their temperamental preferences are equivalent to social imperatives.

Note the emphasis on "might." At the risk of throwing my shoulder out of whack due to unjustifiably vigorous self congratulation, I think my assessment of S&P's seminal groundbreaking paper shows that they can reach their conclusion only by ignoring every element of reality that might contradict The Narrative.

Just so here. Behind a cloak of flashy, but trite, mathematical formalism, S&P produce a seminal groundbreaking result that flatters the self-regard of Progressives without putting themselves through the bother of properly identifying global cultural trends, understanding the nature some particular group, or the opportunity costs of replacing the monetary decisions of individuals with the tender mercies of an increasingly bloated government.

But it must be OK. After all, it the NYT thought it was just fine, and so does the Obama administration.



Blogger erp said...

To the lefty elites all workers are inter-changeable cogs in a wheel. Suits and creative genius types who don't work in fields or assembly lines aren't real workers.

There was an interesting article from Reuters of all places about how favored companies in favored states are allowed to keep the state taxes collected from their employees and use the money as they wish.

I guess what lefties mean by fairness and income redistrubtion is confiscating people's hard earned money and giving it to them that's got plenty and give pots of it to Democratic politicians.

Dear Lord how much more of this came we take.

April 17, 2012 6:38 AM  
Blogger Bret said...

Hey Skipper wrote: "...the certainty that no small amount of that multiple is due to the far higher compensation of entertainers now than, say, the 1970s."

So given the certainty, what percentage of the top 1% of income goes to entertainers and atheletes? I looked at that a while back and can't remember exactly, but my recollection was that it wasn't all that high (5% comes to mind). If so, it wouldn't change their results much to exclude that group.

Also, S&P aren't interested in helping the poor (at least not directly), they're only interested in "equality" and if that means making everybody quite a bit poorer but the rich way, way poorer, that's not only not a problem, it's great. They believe that even though the poor might be worse off materially, they'll be oh-so-much happier knowing that hardly anybody else is doing better than them. That's certainly one way to view the concept of fairness and economic justice, just one that I don't happen to share.

April 17, 2012 8:21 AM  
Blogger Hey Skipper said...

Bret: I think they were talking about high income earners, which to them is anything above $350k. I'll have to check on that later today.

April 17, 2012 11:30 AM  
Blogger Bret said...

Sure, but isn't $350K roughly around the top 1% mark?

April 17, 2012 11:56 AM  
Blogger Hey Skipper said...

I couldn't find anything off hand that specifically stated what the income threshold of the top 1% is, but I did find a source that said 2% (2.3 million) of US households have incomes exceeding $250k. So 1% (no more than 1.1 million households) and $350k sound about right.

I couldn't manage to come up an occupational breakdown for that 1%. But it does include, every NFL, NBA, and MLB player, plus every speaking part actor in a movie or TV series. Then toss in successful authors, surgeons, race car drivers, artists, and entrepreneurs.

I have no idea what that number comes to, but it has to be a measurable part of 1.1 million.

Their "analysis" [link now points to the correct paper, BTW] makes a whole slew of questionable assumptions. Perhaps chief among them is that provided the tax regime is completely uniform (all income treated the same, internationally uniform tax regimes, and rigorous enforcement), a 90% tax rate will not result in any significant dimunition of economic activity. (That is, government's long term tax take at a 90% marginal rate will exceed that from, say, a 35% rate.) They get there by assuming that people doing CEO-ish stuff will continue doing the same amount of it for $350-ish thousand as they would for $1 million. Perhaps.

But since the paper only addresses executive type occupations, without one syllable considering the consequences to all the other non-executives in that top 1%, it completely sidesteps two issues: fairness (in what manner is it more fair to tax at 90% entertainers' peak earnings when, taken over a lifetime, they are much more modest?) and economic growth (there is an outside chance that a 90% marginal rate will kill entrepreneurship, and with it trickled-down economics).

April 18, 2012 12:39 PM  
Blogger Bret said...

Hey Skipper,

You generally get no argument from me about the potentially devastating effect of a 90% bracket, both in terms of economic effect over the long term (somewhat objective) and in terms of what I consider to be fair (mostly subjective).

I was just quibbling over the effect of just entertainers and athletes.

My personal story I think illustrates the economic disincentive pretty well. I've been working at this robot thing that I started for 13 years so far and realistically it'll push 20 before I get any significant money out of it. In the meantime I've been working for way, way below market salary (around $50K per year below), so I'll have given up a cool $1M in income over the 20 years.

So let's say after 20 years I'm able to cash out for $5M (and even that is still a long shot). A first blush, it sounds good. But even at current tax rates of 15% capital gains plus California's 10%, I'll still lose about a quarter of it to taxes. Divide the remainder by 20 years and it'll be less than $200K per year. So it's nice, but to work 7/24 for 20 years at a substantially reduced salary with the stress and only a small shot at success, not so great.

But now the government wants to take 90%? Then I'm left with only a $20K per year return? That I gave up $50K per year to achieve? Who's gonna do that in the future? In fact, I'm kinda wondering why I'm such a chump as to keep going 'cause it looks to me like Obama and the government are gonna take it away. I should've taken the full salary working at someone else's company while the taking was good.

Oh well. Sometimes you lose, sometimes you lose big.

April 18, 2012 2:46 PM  
Blogger Hey Skipper said...

Your example adds to my entertainers & atheletes point, which is that the S&P analysis (as does much Progressive blather on this subject) omits a significant component of the phenomena it is analyzing.

Asserting that the effect of confiscatory income taxes on the economy is solely limited to the consequent decisions of CEO-ish people should have earned a shellacking. You would never set foot on a bridge designed with such a thorough disregard for reality.

But even more important is how this displays the Progressive disease: the delusion that Progressive preferences are correct merely because Progressives hold them.

Progressives think income inequality is bad. Therefore, we need to get rid of inequality without regard to determining who it is bad too, in what way, or addressing behaviors that contribute to inequality.

It is a conclusion without an argument. The mystery is why Progressives are so prone to that.

April 18, 2012 3:56 PM  
Blogger Harry Eagar said...

If income inequality is a good thing, we now have enough of it to satisfy anyone this side of a Russian grand duke.

Obviously, the Reagan and subsequent tax cuts have not had the effect we were promised. I have no particular brief for how rates should be graduated, but even Mellon thought they should be.

That's conservative enough for me.

I cannot think of any reason to separate classes of income. All income should be treated as ordinary income.

I would be in favor of indexing long-term (much longer than one year) capital gains, but in that case, no whining if deflation leaves you owing more than you made.

April 22, 2012 7:42 AM  
Blogger Harry Eagar said...

This comment has been removed by the author.

April 22, 2012 7:42 AM  
Blogger Hey Skipper said...

If income inequality is a good thing, we now have enough of it to satisfy anyone this side of a Russian grand duke.

There's the problem in a sentence. Neither you nor S&P can demonstrate whether income inequality is good, bad, or neither. Yet, despite that, and the manifest inadequacies of their argument, you simply conclude that it is, and endeavor to eliminate it, no matter the means, and heedless of the consequences.

I cannot think of any reason to separate classes of income. All income should be treated as ordinary income.

Here's one. Investment gains have already been taxed twice. At the corporate level, where profits have already been taxed, then at the personal level, where there are fewer resources with which to purchase investments because of income tax.

Here's another. Cap gains taxes socialize gains, and privatize loss.

Which leads to the third. Investment helps the economy in the long run. If you want less of it, tax it more. We got to the rates we have for several good reasons; track the amount paid with respect to rate over time.

Reducing cap gain rates has reduced income to the treasury, right?

Obviously, the Reagan and subsequent tax cuts have not had the effect we were promised.

Oh, they have. You are just to blinkered to see the effects that surround you.

I have no particular brief for how rates should be graduated, but even Mellon thought they should be.

I happen to agree, but given the overall shares of the taxation burden shouldered by the various tax groups, I think it is about right. With the top 10% paying something like 90% of income taxes, it seems unlikely the system isn't progressive enough.

Also, the fevered dreams of the expropriators fail to take into account two things: avoidance, and concentration.

The former has been demonstrated many times, and California is showcasing the latter as we speak.

May 04, 2012 8:43 AM  
Blogger erp said...

People with means vote with their feet. They'll take their money and move where they are welcomed.

BTW, the same will happen with health care. Those who can, will go off shore either paying as they go or purchasing an insurance policy issued by an off shore company. The best medical people will move where the money is as well leaving the rest of us at the mercy of the same union thugs who manage the rest of the onerous bureaucracy.

I've long thought Cuba might be such a place as soon as the current despots finally meet their maker. I have a feeling Cubans have had their fill of el socialismo and will be ready to let the good times roll.

May 04, 2012 11:28 AM  
Blogger Harry Eagar said...

When Mellon was secretary, !00% of income tax was paid by the rich. It was FDR who moved it downmarket, reaganism that moved it back upmarket by destroying the middle class

May 06, 2012 1:29 PM  
Blogger Hey Skipper said...


How about discussing the amount of tax paid vs. rate over time? Since you used Mellon's tenure, that should serve as a useful basis.

You keep throwing out the trope about Reaganism destroying the middle class, without ever noting the means, or, for that matter, substantiating the results.

The only way you get anywhere close to that conclusion, BTW, is to use a tendentious concept: "adjusted for inflation."

The problem should be obvious, but apparently not enough. Let's say the CPI overstates actual inflation by, say, 1%. Does the conclusion still hold?

And I'm betting the CPI exagerates ignoring hedonic effect, overstates actual inflation by far more than that.

Example: it takes the same number of work weeks to buy a new car now as it did in 1979 (and is down more than 20% since the mid-90s).

So, what is the rate of inflation?

How much would it cost to purchase today's average new car in 1979?

So, what is the rate of inflation?

May 07, 2012 3:48 PM  
Blogger Harry Eagar said...

Well, as Froma Harrop said, let's take indoor plumbing as a given for the 21st c.

Sure, Jefferson didn't have it at Monticello.

The Reagan tax changes plus globalization have hollowed out the middle class. Sure, most of the globalization changes were inevitable. The taxes weren't.

It's hard to compare apples to apples when you have the vast structural changes we have seen over the last 30 years or so.

I don't think many people realize it, but only about 3/4 of American men are now in the workforce. It used to to closer to 90%.

3/4 of women are, too, now, and it used to be closer to 20%.

Think about that: one man in 4 is unproductive.

Why does the TP never rail against this?

May 29, 2012 1:21 PM  
Blogger Susan's Husband said...

"Why does the TP never rail against this?"

They do, you just don't pay attention. Netsearch on "mancession" for one example. NPR reports that it was coined at the American Enterprise Institute, a very Tea Partier kind of place.

They just realize that its due to too big a government and realize that fixing that will fix most of the job losses.

May 29, 2012 5:00 PM  
Blogger Harry Eagar said...

AEI recognized this 6 years ago?

I recognized it over 25 years ago.

Now, what is the cause? Big government would not be my pick.

Having hung out at the job retraining center -- where the absence of guys was striking -- I have another explanation.

May 29, 2012 5:20 PM  
Blogger Hey Skipper said...

The Reagan tax changes … have hollowed out the middle class.


I don't think many people realize it, but only about 3/4 of American men are now in the workforce. It used to to closer to 90%.

Perhaps the reason many people don't realize that is because it isn't true.

As of 2007 (the latest figures I could easily find), men aged 20-54 make had a roughly 93% labor force participation rate, representing a slow 60-year decline from about 97%.

Aside from the fact that 93% is a lot higher than 75%, there is a decline to account for.

The long-run trend has been a gradual but consistent reduction in labor force participation; it has been linked to early withdrawals from the labor market associated with access to disability benefits and incentives embedded in defined benefit retirement programs.

But what the heck does the Federal Reserve Bank of San Francisco know?

Still waiting to hear about the amount of tax paid vs. rate during Mellon's tenure.

And regarding inflation:

It's hard to compare apples to apples when you have the vast structural changes we have seen over the last 30 years or so.

Then stop doing it. The left only gets to the stagnant wages trope via serially abusing "inflation".

June 03, 2012 8:41 PM  
Blogger Harry Eagar said...

Not stagnant. Declining, for most of us.

Krugman recently put up several relevant charts.

June 05, 2012 4:21 PM  
Blogger Hey Skipper said...

How about doing everyone a favor and providing a link?

(BTW, why will I not be surprised when Krugman's graphs turn out to be tendentious cherry picking.)

June 06, 2012 9:28 PM  
Blogger Hey Skipper said...

Another BTW: any explanation for "only 3/4 of white men are in the workforce?"

June 06, 2012 9:29 PM  
Blogger Susan's Husband said...


Some data is here.

June 07, 2012 7:05 AM  
Blogger Harry Eagar said...

'any explanation for "only 3/4 of white men are in the workforce?" '

I have a couple of ideas but nothing I can be certain of.

I was interested, some years ago when my wife was RIF'd and enrolled in a job retraining program, to observe that ALL the enrollees were women.

I think that a sizable fraction of male voluntary unemployment can be attributed to the fact that women now can make a sizable income. Those guys who would rather live off a woman have an easier time of it than they used to, although if you read, eg, Harry Golden or the letters to the Vorwarts from a century ago, you can find plenty of traces of easy riding sentiment.

Also, some people who have had higher paying jobs would rather not work at all than work for less. Men, since they were more likely to have made more, would be disproportionately represented here.

(Many years ago, I wanted a particular job and was qualified for it. It would have meant a meaty pay cut, but I was willing. The employer said he would not hire me because, in his experience -- which was considerable -- men who said they were willing to take a pay cut always developed resentments after a time.)

It is easier to think these possible trends are real if you disbelieve in the concept of the 'economically rational man,' as I do.

But I am not ready to insist that these proposals account for all, or even a big fraction of the reason.

July 03, 2012 4:15 PM  

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