Why Oh Why is Income Inequality Increasing?

That increasing income inequality is a reality is widely acknowledged by economists, the debate has shifted to the source of the inequality, e.g. see Brad DeLong, Greg Mankiw, Paul Krugman, and Alex Tabarrok for openers. Is it due to a skill premium, non-linearities in returns to education, a rising oligarchy, a winner take all economy, luck, or some other factor?:

Brad DeLong: Optimal Tax Policy: An old New York Times column by Hal Varian:

Hal Varian: In the debate over tax policy, the power of luck shouldn't be overlooked: Those who argue for a more progressive income tax emphasize equity: a tax dollar paid by a rich person causes less pain than a tax dollar paid by a poor person. Those who argue for a less progressive system emphasize efficiency: the most productive people should face lower tax rates to give them strong incentives to work harder and produce more.... This formulation of the optimal income tax problem was first examined by the economist James Mirrlees of Cambridge University, who received a Nobel in economic science for his analysis. In the simplest version of the Mirrlees model... those at the very top of the income scale should face low marginal rates....

Of course, the fact that it pays to reduce the marginal tax rate for billionaires doesn't say much about what tax rates should be like for mere millionaires.... But the intuitive argument presented above is pretty compelling: if income depends only on ability, those at the very top of the income-ability distribution should face low marginal tax rates.

But perhaps this model is too simple.... So let's consider a different model: one in which differences in income are a result only of luck.... In this case, the optimal income tax may well involve taxing billionaires at very high marginal rates. True, aspiring billionaires won't work quite as hard.... But the chances of becoming a billionaire are pretty low anyway, so taxing billionaires at a high rate won't really discourage much effort by those hoping to become one.... This is about as far as theory can take us, but it highlights the critical question: How much income results from ability and how much from luck?...

Christopher Jencks, and his collaborators pointed out many years ago that income inequality among brothers, who share similar genetic and environmental characteristics, is almost as great as for the population as a whole....

If luck plays a substantial role... it makes sense to have a progressive income tax, creating a form of social insurance in which the lucky subsidize the unlucky. Perhaps the folk singer Phil Ochs had the best answer for why the upper half of the income distribution should pay so much more in taxes than the lower half: ''And there but for fortune, may go you or I.''

Comments

[yartrebo]

This article makes a major (and false in my opinion) assumption that rich people are rich because they're extremely productive people.

Rich people are generally rich because they either inherited it or got it through the work of others (generally transferred via the profits that come from the private ownership of productive capital - be they rents, interest, or profits).

What exactly do rich people do get money? The arguably productive ones are in overpaid positions such as CEOs, movie stars, etc. The majority don't do anything and get money from money.

The latter is obviously not productive as nothing is produced and no thinking is done. The former is productive, but as I will argue, the productivity is far less than how much they are compensated.

A movie star certainly has enough bargaining power to demand the wages they receive, but the fame that makes up the bulk of a star's resume is created not by them but by society and is a zero-sum good. If the star wasn't there, the fame would have been allocated to someone else. As such, stars and thier marketing departments only take or lose fame to competing stars and this is not productive work.

CEOs might be essential to having an organization run, but the same can be said that spark plugs are essential to making a car run. They're essential, but so are a lot of other parts, and all-in-all, the CEO has a awfully easy job. It takes one CEO and a few top executives to run a large corporation but thousands of line workers to actually produce the goods. Only a modest amount of intelligence is needed for the position - more than a line worker but less than many research positions. What is needed is connections, which is cronyism or nepotism, and isn't productive.

[realpc]

The lucky can subsidize the unlucky with a flat tax. There would be much less cheating if we all paid a reasonable flat rate, so tax revenues would probably increase. Get rid of all convoluted tax laws and incentives. Low income workers would not pay any tax, and those unable to work would be subsidized. The upper middle class would stop being penalyzed for working hard, and the really rich would still do most of the subsidizing.
Everyone would feel better off, and far less resentful.

[anne]

"There would be much less cheating if we all paid a reasonable flat rate, so tax revenues would probably increase."

Huh? I would prefer to pay no tax of course, but I cannot imagine how much more reasonable the tax system could be for the moderately wealthly to wealthiest or how the taxes they pay could be much flatter. Now an accountant is of course needed and there could be simplicity to an extent, but taxes sure are not penalyzing the wealthy for working hard.

[Dave Eaton]

I wonder about whether most rich people got their money by inheritance or by work- it may depend on where the cutoff for rich is. I am not throwing stones, I figure that this must be a knowable fact, and while I would assume that inheritance is important, it makes sense to most question the assumptions that reinforce what I already believe.

My guess (and that is all it is) is that making a fortune is like everything else- motivation and persistance counts as much as ability and luck.

Is it possible that income disparity is a function of the fact that one can be well down on the totem pole and still do OK? That is, there is a down side to the accumulation of wealth, in that it is very costly in terms of time sacrifice. CEOs may not be hyperintelligent, but they are, in my experience, almost always busy. To me this would count as a cost mitigating against the job. The US has fat poor people- I am not trying to be glib, but this is anecdotal evidence for my hypothesis.

The fact that it takes a few executives to lead a lot of employees does not in any way mean that the executives job is easy. It takes few scientist and engineers to develop products that thousands of employees produce- would it follow that the engineers and scientists have an easier job?

The CEO is productive in that his work gets leveraged into the actions of many. The success or failure of the company depends on product being made correctly, certainly, but more on the correct product being made correctly.

[James Kroeger]

DeLong, Mankiw, et al. are debating whether or not high-income earners deserve everything they are able to get from the marketplace because they make such invaluable contributions, or if maybe they deserve less because they are largely beneficiaries of luck.

The reason why rich people should be taxed at more steeply progressive rates is not because they do not "deserve" it; they should be taxed at more steeply progressive rates because requiring that they do so does not impose any real material sacrifice on them whatsoever. The Progressive Income Tax collects money from taxpayers in a in a way that always preserves every citizen's purchasing power. All rich people end would up with lower disposable incomes than they now enjoy under current tax law, but those lower disposable income would purchase just as much as they did before because markets work.

If rich people are required to pay taxes in a way that completely preserves the purchasing power of their incomes in the marketplace, then what punishment are they actually receiving from the government? None.

By the way, Robert H. Frank---the Cornell economist who co-wrote "The Winner-Take-All-Society" agrees with the reasoning I am using.

[James Kroeger]

"All rich people end would up with lower disposable incomes..." should read "All rich people would end up with lower disposable incomes..."

[anne]

James Kroeger:

'The reason why rich people should be taxed at more steeply progressive rates is not because they do not "deserve" it; they should be taxed at more steeply progressive rates because requiring that they do so does not impose any real material sacrifice on them whatsoever.'

Nicely argued :)

[muckdog]

According to The Millionaire Next Door, most folks get rich by working hard over their lifetimes, not running up debt, and saving and investing as they go. I get tired of this nonsense from those who think the majority of the rich got that way through no effort of their own. What a bunch of hogwash.

Also, we do have a progressive tax system. Almost half of the population pay $0 in income taxes. The tax rate is graduated, and increases as income brackets increase.

There are also some examples where progressive tax systems can faulter. One would be CA just a few years ago. The state tax structure is so progressive, that when the recession hit (as mild as it was), the state tax revenues got hit extremely hard because the rich pay most of the taxes. This created a structural budget deficit that exists to this day, because the politicians don't want to raise taxes and/or cut spending to close the gap.

[save_the_rustbelt]

This is really confusing.

If the question is...

Why Oh Why is Income Inequality Increasing?

...much of this conversation in on the wrong topic.

The tax system has very little to do with how income is distributed. Who gets taxed how much is another important conversation.

If this is our question...

...Is it due to a skill premium, non-linearities in returns to education, a rising oligarchy, a winner take all economy, luck, or some other factor?...

The answer is yes, plus trade policies, government-by-the-wealthy, a changing world we don't completely understand, the Bush-ites, and a lack of sophistication in public policy.

[Richard]

Christopher Jencks, and his collaborators pointed out many years ago that income inequality among brothers, who share similar genetic and environmental characteristics, is almost as great as for the population as a whole....

This does not pose much evidence either for or against the claim that wealth might substantially be the product of chance.

Two brothers could have differing wealth outcomes due to differing fortunes in their lives.

Two brothers could also have differing wealth outcomes due to differing levels of motivation and drive.

Personally, I've always assumed that luck plays a large role in the dispersion of wealth, but I've never seen any carefully crafted studies that would suggest what the R**2 would be, one way or the other.

And in my book, the wealthy should want to pay moderately higher taxes, not for any charitable reasons but for entirely selfish reasons. The wealthy have a good deal and should be willing to pay more to ensure stability. I think of this often when I see Warren Buffet espousing traditionally Democratic policies.

[Bruce Wilder]

Like STR, I find I am more than a little irritated by the framing: rising inequality is presented as a surprising mystery. The complex details may be a mystery, but it should surprise no one, who has read a newspaper more than once a year since 1980.

Right-wing economists like Mankiw have spent years devising, supporting and implementing policies deliberately designed to redistribute income and wealth in favor of the very, very rich, and then, we find out that income and wealth have been redistributed and we are surprised. And, Mankiw feigns any understanding, like he's never, say, proposed a reform of Social Security aimed at redistributing income and wealth from poor to rich.

And, then, liberal economists are asked, what can we do, and they reply, "uh, I don't know, let's try to figure out what's happening, maybe it's a skill premium . . . ".

Antitrust is eviscerated, estate taxes are reduced toward vanishing, unions are neutered, fantastic rates of inflation are encouraged in medicine, FICA taxes are increased while top income tax rates are lowered, the SEC has been put to sleep, and on and on. Everyday, in every way, for 25 years, the Republicans have been tirelessly redistributing income and wealth in favor of the richest Americans; they succeed; nobody can figure it out.

A few days ago, Mark Thoma linked to an excellent and detailed study of income distribution. Did anyone read it? In diffident language, they noted the huge increases in share of income going to people receiving extremely high labor compensation -- movie stars and corporate CEOs. Call me naive, but CEOs don't have "skills" in the conventional sense, so, no, they don't get a "skills" premium. What they have is power. And, the rules on corporate governance have been written to insulate corporate management from stockholder control in most cases. The CEOs hire a bunch of business school whores to spin out a fog of nonsense about how stock options align incentives (truth: they don't align incentives properly at all, because they have no downside; from the stockholder's point of view, stock options are insane, encouraging fraudulent financial reporting practices and extreme risk-taking with other people's money), while they backdate their option grants to defraud the shareholders. But, let's not connect backdated options grants with the distribution of income; let's debate skills premiums.

In principle, I would welcome a careful analysis, and I recognize that it would be detailed and complex and touch on a lot of topics, including, for example, feminism and the rising wages of female workers.

I think economists should think long and hard about the income distribution problem on a theoretical level. I am not at all impressed with the application of a marginal product framework to the compensation of a corporate CEO. It is not clear to me, on the most fundamental level, that a principal-agent analysis can be reconciled with a production function. If there's to be hand-waving over the application of computers and technologies of control, and b.s. about their implications for the distribution of income, then I want to see a model of production, where control is featured, not a production function where it is arrogantly assumed away.

[Winslow R.]

" If there's to be hand-waving over the application of computers and technologies of control, and b.s. about their implications for the distribution of income, then I want to see a model of production, where control is featured, not a production function where it is arrogantly assumed away."

I find it interesting that the high salaries of sports figures have a monopoly business control component with the MLB, NBA, NFL, NHL etc. It seems to take quite a bit of power (control) to maximize the return on talent.

Perhaps in the movie industry 'star talent' is really just 'studio power' as well.

[Tymbrimi]

Jeesh. Go for counseling. The reason for low marginal rates is because this best promotes economic growth, capital formation, investment, and growth in productivity. This explains our current decades high growth in productivity.

This issue is no longer in question. All nations have been in the process of lowering marginal rates, and many have moved to a flat rate.

[Cloudy]

Movie stars and rock musicians get most of their income from royalties. And who defines copyright, sets royalty rates, and makes sure they get paid? The government.
http://www.rollingstone.com/news/story/9447993/the_richest_rock_stars_of_2006
http://www.forbes.com/free_forbes/2003/0707/078.html

[hj]

One has to ask why the losers from the US income distribution system are not more agitated about the matter. Here I think the classic explanation of Marx is the answer: religion is used to dull the awareness of the masses and lead them to accept their lot. That seems very much to be the case in contemporary America. And it is certainly not irrelevant that the party that is busy working to increase inequality is the same one that is busy dishing out religion to the masses.

[chris]

...and the subscription to that religion assumes "better" after life so even if one fails to attain the "american" dream (because MOST won't by definition), one does not bitch about it...

[Bruce Webb]

Well it is pretty reductionist to reduce this question to "luck or skill", "did you earn it or did it fall in your lap?". In my opinion the answer is neither, distributions of productivity are determined by the distributers and throughout history they have made the decision that their share should be the biggest.

The nominal reasons vary. Absolute monarchs reserve the largest share for themselves because under one analysis everything belongs to them anyway and all other shares are at their pure grace, or in another model they are God's direct representative on earth and have to put up a good front in His Name. Benedictine monks made the same case in those centuries when they held a disporportionate share of society's assets and despite their vows of poverty lived very well indeed. They didn't want to stuff themselves like pigs or wear embroidered clothing, but as God's representatives on earth were obliged to lest they be an embarrassment to Him. Or in eras and areas where feudal lords gained the upper hand the answer was that they deserved the larger share because they were offering military protection.

But whether you are talking feudalism or monasticism or abosolute monarchies or capitalism or managerialism one verity remains the same. One segment of society retains pricing power over compensation and they routinely exercise it - for themselves.

This isn't hard. Orwell skewered communism in Animal Farm while giving the backhand to capitalism at the same time. At the end of the book you could not tell the difference between the Pigs (erstwhile communists) and the Humans (exploitive capitalists) whether your title was Commissar or Corporate Director you found a reason to assign yourself a nice Dacha outside Moscow or Country Estate in Westchester.

When you get the same outcome regardless of the economic system you begin to suspect that the distribution of the productivity pie has little to nothing to do with the internals of that economic organization and everything to do with the people that own the pie slicer.

Now there are reasons WHY the pie slicer changes hands, why Greek Tyrants have it one day, then Roman Patricians, then Roman Emperors, then Carolingian Emperors, then Benedictine Abbots and Feudal Barons, then Absolute Kings, then Merchant Adventurers, then Commissars and Monopolizing Capitalists, and now in large part Managers. And to some degree those reasons for passing the slicer can derive from the particular economic system but taking a look at human history as a whole it is pretty clear that Lord Acton identified the fundamental factor:

Power Corrupts, and Absolute Power Corrupts Absolutely. Why in any human society across continents and across history do the wealthy have the wealth? Because they have control of the pie slicer and use it quite naturally to grant themselves the bigger pie slice.

You can credit it to Divine Right of Kings, Grace of God, or Smith's Invisible Hand, the outcome is always remarkable similar. Someone controls the distribution process and they always keep a bigger share. Always have and always will.

I am a Social Democrat and could advance all kinds of reasons why Progressive Taxation makes moral sense given the imbalance in pricing power I am suggesting here. But under what set of circumstances would I be able to enforce that? When Social Democrats have the pie slicer in their hands.

That I happen to strongly believe that I am right morally and historically really means little, Louis the XIV "l'etat, c'est moi" believed the moral and historical verities were backing him. As long as we are working within a DemoCratic system the Demos (people) who have the Crasis (power to rule) get to determine the distribution. Now lots of people may be more comfortable in a Theocracy or an Aristocracy or a Plutocracy, may well feel that God, or Noble Birth, or Adam Smith really really entitles them to keep control of the slicer. Fine, see you at the Ballot Box, or if things get really ugly. at the Barricades.

[Bruce Webb]

"The reason for low marginal rates is because this best promotes economic growth, capital formation, investment, and growth in productivity."

Hey Tymbrimi! Come up with an explanation for the Fifties yet? Because by your formulation none of that should have ever happened. Yet somehow all that housing stock, new college campuses, and Interstate Highway system came into being with 90% plus marginal rates. Did they do it with fairy dust?

"The issue is no longer in question." Well in your mind anyway, I am not quite as ready to write off FDR and Ike in favor of Uncle Miltie as you apparently are.

Do you know Josh Trevino? or Victor Hanson? Because your habit of simply laying down the Law like Moses Jr practically echoes Tacitus and Hanson (who between them got everything wrong on the Iraq war and still are looking down their noses at those of us who predicted "clusterfuck").

The issue is very much in question. In large part that is why we are here discussing these topics today. This thread is entitled "Why Oh Why is Income Inequality Increasing?". Well because we wasted 26 years listening to people like Tymbrimi bleating "Markets!" as the solution to every damn thing from poverty to civil rights. Well the rising tide did not in fact lift all boats and your insistance that we live "In the Best of All Possible Worlds" kind of ignores the fact that 'Candide" was intended as satire.

[yartrebo]

Bruce Webb: Great point there.

The housing stock was built because ordinary people had rapidly rising incomes and could place the orders for new housing.

The interstate highway system was built using government investment.

Likewise the mass of new colleges was built and funded using government funds.

[Bruce Webb]

Yes, and don't discount the GI Bill which paid the tuition for vets to attend those new colleges and the VA Loan which substituted for the down payment on that new housing.

I am an owner occupier for one single reason. I was broke and unemployed and joined the military. Was I a patriot? Yeah sure, to a point. Would I have taken a civilian job instead? Well yeah, the pay and work conditions would have been way better. But fully 20 years after leaving the military that VA Loan eligibility got me into my condo on a zero/zero loan. I am sitting on a pile of equity because the government (not for free mind you, but on the basis of services rendered) gave me a boost.

I know I wasn't born on third base, hell I am not on third base now, but I certainly do not delude myself that what I do have I owe entirely to my talent and luck. Somebody paid for that elementary school and those teachers' salaries for me to go to school, for that matter my grandparents went to public schools.

Some people breeze through life thinking they are Robinson Crusoe without understanding the social externalities that make that life possible.

[spencer]

Bruce has the main point, the rise in inequality has not been accompanied by any improvement in the performance of the US economy. In sharp contrast to the claims by Tymbrimi the increase in inequality has been accompanied by a sharp drop in savings and investments by the wealthy. Nonresidential fixed investment by individuals, s-corps, partnerships, proprietors, etc., has been falling as a share of total investments and the economy throughout this period. The facts say that Tymbrimi is essentially 100% wrong if he is describing the current US economy -- maybe the US economy in 1850s but clearly not the US economy in 2000.

Since 1950 the share of investments and savings by those subject to the individual income tax has had a very strong positive correlation with the marginal tax rate -- the correlation says that lower tax rates have lead to lower investments and savings.

Maybe Tymbrimi would like to explain why his theories have not worked.

In his Blog the other day KNZN made a very good point about the steady decline in proprietors’ income in the national income accounts that clearly demonstrated this point.

[James Kroeger]

Nicely argued :)Thanks, Anne.

Did you, by any chance, read through my essay on the Progressive Income Tax?

Am I correct in thinking that my arguments render much of this discussion of the "worthiness" of wealthy income earners to be moot?

[Miguel]

James Kroeger:

Imagine that Bill earns US$1,000 and Paul earns US$10. Then, the state taxes US$100 from Bill and gives a subsidy of US$90 to Paul (now, Bill has US$900 and Paul has US$100).

You really thinks that the purchansig power of Bill and Paul remains the same??

[nyuk]

I read James Kroeger's essay on the Progressive Income Tax. Absolutely fascinating. Very courageous. I love the idea that the wealthy can get (really) wealthier if the nation creates national wealth.

[Movie Guy]

Interesting comments.

Any time that Spencer reaches for his data (and he has TONS of it), you know that someone is about to bite the dust or he is prepared to make a strong point.

In the spirit of the Old West, I'm sure that he is packing a two gun rig. He'll get ya. More power to him. Keep the econ blog posters honest, sheriff.

[anne]

James,

Yes; I read your essay on the progressive income tax, and found your argument, that worthiness or lack of worthiness of the wealthy is a moot issue for asking after the principle for and usefulness of the tax, to be persuasive.

[realpc]

It's easy to explain why inequality increases. Rich people have advantages and connections because of their famiies. They borrow and inherit money from their parents, they get good jobs throught their rich friends.

You cannot stop people from having friends, and they will usually make friends who are similar to themselves. Poor people have poor friends who cannot help them very much.

You can't stop parents from helping their children.

This is all so obvious, but does not stop socialist economists from blaming the evil capitalist system.

It's easier to get rich in America than in countries that lean more towrads socialism, so we have more inequality. You can make it harder to get rich by punishiing business, but that does not improve the status of workers and does not increase their chances of getting a good job.

People from poor or middle class backgrounds can get rich but it's less likely and depends partly on luck. Anyone can become a famous athlete, entertainer or busines owner, but it is not likely. But if you are from a rich family you have many more opportunities, and can do well without extreme talent or fabulous luck.

You can come from a rich family and still be a loser, if you try hard enough. But with a reasonable amount of effort and motivation you can do very well, much more easily than most of us who don't have the connections and advantages.

This seems to be a fact of life, unrelated to ideology. Of course it causes envy. But what can you do -- make inheritance illegal? They would still have the other advantages, and anyway leaving money to hiers is considered a right, and would be impossible to outlaw.

Why doesn't this discussion ever mention these aspects? Is it luck or talent or hard work? Well obviously all three in different amounts, depending on what you were born into.

[James Kroeger]

James Kroeger:

Imagine that Bill earns US$1,000 and Paul earns US$10. Then, the state taxes US$100 from Bill and gives a subsidy of US$90 to Paul (now, Bill has US$900 and Paul has US$100).

You really thinks that the purchansig power of Bill and Paul remains the same??It depends, Miguel.

If only Bill and Paul were affected by the tax/subsidy and all other income earners were excluded from the policy, then they would both be dramatically affected by the changes you described.

But if all other income earners (in addition to Bill and Paul) were affected by the same tax policy in a way that preserved the comparative 'bidding positions' of all of them within the hierarchy of disposable income, then none of them would lose/gain any purchasing power.

You have to understand how markets work (to auction off scarce goods/services) in order to see why this is true.

[anne]

RealPC, simply modify your analysis a little and you approach equity, which is all that is needed, as James nicely explains.

[anne]

Jared Diamond, by the way, is far less referred to than helpful and the work which students find exciting is argued with professionally far more than helpful for understanding the applicability.

[Miguel]

"But if all other income earners (in addition to Bill and Paul) were affected by the same tax policy in a way that preserved the comparative 'bidding positions' of all of them within the hierarchy of disposable income, then none of them would lose/gain any purchasing power."

Imagine that they are the only people in the country (or that there are 1,000 Bills and 1,000 Pauls)

"But if all other income earners (in addition to Bill and Paul) were affected by the same tax policy in a way that preserved the comparative 'bidding positions' of all of them within the hierarchy of disposable income, then none of them would lose/gain any purchasing power."

"You have to understand how markets work (to auction off scarce goods/services) in order to see why this is true."

Let's imagine that Bill and Paul are the only persons in the world. Imagine that we have 10 apples.

If Bill has $1,000 and Paul has $10, Bill can buy all the apples - if he offers $11 per apple.

If Bill has $900 and Paul has $100, Paul can buy an apple (he can offer a price of $100 per apple, and Bill can't cover his offer) - I expect the you understand my confuse English

[Miguel]

If James Kroegar was right, it will be good news: these mean that we can have any kind of tax (progressive, flat, regressive, etc.) without losing purchasing power (this sounds a bit unprobable to me)

[James Kroeger]

If James Kroegar was right, it will be good news: these mean that we can have any kind of tax (progressive, flat, regressive, etc.) without losing purchasing power (this sounds a bit unprobable to me)Any tax that maintain's the comparative 'bidding positions' of all taxpayers within the hierarchy of disposable income, ensures that none of them will lose/gain any purchasing power.

The reason why it is a good idea to tax the wealthy with steeply progressive income taxes is because---normally---the economy needs an economic stimulus in order to reduce unemployment and increase the production of real wealth. Taxing savings will accomplish that objective. Once there is zero unemployment, if there is a need to increase government revenue further (like say to finance a war), then I would recommend a progressive consumption tax, instead.

[Tymbrimi]

No, the facts are that investment and capital formation are doing very well, and your measurements aren't capturing it, because they are becoming obsolete. Do you think we have a high growth in productivity from magic? Try not to be idiots. And explain to me why all countries are seeking to lower their marginal rates, and many have adopted flat rate tax structures.

The 1950s rode on the shoulders of WW2 investment. It was so long ago, those times are irrelevant to today. :)

[Miguel]

"No, the facts are that investment and capital formation are doing very well, and your measurements aren't capturing it, because they are becoming obsolete. Do you think we have a high growth in productivity from magic?"

There are many reason for an high growth in productivity besides more investiment and capital formation: better investiment, better management systems, more qualified workers, more intelligent workers, ec.

And, if you don't belive in the statistics for investiment, how you can belive in the statistics for productivity? They are calculated from the same features, after all.

[Tymbrimi]

I do know the investment figures are growing obsolete, as they were designed for an industrial society, as opposed to a knowledge based economy. miguel, I don't know how true, if at all, your assertion is. To the extent it is true, then the growth in productivity is being underestimated.

[Bruce Webb]

"Do you think we have a high growth in productivity from magic?" What high growth?

Is 2% high growth? Down from 3% in 2004? Growth is dropping through the floor hell bent on hitting 1.7% in 2013. I know this because I read Government Reports and surely they would not be lowballing growth numbers for ulterior purposes.

Nope growth dropped sharply last year and is going to stay at below historic rates forever. How do I know this? Because the Secretary of Treasury, the Secretary of Labor, the Secretary of HHS, the Commissioner of Social Security and both Public Trustees have told me so. In the first column of Table V.B1. In this years SSA Report.

http://www.ssa.gov/OACT/TR/TR06/V_economic.html#wp188118

Hey if these numbers are good enough for Professor Samwick and Bruce Bartlett they ought to be good enough for you.

(Oddly enough they are not particularly compelling to me. Then again I am not trying to badmouth Social Security financing).

says...

James, I did read your article and while I would love your argument to be true, there are just too many oversights and that seems to make it wishful thinking.
To start with, you ignore external factors. For your argument to be made, the order in the hierarchy would have to be kept stable WORLDWIDE. Now how do you arrange that?
But even then, another problem is that in real life, you don't get standard of living packages, with an obvious order of choice between them, that then get auctionned. You purchase various things in a completely different manner. For a simplistic example, take an economy where the sole good is a single opera ticket per month. In Miguel's example, let me be Bill. I like opera and would like to go every month. Now I can always get the ticket because my income is more than 12 times Paul's. But after the suggested redistribution Paul gets 1.3 ticket per year on average. I'm not saying this is unfair of course, but it does mean I would get less.
Whereas you imply that the whole package would get auctioned and I would still get it at $101. But it's not how we purchase our standards of living.

Again, I would really love your argument to be bulletproof (I am to the left of politics in FRANCE, which is probably a position not represented at all in American politics, when the Democratic party is about equivalent to our most conservative mainstream party), and I do agree that a well thought progressive taxation is the way to go. But we would be weakening our argument by advocating something easily refuted.

[Cyrille]

Sorry I didn't sign that post above -that was me.

[Blissex]

«Any tax that maintain's the comparative 'bidding positions' of all taxpayers within the hierarchy of disposable income, ensures that none of them will lose/gain any purchasing power.»

It is surprising to me that nobody has mentioned yet the obvious, glaring flaw with this argument (yet another ''cæteris paribus'' one): this may apply only if the government then writes off the tax revenue thus collected.

Conservatives, who think arguments through because so many of them are businessmen, don't really object to taxes, but rather to spending they don't control.

If government spent taxes, instead on the exploitative and parasitical poor, to reward ''highly productive'' persons by giving them a matching million for every million they earned in the 1-100 million range, and two millions for every million earned in the 101-1,000 million range, I suspect they would think taxes to be on the whole a very good idea. :-)

[Blissex]

«No, the facts are that investment and capital formation are doing very well,»

The facts are that the pre-tax share of the top 1% was half of what it is now in the 1950s and 1960s, and taxes on the top 1% were rather higher, and they were very, very good decades for the USA economy, and for the top 1% themselves.

Then consider the 70s and 80s as a counterexample, and it is pretty obvious that within very wide margins the share of pre-tax income going to the top 1% and their tax rate does not matter much either way.

Even better, look at OECD/G7 countries and the same conclusions happen.

The argument against extremely progressive taxation is moral, not economic: that marginal rates of 93% are confiscatory, unless necessary (e.g. war or other catastrophe).

But for overall rates in the vicinity of the USA's mostly flat (if not regressive) 25-30% there is abundant evidence, both in USA's own history and across the world, that that a fair bit more or even a bit less (say in the 20-50% total take range) would not cause a lot of effect either way, in itself. How the loot gets spent probably matters a whole lot more.

[anon@whitehouse.gov]

A few points:

The USA's system isn't flat at all, most of the tax base if funded by the wealthy.

The top rate is 35%, please get your facts straight. This is only the federal rate, some states add up to 11%.

That 93% rate you speak of during WWII was full of loopholes, so the effective rate was far less.

Russia has a flat rate and an economy growing at a rate better than ours, which calls into doubt your claim that economic arguments cannot be made against the progressive tax.

[dryfly]

Russia has a flat rate and an economy growing at a rate better than ours, which calls into doubt your claim that economic arguments cannot be made against the progressive tax.

And besides Russia has crony capitalism & a rapidly disappearing vestige of what might once have been called a Democracy - what more could somebody with a handle 'whitehouse.gov' want?

[dryfly]

Since 1950 the share of investments and savings by those subject to the individual income tax has had a very strong positive correlation with the marginal tax rate -- the correlation says that lower tax rates have lead to lower investments and savings.

As a small business person I can tell you why I think that's happened - depreciation. The lower the rate the less depreciation allowance factors in as a 'tax shelter'. Depreciation is the direct result of investment. If you make pursuit of depreciation less attractive then investment becomes less attractive.

Depreciation is an immediate payback - right now - future returns or capital gains is maybe someday. Anyone using time-value-of-money analysis gets this.

It isn't theory for me anyway - I get it intuitively.

If you want more investment - increase marginal rates & simultaneously allow for accelerated depreciation. Carrot & stick.

On the other hand - you want consumption, lower rates & marginalize depreciation as a relative factor.

And if you want to super charge investment - increase marginal rates AND simultaneously incorporate a VAT... do both.

But maybe more investment isn't what we want.

[dryfly]

Ooops, forgot a piece...

And if you want to super charge investment - increase marginal rates AND simultaneously incorporate a VAT... do both.

Should have read...

And if you want to super charge investment - increase marginal rates, accelerate depreciation AND simultaneously incorporate a VAT... do all three.

[reason]

Tymbrini,
stumbled quite by accident on the key point and then didn't notice it. Productivity has been increasing, but this has not resulted in higher wages (despite historically low levels of measured unemployment). THAT is the puzzle that the liberal economists are worrying about.

[reason]

On a different point, the real issue with high marginal rates is the effect it has on international investment flows in a world relatively free from restrictions on international capital flows. Rates are becoming flatter, not because it is proved to be stimulative, but because at the margin DFI is influenced by it. People who sit in the middle of the huge US economy cannot see this very clearly, but imagine being Slovakia or Ireland and the issue becomes clearer.