Economist's View

New Data on Wealth Mobility and Their Impact on Models of Inequality

Daniel Carroll and Nick Hoffman of the Cleveland Fed:

New Data on Wealth Mobility and Their Impact on Models of Inequality: Wealth inequality, the unequal distribution of assets across households, has been rising for decades. However, this statistic alone gives an incomplete picture of the inequality of households’ economic experiences and opportunities. A fuller understanding comes from also knowing how much movement within the distribution households experience over time. For instance, is it likely that someone with low wealth today will be a wealthy person at some point in the future, or are they rigidly stuck at the bottom? In other words, a fuller understanding of households’ economic opportunity comes from a combination of data on both wealth inequality and wealth mobility.

This Commentary explores the topic of wealth mobility in the United States during the past three decades (see Carroll and Chen 2016 for similar work on income inequality and mobility). Examining supplemental data from the Panel Study of Income Dynamics (PSID), which track families’ wealth over time, we calculate changes in relative wealth mobility; that is, how likely families are to move up or down the wealth distribution, relative to one another. We find that wealth mobility has declined since the 1980s, a trend that is robust to a wide range of measures. Finally, we identify savings behaviors that are associated with more mobile families. Such behaviors may explain the disparity between observed levels of mobility and the levels predicted by the standard model used to study inequality. ...

Jumping ahead:

Conclusion Wealth mobility depends on luck and household choices. It is a reflection of households’ opportunities as well as their responses to those opportunities. Panel data from the past 30 years show a decline in wealth mobility across several measures. It appears that families are less likely to change wealth quintiles over time, while those that do move are less likely to move very far. The reasons for these trends are not fully known, but increasing wealth inequality has contributed to the decline. Families that do make large movements through the wealth distribution appear to be more likely to own some form of a risky asset, as compared to families that do not make large movements.

'On the Ethics of Redistribution'

Curious to hear what people think of this:

On the Ethics of Redistribution, by V. V. Chari and Christopher Phelan, The Region, FRB Minneapolis: When evaluating economic inequality, economists frequently employ the ethical principle referred to as behind-the-veil-of-ignorance. Originated by Nobel Laureate John Harsanyi and philosopher John Rawls, this criterion imagines the social contract that would be developed by a society of risk-averse people who don’t yet know where each of them will end up in that society’s distribution of income.¹ ...

From behind the veil of ignorance, no individual could know into which country (or economic class) he or she will be born. Behind-the-veil, risk-averse people would therefore want to ensure that people born in rich countries do not adopt policies that hurt people born in poor countries. Nevertheless, analysts almost invariably ignore the effects of domestic tax policy on those in other nations. But consistent use of the behind-the-veil criterion would mean that analysts cannot treat people who live in rich, developed economies differently than they treat people who live in poor, less-developed economies. ...

Increasing world trade is an example of the tension between policies that help those in developing countries versus those that help those lower in the income distribution in developed countries. According to a World Bank Study, in the three decades between 1981 and 2010, the rate of extreme poverty in the developing world (subsisting on less than $1.25 per day) has gone down from more than one out of every two citizens to roughly one out of every five, all while the population of the developing world increased by 59 percent.⁸ This reduction in extreme poverty represents the single greatest decrease in material human deprivation in history.

But this decrease in extreme poverty in the developing world has coincided with a marked increase in income inequality in the developed world, and the latter has received much more attention, at least from policy analysts in these richer nations.

One possible cause of both trends has been the increase in international trade, which lessens the market value of less-skilled labor in developed countries while increasing its value in developing countries.⁹ If one uses a behind-the-veil criterion focused only on developed countries, then the increase in trade has made things worse. If instead one considers the entire world, then the trade increase has made the world phenomenally better. ...

We conclude that using the behind-the-veil-of-ignorance criterion to advocate for redistributive policies within developed countries while ignoring the effect of these policies on people in poor countries violates the criterion itself and is therefore fundamentally misguided.

Many economic analysts use social welfare functions in which, implicitly, only the well-being of domestic residents matters. This type of analysis is acceptable as long as the analyst acknowledges that such a social welfare function is not developed from deeper ethical considerations. A giant literature in public finance justifies such social welfare functions by appealing to the veil-of-ignorance. Our point simply is that those who use this criterion should weight the welfare of poor people in Chad, the world’s poorest nation, very heavily. To our knowledge, very little if any of the relevant research does so.

'Okun’s Equality and Efficiency'

An excerpt from Larry Summers' prepared remarks delivered at the Brookings Institute on the 40th anniversary of Okun’s "Equality and Efficiency: The Big Tradeoff":

Okun’s Equality and Efficiency: ... For many years now, it has been the case that the income distribution has been growing much more unequal. ... Certainly because of what has happened in the economy, I would in thinking about tax policy put much more emphasis on distributional issues relative to efficiency issues than I would have during much of my career.  Similarly, I believe that concern with issues relating to the cost of capital and the adverse effects of taxes in increasing it has been very legitimate at points in the past. At present, when zero interest rates make capital costs as low as they have ever been but corporate profits are at record levels, there needs to be much less concern with capital costs and more concern with the distributional aspects of capital taxation.

The same basic idea that rising inequality tips the balance between fairness and efficiency applies in other areas of policy as well. ... I would judge that he benefit cost ratio seems tilted towards minimum wage increases and towards relaxation of the rules regarding the rights of private sector workers to bargain with management.

Another area where conditions have changed over the years is with respect to policy directed at the financial sector and corporate governance. The financial sector has shown itself to be less of a source of diversification and stability and more of a source of instability than most judged a generation ago.  At the same time compensation levels in the sector, and in firms engaged with the sector has gone up rapidly. The simultaneous emergence of high profits and low interest rates raises the question of whether monopoly power is on the increase. So the question of regulatory actions looms much larger than it has for many years. ...

Welfare Economics

Steve Waldman at Interfluidity:

Welfare economics: an introduction (part 1 of a series): Commenters at interfluidity are usually much smarter than the author whose pieces they scribble beneath, and the previous post was no exception. But there were (I think) some pretty serious misconception in the comment thread, so I thought I’d give a bit of a primer on “welfare economics”, as I understand the subject. It looks like this will go long. I’ll turn it into a series. ...

'Pareto, Inequality and Government Debt'

Simon Wren-Lewis:

Pareto, Inequality and Government Debt: Or is economics inherently right wing?

I noted in passing in an earlier post that Pareto efficiency was obviously not a value free criteria. So those who argue that economists should only look for Pareto improvements – changes where no one is made worse off – are making a value judgement. One, and only one, of its implicit normative assumptions is that inequality does not matter. For others see, for example, Elizabeth Anderson (pdf, HT Anon). ...

The only possibly original point I wanted to make here is that the absurdity of restricting policies to Pareto improvements becomes immediately apparent if we think about government debt. Measures to reduce currently high levels of debt will almost certainly make current generations worse off, because they will have to pay the taxes (or whatever) to get debt down. Yet I do not often hear people arguing that we have to let debt stay high because the government can only implement Pareto improvements. ...

Why is there this emphasis on only looking at Pareto improvements? I think you would have to work quite hard to argue that it was intrinsic to economic theory - it would be, and is, quite possible to do economics without it. (Many economists use social welfare functions.) But one thing that is intrinsic to economic theory is the diminishing marginal utility of consumption. Couple that with the idea of representative agents that macro uses all the time (who share the same preferences), and you have a natural bias towards equality. Focusing just on Pareto improvements neutralises that possibility. Now I mention this not to imply that the emphasis put on Pareto improvements in textbooks and elsewhere is a right wing plot - I do not know enough to argue that. But it should make those (mainstream or heterodox) who believe that economics is inherently conservative pause for thought.

[There is quite a bit more detail in the original.]

'What Do Average Americans Think About Inequality?'

Sociologist Claude Fischer:

What do average Americans think about inequality?: ... In her 2013 book, The Undeserving Rich: American Beliefs about Inequality, Opportunity, and Redistribution, sociologist Leslie McCall methodically tries to figure out Americans’ thinking about inequality. ... Here is what McCall found (updated a bit with new surveys):

• First, surveys show that Americans are aware that inequality has grown...
• Second, Americans do not like high income inequality. ...
• Third, most Americans find widening inequality objectionable because it seems to undercut opportunities for economic advancement. ...
• Fourth, a growing percentage of Americans want something done about inequality. ...
• Fifth, what Americans have not increasingly endorsed is having the government redistribute income. ...
• Sixth, what Americans do want the government to do – and there is increasing support for this – is to increase opportunity, notably by funding more education. ...

...I am struck that, in her data and analysis, Americans generally do not object to economic inequality on grounds that perhaps other westerners might: not that it is morally, religiously offensive – Pope Francis speaks of “moral destitution”; nor on the grounds that everyone has a human right to a decent standard of living;  nor because inequality might have damaging psychological consequences or social consequences; nor even because inequality slows economic growth. Generally, Americans object to inequality, it seems, because they think that it undermines the chances that  individual ambition and hard work will succeed.

'A Tax System Stacked Against the 99 Percent'

Except for the dust-up (cyclone?) over the Reinhart and Rogoff results on debt and growth, it's a bit of a slow day and I need to get to a meeting. So, reaching back a few days for a quick post, Joseph Stiglitz does not "eschew the word 'fair'":

A Tax System Stacked Against the 99 Percent, by Joe Stiglitz, Commentary, NY Times: ...About 6 in 10 of us believe that the tax system is unfair — and they’re right: put simply, the very rich don’t pay their fair share. The richest 400 individual taxpayers, with an average income of more than $200 million, pay less than 20 percent of their income in taxes — far lower than mere millionaires, who pay about 25 percent..., and about the same as those earning a mere $200,000 to $500,000. And in 2009, 116 of the top 400 earners — almost a third — paid less than 15 percent of their income in taxes.

Conservatives like to point out that the richest Americans’ tax payments make up a large portion of total receipts. ... Citizens for Tax Justice, an organization that advocates for a more progressive tax system, has estimated that, when federal, state and local taxes are taken into account, the top 1 percent paid only slightly more than 20 percent of all American taxes in 2010 — about the same as the share of income they took home, an outcome that is not progressive at all.

With such low effective tax rates — and, importantly, the low tax rate of 20 percent on income from capital gains — it’s not a huge surprise that the share of income going to the top 1 percent has doubled since 1979, and that the share going to the top 0.1 percent has almost tripled...

Over the years, some of the wealthy have been enormously successful in getting special treatment, shifting an ever greater share of the burden of financing the country’s expenditures — defense, education, social programs — onto others. ...

Economists often eschew the word “fair” — fairness, like beauty, is in the eye of the beholder. But the unfairness of the American tax system has gotten so great that it’s dishonest to apply any other label to it. ...

Society can’t function well without a minimal sense of national solidarity and cohesion, and that sense of shared purpose also rests on a fair tax system. If Americans believe that government is unfair — that ours is a government of the 1 percent, for the 1 percent, and by the 1 percent — then faith in our democracy will surely perish.

So, if we face a choice between cutting programs the middle class relies upon, and making the tax system more progressive, we should... It's not hard to guess my answer.

[The original is much, much longer.]

'Equal Opportunity, Our National Myth'

Joe Stiglitz:

Equal Opportunity, Our National Myth, by Joe Stiglitz, Commentary, NY Times: President Obama's second Inaugural Address used soaring language to reaffirm America's commitment to the dream of equality of opportunity...

The gap between aspiration and reality could hardly be wider. Today, the United States has less equality of opportunity than almost any other advanced industrial country. Study after study has exposed the myth that America is a land of opportunity. This is especially tragic:... there is near-universal consensus that inequality of opportunity is indefensible. ...

And:

How do we explain this? Some of it has to do with persistent discrimination. ... Of course, there are other forces at play, some of which start even before birth. Children in affluent families get more exposure to reading and less exposure to environmental hazards. Their families can afford enriching experiences like music lessons and summer camp. They get better nutrition and health care, which enhance their learning, directly and indirectly. ...

In some cases it seems as if policy has actually been designed to reduce opportunity: government support for many state schools has been steadily gutted..., especially in the last few years. Meanwhile, students are crushed by giant student loan debts that are almost impossible to discharge, even in bankruptcy. This is happening at the same time that a college education is more important than ever for getting a good job. ...

And increasingly even a college degree isn't enough; one needs either a graduate degree or a series of (often unpaid) internships. Those at the top have the connections and social capital to get those opportunities. Those in the middle and bottom don't. The point is that no one makes it on his or her own. And those at the top get more help from their families than do those lower down on the ladder. Government should help to level the playing field.

Americans are coming to realize that their cherished narrative of social and economic mobility is a myth. ... Without substantial policy changes, our self-image, and the image we project to the world, will diminish...

Why Tax Rates Should be Progressive

What is the basis for progressive taxation? One principle of taxation (there are others) is "equal marginal sacrifice," i.e. that the last dollar in taxes paid by the rich and the poor should cause the same amount of pain. This is from Miles Corak:

... Alfred Marshall in his Principles of Economics, the most used economics textbook from the 1890s to the 1920s, not just in Cambridge England where he taught, but in the whole English-speaking world, wrote that:

A rich man in doubt whether to spend a shilling on a single cigar, is weighing against one another smaller pleasures than a poor man, who is doubting whether to spend a shilling on a supply of tobacco that will last him for a month. The clerk with £100 a-year will walk to business in a much heavier rain than the clerk with £300 a-year; for the cost of a ride by tram or omnibus measures a greater benefit to the poorer man than to the richer. If the poorer man spends the money, he will suffer more from the want of it afterwards than the richer would. The benefit that is measured in the poorer man’s mind by the cost is greater than that measured by it in the richer man’s mind.

In other words, losing a dollar when you already have many causes less pain than when you have only a few. Marshall’s argument is the basis for both the substance and the method of a good deal of basic micro-economics: it explains the “law of demand”—why lower prices induce people to buy more—but also why tax rates should rise with income.

Economists judge the functioning of the tax system in a number of ways: certainly the system should not be administratively cumbersome, and it should, to the greatest degree possible, not cause individuals in a well-functioning market to change their behavior. It should also treat equals equally. Finally, the tax system should raise more revenue where it will cause the least pain. And this last concern, when coupled with Marshall’s reasoning, suggests that tax rates should be progressive: as income increases, the greater the fraction that should be paid in taxes. ...

Low Mobility Is Not a Social Tragedy?

How would you respond to Greg Clark?:

...Many commentators automatically assume that low intergenerational mobility rates represent a social tragedy. I do not understand this reflexive wailing and beating of breasts in response to the finding of slow mobility rates. The fact that the social competence of children is highly predictable once we know the status of their parents, grandparents and great-grandparents is not a threat to the American Way of Life and the ideals of the open society.

The children of earlier elites will not succeed because they are born with a silver spoon in their mouth, and an automatic ticket to the Ivy League. They will succeed because they have inherited the talent, energy, drive, and resilience to overcome the many obstacles they will face in life. Life is still a struggle for all who hope to have economic and social success. It is just that we can predict who will be likely to possess the necessary characteristics from their ancestry.

Quickly: I don't buy that individuals in all of these groups have an equal chance to reach their potential, whatever that might be. I do buy that the barriers that prevent an equal chance to realize potential have been present for a long, long time.

The 1935 Version of 'Who Built That"

Remember the debate over "who built that?" in the election? I was scrounging around for information on the history of the income tax and came across this "excerpt from the Ways and Means Committee's report on the Revenue Act of 1935" that discusses this and other issues. As noted in the introduction, "The report reproduces a June 19, 1935, message from President Roosevelt to Congress advocating an inheritance tax, in addition to the estate tax. Although the inheritance tax proposal was not adopted, the message provides information on why the taxation of individuals' estates was considered appropriate." (This is an excerpt of the excerpt):

Message to Congress on Tax Revision June 19, 1935: ... Our revenue laws have operated in many ways to the unfair advantage of the few, and they have done little to prevent an unjust concentration of wealth and economic power.

With the enactment of the Income Tax Law of 1913, the Federal Government began to apply effectively the widely accepted principle that taxes should be levied in proportion to ability to pay and in proportion to the benefits received. Income was wisely chosen as the measure of benefits and of ability to pay. This was, and still is, a wholesome guide for national policy. It should be retained as the governing principle of Federal taxation. The use of other forms of taxes is often justifiable, particularly for temporary periods; but taxation according to income is the most effective instrument yet devised to obtain just contribution from those best able to bear it and to avoid placing onerous burdens upon the mass of our people.

The movement toward progressive taxation of wealth and of income has accompanied the growing diversification and interrelation of effort which marks our industrial society. Wealth in the modern world does not come merely from individual effort; it results from a combination of individual effort and of the manifold uses to which the community puts that effort. The individual does not create the product of his industry with his own hands; he utilizes the many processes and forces of mass production to meet the demands of a national and international market.

Therefore, in spite of the great importance in our national life of the efforts and ingenuity of unusual individuals, the people in the mass have inevitably helped to make large fortunes possible. Without mass cooperation great accumulations of wealth would 'be 'impossible save by unhealthy speculation. As Andrew Carnegie put it, "Where wealth accrues honorably, the people are · always silent partners." Whether it be wealth achieved through the cooperation of the entire community or riches gained by speculation—in either case the ownership of such wealth or riches represents a great public interest and a great ability to pay.

The call for inheritance and gift taxes:

I My first proposal, in line with this broad policy, has to do with inheritances and gifts. The transmission from generation to generation of vast fortunes by will, inheritance, or gift is not consistent with the ideals and sentiments of the American people.

The desire to provide security for oneself and one's family is natural and wholesome, but it is adequately served by a reasonable inheritance. Great accumulations of wealth cannot be justified on the basis of personal and family security. In the last analysis such accumulations amount to the perpetuation of great and undesirable concentration of control in a relatively few individuals over the employment and welfare of many, many others.

Such inherited economic power is as inconsistent with the ideals of this generation as inherited political power was inconsistent with the ideals of the generation which established our Government.

Creative enterprise is not stimulated by vast inheritances. They bless neither those who bequeath nor those who receive. As long ago as 1907, in a message to Congress, President Theodore Roosevelt urged this wise social policy:

"A heavy progressive tax upon a very large fortune is in no way such a tax upon thrift or industry as a like tax would be on a small fortune. No advantage comes either to the country as a whole or to the individuals inheriting the money by permitting the transmission in their entirety of the enormous fortunes which would be affected by such a tax; and as an incident to its function of revenue raising, such a tax would help to preserve a measurable equality of opportunity for the people of the generations growing to manhood."

A tax upon inherited economic power is a tax upon static wealth, not upon that dynamic wealth which makes for the healthy diffusion of economic good.

Those who argue for the benefits secured to society by great fortunes invested in great businesses should note that such a tax does not affect the essential benefits that remain after the death of the creator of such a business. The mechanism of production that he created remains. The benefits of corporate organization remain. The advantages of pooling many investments in one enterprise remain. Governmental privileges such as patents remain. All that are gone are the initiative, energy and genius of the creator—and death has taken these away.

I recommend, therefore, that in addition to the present estate taxes, there should be levied an inheritance, succession, and legacy tax in respect to all very large amounts received by any one legatee or beneficiary; and to prevent, so far as possible, evasions of this tax, I recommend further the imposition of gift taxes suited to this end.

Because of the basis on which this proposed tax is to be levied and also because of the very sound public policy of encouraging a wider distribution of wealth, I strongly urge that the proceeds of this tax should be specifically segregated and applied, as they accrue, to the reduction of the national debt. By so doing, we shall progressively lighten the tax burden of the average taxpayer, and, incidentally, assist in our approach to a balanced budget.

A call for an increase in the income tax rate on high income households:

II The disturbing effects upon our national life that come from great inheritances of wealth and power can in the future be reduced, not only through the method I have just described, but through a definite increase in the taxes now levied upon very great individual net incomes.

To illustrate: The application of the principle of a graduated tax now stops at $1,000,000 of annual income. In other words, while the rate for a man with a $6,000 income is double the rate for one with a $4,000 income, a man having a $5,000,000 annual income pays at the same rate as one whose income is $1,000,000.

Social unrest and a deepening sense of unfairness are dangers to our national life which we must minimize by rigorous methods. People know that vast personal incomes come not only through the effort or ability or luck of those who receive them, but also because of the opportunities for advantage which Government itself contributes. Therefore, the duty rests upon the Government to restrict such incomes by very high taxes.

But what about small businesses?

III In the modern world scientific invention and mass production have brought many things within the reach of the average man which in an earlier age were available to few. With large-scale enterprise has come the great corporation drawing its resources from widely diversified activities and from a numerous group of investors. The community has profited in those cases in which large-scale production has resulted in substantial economies and lower prices.

The advantages and the protections conferred upon corporations by Government increase in value as the size of the corporation increases. Some of these advantages are granted by the State which conferred a charter upon the corporation; others are granted by other States which, as a matter of grace, allow the corporation to do local business within their borders. But perhaps the most important advantages, such as the carrying on of business between two or more States, are derived through the Federal Government. Great corporations are protected in a considerable measure from the taxing power and regulatory power of the States by virtue of the interstate character of their businesses. As the profit to such a corporation increases, so the value of its advantages and protection increases.

Furthermore, the drain of a depression upon the reserves of business puts a disproportionate strain upon the modestly capitalized small enterprise. Without such small enterprises our competitive economic society would cease. Size begets monopoly. Moreover, in the aggregate these little businesses furnish the indispensable local basis for those nationwide markets which alone can ensure the success of our mass production industries. Today our smaller corporations are fighting not only for their own local well-being but for that fairly distributed national prosperity which makes large-scale enterprise possible.

It seems only equitable, therefore, to adjust our tax system in accordance with economic capacity, advantage and fact. The smaller corporations should not carry burdens beyond their powers; the vast concentrations of capital should be ready to carry burdens commensurate with their powers and their advantages.

We have established the principle of graduated taxation in respect to personal incomes, gifts and estates. We should apply the same principle to corporations. ...

And relevant to the current corporate cash accumulation:

We should likewise discourage unwieldy and unnecessary corporate surpluses. ...

I'm always amazed at the degree to which we have the same political debates over and over again.

'There is Nothing Inevitable about Low Rates of Economic Mobility'

Miles Corak:

There is nothing inevitable about low rates of economic mobility, by Miles Corak for Free Exchange: This week's Free exchange column discusses new research on rates of inter-generational social mobility (summary here). We are inviting experts in the field to comment on the piece and related research. Up first is Miles Corak...

[I]t seems to me that the series of papers by Long and Ferrie also suggest there is nothing inevitable about long-term persistence [in low economic mobility]. When labor markets become more dynamic, when public policy changes—particularly when it invests more broadly in the health, education and other forms of human capital of children—and when as a result families become more endowed with both monetary and non-monetary resources from which their children can benefit, then mobility will increase.

The real lesson from the historical research is not that there is anything inevitable about a low degree of inter-generational mobility, or that it signals more persistence than other research. The most privileged will do everything they can to perpetrate their status across generations, and in past eras the structure of labor markets and public policies permitted, and in some measure continue to permit, a non-level playing field.

Rather, the real lesson is that dynamic labor markets offering new opportunities to the population as a whole, progressive public policies of relatively more benefit to the relatively disadvantaged, and strong families with growing incomes and human capital will lead to much more mobility than aristocrats of a pervious era could ever have imagined.

'Wages, Fairness, and Productivity'

Chris Dillow:

Wages, fairness & productivity: Do higher wages motivate workers to work harder? A recent experiment conducted on Swiss newspaper distributors suggests the answer's yes, but only partially so:

Workers who perceive being underpaid at the base wage increase their performance if the hourly wage increases, while those who feel adequately paid or overpaid at the base wage do not change their performance.

This suggests that people are motivated not so much by the cold cash nexus as by feelings of reciprocal fairness...

Summers: How to Fix Our Costly and Unjust Tax System

Larry Summers:

How to fix costly and unjust US tax system, by Lawrence Summers, Commentary, Financial Times: Sooner or later the American tax code will be reformed. ...

So far, the debate has focused on scaling back provisions of the tax code that have favored activities traditionally deemed to be valuable..., reducing reliefs for charitable contributions, taxes paid to state and local governments, home mortgages, employer-provided health insurance and many less important provisions. There are reasonable arguments ... in each case. But taking only the “limit tax incentives” approach to tax reform has several major defects. [lists] ...

What is needed is an additional element, one that has largely been absent to date: the numerous exclusions from the definition of adjusted gross income... There are far too many provisions that favor a small minority of very fortunate taxpayers. ... it should not be possible to accumulate and transfer large fortunes while avoiding taxation almost entirely. Yet this is all too possible today. ... [lists several ways] ...

I believe it is plausible to raise $1tn over the next 10 years by going after provisions that cause what adds to wealth and spending not to be regarded as income.

It has been observed that the greatest scandals are not the illegal things that people do but the things that are fully legal. This is surely true with respect to a tax code in urgent need of reform.

[If you can't get to the article, it usually appears on the Washington Post's editorial page later in the day, though sometimes the editing is slightly different. Update: It's here.]

Robber Barons

The entry below this one reminded me of this old post featuring Brad DeLong on the Robber Barons (he wrote this in 1998, the actual essay is much, much longer):

Robber Barons, by J. Bradford DeLong, 1998: I. Introduction "Robber Barons": that was what U.S. political and economic commentator Matthew Josephson (1934) called the economic princes of his own day. Today we call them "billionaires." Our capitalist economy--any capitalist economy--throws up such enormous concentrations of wealth: those lucky enough to be in the right place at the right time, driven and smart enough to see particular economic opportunities and seize them, foresighted enough to have gathered a large share of the equity of a highly-profitable enterprise into their hands, and well-connected enough to fend off political attempts to curb their wealth (or well-connected enough to make political favors the foundation of their wealth).

Matthew Josephson called them "Robber Barons". He wanted readers to think back to their European history classes, back to thugs with spears on horses who did nothing save fight each other and loot merchant caravans that passed under the walls of their castles. He judged that their wealth was in no sense of their own creation, but was like a tax levied upon the productive workers and craftsmen of the American economy. Many others agreed: President Theodore Roosevelt--the Republican Roosevelt, president in the first decade of this century--spoke of the "malefactors of great wealth" and embraced a public, political role for the government in "anti-trust": controlling, curbing, and breaking up large private concentrations of economic power.

Their defenders--many bought and paid for, a few not--painted a different picture: the billionaires were examples of how America was a society of untrammeled opportunity, where people could rise to great heights of wealth and achievement on their industry and skill alone; they were public benefactors who built up their profitable enterprises out of a sense of obligation to the consumer; they were well-loved philanthropists; they were "industrial statesmen."

Over the past century and a half the American economy has been at times relatively open to, and at times closed to the ascension of "billionaires." Becoming a "billionaire" has never been "easy." But it was next to impossible before 1870, or between 1929 and 1980. And at other times--between 1870 and 1929, or since 1980--there has been something about the American economy that opened roads to the accumulation of great wealth that were at other times closed.

Does it matter whether an economy is open to the accumulation of extraordinary amounts of private wealth? When the economy is more friendly to the creation of billionaires, is economic growth faster? Or slower? And what role does politics play? Are political forces generally hostile to great fortunes, or are they generally in partnership? And when the political system turns out to be corrupt--to serve as a committee for extracting wealth from the people and putting it into the pockets of the politically well-connected super-rich--what is to be done about it? What can be done to curb explicit and implicit corruption without also reducing the pressure in the engine of capital accumulation and economic growth?

These are big questions. This essay makes only a start at answering them.

Here's an interesting note:

And this is the third thing ... about the turn of the century robber barons: even though the base of their fortunes was the railroad industry, they were for the most part more manipulators of finance than builders of new track. Fortune came from the ability to acquire ownership of a profitable railroad and then to capitalize those profits by selling securities to the public. Fortune came from profiting from a shift--either upward or downward--in investors' perceptions of the railroad's future profits. It was the tight integration of industry with finance that made the turn of the twentieth century fortunes possible. ...

The jump in wealth of the founders of these lines of business was intimately tied up with the creation of a thick, well-functioning market for industrial securities. And that would turn out to be a source of weakness when Wall Street came under fire during the Great Depression. ...

And:

Progressives did not believe that the billionaires were just the helpless puppets of market forces. In 1896 Democratic presidential candidate William Jennings Bryan called for the end to the crucifixion of the farmer by a gold standard working in the interests of Morgan and his fellow plutocrats. Fifteen years later Louis Brandeis warned Morgan partner Thomas Lamont--after whom Harvard University's main undergraduate library is named-that it was in fact in Morgan's interest to support the Progressive reform program. If Morgan's partners did not do so, Brandeis warned, the Progressives would recede. Their successors on the left wing of American politics would be real anarchists and real socialists (DeLong, 1991).

Louis Brandeis and company did not much care whether the billionaires of what they called the "money trust" were in any sense economically efficient. In Brandeis's mind, they're evil because their interests were large..., size alone made a billionaire's fortune "dangerous, highly dangerous." ...

Populists from the American midwest found this set of issues a reliable one, and their senators took turns calling for political and economic changes to reduce the power exercised by the super-rich. ...

The political debate was resolved only by the Great Depression. The presumed link between the stock market crash and the Depression left the securities industry without political defenders. The old guard of Progressives won during the 1930s what they had not been able to win in the three earlier decades.

Ironically, it was Republican president Herbert Hoover who triggered the process. Hoover thought that Wall Street speculators were prolonging the Depression and refusing to take steps to restore prosperity. He threatened investigations to persuade New York financiers to turn the corner around which he was sure prosperity waited. Thus, as Franklin D. Roosevelt put it, "the money changers were cast down from their high place in the temple of our civilization." The Depression's financial market reforms act broke the links between board membership, investment banking, and commercial banking-based management of asset portfolios that had marked American finance before 1930. Investment bankers could no longer be commercial bankers. Depositors' money could not be directly used to support the prices of newly-issued securities. Directorates could not be interlocked: that bankers could not be on the boards of directors of firms that were their clients.

D. The Drying-Up of the Flow of Billionaires

Whatever else Depression-era financial reforms did (and there are those who think it crippled the ability of Wall Street to channel finance to new corporations) and whatever else the New Deal did (and it did a lot to bring social democracy to the United States and to level the income distribution), one important--and intended--consequence was that thereafter it was next to impossible to become a billionaire.

Not that it was ever easy to become a billionaire, mind you, but the channels through which lucky, skilled, dedicated, and ruthless entrepreneurs had ascended were largely closed off. ...

The hostility of Roosevelt's New Deal to massive private concentrations of economic power was effective: the flow of new billionaires dried up, as the links between finance and industry that they had used to climb to the heights of fortune were cut.

This is the important question:

Did the hostility of America's political and economic environment to billionaires between 1930 and 1980 harm the American economy? Did it slow the rate of economic growth by discouraging entrepreneurship? As an economist--someone who believes that there are always tradeoffs--I would think "yes." I would think that there must have been a price paid by the closing off of the channels of financing for entrepreneurship through which E.H. Harriman, James J. Hill, George F. Baker, Louis Swift, George Eastman, and others had made their fortunes.

But if so, there are no signs of it in aggregate growth data. ...

V. Tentative Conclusions

So what can Americans expect from their current crop of billionaires? Or rather what can they expect from the processes that have allowed their creation?

They should be extremely dubious about billionaires' social utility. Their relative absence from the 1930s to the 1970s did not seem to harm economic growth in the United States. Their predecessors' claim to much of their wealth is, to see the least, dubious. And their large-scale presence was associated with the serious corruption of American politics.

Perhaps those who are going to be industrial statesmen have as reasonable a chance of truly being industrial statesmen in an environment hostile to billionaires, as in an environment friendly to their creation: at that level of operations, after all, money is just how people keep the score in their competitions against nature and against each other. ...

On the other hand, their personal consumption is only an infinitesimal proportion of their total wealth. Much less of Andrew Carnegie's fortune from his steel mills went to his own personal consumption than has gone to his attempts to promote international peace, or to build libraries to increase literacy.

The child who in mid-nineteenth century Scotland painfully learned to read from the handful of books he had access to in his family's two-room cottage as they fell closer and closer to the edge of starvation--that child is visible in the Carnegie libraries that still stand in several hundred cities and towns in the United States, and is visible around us now. ...

So if there is a lesson, it is roughly as follows: Politics can put curbs on the accumulation of extraordinary amounts of wealth. And there is a very strong sense in which an unequal society is an ugly society. I like the distribution of wealth in the United States as it stood in 1975 much more than I like the relative contribution of wealth today. But would breaking up Microsoft five years ago have increased the pace of technological development in software? Probably not. And diminishing subsidies for railroad construction would not have given the United States a nation-spanning railroad network more quickly.

So there are still a lot of questions and few answers. At what level does corruption become intolerable and undermine the legitimacy of democracy? How large are the entrepreneurial benefits from the finance-industrial development nexus through which the truly astonishing fortunes are developed? To what extent are the Jay Goulds and Leland Stanfords embarrassing but tolerable side-effects of successful and broad economic development?

I know what the issues are. But I do not yet--not even for the late nineteenth- and early twentieth-century United States--feel like I have even a firm belief on what the answers will turn out to be.

He's a bit reluctant to take a strong position against the robber barons, they are, perhaps, "tolerable side-effects of successful and broad economic development." I see more costs and fewer benefits than Brad, so I wouldn't give as much ground here as he does. But this was written before the Great Recession, and I'd be curious to hear if his view of "the entrepreneurial benefits from the finance-industrial development," and the necessity of tolerating these "side-effects" has changed in light of recent events.

Stiglitz: Mitt Romney’s Fair Share

Mitt Romney, and others like him, are weakening "the bonds that hold a society together":

Mitt Romney’s Fair Share, by Joseph Stiglitz, Commentary, Project Syndicate: Mitt Romney’s income taxes have become a major issue... Is this just petty politics, or does it really matter? In fact, it does matter... Economies in which government provides ... public goods perform far better than those in which it does not. But public goods must be paid for, and ... those at the top of the income distribution who pay 15% ... clearly are not paying their fair share. ...

Democracies rely on a spirit of trust and cooperation in paying taxes. If every individual devoted as much energy and resources as the rich do to avoiding their fair share of taxes, the tax system either would collapse, or would have to be replaced by a far more intrusive and coercive scheme. Both alternatives are unacceptable.

More broadly, a market economy could not work if every contract had to be enforced through legal action. But trust and cooperation can survive only if there is a belief that the system is fair. ... Yet, increasingly, Americans are coming to believe that their economic system is unfair; and the tax system is emblematic of that sense of injustice. ...

Romney may not be a tax evader; only a thorough investigation by the US Internal Revenue Service could reach that conclusion. But, given that the top US marginal income-tax rate is 35%, he certainly is a tax avoider on a grand scale. And, of course, the problem is not just Romney; writ large, his level of tax avoidance makes it difficult to finance the public goods without which a modern economy cannot flourish.

But, even more important, tax avoidance on Romney’s scale undermines belief in the system’s fundamental fairness, and thus weakens the bonds that hold a society together.

On the unfairness, beyond taxes Stiglitz also notes that:

...much of the money that accrues to those at the top is what economists call rents, which arise not from increasing the size of the economic pie, but from grabbing a larger slice of the existing pie. Those at the top include a disproportionate number of monopolists who increase their income by ... anti-competitive practices; CEOs who exploit deficiencies in corporate-governance laws to grab a larger share of corporate revenues for themselves (leaving less for workers); and bankers who have engaged in predatory lending and abusive credit-card practices (often targeting poor and middle-class households). It is perhaps no accident that rent-seeking and inequality have increased as top tax rates have fallen, regulations have been eviscerated, and enforcement of existing rules has been weakened: the opportunity and returns from rent-seeking have increased.

To the extent that this is true, those at the top are receiving income they didn't earn through their contributions to GDP. It is the result of rent-seeking -- they didn't "build that"  -- and clawing back those gains through taxes is not unfair, and it does not distort economic activity. Instead it reverses existing distortions that send income to the top of the income distribution instead of to the working class as a reward for their increased productivity.

Equal Opportunity and Economic Growth

Republicans tell us that tax cuts promote economic growth. But the evidence doesn't support this. As Paul Krugman says:

Remember how the economy tanked after Clinton raised taxes? Remember how great things were after Bush cut them? Oh, wait.

But the evidence is much more favorable to something the Democrats favor, increasing opportunity:

Equal Opportunity and Economic Growth,  by Tim Taylor: A half-century ago, white men dominated the high-skilled occupations in the U.S. economy, while women and minority groups were often barely seen. Unless one holds the antediluvian belief that, say, 95% of all the people who are well-suited to become doctors or lawyers are white men, this situation was an obvious misallocation of social talents. Thus, one might predict that as other groups had more equal opportunities to participate, it would provide a boost to economic growth. Pete Klenow reports the results of some calculations about these connections in "The Allocation of Talent and U.S. Economic Growth," a Policy Brief for the Stanford Institute for Economic Policy Research. ...

Klenow can ... estimate how much of U.S. growth over the last 50 years or so can be traced to greater equality of opportunity, which encouraged many in women and minority groups who had the underlying ability to view it as worthwhile to make a greater investment in human capital.

"How much of overall growth in income per worker between 1960 and 2008 in the U.S. can be explained by women and African Americans investing more in human capital and working more in high-skill occupations? Our answer is 15% to 20% ... White men arguably lost around 5% of their earnings, as a result, because they moved into lower skilled occupations than they otherwise would have. But their losses were swamped by the income gains reaped by women and blacks."

At least to me, it is remarkable to consider that 1/6 or 1/5 of total U.S. growth in income per worker may be due to greater economic opportunity. In short, reducing discriminatory barriers isn't just about justice and fairness to individuals; it's also about a stronger U.S. economy that makes better use of the underlying talents of all its members.

"The Age of Equality"

The history of the "widely accepted compromise between aggregate prosperity and distributional equality":

The Age of Equality, by Richard Pomfret, Vox EU: Economic reporting in the media frequently appears superficial since important economic processes may take decades for their consequences to work through, whereas media typically need fresh daily or weekly news. Economic history provides an antidote to this rush-to-judgement (e.g. Frindlay and O’Rourke 2008, Eichengreen and Irwin 2009).

It is in this spirit that my new book, The Age of Equality, argues that we are still experiencing the long-term consequences of the industrial revolution of the 1700s, and that the current state of that process involves a widely accepted compromise between aggregate prosperity and distributional equality.

Unlike political revolutions that can be dated to 1789 or 1917, the industrial revolution does not have a precise date. However, by the early 1800s it had clearly taken hold in parts of northwest Europe. The new industrial production involved factories with division of labour (exemplified by Adam Smith’s pin factory on the UK’s £20 banknotes) which employed increasingly capital-intensive techniques and applied the results of scientific, or at least casual empirical, observation. It was associated with risk-taking entrepreneurs and mobile workers, who responded to price incentives and were rewarded if they made the right decisions. The process was opposed by those enjoying privileges in the pre-industrial economy, e.g. inherited monarchs with absolute power, landowners with serfs or guild members.

Countries adopting the new system enjoyed unprecedented long-term economic growth. They sought and won global markets for their products so that they could expand the division of labour and capital-intensity of their factories, and they established global empires. Success was no secret. The new system spread across Europe, regions settled by Europeans, and a few other places (notably Japan).

Change was resisted by the ancien régime or by imperial rulers. The 1800s were an Age of Liberty because successful economies were those in which people enjoyed sufficient freedom to respond to economic incentives. The pressure to allow such freedom culminated in the 1910s, with the collapse of the great dynastic empires centred in Saint Petersburg, Vienna, Berlin, Constantinople and Peking.

Opposition to unbridled capitalism

Yet, even as living standards increased, opposition to unbridled capitalism strengthened. In all of the high-income countries there is evidence of income inequality peaking around the first decade of the twentieth century.

• In the US, progressives pushed to reduce the power of the rich by antitrust legislation and to protect the poor by social policies.
• In Europe, socialists’ challenge to capitalism was more fundamental.

The great experiment of the twentieth century was a competition between economic systems over which could best balance prosperity and equality.

The principal challenger was the Soviet centrally planned economy. The success of planning in mass-producing a standardised good was highlighted by the Red Army’s successes in 1938-9 against Japan and in the 1941-5 war against Germany. Central planning was also successful in mobilising resources for a specific goal (e.g. sputnik, the first man in space, or winning Olympic medals) and to satisfy basic needs (e.g. housing, education and healthcare).

Central planning was less successful at continuously improving workplace productivity once the initial enthusiasm for Communism or wartime patriotism had ebbed, or in meeting diversified consumer wants once basic needs had been satisfied. Most of all the central planning was hopeless in allocating capital so that diminishing returns were offset by technical change. The clearest statistical indicator of economic failure is the increasing incremental capital-output ratio (i.e how much capital is needed to generate a one unit flow of output) in the Soviet Union from a normal 3-4 in the 1950s to 15 in the early 1980s. By then the economic failure of central planning was obvious to all.

Capitalism’s mixed fortunes

The market-based economies experienced mixed fortunes in the first half of the twentieth century. Memories were dominated by the depression of the 1930s, which fuelled demands for reduced inequality. However, Europe enjoyed economic growth over the years 1919-39, and for North America the 1920s were a period of prosperity and innovation.
Henry Ford extended the productivity of the factory system by combining interchangeable parts with the assembly line, bringing down the price of a car to the extent that by 1929 over 23 million cars were in use in the US, for a population of 123 million. Ford, however, lost its premier position in the 1930s to General Motors, which adopted assembly line production and offered a choice of models and colours.

The interwar period also saw the spread of vacuum cleaners, which required novel marketing to convince housewives of their value; of refrigerators, whose value was augmented by Clarence Birdseye patenting an effective frozen food technology, and of washing machines, whose use was increased by the innovation of laundromats. These durable consumer goods were all items that central planning was poor at producing in a range of attractive models accessible to a mass market.

The 1989 watershed

By 1989 the victory of market-based economic system was clear, but the winner was not pure capitalism. Governments intervened not just in the classic roles of supplying law and order and public goods, but also to provide greater equality of opportunity and outcome. In a market economy people are rewarded according to the value of their marginal product, but this is low for the old, the sick, or the handicapped People may lose their source of income for reasons beyond their control, and require time to search for the best new source of income. The children of rich parents get a better start in life through better nutrition, healthcare and education. In all of these areas, governments intervene. The relative focus on equality of outcome and equality of opportunity vary, but the desirability of intervention is no longer a matter of serious disagreement.

On a global scale, the gross inequalities of the early 1900s have been eroded. In the mid-1900s empires were dissolved and modernising governments came to power. Influenced by Soviet success, most regimes adopted economic systems with a heavy state hand, which succeeded initially in mobilising resources, but whose limitations were clear by the 1970s. In the final quarter of the twentieth century, country after country adopted more market-based systems and integrated into the global economy. These emerging economies included some of the world’s most populous countries, i.e. China, Mexico, India, Brazil, Indonesia and many more.

Emerging economies: Mixed models

The emerging economies are clearly market-based, but none embraces pure capitalism. Even Hong Kong, the most capitalist economy even while a colony, provided efficient social services and universal public education and healthcare. By the early 2000s, the market economy, and associated pressures for liberty and equality, held undisputed status as the desirable economic system.

This is not the end of history. Debates, rightly, rage in democratic market economies about the appropriate balance between market-driven prosperity and state-mediated equality. In the US the current focus is on healthcare, and in Europe and Australasia on funding for tertiary education. In all countries, aging populations and archaic pension rights pose serious challenges.

At a global level, tensions between established and emerging powers, unlike in 1914-45, cannot be settled by total war. The presence of weapons of mass destruction, cross-border environmental issues and global warming, the responsibility to protect citizens from barbaric governments and the dangers of rogue states all point to the need for international cooperation. The WTO with its almost universally agreed, and abided by, rules for trade despite the lack of serious enforcement mechanisms is an example of imperfect, but functioning, mutually beneficial cooperation. Governance of other multilateral institutions established in the 1940s (the UN, IMF and World Bank) clearly requires reform, while some global and regional problems may require novel institutions. Initiatives like the Svalbard Global Seed Bank, which is supported by regimes as varied as Zimbabwe, North Korea and Syria, provide insurance against inadequate crop biodiversity. The twenty-first century will be the Age of Fraternity because cooperation will be required in the global economy, even though the process may be slow and uneven.

What are the implications for the nearer future? Politicians who rail against socialism or the market always adopt a more moderate stance after they come into office – not because they are cowed by outside forces, but because this is what their electorates want. At any point in time, some voters will be animated by encroachments of the state or by market-generated excesses, but these cannot plausibly be seen as appeals for unfettered capitalism or central planning. The reality is of choices within a narrow band whose limits have been determined by a quarter millennium of economic history.

References

Pomfret, Richard (2011). The Age of Equality: The Twentieth Century in Economic Perspective, Harvard University Press.

Findlay, Ronald and Kevin H O’Rourke (2008), “Lessons from the history of trade and war”, VoxEU.org, 10 March.

Eichengreen, Barry and Douglas Irwin (2009), “The protectionist temptation: Lessons from the Great Depression for today”, VoxEU.org, 17 March.

Equal Rights Spurred Productivity

Chrystia Freeland highlights research showing that reduced discrimination over the last 50 years gave the economy a substantial boost -- increased fairness gave us increased efficiency. Unfortunately, however, it appears that new barriers may be emerging:

Equal rights and the U.S. economy, by Chrystia Freeland: Are equal rights good for the economy? ... A draft paper by four U.S. economists makes the strong empirical case... Fairness, they contend, has made the economy more productive. Chang-Tai Hsieh, Erik Hurst, Charles Jones and Peter Klenow argue that as much as 20 percent of the growth in productivity in the United States over the past 50 years can be attributed to expanded opportunities for women and blacks. ...

Few women or blacks would describe the United States today as a perfectly color- or gender-neutral economy. But ... female and black workers have felt the change directly in their paychecks. According to the paper, the reduction in frictions since 1960 increased real wages for white women 39 percent; those of black women, who suffered double discrimination and therefore got a double boost, 57 percent; and those of black men 44 percent.

But while the economy as a whole benefited, there was one group that lost out. The paper calculates that the “reduced friction” for women and blacks meant that the real wages of white men were 4.3 percent lower than they would have been without the increased competition. That result explains a political reality that we often don’t like to admit: Gains for women and blacks have come at a price for white men, and that is surely why some of them still resist the rights revolution. ...

The story in their draft paper on women and blacks is positive... But the four economists suspect that for one category of Americans, the poor, the external barriers to professional success have actually increased. ...

Hurst made sure I understood that this final point was just a hypothesis. The economists plan to run it through their model over the next few months and report on their results later this year. But if their theory pans out, their work will tell a story about America over the past 50 years that many of us intuitively will feel to be true – a country that discriminates less and less on the basis of gender, race and now sexual orientation, but where the class divide is becoming so stark as to constitute a new form of discrimination.

Increased inequality and the associated decrease in mobility are usually presented as as issues of fairness, but when barriers prevent people from realizing their potential that has implications for efficiency as well. It hurts both individuals and the economy as a whole when some groups of people face "external barriers."

Fairness Matters

Chrystia Freeland:

Fairness Can Pay Economic Dividends, by Chrystia Freeland, NY Times: There’s a reason they call economics the dismal science, but Professor Armin Falk’s presentation at an economics conference in Berlin a few days ago made me smile. That’s because his big conclusion — fairness has a financial pay-off — is so cheering...

Prof. Falk’s conclusion is easy to square with our experience of everyday life. Any parent — I’m a mother of three — knows that nothing enrages a child a more than the belief that her brother or sister is getting preferential treatment. Everyone with a job knows the same thing — there are few things more demotivating than discovering that the guy in the cubicle next to you, who does the same job you do, earns more.

But that instinctive sense that fairness matters hasn’t always been shared by mainstream economics. Instead, economists have built their models around the idea of ‘homos economicus,’ a human being who is perfectly rational and whose only goal is to pursue his economic self-interest.

Prof. Falk goes a long way to debunking that view. ... Read what conclusions he comes to in my column...

Here's a bit from the link (which is broken in the actual article). For those who think efficiency is all that matters, notice that fairness matters for efficiency:

The Triumph of the Social Animal, by Chrystia Freeland, Reuters: Does fairness matter? .... Economics ... hasn’t traditionally been much concerned with fairness. ... The alternate view was advanced by Armin Falk, a Bonn University economist, at a recent economics conference in Berlin organized by the Institute for New Economic Thinking. It emphasizes the importance of fairness and trust to human behavior. This approach takes as its starting point the idea that we are social animals, driven powerfully by how we fit into our community.

The social animal school may sound touchy-feely, but one of its favorite research tools is the M.R.I. ... In one experiment, subjects were paid 50 percent more, the same amount or 50 percent less than a peer for doing the same amount of work. Crucially, the absolute payment the research subject received in each case was identical.

But brain scans showed that fairness had a strong impact at a neurological level. Anyone who has ever held a job or has a sibling won’t be surprised to learn that the most powerful response was evoked when the research subject was underpaid, compared with his identically tasked peer. Interestingly, when researchers simulated low social status..., unfair treatment mattered less. The meek may inherit the earth, but in the meantime they have been conditioned to accept less than their fair share.

In another experiment, Dr. Falk and Ernst Fehr, of the University of Zurich, investigated [the question]: Does our perception of fairness influence how hard we work? Their answer is yes — workers who are underpaid don’t work as hard. ...

The next step is to adopt these discoveries about the social animal to our thinking about the broader political economy. In one way or another, this year’s pivotal elections will all be about the economy, stupid. But a sophisticated understanding of how the economy really works means thinking not just about gross domestic product, but about fairness and autonomy, too.

Here's a video of the talk:

"The Difference Between Private and Public Morality"

I don't have Robert Reich's flair as a writer, but this is exactly what I was trying to say in "The Real Moral Problem" which was written in response to a column from David Brooks about the supposed moral decay in the middle class:

The Difference Between Private and Public Morality, by Robert Reich: Republicans have morality upside down. Santorum, Gingrich, and even Romney are barnstorming across the land condemning gay marriage, abortion, out-of-wedlock births, and access to contraception, and the wall separating church and state.

But America’s problem isn’t a breakdown in private morality. It’s a breakdown in public morality. What Americans do in their bedrooms is their own business. What corporate executives and Wall Street financiers do in boardrooms and executive suites affects all of us.

There is moral rot in America but it’s not found in the private behavior of ordinary people. It’s located in the public behavior of people who control our economy and are turning our democracy into a financial slush pump. It’s found in Wall Street fraud, exorbitant pay of top executives, financial conflicts of interest, insider trading, and the outright bribery of public officials through unlimited campaign “donations.” ...

Americans are entitled to their own religious views about gay marriage, contraception, out-of-wedlock births, abortion, and God. We can be truly free only if we’re confident we can go about our private lives without being monitored or intruded upon by government, and can practice whatever faith (or lack of faith) we wish regardless of the religious beliefs of others. A society where one set of religious views is imposed on a large number of citizens who disagree with them is not a democracy. It’s a theocracy.

But abuses of public trust such as we’ve witnessed for years on the Street and in the executive suites of our largest corporations are not matters of private morality. They undermine the integrity of our economy and democracy. They’ve led millions of Americans to conclude the game is rigged. ...

An economy is built on a foundation of shared morality. Adam Smith never called himself an economist. The separate field of economics didn’t exist in the eighteenth century. He called himself a moral philosopher. And the book he was proudest of wasn’t “The Wealth of Nations,” but his “Theory of Moral Sentiments” – about the ties that bind people together into societies.

Twice before progressive have saved capitalism from its own excesses by appealing to public morality and common sense. First in the early 1900s, when the captains for American industry had monopolized the economy into giant trusts, American politics had sunk into a swamp of patronage and corruption, and many factory jobs were unsafe – entailing long hours of work at meager pay and often exploiting children. In response, we enacted antitrust, civil service reforms, and labor protections.

And then again in 1930s after the stock market collapsed and a large portion of American workforce was unemployed. Then we regulated banks and insured deposits, cleaned up stock market, and provided social insurance to the destitute.

We must do so again.

I put it this way just before the Occupy Wall Street protests broke out:

... Many of the policies enacted during and after the Great Depression not only addressed economic problems but also directly or indirectly reduced the ability of special interests to capture the political process. Some of the change was due to the effects of the Depression itself, but polices that imposed regulations on the financial sector, broke up monopolies, reduced inequality through highly progressive taxes, and accorded new powers to unions were important factors in shifting the balance of power toward the typical household.

But since the 1970s many of these changes have been reversed. Inequality has reverted to levels unseen since the Gilded Age, financial regulation has waned, monopoly power has increased, union power has been lost, and much of the disgust with the political process revolves around the feeling that politicians are out of touch with the interests of the working class.
 
We need a serious discussion of this issue, followed by changes that shift political power toward the working class. But who will start the conversation? Congress has no interest in doing so; things are quite lucrative as they are. Unions used to have a voice, but they have been all but eliminated as a political force. The press could serve as the gatekeeper, but too many news outlets are controlled by the very interests that the press needs to confront. Presidential leadership could make a difference, but this president does not seem inclined to take a strong stand on behalf of the working class despite the surprising boldness of his job-creation speech.
 
Another option is that the working class will say enough is enough and demand change. There was a time when I would have scoffed at the idea of a mass revolt against entrenched political interests and the incivility that comes with it. We aren’t there yet – there’s still time for change – but the signs of unrest are growing, and if we continue along a two-tiered path that ignores the needs of such a large proportion of society, it can no longer be ruled out.

Despite the fact that things are calmer now in terms of OWS and other visible signs of protest, and the fact that the outlook for the economy is improving, the underlying tensions are still there, and still building. If recovery means a whole bunch of people with worse jobs than before, reduced social protection in the name of deficit reduction, and a continuation of the trend toward an increasingly two-tiered society, the dissatisfaction won't end.

Stiglitz: Income Inequality Bad for Economy

Via the Joe Stiglitz fake twitter feed:

Famed economist: Income inequality bad for economy, by Andrew Tangel, NorthJersey.com: Joseph Stiglitz ... offered a sobering outlook on Europe's debt crisis...

After his speech Wednesday — part of the Eastern Economic Association speaker series — The Record sat down with Stiglitz to talk about wealth inequality, taxes and how to spur growth in the United States.

Q. Occupy Wall Street has forced income inequality into national discourse. Putting aside the question of whether disparities in income and wealth are fair, what is the impact of income and wealth inequality in this country, and if that gap continues to grow, what could be the economic consequences?

Inequality is bad for growth, stability and efficiency. … Inequality peaked both before the Great Depression and before the Great Recession, and it's not an accident. So basically, when we have a lot of inequality, demand goes down. … All this inequality was offset by creating a bubble. The bubble allowed people to consume more. Now we have the inequality but we don't have a bubble, and that means that we will have persistent, weak demand, and therefore unless we create another bubble it's going to be very difficult for us to get back to full employment.

A lot of the inequality that we have in the United States is created by distortions – excessive financial sector, monopolies like Microsoft … giving the oil companies, mining companies resources at a discount. … These things distort the economy, while they create wealth at the top. So it's not wealth creation – it's wealth redistribution, which makes the size of the pie smaller. ...

Q. We're in a presidential election and there are a lot of economic arguments being made regarding tax and regulatory policies and the labor market. What do you see some of the biggest economic myths — and misunderstandings — permeating today's political discourse in the United States?

The first is that reducing the budget deficit would stimulate the economy by restoring confidence... No evidence that has ever worked. You might call it the austerity myth – that's the most serious one.

The second one is that raising taxes on upper-income individuals will lead them to save less, invest less, will have adverse supply-side effects. Again, no evidence of that.

The third is that lowering [the] corporate income tax rate across the board will stimulate investment in the United States. No evidence of that. … If you want to encourage investment, what you do is lower taxes on firms that invest and you raise taxes on firms that don't invest. You can restructure the taxes to provide incentives to invest.

The answer to the first question makes a point I've been trying to emphasize. If the distribution of income is distorted by monopoly power, political power, and other market failures (e.g. taking advantage of informational asymmetries to sell questionable assets to unsuspecting customers who are reassured by triple A ratings, and so on), then taxing away some of the money and redistributing it to where it would have gone without the distortions is justifiable. And it shouldn't create the sort of distortions to job creation, etc., that the wealthy complain about in response to proposals to raise their taxes. In fact, it's doubtful that taxing the wealthy would have harmful effects of growth even if the distortions to the income distribution were eliminated. But when distortions exist, when taxes are simply returning the distribution of income to the proportions that conservatives argue are optimal, there's no need to even ask the question about whether it will harm growth. It won't. In fact, as Stiglitz notes (and as I have not noted nearly enough when talking about this), the distorted flow of income distorts incentives away from their optimal configuration and thus, if anything, lowers economic growth. I don't think the growth (efficiency) effects are large, for me this is more about equity than efficiency, but conservatives believe these distortions are very important and thus, if growth rather than upward redistribution was really their concern, they'd support efforts to eliminate these distortions. The fact that they don't is telling.

And note another important point. Redistributing the tax burden can do more to promote growth than lowering taxes across the board. The reason is that lowering taxes for everyone gives benefits -- needlessly -- to firms who have no plans to invest, tax cut or not. From an incentive point of view, that's wasteful. Money was spent that did nothing to generate investment. Had the money been used elsewhere, e.g. to promote investment among firms that might actually respond, then we would get more growth per dollar of tax cuts ("bang for the buck" ought to be just as important for tax cuts as it is with government spending). Thus, as Stiglitz says, we can take tax cuts away from firms who are not responding to them and redirect them elsewhere. That gives us the desired increase in investment and growth without increasing the deficit, and hence reduces the pressure to make cuts in social programs or to raise taxes elsewhere to compensate for all the money wasted on tax cuts given to firms who will not increase investment in response. Giving tax cuts to firms who will not react to them simply redistributes income without producing the desired outcome on economic growth. Once again, if anything this type of redistribution lowers efficiency and growth, the opposite of what is intended.

DeLong: The 70% Solution

Busy morning -- quick one between meetings:

The 70% Solution, by J. Bradford DeLong, Commentary, Project Syndicate: Via a circuitous Internet chain – Paul Krugman of Princeton University quoting Mark Thoma of the University of Oregon reading the Journal of Economic Perspectives – I got a copy of an article written by Emmanuel Saez, whose office is 50 feet from mine, on the same corridor, and the Nobel laureate economist Peter Diamond. Saez and Diamond argue that the right marginal tax rate for North Atlantic societies to impose on their richest citizens is 70%.

It is an arresting assertion, given the tax-cut mania that has prevailed in these societies for the past 30 years, but Diamond and Saez’s logic is clear. The superrich command and control so many resources that they are effectively satiated: increasing or decreasing how much wealth they have has no effect on their happiness. So, no matter how large a weight we place on their happiness relative to the happiness of others – whether we regard them as praiseworthy captains of industry who merit their high positions, or as parasitic thieves – we simply cannot do anything to affect it by raising or lowering their tax rates.

The unavoidable implication of this argument is that when we calculate what the tax rate for the superrich will be, we should not consider the effect of changing their tax rate on their happiness, for we know that it is zero. Rather, the key question must be the effect of changing their tax rate on the well-being of the rest of us.

From this simple chain of logic follows the conclusion that we have a moral obligation to tax our superrich at the peak of the Laffer Curve... [continue reading]...

The Source of Cronyism Is *Not* Social Programs for the Poor

Jeff Sachs:

Fairness and the Occupy Movement Revisited, by Jeff Sachs: A recent Wall Street Journal article by Arthur C. Brooks on the Occupy Movement and fairness says some interesting things about potential common ground between free-market ideas and the Occupy movement. Yet Brooks also commits some very important errors. ...

Brooks, the head of the American Enterprise Institute, denounces crony capitalism as the dark side of American politics and economics. On this we should all agree. The level of corruption in Washington is staggering, growing, and rife in both parties. ...

The Republicans answer to crony capitalism is to slash government. Yet by this they mean mainly an attack on the remaining social programs. This is a kind of bait-and-switch strategy: rev up the anger against government corruption, and then kill the life-support programs of the poor and working class. Crony capitalism exists mainly in the big-ticket sectors of the economy -- banking, oil, real estate, private health insurance, military contractors, and infrastructure -- not in the essential but much smaller parts of the economy: malnutrition of poor children, lack of quality pre-school, insufficient job training, and inadequate student loan coverage.

Yes, crony capitalism should be confronted anywhere in the economy, yet cutting the life-support systems for the working class and poor won't fix government, but instead would cripple the prospects of more than 100 million poor and near-poor Americans. To control crony capitalism, we need to direct our attention where it belongs: the wealth-support systems of the rich, not the life-support systems of the poor. ...

Yes, Mr. Brooks, let us find common ground. We all agree on the need to end crony capitalism. But let us also work together not to cripple government but to make it work for all Americans.

The hope for common ground where there is none can lead to Obama like one-sided concessionary behavior, and we have more than enough of that already. Yes, let's find common ground where it exists, but let's also be careful not to try to meet in the middle when the other side is pursuing a bait and switch strategy. The Republican goal of reducing the size of government through reductions in social programs is unwavering, and they will pursue any argument handy at the moment to bring this about. In recessions, they tell us tax cuts are needed to stimulate the economy, but the real goal is to cut funding for the government permanently. Once the taxes are reduced, they won't agree to increase them again (unless it's to protect their cronies, i.e. an increase in payroll taxes is fine so long as it prevents the increase in taxes on the wealthy needed to fund it). In normal times, we're told tax cuts stimulate economic growth even though there's not much evidence to support this claim. Presently, it's the cronyism argument, and tomorrow it will be something else. The Republicans have their eyes on the ball, and the rules of the game are to be adjusted as necessary to allow them the best opportunity to take the ball across the goal line. Winning is all that matters. Fairness for both sides playing the game, etc. has nothing to do with it and we'd be wise to keep our eyes on the ball as well.

The other thing to note is that the location of common ground has shifted to the right from where it used to be. "Meet us in the middle" now means meeting on ground that would have been considered on the right not all that long ago. Democrats have already conceded too much in the ideological war, and there comes time when leaders in the party must take a stand and hold their ground. That time is long past.

Stiglitz: The Globalization of Protest

Swamped today -- quick one on "successful (and sometimes corrupt) rent-seekers":

The Globalization of Protest, by Joseph E. Stiglitz, Commentary, Project Syndicate: The protest movement that began in Tunisia in January, subsequently spreading to Egypt, and then to Spain, has now become global, with the protests engulfing Wall Street and cities across America. Globalization and modern technology now enables social movements to transcend borders as rapidly as ideas can. And social protest has found fertile ground everywhere: a sense that the “system” has failed, and the conviction that even in a democracy, the electoral process will not set things right – at least not without strong pressure from the street.

In May, I went to the site of the Tunisian protests; in July, I talked to Spain’s indignados; from there, I went to meet the young Egyptian revolutionaries in Cairo’s Tahrir Square; and, a few weeks ago, I talked with Occupy Wall Street protesters in New York. There is a common theme, expressed by the OWS movement in a simple phrase: “We are the 99%.”

That slogan echoes the title of an article that I recently published, entitled “Of the 1%, for the 1%, and by the 1%,” describing the enormous increase in inequality in the United States: 1% of the population controls more than 40% of the wealth and receives more than 20% of the income. And those in this rarefied stratum often are rewarded so richly not because they have contributed more to society – bonuses and bailouts neatly gutted that justification for inequality – but because they are, to put it bluntly, successful (and sometimes corrupt) rent-seekers. ...[continue reading]...

Raise Taxes on the Wealthy: It’s the Fair Thing to Do

When this column appeared appeared on MSN.com, it got hundreds of comments (it was originally published here). I didn't read them, the 73% thumbs down (plus the email I received) was enough to tell me what the comments probably said, and a few people who did read them said I shouldn't bother -- for the most part they hated it.

Here's the unedited version:

Raise Taxes on the Wealthy: It’s the Fair Thing to Do: Many economists worry that making societies more equal through income redistribution lowers economic growth. This “big tradeoff” between equality and efficiency, which is supported by comparisons of capitalist and socialist countries, implies that there is a limit to how much redistribution a society should pursue. At some point the tradeoff of more equality for less output – which worsens as we push toward more and more equality – becomes intolerable.

The Bush tax cuts were justified, in part, by the claim that equity had overshadowed efficiency in tax policy decisions. Taxes on the wealthy and the inefficiencies that come with them were much too high, it was argued, and lowering taxes would cause output to go up enough to lift all boats substantially. Accordingly, the lower end of the income distribution would fare much better after income trickled down than it would under redistributive policy.

The economy did grow after the tax cuts, but the rate of growth was unremarkable, especially for jobs, and there’s little evidence that the Bush tax cuts caused large increases in output growth as promised. In fact, there’s little evidence that they had any effect at all.

And the tax cuts at the upper end of the income distribution did nothing to correct for the fact that although worker productivity was rising, wages remained flat – a problem that began in the mid 1970s. This was an indication that something was amiss in the mechanism that distributes income to different members of society. Workers were helping to increase the size of the pie, but income did not trickle down as promised and their share of the pie was no larger than before.

This is not the only way in which the distribution of income has become disconnected from productivity. While some argue that those at the top of the income distribution earn every cent they receive, and hence deserve to keep all of it, there is plenty of evidence that the income of financial executives, CEOs of major corporations, etc. exceeds the value of what they contribute to society by a considerable margin. That holds true even without the financial crisis, but how, exactly, can we justify the extraordinarily high income of this group when the result of their actions was to ruin the economy?

If those at the top of the income distribution receive far more than the value of what they create, and those at lower income levels receive less, then one way to correct this, at least in part, is to increase taxes at the upper end of the income distribution and use the proceeds to protect important social programs that benefit working class households, programs that are currently threatened by budget deficits. This would help to correct the mal-distribution of income that is preventing workers from realizing their share of the gains from economic growth.

And there is another reason why taxes on the wealthy should go up. Someone has to pay taxes, and the question is how to distribute the burden among taxpayers. Many believe, and I am one of them, that progressive taxes are the most equitable way to do this. In particular, the last dollar of taxes paid should cause the same amount of sacrifice for rich and poor alike.

There has been an attempt to make it appear that taxes are mostly paid by the wealthy, e.g. the deceptive claim that half the people pay no taxes is part of this. But taxes are less progressive than before the Bush tax cuts, and when all taxes at all levels of government are taken into account “the U.S. tax system just barely qualifies as progressive.” Making taxes more progressive would, in my view, make them more equitable.

We face a choice between cutting key benefits for the middle class and creating an ever more unequal society, or raising taxes on the wealthy to preserve the social programs that lower income households rely upon. We hear that raising taxes is unfair, and that tax increases will harm economic growth. But there’s nothing unfair about correcting the mal-distribution of income that we’ve seen in recent decades, or about making sure the burden from paying taxes is more equitable than it is now. And there’s no reason to fear that economic growth will be lower if taxes are increased. Cutting taxes on the wealthy during the Bush years didn’t stimulate growth and raising taxes back to the levels we’ve had in the past – times when growth was quite robust – won’t have much of an effect either.

The claim that there is a tradeoff between equity and efficiency was a key part of the argument for tax cuts for the wealthy, but the tradeoff didn’t materialize. We sacrificed equity for the false promise of efficiency and growth, and society is now more unequal than at any time since the early part of the last century. It’s time to reverse that mistake.

"The Flat-Tax Fraud"

Robert Reich does not like the flat tax (I don't either):

The Flat-Tax Fraud, and the Necessity of a Truly Progressive Tax, by Robert Reich: Herman Cain’s bizarre 9-9-9 plan would replace much of the current tax code with a 9 percent individual income tax and a 9 percent sales tax. He calls it a “flat tax.” Next week Rick Perry is set to announce his own version of a flat tax. ...

The flat tax is a fraud. It raises taxes on the poor and lowers them on the rich. ... The rich usually pay a higher percent of their incomes in income taxes than do the poor. A flat tax would eliminate that slight progressivity.

Nowadays most low-income households pay no federal income tax at all – a fact that sends many regressives into spasms of indignation. They conveniently ignore the fact that poor households pay a much larger share of their incomes in payroll taxes, sales taxes, and property taxes (directly, if they own their homes; indirectly, if they rent) than do people with high incomes. ...

The truth is the current tax code treats everyone the same. It’s organized around tax brackets. Everyone whose income reaches the same bracket is treated the same as everyone else whose income reaches that bracket (apart from various deductions, exemptions, and credits, of course).

For example, no one pays any income taxes on the first $20,000 or so of their income... People in higher brackets pay a higher rate only on the portion of their income that hits that bracket — not on their entire incomes.

So when Barack Obama calls for ending the Bush tax cut on incomes over $250,000, he’s only talking about the portion peoples’ incomes that exceed $250,000. He’s not proposing to tax their entire incomes at the higher rate that prevailed under Bill Clinton.

Republicans have tried to sow confusion about this. They want Americans to believe, for example, that if the Bush tax cut ended, small business owners with incomes of $251,000 a year would suddenly have to pay 39 percent of their entire incomes in taxes rather than 35 percent. Wrong. They’d only have to pay the 39 percent rate on $1,000 – the portion of their incomes over $250,000. ...

The Republicans’ push for a flat tax masks what’s really going on.

Remember: The top 1 percent is now raking in over 20 percent of the nation’s total income and owns over 35 percent of the nation’s wealth. Under almost anyone’s view of fairness, these are grotesque portions. They’re especially large relative to what they were as recently as thirty years ago, when the top 1 percent raked in under 10 percent. And these huge portions at the top continue to increase.

Simple fairness requires three things: More tax brackets at the top, higher rates in each bracket, and the treatment of all sources of income (capital gains included) exactly the same. ...

The confusion over marginal tax rates (i.e. that higher tax rates only apply to income past certain thresholds) is widespread and an obstacle to progressive tax reform.

Raise Taxes on the Wealthy: It’s the Fair Thing to Do

New column:

Why America Should Spread the Wealth

Sharing the Burden

It's true that raising taxes on the wealthy won't, by itself, solve the long-run deficit problem. But it can still contribute quite a bit to the solution:

...Returning the average tax rate on the top 1 percent of taxpayers to its 1996 level of 29 percent could raise about $100 billion a year, or $1 trillion over the next decade.

By itself, of course, that wouldn’t solve the country’s long-term fiscal problems. ...  But $1 trillion over ten years is real money and would make a real dent in the deficit.

Increasing Taxes on the Wealthy is Unfair???

Matthew Yglesias via Brad DeLong:

Have We Won the Empirical Debate About Economic Policy, by Brad DeLong: Matthew Yglesias:

Yglesias » Pity For The Rich: You can tell something’s happening in the economic policy debate when you start reading more things like AEI’s Arthur Brooks explaining that it would simply be unfair to raise taxes on the rich. Harvard economics professor and former Council of Economics Advisor chairman Greg Mankiw has said the same thing. And of course Representative Paul Ryan is both a fan of Books and a fan of the works of Ayn Rand. Which is just to say that we used to have a debate in which the left said redistributive taxation might be a good idea and then the right replied that it might sound good, but actually the consequences would be bad. Lower taxes on the rich would lead to more growth and faster increase in incomes.

Now that idea seems to be so unsupportable that the talking point is switched. It’s not that higher taxes on our Galtian Overlords would backfire and make us worse off. It’s just that it would be immoral of us to ask them to pay more taxes even if doing so would, in fact, improve overall human welfare.

If that sounds remotely plausible to you, you might have a lucrative career ahead of you working as an apologist for said Galtian Overlords. If not, then congratulations for possessing a modicum of common sense.

The immorality is based upon the idea that the wealthy earned every penny they received and it would be immoral to take it away and give it to those who didn't toil as hard, as effectively, or at all (you know, the people whose wages have not kept up with their productivity). The arguments against the idea that pay at the top reflects merit alone are well known -- the contention hardly passes the laugh test -- and I won't repeat them here. But anyone who thinks the reward for crashing the financial sector ought to be unimaginable wealth should rethink their ideas.

Let me focus instead on the opening paragraph:

The Ryan plan is based on three premises. First, our economy is headed for a predictable disaster because of the ruinous levels of government spending. (Standard & Poors’ decision this week to downgrade its outlook for U.S. debt only confirms this worry.) Second, we already have one of the highest corporate tax rates in the world, and we can’t load more income taxes onto entrepreneurs without expecting collateral harm to jobs and economic growth. Third, therefore, we must cut spending and reform entitlements, and this would necessarily affect the nearly 70 percent of Americans who take more from the government than they pay in taxes.

On the first point, it's debt, not spending, that is at issue. You can have high spending with little debt if you are wiling to collect the taxes to support it. In addition, the problem is mainly rising health costs, not spending in general -- so that's what we ought to be talking about.  We shouldn't let deception over where the true problem is lead us to solutions that meet the ideological goal of Brooks and others of smaller government, but do little to help solve the main problem.

On the second and third points, the third follows from the second, but the evidence for the second proposition is shaky at best even given the narrow way it is stated (income taxes on entrepreneurs as opposed to taxes more generally). We can raise taxes on the wealthy without harming economic growth, particularly since we are taxing away income that was earned on some basis other than merit (and even if we do buy into the claim that it is all merit, would you work substantially less if the reward this year was only $16 million rather than $20 million?). There is no solid empirical evidence that suggests that changes in taxes at the rates we are considering would have any meaningful effect on economic growth and employment. Thus, it is not true that our only choice is to cut spending -- the cuts would be too large to be tolerable anyway -- tax increases must also be part of the solution.

We've heard versions of these arguments before. But the only thing that seems to trickle down after tax cuts at the top is the hole in the budget they bring about, and the desire to pay for those cuts through cuts to programs that provide important benefits to middle and lower income households.

Update: Paul Krugman has a slightly different take on this:

On Pity for the Rich, by Paul Krugman: Matt Yglesias has a good question, but I don’t think that I agree with his answer. He points out that

we used to have a debate in which the left said redistributive taxation might be a good idea nd then the right replied that it might sound good, but actually the consequences would be bad. Lower taxes on the rich would lead to more growth and faster increase in incomes.

but that now the right seems fixated on the point that taxing the rich is unfair — they made it, they should keep it.

And he suggests that the right is, implicitly, conceding that trickle-down economics doesn’t work.

But my take is that what we’re looking at is the closing of the conservative intellectual universe, the creation of an echo chamber in which rightists talk only to each other, and in which even the pretense of caring about ordinary people is disappearing. I mean, we’ve been living for some time in an environment in which the WSJ can refer, unselfconsciously, to people making too little to pay income taxes as “lucky duckies”; where Chicago professors making several hundred thousand a year whine that they can’t afford any more taxes, and are surprised when that rubs some people the wrong way. Why wouldn’t such people find it completely natural to think that the hurt feelings of the rich are the main consideration in economic policy?

The Fairness of Progressive Taxation

Chris Dillow defends progressive taxation:

The fairness of 50p, by Chris Dillow: Over in the twitterverse, a Very British Dude has asked whether I think it reasonable to confiscate by force more than half of someone’s marginal earnings. ... I’d suggest three possible answers here, which vary in force depending upon the precise type of the rich:

1. A high tax is a dividend, paid to the state in return for its investment in the things that made you rich.

Even if the state did not educate you, the chances are that it educated your colleagues and customers, whose education benefits you. The state has provided the domestic peace that has enabled the economy to grow and thus give you the chance to get rich; very few of the UK’s top earners would be so rich had they been born in sub-Saharan Africa. It has provided laws - such as patents and copyright protection - that allow artists and entrepreneurs to profit from their efforts and talent. And in various ways the state helps to sustain capitalism and hence profits and high earnings.
Why shouldn’t it demand payment for such benefits?

2. The state’s force is a form of countervailing power. Some (many?) of the rich owe their fortune to the fact that they are powerful. Most egregiously, this power consists of an ability to extract cash from the state. When the government taxes bankers or the bosses of BAe, Serco or Capita, it is merely getting its money back.

 In other cases, high earnings come from a power to extract rents from either shareholders or workers... In these cases, state power corrects for private power.

3. Inequality is a form of market failing. Imagine we were all behind  a veil of ignorance, not knowing what talents we’d be born with. Isn’t it plausible that, behind such a veil, people would agree to enter into insurance contracts such that if they got lucky or talented they would pay out to the unlucky and untalented? People would, surely, agree to pay out a proportion of the £1m-plus a year they would earn as Premiership footballers in order to soften the misery of being born with no marketable skills.

You can therefore regard redistributive taxation as, in effect, the sort of insurance payments that would be made, if such contracts were  feasible. In this sense, the tax merely fills in for the missing market.

These arguments do not get us to a precise tax rate. But they do suggest a case for some degree of progressivity in the taxes.

And let’s be clear. A 50p tax is not massively progressive. Overall revenues are equal to just over 37% of GDP. Under a purely proportionate tax system, then, we would all pay 37% of our income. ... Expecting a tiny proportion to pay 50% (yes, for some the marginal rate is 62%, but the average rate is lower than this) strikes me as not wholly unreasonable.

"Fairness and Tax Policy -- A Response to Mankiw's Proposed 'Just Deserts' "

Jonathan Weinstein:

This essay started as a short post responding to an article by Greg Mankiw and grew longer than I expected, so to avoid cluttering the blog I switched formats. As you might guess from the potpourri in the title, the essay is intended to be readable by a broad audience. The portions which discuss the use or misuse of economic theory in the tax debate are, it is my fond hope, of interest to economists and accessible to non-economists, as is Mankiw’s article. I began this last week, so it doesn’t refer directly to this week’s big news of the Great Tax Compromise of 2010, but the ongoing negotiations were a major motivation.

Here's the introduction to the essay:

Fairness and Tax Policy -- a response to Mankiw's proposed "Just Deserts", by Jonathan Weinstein, Kellogg School of Management, Northwestern University: I recently came across an address by Greg Mankiw, "Spreading the Wealth Around: Reflections Inspired by Joe the Plumber." With the famous exchange between Samuel "Joe" Wurzelbacher and Barack Obama as his launching point, Mankiw suggests that the utilitarian framework1 commonly used by economists to analyze optimal taxation conflicts with moral intuition. Mankiw argues, and I agree, that most people believe that taxation should be decided by principles of fairness: the pay people keep should be proportional to their contribution to society. He calls this "Just Deserts2 Theory." He makes a very good point this far, but I must debate some implications he draws. In fact, I believe Mankiw has identified the strength of conservative rhetoric in the public debate on tax policy, and given one answer to "What's the matter with Kansas?", i.e. why the working class vote against their own interests. Conservatives have successfully caricatured the progressive position as placing value on equality of outcomes for its own sake, and this is a value which most Americans find distasteful.

In fact, I think life in a world with equality of outcomes is fundamentally unappealing; the struggle to do better, and to be recognized fairly for achievement and productivity, is a basic human drive we would not want to lose. This is why, when conservatives convince the public of Mankiw's basic position that the free market is the ideal, perfectly fair arbiter of Just Deserts, they win broad support for their policies, even when these policies favor the few over the many. Just as serfs once accepted that their position was allotted to them by a divine order, today's growing inequality in wealth is considered acceptable if it is the outcome decreed by the ideal, uncorrupted free market. Progressives must make it clear that they support the premise of fair compensation for the contributions of each individual, but dispute the notion that fairness is best achieved by an extreme laissez-faire version of capitalism. I'll start with some verbal arguments, then, on a slightly more technical level, will point out the flaws in Mankiw's applications of classic economic theorems before suggesting a different formal approach to fairness.

Mankiw's concluding sentence (which he is careful to qualify with "it is very possible") implies that Obama comes to his tax policy by utilitarian considerations while Joe's are based on fairness. While Mankiw is fair enough to briefly acknowledge that one could make a Just Deserts case for progressive taxation, his main argument is that fairness would favor Joe the Plumber's preferred (less progressive) tax plan over Obama's. Let's look at these claims. ...[continue reading]...

"Bring Back the Estate Tax Now"

Dear Deficit Hawks:

Bring Back the Estate Tax Now, by Robert Rubin and Julian Robertson, Commentary, WSJ: ...Congress is finally turning its attention to the expiring 2001 and 2003 tax cuts. But there is one tax issue that should have long since been addressed: the federal estate tax. That tax expired at the end of last year, and there have been no estate taxes levied this year. If a new estate tax is not enacted as soon as Congress returns from its August recess, this void will continue until the end of the year.

We would recommend continuing 2009's regime, with a top rate of 45% and a $3.5 million individual exemption. Small businesses and family farms can be protected both through the exemption (which is $7 million for a couple) and through special deferred payment rules.

We both believe that the estate tax should be a component of any federal tax system. ... A key criterion in choosing taxes is to have the least negative impact on economic activity. The estate tax, in our opinion, meets that test. An estate tax can provide revenue—with little, if any, adverse supply-side economic impact—to fund deficit reduction, additional public investment or added assistance to those affected by the economic crisis. ...

We also share the view that the estate tax is grounded in powerful philosophical underpinnings. Our nation views itself as a meritocracy and a land of opportunity and we have a proud legacy of upward mobility. An estate tax helps us promote this legacy, by avoiding the accumulation of inherited economic—and political—power that is antithetical to this historical vision of our society and to the vitality and dynamism that has contributed so much to our success. ...

Our country is losing revenue that, with its stressed fiscal conditions, it can ill afford to forego.

I don't have any disagreement with this. If anything, I'd favor even higher rates once the estate value passes certain thresholds, i.e. additional steps in the rates.

"Is Health Care Special?"

Uwe Reinhardt:

Is Health Care Special?, by Uwe E. Reinhardt, Economix: On a recent episode of the television talk show “Raw Nerve,” the host William Shatner, of “Star Trek” fame, had this exchange with Rush Limbaugh:

Shatner: “Here’s my premise, and you agree with it or not. If you have money, you are going to get health care. If you don’t have money, it’s more difficult.”

Limbaugh: “If you have money you’re going to get a house on the beach. If you don’t have money, you’re going to live in a bungalow somewhere.” ... “What’s the difference?”

Shatner: “The difference is we’re talking about health care, not a house or a bungalow.”

Limbaugh: “No. No. You’re assuming that there is some morally superior aspect to health care than there is to a house. …”

One must wonder whether physicians, nurses and other workers toiling day and night in health care — let alone the medics and helicopter pilots who risk their lives to help the wounded — see their work and its product quite as Mr. Limbaugh casts it. One further wonders whether families with a cancer-stricken member are likely to view going without health care as the moral equivalent of going without a beach house.

But leaving aside speculation on the moral dimensions of health care..., it should be noted that economists, too, have long wrestled with the question of whether  health care stands apart from other goods and services traded in the market place. ...

The question of in what way health care is special, if at all, was first investigated thoroughly by the Nobel laureate economist Kenneth Arrow in his still widely celebrated 1963 article, “Uncertainty and the Welfare Economics of Medical Care.” ...

To lay down a standard to which to compare the health care sector, Professor Arrow explained first on what basis economists consider a perfectly competitive market for some good or service as “maximizing human welfare,” an outcome economists describe as “efficient.” ... If those and some other conditions are met, Professor Arrow explained, then for any given initial distribution of income and wealth that market will settle down at a unique equilibrium... This equilibrium has important attributes.

First, in what Professor Arrow calls the First Optimality Theorem of welfare economics, it can be shown that in this equilibrium ... it would be impossible through any reallocation to make someone happier without making someone else less happy. It is an allocation that economists call Pareto efficient... For any given initial distribution of income and wealth, economists declare the associated Pareto-efficient allocation ... to be “welfare-maximizing”...

Second, and very importantly, in what Arrow calls the Second Optimality Theorem, he explains that if on ethical grounds society wished to distribute a good or service (for example, education or health care or food or beach houses) among people in a particular way — like egalitarian principles — it need not have government directly involved in producing or distributing that good or service. The desired distribution could be attained by redistributing income and wealth among the citizenry in a way that would drive the perfectly competitive private market to achieve the desired allocation of the good or service among the people. Better still, it would do so in the welfare-maximizing way predicted by the First Optimality Theorem.

It is easy to see why Professor Arrow’s paper fired the imagination of generations of economists ... in their argument that public health policy should confine itself strictly to making the market of health care perfectly competitive and then to redistribute income — perhaps by means of tax-financed vouchers to help subsidize the purchase by poorer people of needed health care — in order to achieve whatever distributive ethic society wishes to impose on health care. That free-market approach would automatically take care of whatever moral aspect society wishes to impute to health care.

Having established this normative benchmark, Professor Arrow explored in the rest of his paper how close the market for health care actually comes to the characteristics of a perfectly competitive norm. In my next post, I will discuss Professor Arrow’s conclusion.

Can you guess what that conclusion will be? These markets are far from the competitive ideal, and conditions such as customers having full knowledge about the relative quality of products in the market will be hard to satisfy in any case.

"The 'Tax Expenditure' Solution for Our National Debt"

The economy is still fragile, and now is not the time to begin solving our long-run debt problem. That would make things worse. But once the economy is on firmer footing, we will need to begin addressing this problem. Martin Feldstein argues that the elimination of special tax rules is a good way to reduce the long-run debt load:

The 'Tax Expenditure' Solution for Our National Debt, by Martin Feldstein, Commentary, WSJ: When it comes to spending cuts, Congress is looking in the wrong place. Most federal nondefense spending, other than Social Security and Medicare, is now done through special tax rules rather than by direct cash outlays. ...

These tax rules—because they result in the loss of revenue that would otherwise be collected by the government—are equivalent to direct government expenditures. That's why tax and budget experts refer to them as "tax expenditures." This year tax expenditures will raise the federal deficit by about $1 trillion... If Congress is serious about cutting government spending, it has to go after many of them. ...

Neither party has focused on controlling this kind of spending. Democrats are reluctant to cut such programs... Republicans also are reluctant to cut these tax perks, because they regard the additional revenue collected by the federal government as a "tax increase"—even though the increased revenue is really the effect of a de facto spending cut. ...

But eliminating tax expenditures does not increase marginal tax rates or reduce the reward for saving, investment or risk-taking. It would also increase overall economic efficiency by removing incentives that distort private spending decisions. And eliminating or consolidating the large number of overlapping tax-based subsidies would also greatly simplify tax filing. ...

If tax expenditures are not cut, taxes on households and businesses will have to rise to prevent an explosion of the national debt... When benefits for Social Security and Medicare are set aside, the rest of the outlay side of the budget is too small—7.5% of GDP—to provide much scope for reducing annual budget deficits that are now projected to average 5% of GDP for the rest of this decade. In contrast, total tax expenditures are now 6.4% of GDP.

Not every type of tax expenditure should be cut. Some provide good incentives while others increase the fairness of the tax system. But they can be reduced by one-third or more. ... Cutting them ... 2% of GDP would reduce the national debt in 2020 by some $4 trillion, bringing the projected debt down to 72% of GDP from 90%. ...

Cutting tax expenditures is really the best way to reduce government spending. And to be politically acceptable, the cuts in tax expenditures must be widespread... While some of the dozens of small tax perks should be eliminated all at once, others should be reduced gradually in order to avoid economic disruptions. Some of the biggest ones, like the deduction on federal tax returns for local property taxes (projected to cost the federal government $25 billion in the coming fiscal year) might be reduced but not completely eliminated. ...

The American public wants to reduce ... deficits... A major reduction of the spending that is built into our tax code is the best way to achieve that.

There aren't any easy solutions to the long-run debt problem. There are special interests attached to each of these tax breaks, so it won't be easy to eliminate enough of them to make a difference. A bill eliminating a substantial number of breaks could be portrayed as a vote against all sorts of popular and/or powerful groups and scare legislators away from supporting such legislation. I know my first thought was that care would need to be taken to ensure that we don't eliminate provisions that help to attain equity or that promote other worthy societal goals, and every group facing the elimination of their tax break will argue that it is needed for these reasons. But these arguments will be made no matter what we do, and to the extent that we can eliminate these tax provisions without harming our ability to pursue these goals, we ought to do so.

However, with that said I should also note that the main driving force behind the long run debt problem is health care costs -- if we solve the health care cost problem then we also solve the debt problem, and if we don't, we don't. Since eliminating these "tax expenditures" does not help with the health care cost problem at all, there's no reason compromise our ability to promote equity or other goals by being overly aggressive in eliminating these tax breaks. Not all of these tax provisions serve a worthy purpose, but many do and those should be preserved.

"Estate Tax: Leave it Alone"

Linda Beale says Congress should allow the estate tax should to revert to 2001 levels as scheduled under existing legislation:

Estate Tax: leave it alone, by Linda Beale: We are almost halfway through 2010, the weirding time under the GOP's estate tax plan when there is no estate tax and the step-up in basis is gone. They had, of course, intended to eliminate the estate tax for good, but knew that it would cause huge deficits and so didn't want to pass that along with the rest of their 2001 tax cuts that already amounted to more than a trillion dollars. So they left it for later.

Repeal was a bad idea to start with. Most of the mythology around the estate tax is just that--sob stories ginned up by the coalition of wealthy families who want to shirk their responsibility to the country for taxes. This is where the President and the Democratic Party should use the bully pulpit to inform people about how the estate tax works. It is relevant for only the largest estates. It doesn't cause family farms to be lost, no matter how many times the wealthy families' coalition spokespersons claim that it does.

We are at a turning point in this country, where our inability to think long term and our need for immediate gratification mean that we are spending ridiculous amounts on a military budget, too little on infrastructure, and incapable of passing a single payer health care system like every other developed economy has. The Bush regime cut taxes over and over again--mostly aiding the wealthy but also costing us in terms of long-term deficits... The economic theory on which the tax cuts were based has been proven wrong again and again...: tax cuts don't generate more revenues, wealthy people who are not taxed on their capital gains don't turn overnight into entrepreneurs.

So now we need to stop the drain of revenues from the federal fisc. Stop excessive military spending--we can't sustain ongoing wars in Iraq and Afghanistan for another decade any better than the USSR could do. ...

That means that the estate tax is an ideal tax. The tax comes at the point when wealth from one generation is being passed to the heirs in the next generation who have done nothing to merit having it. The extraordinarily wealthy that bear the tax already have the lion's share of the wealth of the country, and some method of evening the odds is needed, else we will be a country of the gated rich and the multitudinous poor. The estate tax can be easier to enforce than other taxes (and would be even fairer if only Congress would act to make the various estate planning techniques using trusts and family partnerships unlawful). So Congress should just let the Bush tax change lapse according to the sunset provision that the GOP built into the law. That would mean that in 2011 we would revert to the law before the 2001 tax change.

There is no huge constituency worried about the estate tax--just the wealthy few whose estates might be subject to some taxation. But apparently Sens. Kyl, Baucus, Grassley and Lincoln are working to include a "bipartisan" proposal in the small business tax bill that they hope to put through Congress. Odds are it will cut the estate tax rate and increase the exemption amount, making the wealthy even less likely to pay any estate tax. ...

Will somebody tell me how these Senators can justify another huge tax break for the wealthy when this country has the highest deficits its ever recorded and little prospect of recouping that ... without adding tax increases ... to the mix? ...

We are not Greece, that's clear, but there is a similarity. It's not excessive government spending like you may have been led to believe by deficit hawks, see this comparison chart. The similarity is the (successful) attempt by those with power and influence to avoid paying their fair share of the nation's bills.

Wealth Inequality

Daniel Little on wealth inequality:

Wealth inequality, by Daniel Little: When we talk about inequality in the United States, we usually have a couple of different things in mind. We think immediately of income inequality. Inequalities of important life outcomes come to mind (health, housing, education), and, of course, we think of the inequalities of opportunity that are created by a group's social location (race, urban poverty, gender). But a fundamental form of inequality in our society is a factor that influences each of these: inequalities of wealth across social groups. Wealth refers to the ownership of property, tangible and intangible: for example, real estate, stocks and bonds, savings accounts, businesses, factories, mines, forests, and natural resources. Two facts are particularly important when it comes to wealth: first, that wealth is in general very unevenly distributed in the United States, and second, that there are very striking inequalities when we look at the average wealth of major social groups.

Edward Wolff has written quite a bit about the facts and causes of wealth inequality in the United States. A recent book, Top Heavy: The Increasing Inequality of Wealth in America and What Can Be Done About It, Second Edition, is particularly timely; also of interest is Assets for the Poor: The Benefits of Spreading Asset Ownership. Wolff summarizes his conclusion in these stark terms:

The gap between haves and have-nots is greater now--at the start of the twenty-first century--than at anytime since 1929. The sharp increase in inequality since the late 1970s has made wealth distribution in the United States more unequal than it is in what used to be perceived as the class-ridden societies of northwestern Europe. ... The number of households worth $1,000,000 or more grew by almost 60 percent; the number worth $10,000,000 or more almost quadrupled. (2-3)

The international comparison of wealth inequality is particularly interesting. Wolff provides a chart of the share of marketable wealth held by the top percentile in the UK, Sweden, and the US, from 1920 to 1992. The graph is striking. Sweden starts off in 1920 with 40% of wealth in the hands of the top one percent, and falls fairly steadily to just under 20% in 1992. UK starts at a staggering 60% (!) in the hands of the top 1 percent in 1920, and again, falls steadily to a 1992 level of just over 20%. The US shows a different pattern. It starts at 35% in 1920 (lowest of all three countries); then rises and falls slowly around the 30% level. The US then begins a downward trend in the mid-1960s, falling to a low of 20% in the 1970s; and then, during the Reagan years and following, the percent of wealth rises to roughly 35%. So we are roughly back to where we were in 1920 when it comes to wealth inequalities in the United States, by this measure.

Why does this kind of inequality matter?

Equity and Efficiency in Health Care Markets

This is an attempt to clarify a few of the remarks I've made over the last several days regarding the need for government intervention in health care markets.

There are two separate reasons to intervene, market failure and equity. Taking market failure first, there are a variety of failures in health care and insurance markets such as asymmetric information, market power, and principal agent problems. These can be solved by the private sector in some cases, but in others government intervention is required.

But even if the private sector or the government can solve the market failure problems adequately, there's no guarantee that the resulting distribution of health care services will be equitable. We don't expect the private sector to, for example, make sure that everyone can live on the coast and have an ocean view if they so desire, we use market prices to ration those goods, but we may want to make sure that everyone can get health care when they have serious illnesses. So equity considerations may prompt the government to intervene and bring about a different distribution of health care services than would occur with an efficient market.

I believe that economists have something to offer in both cases. In the first, economic theory offers solutions to market failures, and though not every market failure can be completely overcome, the solutions can guide effective policy responses. I prefer market-based regulation to command and control solutions whenever possible, i.e. I prefer that government create the conditions for markets to function rather than direct intervention. But sometimes the only solution is to intervene directly and forcefully.

In the second case, the idea is a bit different. Here, equity is the issue so somehow society must first designate the outcome it is trying to produce before economists can help to achieve it. Right now, it is my perception that the majority of people want to expand to universal or near universal coverage if we can do so without breaking the bank, and without reducing the care they are used to. If we can find a way to do that, the majority will come on board. If that's the case, if that's what we have collectively decided we want, then the job of the economists is to find the best possible way of achieving that outcome (or whatever outcome is desired) given whatever constraints bind the process (whether political realities should be part of the set of constraints is a point of contention, so I'll stay silent on that).

So if we are only concerned about efficiency, we do our best to resolve the market failures and leave it at that. We make sure, for example, that people have the information they need to make informed decisions about their care, that there aren't incentives that cause doctors to order too much or too little of some type of care or test, that monopoly power is checked, etc., etc. There's no guarantee that everyone will receive care, or that the distribution of care among those who do receive care will be as desired.

But if we are concerned with equity too - and most of us aren't comfortable watching people suffer when we know that help is readily available (perhaps nature imposes this externality upon us purposefully) - if we won't let people die on the street or suffer needlessly due to our sense of fairness and equity - then we will want to intervene to achieve broad based coverage in the least cost and fairest manner we can find (and there may be other equity issue that are important too).

Both reasons, equity and efficiency, can justify government intervention into health care markets. I think equity is of paramount importance when it comes to health care, so for me that is enough to justify government intervention, and the existence of market failure simply adds to the case that government intervention is needed.

So those opposed to government involvement in health care markets have to first argue that there is no market failure significant enough to justify intervention, a tough argument in and of itself, and also argue that people who, for example, go without insurance or cannot afford the basic care they need deserve no compassion whatsoever from society more generally. That's an argument I could never make even for those who could have paid for insurance but chose to take a chance they wouldn't need care, let alone for those who cannot afford it under any circumstances. I want everyone to be covered as efficiently as possible, and to be required to pay their fair share of the bill, whatever that might be, for the care that's made available to them.

Too Big to Prosecute?

John Ashcroft says hang 'em high, but only if it doesn't cost us jobs:

Bailout Justice, by John Ashcroft, Commentary, NY Times: ...[N]o one has discussed the inherent conflict of interest that the government created when it infused large sums of money into [banks].  The government now has an extraordinarily high fiduciary duty to safeguard the stability and health of companies that received hundreds of billions of bailout money. At the same time, the Justice Department has the duty to indict a corporation if the evidence dictates such severe action — and an indictment is often a death sentence for a corporation. The quandary is obvious. How, then, does the Justice Department bring charges against a corporation that is now owned by the government?

The tsunami of corporate scandals that shook our economy in 2001 — Enron, WorldCom, Adelphia and others — provides us with an instructive example. The Justice Department moved swiftly to bring corporate wrongdoers to justice. But we also learned that when dealing with major companies or industries, we had to carefully consider the collateral consequences of our prosecutions.

Would there be unintended human carnage in the form of thousands of lost jobs? Would shareholders, some of whom had already suffered a great deal, lose more of their investment? What impact would our actions have on the economy? We realized that we had an obligation to minimize the harm to innocent citizens.

Among the options we pursued were deferred prosecution agreements. These court-authorized agreements ... offered more appropriate methods of providing justice... In September 2007, for instance, the Justice Department and the nation’s five largest manufacturers of prosthetic hips and knees reached agreements over allegations that they gave kickbacks to orthopedic surgeons. Think of the effect on the community if these companies had been shuttered: employees would have lost their jobs, shareholders and pensioners would have lost their savings and countless people in need of hip and knee replacement would have been out of luck... In these types of circumstances, a deferred prosecution agreement is clearly better for everyone.

The government must hold accountable any individuals who acted illegally in this financial meltdown, while preserving the viability of the companies that received bailout funds or stimulus money. Certainly, we should demand justice. But we must all remember that justice is a value, the adherence to which includes seeking the best outcome for the American people. In some cases it will be the punishing of bad actors. In other cases it may involve heavy corporate fines or operating under a carefully tailored agreement.

In 2001,... we learned that there was often a better solution than closing ... companies. ...

I'm not a big fan of delaying justice even if it means closing a company. And if we started a prosecution today, how long would it be before it would actually came to trial? Years? Isn't that enough of a delay? I certainly don't think anyone should escape justice or be treated less severely because they are too big to prosecute.

[He also says, "I can imagine the attorney general facing not too subtle pressure from the president’s economic team to go easy on such companies." Not too subtle pressure from the president's team? I bet he can imagine that.]

Here's the program he is talking about:

In Shift, Ashcroft to Testify on Oversight Deal, by Carrie Johnson,
Washington Post, February 26, 2008; D01: Former Attorney General John D. Ashcroft agreed last night to appear at a House hearing to discuss his lucrative arrangement overseeing a medical equipment company, averting a showdown with committee members who had planned to meet today to authorize a subpoena.

The move marks an about-face for Ashcroft, who told lawmakers earlier this month that "discussing the details of my legal responsibilities, as requested, in this pending criminal case and related ongoing criminal investigation would violate my ethical obligations."

Ashcroft, who left public service three years ago to start a private consulting firm, won the contract under a settlement the company reached with federal prosecutors in New Jersey. Under a recent government policy, companies facing criminal investigation can accept such outside supervision to avoid indictment.

Ashcroft's consulting firm stands to collect between $28 million and $52 million over 18 months for reviewing the operations of Zimmer Holdings, an Indiana company that makes replacement hips and knees. Zimmer last year settled government charges over kickbacks it allegedly provided doctors in exchange for using its products. ...

Zimmer paid the Ashcroft Group $7.5 million between last September and January... Ashcroft and about a half-dozen senior staff members of his firm are covered under a flat $750,000 monthly payment from Zimmer. ...

No wonder he likes it so much.

"The Asset Bubble Theory of Income Inequality"

Awhile back, I asked "Do large bubbles cause income to become more concentrated, or does the concentration of income cause the bubbles?" There are other possibilities too, causation could be simultaneously and run in both directions, or it could be that there is no causation at all and both bubbles and inequality are driven by a third factor. Justin Fox says he's looked at the data, and the answer is that inequality is driven by bubbles:

The asset bubble theory of income inequality, by Justin Fox: There's been a debate going on for a few years about whether the big rise in income inequality in the U.S. over the past three decades has been at least partly a political phenomenon or purely an economic one. The first camp, whose members include political scientist Larry Bartels and economists Thomas Piketty and Emmanuel Saez (pdf), argues that decisions about taxing and government spending made since the early 1980s have increased the disparity of incomes. The second ... contends that globalization and technological advance have increased the rewards to the most skilled and reduced pay for those whose work can be done by machines or lower-paid workers overseas. Since globalization and technological advance are good things, the increase in inequality thus isn't really something we'd want to stop.

Well now, after looking at the data about the country's 400 highest earners and reading the comments by pneogy and shepherdwong, I am ready to offer an important new theory (well, not entirely new): The rise in income inequality over the past 30 years has to a significant extent been the product of a series of asset-price bubbles. Whenever the market (be it the market in stocks, junk bonds, real estate, whatever) booms, the share of income going to those at the very top increases. When the boom goes bust, that share drops somewhat, but then it comes roaring back even higher with the next asset bubble. It's not the same people raking it in every time—there's lots of turnover in the top 400—but skimming the top off of asset bubbles appears to have become the leading way to get rich in these United States in the past three decades. ...

"Just How Progressive Is the Tax System?"

Catherine Rampell at Economix presents and discusses data on the progressivity of taxes (federal, state, and local, calculations from the Citizens for Tax Justice). As she notes, this comes in rebuttal to claims based upon CBO data that taxes are highly progressive, and that the wealthy pay far more than their share:

Horizontal axis shows the income group. Vertical axis shows the percentage of income that the average member of that group pays in taxes. Taxes include all federal, state and local taxes (personal and corporate income, payroll, property, sales, excise, estate, etc.). Incomes include cash income, employer-paid FICA taxes and corporate profits net of taxable dividends.

Horizontal axis shows the income group. Taxes include all federal, state and local taxes (personal and corporate income, payroll, property, sales, excise, estate, etc.). Incomes include cash income, employer-paid FICA taxes and corporate profits net of taxable dividends.

Update: pgl follows up.

Using Inheritance Taxes to Promote Equal Opportunity

Michael Kinsley is mystified by ten Democratic senators:

Democrats for Rich Heirs?, by Michael Kinsley, Commentary, Washington Post: ...Meanwhile, the Senate is considering what to do about the estate tax. It is scheduled to be abolished next year, in one of several landmines the Bush administration set to go off after it left town. Obama proposes to reinstate the tax, at a 45 percent rate, on estates worth more than $3.5 million. Since there's no tax on what you leave to your spouse, married couples could pass on $7 million before needing to pay a dollar -- or needing to consult a lawyer who can use loopholes to save millions more.

The House has passed this measure as part of the budget. In the Senate, there's trouble. Ten Democrats have joined the Republicans in calling for a $10 million exclusion and a 35 percent rate. This is amazing. The number of people who leave estates of even $7 million is minuscule. The number leaving more than $10 million is smaller still. Yet to save these very few very wealthy people a small fraction of their estates, these senators are willing to hand their party's president an embarrassing defeat. Why on earth?

Oh, small business blah blah blah. ... To be affected by the estate tax, a business must be owned by someone of large means: at least $7 million. ...

But why the populist fury over those AIG bonuses of a few million dollars while no one seems to care much about billions being transferred through inherited wealth? The obvious answer -- that there's a difference between what people do with our hard-earned money and what they do with their own hard-earned money -- isn't actually as persuasive as it seems.

Perusing the Forbes 400 list of America's richest people, it's striking how few of them made the list by building the proverbial better mousetrap. The most common route to gargantuan wealth, like the route to smaller piles, remains inheritance. ...

Dozens of Forbes 400 fortunes derive from the rising value of land or other natural resources. These businesses are fundamentally different from mousetrap building. Land does not need to become "better" to increase in value, and that value increase doesn't produce more land. Yet other fortunes depend directly on the government. The large fortunes based on health care and pharmaceuticals would not exist if not for Medicare and Medicaid. The government hands out large fortunes even more directly in forms as varied as cable-TV franchises; cellphone licenses; drilling, mining and mineral rights; minority small-business loans; and other special treatment.

Most important, every American selling anything benefits from doing so in the world's richest market. An American doctor earns many times what the same doctor would earn in, say, India. This is not because he or she works many times harder. ... It's because we are a richer society, for reasons the American doctor had nothing to do with.

The debate over whether the estate tax should start at $7 million or $10 million is largely symbolic. That makes the push by those 10 Democratic senators for the higher amount even more mysterious.

Via Brad DeLong:

Think Progress: Lincoln’s $250 billion estate tax plan would cut taxes for only 60 ’small businesses.’: Last week, 10 Democrats in the Senate joined all 41 Republicans in voting for a $250 billion proposal to cut estate taxes... Touting the tax cut in a press release, Lincoln claimed that it was “aimed at farms and small businesses.” However, according to an analysis by the Tax Policy Center, Lincoln’s $250 billion proposal would save just 60 small businesses or farms from the estate tax:

An always charged issue is how the estate tax affects small farms and family-owned businesses. We estimate that under the Obama proposal, 100 family farms and businesses [a year] would owe tax.... The Lincoln-Kyl proposal would cut the number to 40.

According to the Congressional Budget Office, “almost all such estates are able to pay the tax bill without having to sell business assets.”

To try to overcome the political opposition, and to try to meet a worthy goal, I would increase and broaden the tax, and then earmark the revenues specifically for programs designed to promote equal opportunity, e.g. Head Start programs, funds to allow anyone to attend the college of their choice without running up large debts, or alternatively to help to start a business, and so on. To further help with the political opposition, the collected funds, or more precisely the programs the funds support, would be made available to everyone on an equal basis.

"An Egocentric Sense of Fairness"

Monkeys don't like the perception of inequity:

Monkeys Hate Others' Bonuses, Too, Scientific American: Even monkeys know when they’re getting a bad deal, said primatologist Frans de Waal... Give two side-by-side monkeys a piece of cucumber for performing a simple task and there’s no problem. But if one sees his neighbor get a more desirable grape—“now grapes are far better than cucumber and the monkeys know that”—for doing the same thing, “they become agitated. They don’t like this experiment anymore, even though they get exactly the same food as before. But the partner is now getting grapes. And if you give the partner a grape without any task, then they really don’t like it anymore. So this is, I usually call it an egocentric sense of fairness, it’s like resentment or envy. It’s very similar actually to the response that we have currently to Wall Street bonuses. I always say we live in Cucumberland and they live in Grapeland, basically.”

Women’s Rights: What’s in it for Men?

I'd be interested in hearing other theories as to why power relationships between men and women change as economies develop. Here's one argument:

Women’s rights: What’s in it for men?, by Matthias Doepke and Michèle Tertilt, Project Syndicate: Improving women’s rights is one of the main goals of development policy; the United Nations names “promoting gender equality and empowering women” as one of the eight Millennium Development Goals. As Figure 1 shows, today most rich countries are close to the ideal of gender equality, while in the poorest countries women have only limited rights and face widespread discrimination. What, if anything, can development policy do to close the gap in gender equality between rich and poor countries?

Hard-Wired for Fairness

Fairness makes us happy:

Brain reacts to fairness as it does to money and chocolate, EurekAlert: The human brain responds to being treated fairly the same way it responds to winning money and eating chocolate, UCLA scientists report. Being treated fairly turns on the brain's reward circuitry.

"We may be hard-wired to treat fairness as a reward," said study co-author Matthew D. Lieberman, UCLA associate professor of psychology...

"Receiving a fair offer activates the same brain circuitry as when we eat craved food, win money or see a beautiful face," said Golnaz Tabibnia, a postdoctoral scholar at ... UCLA and lead author of the study...

The activated brain regions include the ventral striatum and ventromedial prefrontal cortex. Humans share the ventral striatum with rats, mice and monkeys, Tabibnia said.

"Fairness is activating the same part of the brain that responds to food in rats," she said. This is consistent with the notion that being treated fairly satisfies a basic need, she added.

In the study, subjects were asked whether they would accept or decline another person's offer to divide money in a particular way. If they declined, neither they nor the person making the offer would receive anything. Some of the offers were fair, such as receiving $5 out of $10 or $12, while others were unfair, such as receiving $5 out of $23.

"In both cases, they were being offered the same amount of money, but in one case it's fair and in the other case it's not," Tabibnia said.

Almost half the time, people agreed to accept offers of just 20 to 30 percent of the total money, but when they accepted these unfair offers, most of the brain's reward circuitry was not activated; those brain regions were activated only for the fair offers. Less than 2 percent accepted offers of 10 percent of the total money. The study group consisted of 12 UCLA students...

"The brain's reward regions were more active when people were given a $5 offer out of $10 than when they received a $5 offer out of $23," Lieberman said. "We call this finding the 'sunny side of fairness' because it shows the rewarding experience of being treated fairly."

A region of the brain called the insula, associated with disgust, is more active when people are given insulting offers, Lieberman said.

When people accepted the insulting offers, they tended to turn on a region of the prefrontal cortex that is associated with emotion regulation, while the insula was less active.

"We're showing what happens in the brain when people swallow their pride," Tabibnia said. "The region of the brain most associated with self-control gets activated and the disgust-related region shows less of a response."

"If we can regulate our sense of insult, we can say yes to the insulting offer and accept the cash," Lieberman said.

Can taking economics courses can to overcome the fairness hard-wiring?:

We Are What We Learn, by Ray Fisman, Forbes: ...[W]e put 70 Yale Law students in a computer lab, and had them play a game that would reveal to us their views on fairness. (The study, which was coauthored with Shachar Kariv and Daniel Markovits, can be found here.)

The students made 50 decisions about giving. In some cases students started with $10, and for each dollar they gave up, their (anonymous) partner in the game would get, say, $5. In this case, giving was "cheap." In others, giving was expensive (each dollar given up yielded only 20 cents for the partner).

Someone who gives a lot when it's cheap and keeps most of the pie for himself when giving is expensive focuses on efficiency: He's making sure the maximum amount is paid out to him and his partner combined. Someone who keeps 80% of the pie when it would be cheap to give is more focused on equality. Someone who always keeps everything, regardless of the price of giving, is just plain selfish, the very embodiment of the rational, self-interested Homo economicus.

It turns out that exposure to economics makes a big difference in how students split the pie, in terms of both efficiency and outright selfishness. Students assigned to classes taught by economists were more likely to give a lot when it was cheap to do so. But they were also much more likely to take the whole pie for themselves.