Asymmetrical Information

That last paragraph was awesome Jane! Keep 'em coming. Happy Thanksgiving!

Great post. Question: Isn't it possible that the Reagan tax cuts coincided with the end of the recession because the cuts increased incentives to work and invest thereby ending the recession? Obviously the end of hyperinflation helped a whole bunch too.

"Governments should not create massive hyperinflation, they should not nationalise industries, they should not implement regulations that allow industries to function as cosy little cartels, they should not block trade with other nations, they should not enact currency or price controls, they should not indulge in confiscatory taxation" : but those are how politicians mainly occupy their time.

Perhaps Jane can recall them better than I can, sausagegut, but I seem to remember that there have been multiple studies that show that cuts on the level of the Reagan cuts just aren't massive enough to really change behavior that much.

A 45%, combined with state income tax (10%), S.S. (12%) and medicare, are over 60%.
Does the rate need to go above 100 to be confiscatory?

Joe forgot the sales and excise taxes, not to mention the skim on various "govt services".

sausagegut: American inflation rates never came near hyperflation.

Jane: Do you really think reducing illegal immigration (OK, not by shooting illegal immigrants) is a bad thing?

Jane,

The policy of our current administration is to continue to make tax cuts that will benefit primarily the wealthiest Americans. Just look at the nature of the additional $70 billion that is currently proposed. In addition they and their allies in the House would like to completely eliminate taxes on capital gains which would benefit more people but still provide the greatest benefits to the wealthiest people. None of these breaks guarantee that the money will be invested in the United States in such a way as to create jobs and I would be willing to bet that a large amount of it would go to investments in China, India and other low wage countries and only provide the smallest of benefits back in this country. Also, if there are no taxes on capital how difficult would it be for the extremely wealthy to structure their income so as to pay virtually no federal taxes?

Jim,

"The policy of our current administration is to continue to make tax cuts that will benefit primarily the wealthiest Americans."

The wealthy pay the most taxes in absolute measure. Ergo, an 'equal' percentage cut will always grant them the most absolute benefits. It would be impossible for any tax reduction measure to give more benefits to the poor simply because the poor (and even the middle class) only pay a fraction of the taxes the rich do.

"In addition they and their allies in the House would like to completely eliminate taxes on capital gains which would benefit more people but still provide the greatest benefits to the wealthiest people."

So what?. The majority of stock ownership in the USA (more than 60%) are owned by institutional investors like CALPERS and life insurance companies. Their obligations are to the pensions and insurance contracts of middle-class America. If the capital gains taxes help every single person in America, should we not do it simply because it will benefit some more than others? That's perverse.

"None of these breaks guarantee that the money will be invested in the United States"

I should hope not. Mercantilism is BAD(tm).

"China, India and other low wage countries and only provide the smallest of benefits back in this country."

If by small benefits you mean small prices for consumer products (China) and consumer services (India), then you're correct. If by small benefits you're suggesting that investing in India and China is a net loss to America, you're wrong. Recent studies suggest that for every $1 we out-source we receive $1.20 in return. That's why trade is better than isolationism.

"Also, if there are no taxes on capital how difficult would it be for the extremely wealthy to structure their income so as to pay virtually no federal taxes?"

Pretty hard, since stocks and dividends would still be taxed at the individual level, just not the corporate one. The reform simply prevents them from paying taxes twice. Actually, the tax reform suggestions gets rid of the largest current loophole for the rich: municipal bonds. Up until now muni bonds were tax-free, and the super-wealthy like Mrs. Heinz-Kerry invested tens of millions in muni portfolios to avoid taxes. If Bush's reform goes through as the panel suggests, that loophole would close.

Getting away from political economy for a moment to focus on the suggestion of replacing GDP growth with trends in median wages, I'm surprised Drum would make this suggestion. Ignoring huge problems in measurement and usefulness outside of welfare economics, by and large, doing so would filter out things like non-cash fringe benefits and government services - things Drum seems to view as priorities - out of the welfare equation.

Jim: The idea isn't that you need to "change behavior that much" but that you incent the marginal actor to engage in more productive activity (work and investment etc.) than he otherwise would. It isn't that people are just sitting around doing nothing but that they aren't doing as much as they could or would do if after tax returns were greater. Of course the bigger the cuts the bigger the change in behavior, but small cuts change behavior nonetheless.

IP: Also, I should not have used the term hyperinflation in the earlier comment.

A 45%, combined with state income tax (10%), S.S. (12%) and medicare, are over 60%.

Estimating the actual marginal tax rate can be tricky. If your income is $100K per year and you live in Colorado and we use today's numbers, the marginal rates would be: federal income tax (33%), SS (0% as you're over the cap), state income tax (4.63%), Medicare (2.9%). Totaling a little under 42%. Property taxes here for residential property are effectively capped and are independent of income, so the marginal rate for that is 0%. Sales taxes average about 6%, but in this scenario you probably spend less than 50% of the marginal dollar, so call the marginal rate there 2%. That gets you up to 44%, less than Jane's hypothetical rate. And that's almost the top marginal rate -- make $10M and the only percentage that goes up is the federal rate, from 33% to 35%.

The top rates are somewhat higher in some states (eg, NY) and lower in others (eg, TX). In general, there's very little progressivity in US tax rates once you get above about $95K in income.

"But more deeply, I don't see either of these metrics as a very good guide to policy, because I don't believe that there is very much the government can do to influence them, for good or ill."

TVA, Hoover Dam, Interstate Highways, FAA, Air Traffic Controlers, and Al Gore's internet creation program activities, the Army Corps of Engineers maintaining our navigatable waterways, Customs at port facilities, all these and more Jane would deny as having an influence, for good or ill, on the medium wages of American workers.

How can anyone take a person like this seriously?

But even more deeply, with all the avenues for education available today how can people like Jane remain so totally ingorant of basic economic facts? The debates over 'internal improvements' took place in the earliest part of our nations history. The progressives won those debates. That Jane, and so many others here, are blissfully unaware of what goes on in the real world is sad, really.

Oh dear, Ken's out of his playpen again. And he's worried about the wages of the country's Mediums.

A 30% tax rate is less confiscatory than a 60% tax rate, but still confiscatory. Tell me if I'm wrong.

You're wrong. Next?

Jane:

You've fairly expressed the problem without quite realizing it. It's not that the elites at the top have become relatively more productive because they're more skilled than previous elites; it's that they're more productive because that capital they have the levers to is more productive than the labor it replaces. In other words, you've unwittingly conflated capital and labor. The problem is really pretty simple: capital ownership and control is either not becoming more diffuse so as to match its contribution to productivity... (it reduces the leverage of labor, without allowing labor to be invested in capital) or it's becoming even more concentrated. The cure is also pretty simple, and although it can be effected by government to some extent (mainly through changes and reform of the banking and finance industry) it doesn't necessarily need to be done by government, once the proper finance instruments have been legitimized.

What the government provides is an insurance that backs up investment, something like the FDIC. But it could be another very large institution, and need not be governmental at all.

Er, this is the "ownership society" we're talking about. At the moment though the elites are just paying it a little lip service. Things may need to get a lot more painful before anything substantive happens.

The numbers don't back you up. Capital ownership is, in fact, vastly more diffuse than it was in the halcyon days of the 1950's and 1960's. Moreover, capital's share of national income has been roughly stable, meaning that increasing returns to wealth cannot account for the income inequality we currently see. In fact, the growing inequality is being driven by inequality in earned income, ie wages; it's the management consultants and investment bankers who are skewing the numbers, not the Paris Hiltons, of which we have no more than we used to. Moreover, the most noticeable driver of the inequality trend is the returns to education, which have skyrocketed for those with at least some college and above, and stayed stagnant for high school graduates and dropouts. So the big story is skills, not capital.

So what would you consider confiscatory marginal rates?

I wonder if you could consider the psychological effect some can have on productivity. I clearly remember Reagan's first inaugural address and thinking "Damn straight! America rocks." I know for a fact that I started working harder, as I had a newfound purpose. Two years of hard work later, America was back on top.

Reagan certainly gave me hope when hope was what I needed. Could his words alone increase productivity? I leave it to better minds than mine (mine's old) to decide.

Kevin,

I'm not sure it can be quantified, but I'm certain that charismatic leaders can effect enormous change in even very large corporations. The first step in turning around a company or an economy has got to be convincing the workforce it can succeed. Reagan's most important contribution was not any policy or tax change but rather simply getting us to believe in ourselves. We may not be able to prove that Reagan's confidence inspired hard work and innovation, but I'm a believer.

How can anyone take a person like this seriously?

It's quite simple, really. It involves not taking YOU seriously, a task which your own arguments readily enable.

"In general, there's very little progressivity in US tax rates once you get above about $95K in income."

You are forgetting that a number of tax breaks are phased out at various income levels, thus increasing/extending the progressivity. For example, somewhere in the neighborhood of $150k (don't have the exact number handy) it is no longer possible to put money into an IRA tax free. There are also caps on 401k plans, etc.

Unknown—interestingly, it sounds like those would all be all-or-nothing cutoff-type extra charges. So there could be a falloff from $149,999 to $150,001, (assuming the $150,000 figure is correct), but on most of those dollars the marginal tax rate (well, the marginal effect of the increased tax rate) would be zero. Unless I'm misunderstanding you.

Working harder is the opposite of productivity.

Productivity is getting more output from the same or less input.

Overall a very good article. But, how do your reconcile your original thought that the government plays a marginal role with the statements later that the Reagan policy made a big difference. This is especially true since the Reagan policies did not work. Trend real GDP growth was less in the 1980s then in the 1960s, 1970s, and 1990s as was trend productivity growth After the supply side tax cuts, investments as a share of GDP fell and personal savings plunged.

About all the supply side "miracle" has achieved was shifting the US from the world's largest creditor to the worlds largest debtor.

When you look at the source of capital spending in the US it is hard to see why anyone can make the type of claims they do about marginal tax rates and capital spending and growth.

In the US economy corporations account for some
72% of nonresidential fixed investments, households, partnerships, etc., that are subject to the individual tax rates only account for 11% of capital spending while tax exempt institutions account for 7%. Moreover, the share from the sectors subject to the individual tax rates has been falling since the 1980s when marginal tax rates were cut. So the actual experience has been that cutting marginal tax rates on upper income groups has been accompanied by a decline in the importance of individuals contribution to capital spending. Note, I am not saying that the tax cuts caused a fall in capital spending by individuals. Rather, I am questioning the claim that cuts in individual tax rates has made a contribution to economic growth.

But to take the subject back to your original thesis. You are right that it is largely natural economic forces that is creating much of the increasing income inequality in this country.
But the question is why should public policy be working hard on reinforcing this trend and making it worse, which is what giving top income groups larger tax cuts does. Shouldn't public policy be working on reducing the negative impacts of the trend of rising income inequality. Consequently, since it is clear that lowering marginal tax rates on the top income groups has not contributed to better economic growth shouldn't public policy be giving larger tax cuts to middle and lower income groups then to upper income groups? This would ease some of the pain of rising income inequality without harming the economy.

Spencer wrote:

"Working harder is the opposite of productivity."

"Productivity is getting more output from the same or less input."

I think productivity is the ratio of output to UNIT of input. The unit is generally considered to be the person-hour. I'll agree that getting workers to work longer does not by itself increase productivity. But when the workers produce more with the same amount of hours, productivity has increased.

Yes, but someone earlier had said that the Reagan tax cuts got him to work harder and I just wanted to point out that working harder has nothing to do with productivity. Productivity is working smarter and the primary way that is achieved is by increasing the capital/labor ratio, especially if you consider education imbedded capital.

Spencer wrote:

"Trend real GDP growth was less in the 1980s then in the 1960s, 1970s, and 1990s as was trend productivity growth."

I'd appreciate a little more information about your GDP figures. Reagan's economic policies were in effect from fiscal year 1982 through fiscal year 1989, not through the entire 1980's. in 1996, Cato Institute economists compared GDP growth during Reagan years with that of the pre- and post- Reagan years:

http://www.cato.org/pubs/pas/pa-261.html

1974-1981 GDP grew 2.8%
1981-1989 GDP grew 3.2%
1990-1995 GDP grew 2.1%

They also looked at GDP growth per working adult, to eliminate the effects of demographic changes. That was necessary because of the large number of baby boomers entering the workforce during the 70's. They found that:

"GDP growth per adult aged 20-64 in the Reagan years grew twice as rapidly, on average, as it did in the pre- and post- Reagan years."

Because this study was done in 1996, it does not include the second Clinton term.

Spencer, have you seen data that contradicts what Cato reported? Does that data adjust for demographic changes?

Is it really valid to compare 1980's GDP growth with growth in the 60's? I think a major cultural shift through the 60's was the rise of two-worker families. That, combined with the Kennedy tax cuts, probably accounted for any abnormally high growth in 60's GDP.

None of these [tax] breaks guarantee that the money will be invested in the United States in such a way as to create jobs and I would be willing to bet that a large amount of it would go to investments in China, India and other low wage countries

I'd disagree, and my opinion is hardly radical. It's utterly mainstream economics that leaving more money in the pockets of consumers will tend to maximize productivity. Who knows how they'll spend or invest it, but as free agents in a free market, what they do with the money is inherently more productive than what the gov't would do with the money.

I firmly believe that the standard metrics fail do describe or reveal what's really going on. Regardless of the median wage metric over the past (say) 15 years, I think it's clear that he median person is substantially better off than 15 years ago. And this isn't being captured in any metrics I've seen yet; perhaps the measures of productivity come closest but I suspect that deson;t capture everythign either.

That "median person" has all the goods and services he had 15 years ago, but now has a hell of a lot more besides. Would any of us give up the Internet, the cell phone, the music downloads, the iPod, HDTV/LCD/Plasma, bigger better houses, to go back to what we had in 1990? If you run the numbers and find median income is the same ... then you're missing something.

What you're missing is, well, consumer surplus or "realized utility" or perhaps something else?

I firmly believe that the standard metrics fail to describe or reveal what's really going on. Regardless of the median wage metric over the past (say) 15 years, I think it's clear that he median person is substantially better off than 15 years ago. And this isn't being captured in any metrics I've seen yet; perhaps the measures of productivity come closest but I suspect that doesn't capture everything either.

That "median person" has all the goods and services he had 15 years ago, but now has a hell of a lot more besides. Would any of us give up the Internet, the cell phone, the music downloads, the iPod, HDTV/LCD/Plasma, bigger better houses, to go back to what we had in 1990? It's quite clearly not just rich people who buy these things. If you run the numbers and find median income is the same ... then you're missing something.

What you're missing is, well, consumer surplus or "realized utility" or perhaps something else?

Also I think a big key to this is the mismeasurement of inflation. Inflation, after all, underpins just about all these metrics as a factor to be corrected for. If it's measured incorrectly, that undermines the analysis.

Could give a thousand examples: one is, much of the food I buy is half the price it was 3 years ago. Why? Because now those products are available as discounted store brands. Add in the rise of Costco/Sam's, e-bay, used books on amazon, etc etc. Is that kind of thing FULLY accounted for in measures of inflation? I doubt it.

Supercat,

That's an interesting observation - that new products are not captured in inflation or productivity metrics. I don't see how inflation measures could include new features of existing products, either. We may pay more for an automobile than we did 15 or 20 years ago, but we're not buying the same automobile. Some changes such as standard airbags are obvious. Others such as improved paint finishes are not. It seems, though, that inflation and productivity metrics should reflect such changes.

hi all,
"So why have median wages been stagnating even though productivity began increasing in the 1990s? Two reasons: increasing labour supply, and increasing costs for benefits. While median wages have stagnated, total compensation hasn't. In essence, workers have been consuming all of their income increases as health care."

the only problem with this is that when one does look at total compensation packages, they don't actually add up in the way that meagan says they do. the stats suggest that productivity tis still way ahead of total compensation. so, i modestly suggest another answer. surprisingly, i don't think it has to do with massive exploitation (though there is some of that going on--hence the divergence in compensation for the top 1% of wealth holders in this country--i think that is a serious problem...).

it has to do with a confusion that meagan has let into the discussion--namely an implicit assumption she hasn't made explicit regarding prices. what we are interested in is not productivity per se, but rather the value of marginal product (or marginal revenue product if you really want to get into the trenches).

VMP = P x MPL

If mpl goes up, whilst p falls, this suggests that firms cannot give workers the raises those workers think they deserve, because the compensation going back to firms is not as great as it otherwise might be. the cause of falling prices--more competition here (and especially abroad).

having said that, i am less sanguine that this explains all of the differential. the economist reported a few months ago on the split of profits and wages in this country (meagan's favourite mag!). its conclusion--that returns to capital over the last few years has been very, very good, in terms of growth, whilst returns to workers have been stagnant. that doesn't appear, on the face of it, to support megan's point of view. so, that is worth exploring, i think.

Returns to capital have indeed risen over the past few years, but that's pretty much par for the course in an economy recovering from recession; at the peak of the boom, labour will screw out more in wages, and labour's share will grow faster than capital's. The stagnation in real wage growth has lasted thirty years, during which time returns to capital have been roughly stable.

As for total compensation, what you describe is pretty much what we'd expect if wage growth was taking place at the top, where benefits are a small part of overall compensation. The figures I've seen, for median compensation, seemed to show benefits roughly tracking productivity. In recent years, I believe they've exceeded it, as health care costs have been rising at a 15% annual clip.

"TVA, Hoover Dam, Interstate Highways, FAA, Air Traffic Controlers, and Al Gore's internet creation program activities, the Army Corps of Engineers maintaining our navigatable waterways, Customs at port facilities, all these and more Jane would deny as having an influence, for good or ill, on the medium wages of American workers."

Ok, what persistent effect has a government electrical utility on the median wages of American workers?

Now keeping the skies nearly empty and regulating the personal aircraft nearly out of existence does have an effect on the median real wages and the utility of average Americans, but I would not assume it is a positive one.

And without Customs at port facilities, why, we might have to endure the nightmare of unlimited free trade!

As for Reaganomics, I believe the tax cuts also coincided with some deregulation efforts that might be far more responsible for the recovery, prosperity, and increasing tax revenues that followed.

johndewey --What the CATO numbers on real gdp growth have done is take a trought to peak data for the 1980s and compared it to the peak to peak or mid-cycle to mid-cycle numbers for the other periods.

The Cato numbers or a very biased comparison where they cherry picked the exact points that would give them favorable numbers.

It is the exact point Jane made in her original essay about the Reagan years being distorted by the recession.

Jadagul,

I'm pointing out that Cain's assertion that progressivity flattens after about 95k in income is wrong because of phased out tax breaks above that point. Call them what you want, but if you can take fewer deductions/credits/etc. at income levels higher than 95k, the net effect is progressivity and fairly steep at that since it involves cut off points. Progressivity flattens out at a much higher point that 95k.

John Dewey, the numbers attempt to take improvements into account. I'd argue that they don't do so very well; it seems to me indisputable that even the very poor are unambiguously better off than they were thirty years ago, at least in terms of things the economy can provide. But they do try.

The talk of progressivity seems to be ignoring the large and growing impact of the alternative minimum tax. A subject that makes my head swim.

hi meagan,
the figures i see you could be using, for e.g., http://www.epf.org/pubs/factsheets/2005/fs20050331.pdf, seen as an example. i am not convinced by these arguments. the epf seems reticent about looking at recent data (beyond 1995). i think one should also be compared with bls figures like http://www.bls.gov/news.release/prod2.nr0.htm for the third quarter, 2005.

i found the discussion and associated threads at http://macroblog.typepad.com/macroblog/2005/08/the_nonmystery_.html interesting reading--which points to possible divergence between total compensation and productivity over the last year and a half; but i am not swayed by the models used, though i am open to being convinced.

but it still gets back to this point i made earlier:

i would still like to hear what you think about vmp issue. the thing i find interesting is that the epf talks about linking productivity to prices of goods sold: "Ultimately, it is the value of production which determines how much employees are compensated." http://www.epf.org/pubs/newsletters/1996/ff2-3.asp

sizegenetics device

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