Muddled Thinking on Small Business Taxes

I am currently taxed as an independent contractor, which while not really a small business makes up the majority of what are referred to as small businesses in political rhetoric. Having some direct experience of this is what made me look really derisively at this article from the Washington Post. Specifically, this claim:

What policymakers fail to realize is that most small business owners, who also employ most of the country’s workforce, declare their business profits on the owner’s personal income tax return and are taxed at the personal income tax rate. Given that the net income number for many will be over $250,000, the proposed tax hikes could have a dramatic effect on small businesses and the growth and hiring decisions they will make.

Another point policymakers overlook is that business owners will ultimately pass this cost on to the middle class by raising prices on goods and services, possibly triggering layoffs and stalling hiring. With the combined tax increases and the cut in spending, it equates to roughly half a trillion dollars being removed from our economy. The U.S. gross domestic product will fall, causing the U.S. to face a possible downgrade by Moody’s. If that happens, business lending will shrink to levels near or worse than those we experienced in 2008.

The technical term for this crap is bullshit. Taxes on profit only act as a cost to be passed on when assuming liquid investors comparing the investment versus a normal rate of return (not always a realistic assumption even in public corporations, and an assumption that only works if the business has the market power to do this, if it is already at the optimal price for its rate of return shifting from this can only lower net profits). This does not characterize small business owners heavily invested in illiquid assets and deriving a significant portion of that capital from their own labor. If a small business could raise its rate of return by raising prices it would have done so already, small business is competitive and can't afford to miss opportunities like this. Raising prices due to higher taxes would just result in that business losing sales and the owner possibly avoiding that tax hike through a lower net income; hardly the desired result.*

Since small businesses also face competition from other, newer, small businesses whose owners are not yet making over $250,000 net there is also no possibility of coordination; a wealthier small business owner that tried to raise prices would find themselves less competitive relative to a newer entrant still not facing the higher tax bracket.

There is also no reason to see how the tax hike could possibly impact hiring decisions, retaining 60.5% of profits vs. retaining 65% of profits from the marginal hire doesn't have any impact on whether or not that new hire is profitable at the margin. It does reduce the magnitude of the incentive, but the magnitude of the incentive only seems to matter with large swings or when relative incentives change (this does increase incentives to shift income to capital gains if the capital gains rate is not raised, but given the large existing discrepancy I believe this is largely baked in).

The rest of the article is much better when it discusses specific provisions regarding tax write offs for investment in new equipment. These provisions could be problematic. But the quoted paragraphs are the kind of ideological claptrap I come across in business books all the time whose purpose seems to be fluffing the egos of business owners rather than carefully thinking through making good business decisions. All this shows is that you don't really need to think through what is actually going on to make your business successful, all you need to do is focus on the narrow task you've set yourself rather than the wider world. Fair enough if this stuff helps sponsor entrepreneurs, but newspapers shouldn't be propagating obviously wrong, ideologically motivated nonsense.

*Alternately, this may also increase a business owners preference for tax deductible investments since the marginal cost to current consumption has become less with higher taxes. An owner may choose to spend more on creditable health care coverage or seek investments to raise long run profits to reach the former pre-tax income. The main individuals this hurts are those with highly volatile year on year income, but most business owners can shelter this money in business investments at least temporarily to smooth this; though this is a hassle no one really wants to bother with.

[Update: For clarifications sake, I am not arguing that firms generally can't pass on costs, such as the corporate tax. What I'm arguing is that passing on costs requires a degree of market power and sales volume that publicly traded corporations tend to have and small businesses tend not to. That Toyota can get away with raising the price on a Camry to reach a profitability target (and experience a trade off of market share vs. profitability with all the relevant consequences) does not mean that your local car wash or dry cleaner can do the same because the tax rate on individuals went up. This should be fairly obvious to anyone that formally studied economics and thought through the implications of the models, but I guess it gets skipped in the economics for business school courses.]

Why Is Capitalism So Efficient?

This is something that has been bouncing around in my head since reading David Graber's Debt: The First 5000 Years and Acemoglu and Robinson's Why Nations Fail. While the central themes of the books are rather different they have polar opposite takes on capitalism's impact on individuals. Graber sees debt (the parallel is imperfect here since Graber is more narrowly focused) as being rooted in exploitative practices and creating, to some degree, a form of bondage between lender and borrower that has become disconnected from other human relations. Acemoglu and Robinson, on the other hand, see the modern capitalist system as one that approaches being an open access system, instead of oppressing its participants it presents a contrast to the exploitative relationships of the past, particularly when combined with democratic political institutions.

This represents a long running divide between the far left and far right. There are two polar opposite ways of thinking about the market, on the far left it is described as having become disembedded from other social relationships, leading to alienated, exploited, and incomplete individuals. On the far right, there is the efficient markets hypothesis which holds that unfettered market interactions can maximize use of all available information to optimize outcomes.

I think both of these perspectives contains important insights. I agree with the left wing view pushed by anthropologists and sociologists, capitalism disembedded many interactions from the human context that they were previously embedded within. However, once disembedded these interactions became sufficiently simplified to allow for efficient maximization behavior. This is a key element that led to the spectacular increase in growth and human welfare.

A Simple Metaphor to Explain Austerity

I periodically see posts from left leaning economists decrying the ill effects of austerity followed by right leaning posts trying to deny that austerity is really happening because the government is spending more money.

I think a simple metaphor will serve to illustrate what I think is going on here. Imagine you are a church in the midst of the downturn. You have an extensive anti-poverty program that gives meals, retraining, and other services to the poor. Your receipts have fallen due to a great economic downturn. Your obligations have risen because you have an open door policy towards the poor.

To try to keep a balanced budget you engage in austerity measures. You don't replace some of your paid staffers when they leave. You cut down on perks like social outings for congregation members. You choose to forgo a scheduled update of the computer system as well as maintenance on the property. Small staff and volunteer perks are cut, like free lunches for volunteers. To try to meet obligations you pressure parish members for larger donations.

However, because of the growing poverty in your area and your well known open door policy the numbers of those seeking your services leads to ever higher expenses. The cost of providing so many with meals raises the food budget to unheard of levels. More parish members are asking for help with medical expenses, matching donations becomes a strain on the budget. Costs of job seeking help rise, providing transportation and other services to job seekers becomes a major drain.

On net, despite sharp cut backs in normal operating expenses and investments, the church is left with growing debt. But to any observer the church is obviously engaging in austerity, its parishioners are receiving less in the way of social activities, volunteers get less perks, and the physical infrastructure is visibly decaying. However, continuing to meet other obligations is proving very expensive and is leading to the church spending more on net.

This is essentially what is happening with most governments engaged in austerity. They have not only obligations to taxpayers and creditors but existing obligations promised by their programs. Engaging in austerity means cutting back on discretionary programs (which tend to have some of the largest positive marginal impacts, unfortunately), funds allocated to current employees, and to needed investment activities. A state engaging in this is obviously engaging in austerity. That expenses keep rising due to other obligations does not change this, though if someone believes that a smaller government sector is essential to growth than obviously austerity will seem insufficient. But that a state chooses to keep its obligations to the poor as well as its obligations to the relatively wealthy bondholders does not indicate that real austerity is occurring.* If an organization other than the state engaged in this form of austerity it would be obvious to us that it was, in fact, cutting back. It should be obvious when the state does this as well.**

The Welfare State and Filial Duty

Something that I believe is not sufficiently acknowledged in public discourse but that is essential to understanding the function of the welfare state is that every welfare state was originally constructed when the voting block of the elderly was relatively weak. This means that large numbers of younger people necessarily had to have some incentive to be willing to pay more today, supposedly in return for some benefit. Now, it is possible that they had some future benefit in mind, but I find it hard to imagine most young people were that much more forward thinking in the 30s to 50s than they are today. Rather, there must have been some current benefit they had in mind (or they could have been far more altruistic, I find this implausible as well).

So what is this benefit? Two passages from this Economist article are instructive.

Some of the national leaders who unleashed those tiger economies would be shocked and disturbed by the development. To them the welfare state was a Western aberration that would serve only to undermine thrift, industry and filial duty. Those virtues, they argued, underpinned their economic miracles and won envious admiration abroad, not least in Western countries bent under the weight of their social obligations. That is not to say that Asia boomed in the complete absence of welfare provisions. But its arrangements took a distinctive form which Ian Holliday of Hong Kong University has termed “productivist”.

This welfare model assumed that Asia’s tightly knit families would take care of the social responsibilities its governments refused to shoulder. But asked to tutor their children, care for their parents and supplement their husband’s income, women have rebelled. The Singaporean women interviewed by Shirley Hsiao-Li Sun, a sociologist at Nanyang Technological University in Singapore, “want more direct and universal state subsidies, especially for education and health care,” she writes.

This is fine so far as it goes, but raises the question of why rebel now? These duties have been done by women as far back as we have recorded history, to stick with China, back when taxes were collected in kind (so before the Ming single whip reforms) there were separate tax requirements for the work men were engaged in, primarily grain, and women's work, such as silk. Child and elder care are central to the Confucian ethos, these are hardly new requirements.

In addition, the western social safety net came into being under similar pressures (Patterson's America's Struggle Against Poverty in the 20th Century is as good a place to start as any on the subject). Given the universality of these demands, that they occur even in system's such as China's that are not terribly responsive to public demands, and that they only seem effective at fairly high levels of development there must be something more going on here than the wealth effect.

Some Thoughts on "Why Nations Fail"

I recently finished Acemoglu and Robinson's Why Nations Fail. I also recently finished Graeber's Debt: The First 5000 Years (more on that later).

My reaction was similar to Fukuyama's (response from Acemoglu and Robinson).

I'd just like to add a few things.

First of all, the bit on Rome I found unconvincing. Building on what Fukuyama already said, it is also possible to look at the transition from Republic to Empire as being a result of new economic realities and creative destruction. Arguably, the "new men," such as Cicero, had interests in businesses different from those of the old Senatorial class and particularly in different areas, outside of the immediate area of Rome and out in the provinces. While the Roman Constitution gave at least some rights to those within Rome itself, it did a very poor job of representing the interests of provincials; the Imperial system may have provided more access.

This raises some important questions regarding putting inclusiveness on an axis. Can it really be represented this way, or are the questions of who is represented, to what extant, and how separate questions? For the Roman case, which was more inclusive; a system that opened elections (to some extent) to many different economic levels but was dominated by a largely closed class of aristocrats and excluded those that could not be present in the city itself, or a system that granted access to the elites throughout the provinces, providing at least some access to the provincials in those provinces, even if less access for all economic groups within the capital itself? How much did representation by tribes matter? How much does indirect vs. direct representation matter for putting a society on this access? I'm not convinced we can meaningfully get policy recommendations or enhance our understanding along such an undefined axis.

Progressives Actually Do Have a Deficit Reduction Plan

Haven't finished reading it yet, so this post is not meant to be an endorsement of the plan in any way. However, it is a common right wing talking point that there is no plan from the left to get America's fiscal house in order. That is just plain false.

Short form, it achieves $6.8 trillion in deficit reduction by cuts to the military, raising taxes on the top of the income distribution (including several new brackets), ending preferential treatment for capital gains, and simplifying the tax code by eliminating many corporate tax expenditures. It also contains substantial stimulus measures.

So agree or disagree with it, there is a plan.

Here is the 1 page summary.

Here is the executive summary.

Also, as Ezra Klein stated about their 2011 budget proposal, "it's much more courageous to propose taxes on the rich and powerful than spending cuts on the poor and disabled."

The Reality of Taxes in America

Andrea Louise Campbell has a great article taking a comparative look at taxes in the United States.

The bottom line is that "the reality of U.S. fiscal policy: compared with its counterparts among the advanced nations, the United States' tax system collects little revenue, poorly redistributes that money across the population, and is mind-bogglingly complex."

An example of this complexity is that "to get another sense of the difference between the United States and other developed countries, consider the subsidization of the cost of raising children. Many advanced-country governments calculate and send allowances to families with children. In the United States, however, households with children must navigate and administer a complex system of tax breaks themselves, such the Child Tax Credit and the Earned Income Tax Credit. And if they file their returns incorrectly, the IRS may fine them."

Furthermore, for the tax system as a whole "the share of taxes paid by each income group essentially resembles the share of income that it receives, which would not be the case in a more progressive system. According to the Institute on Taxation and Economic Policy, a fiscal think tank, in 2011, the lowest fifth of earners received 3.4 percent of total income and paid 2.1 percent of total taxes, the middle fifth received 11.4 percent of income and paid 10.3 percent of taxes, and the top one percent received 21 percent of income and paid 21.6 percent of taxes. "

What do we get for it? "In Europe, regressive taxes are matched with highly redistributive states. In the United States, mildly progressive taxes are matched with a not very redistributive state. As a result, the United States experiences greater inequality than most other advanced nations, with the tax-and-transfer system doing little to alleviate it."

And what does the research say about the consequences? Generally, that the US fiscal state is inefficiently small. "Slemrod and Bakija found little correlation across the OECD countries between taxes as a percentage of the economy and the size of the economy itself, as measured by per capita GDP. Nor, according to their research, is there a high correlation between taxes as a percentage of GDP and the annual rate of economic growth." "There is little evidence that tax rates affect the participation of either middle- or high-income individuals in the work force. And despite higher taxes, higher earners ultimately did not spend much less during the 1990s, since the total income of the top one percent during that decade rose..." "past experience suggests that a tax hike today would not severely damage the economy, and productivity might even rise with the security and investments that government spending can provide."

We face some real decisions over the next few years in this country, and it would be best if we understood the consequences of these decisions. Unfortunately, it seems to me that mythology dominates the tax discussion at the expense of research and reality. I encourage you to read the whole article, it is sobering considering the state of US political debate.

Shared Sacrifice, for the Other Half

I was a little shocked that Paul Ryan was selected for VP. But it does open up wonderful opportunities for articles such as this at the Washington Post. It was fairly obvious from a read through of Ryan's Roadmap in the first place, but a more detailed look at it is worth having.

It does need to be noted that given Ryan's assumptions expressed in the Roadmap having to do with the impact of assistance on individual work ethic and the positive impacts resulting from making real costs felt by an individual, these shifts in spending are fully consistent with Ryan believing his budget not only helps the country but also the poor themselves by reducing dependency and increasing incentives for hard work. I also happen to think that even a passing familiarity with the empirical data on government spending, the impacts of aid, distributional impacts, entrepreneurship, or any other related subject would reveal these assumptions as barking mad. But being barking mad is not inconsistent with thinking you are acting in the best interests of the people whose program's you are cutting.

Why Does the Topic of Welfare Inspire Some Republicans to do their Best Impression of an Outraged Aristocrat?

I hadn't heard this elsewhere, but apparently Obama has been granting waivers to welfare work requirements. This has outraged the right as Jennifer Rubin displays rather well:

Like Kaus, I am at a loss to explain this maneuver on political grounds. (“Requiring that welfare recipients work is a political winner — proven, again and again. . . . And in 2008, Barack Obama didn’t dare suggest that he wanted to do what he has done today. Obama’s given his opponents a huge opportunity to raise the ‘welfare’ issue, to associate him with the unpopular idea of subsidizing women who have children they can’t support, usually out of wedlock — even giving them free community college training that hardworking people who don’t go on welfare can’t get!” )...

Obama's imperious use of executive orders and refusal to enforce the laws of the land fairly and completely is a constitutional disgrace. But his policy judgment is so off-kilter that it also demonstrates Obama’s faulty approach to immigration, welfare, administration of justice, etc. The policy implications are far more politically damaging and reinforce conservatives’ fears that a second Obama term would witness a lurch to the left.

Perhaps this is an instance of a President trying to do what's right. He may have been advised on the issue by someone that has actually read the poverty literature, while work requirements can have a positive impact when the labor market is tight the people forced into work by them are those least able to compete on the labor and most likely to turn to illicit activities if not supported. With high unemployment it is very unlikely that the welfare recipients impacted by the relaxation of work requirements could find decent work, relaxing these requirements may help to alleviate other social problems, aside from the fact that putting food on the table and keeping the lights on for poor kids is a rather decent thing to do. I agree this is almost certainly a political loser but it makes a lot of sense to anyone that has read the poverty literature. In current economic conditions work requirements will almost certainly only drive up the competition for low end jobs and may lead to someone unlikely to keep the job getting it over someone that is more motivated and doesn't need the stick of a benefits cut to work. Even in better economic conditions the impact of work requirements is very small, in current conditions it is all downside and no upside from an economic and social point of view. Perhaps that, and not political considerations, is the motivation here.

It also deserves noting that people never seem to object when the president approves state waivers to tighten welfare, like drug testing or Michigan's restriction of benefits to four years. When states ask for these waivers where is the hue and cry over ignoring current law.

New Report on Economic Mobility

Just finished reading a new report on economic mobility from the Economic Mobility Project at Pew Charitable Trust. In a nutshell, the report reveals that Americans have experienced absolute mobility, families have both more income and wealth then their parents, while relative mobility (between quintiles) has been less remarkable.

A couple of brief observations. First, economic immobility remains substantially correlated with race, there's a very good reason that people continue to seek explanations and solutions to this problem (like affirmative action).

Second, I would find the absolute mobility measures far more useful if a section were added comparing it to overall economic growth. With a rich country expected growth rate of around 2% a year, it would be shocking if any quintile did not experience some absolute growth. The relevant question is whether or not each quintile is experiencing relatively similar rates of growth or if the place in the distribution is a significant determinant of the growth rate. After all, if the lowest quintile is experiencing a 0.1% rate of growth a year over 40 years there will be an absolute improvement but it isn't very impressive if the top quintile was experiencing 3-4% a year growth. This matters for putting absolute increases in perspective.

Also, briefly, the report reinforces the importance of getting people in the lowest economic rungs into further schooling. Education has a much greater impact on these individuals than it does for others who likely have other resources to aid in their income mobility and security. In addition, the report shows that the lowest income quintile appears to have more of a floor under it than in preceding generations. This is open to interpretation, but the continuation of the stickiness of mobility at the bottom provides a hint that income support programs, like a higher minimum wage, the EITC, and more benefits targeted towards children (like SCHIP) may be helping to prevent these individuals from becoming as destitute as 40 years ago. If enhanced access to market income was the cause, I would expect the absolute gains to be associated with greater mobility, though this is only an educated guess.

Some Brief Thoughts on Risk Taking and Growth

I have often heard variations on the theme that exposing people to additional risk is likely to drive growth by a more efficient allocation of resources. Linked to this, I also observe a tendency to describe entrepreneurs as being lean and hungry, as if the thought of not being able to put food on the table is part of the driving motivation.

I have serious doubts about the accuracy of this description. From what I've read of the entrepreneurial literature, most entrepreneurs fall into one of two camps, both better described as fat and happy rather than lean and hungry. One type is the upper middle to upper class individual from a stable family who generally combines drive with a substantial ability to earn a good salary as an employee if their venture fails. This individual does tend to load up on debt in starting their enterprise. However, this hardly means the individual faces outsize risk, at worst they declare bankruptcy, lose a bunch of stuff they bought with other people's money, and go work for the man as a faceless suit.

The other type is generally an older couple whose kids are reaching self-sufficiency. These couple's frequently use their own assets to start a business, so have more exposure than their younger counterparts, but they frequently are able to shelter a significant portion of their assets in case their venture does go under. These individuals also tend to have had successful careers and have a good idea how to run a business, their experience means they are taking a lot less risk.

Alternatives to Socialism and Capitalism, the 3 Ideal Type Model

Something that I believe I have remarked on before is that I am rather dissatisfied with the crude portrayal of the choice between socialism and capitalism given by politicians, sometimes by the media, and that is expressed rather often on comment boards and by the public generally. I personally don't believe that socialism and capitalism accurately capture the choices we face in modern society or the factors that impact society, whether growth, social mores, or politics.

Of course, denigrating a perspective isn't worth much unless an alternative can be suggested. Personally, I prefer a model used frequently by economic historians, the 3 ideal type model.* Rather than a simple line between socialism and capitalism, this model separates economic organization into three ideal types, customary, market economies, and command economies. All three types are visible throughout history and all societies have elements of all three.

The first type, customary or traditional economies, are those dominated by role and custom. This can mean guild organizations, functional age groups (in some very primitive economies), gender roles, household economies, castes, and many other variants. At its most basic, these economies are organized on the notion of reciprocal obligations, each actor has a defined role to play and gets some sort of compensation in return, without the need for money or barter (though more complex, mixed interactions are possible, with either culturally proscribed fair prices or defined occupational roles but with money exchange occurring for the actual production). In the modern economy, the household is the primary example, I cook and my girlfriend cleans house. It would also involve other family obligations, or something as simple as rotating who hosts dinner parties among a group of friends.

A Nice Paper on Taxes and Economic Growth

I came across a link at the Monkey Cage to a paper exploring the correlation between taxes and economic growth on both a theoretical and a factual level. As I've pointed out on my blog before, the case for lower taxes leading to higher economic growth is rather weak, both from a theoretical and empirical standpoint. As the paper points out, there remain other arguments in favor of low taxes, but the evidence is becoming increasingly strong that higher economic growth is not one of these reasons.

I'll have more to say on some related topics later, this paper points in the direction of a few tax topics worth greater discussion.

Why Not a Progressive, and Separate, Tax on Capital?

This idea is the result of a curious mashup of reading about the Ming Dynasty, industrial revolution, state collapse, and poverty, but it seems to me ideal to tax capital and labor separately, and progressively, at the same rates.  It baffles me that this isn't suggested more often.  Why not treat capital income completely separately from labor income, each with equal progressive rates (corporate taxes are already nominally taxed at progressive rates, I have individual investors and sole proprietors in mind here)?

There are numerous benefits from this.  First of all, it would encourage people to diversify their assets.  An individual receiving most of their capital gains from illiquid assets like housing is severely disadvantaged relative to someone that receives a portion of their gains in smaller amounts through dividends and stocks.  Divesting illiquid assets such as housing would be disadvantaged since this would lead to high tax liability in one year relative to a regular income stream from other capital assets.  This would encourage money being put to work in productive enterprises rather than tied up in bidding land prices up.

It would encourage low income households to invest at least some of their money since this would enjoy a separate tax schedule and presumably standard deduction.  While a poorer person may not gain much tax advantage from the 15% capital gains rate, they gain a significant advantage if interest income from stocks and bonds as well as capital gains would be effectively untaxed due to existing on a separate rate.  They would face an effective marginal rate of 0.  This also avoids the perverse incentive of the current tax system that encourages the already well off to invest ever more of their wealth, gaining a greater tax advantage with each step, allowing them to pull ahead of the less well off.

In addition it would avoid the current bias of our system towards capital.  Currently, someone that enjoys a high labor income due to investment in their own human capital faces much higher tax rates than someone that primarily invested in capital.  The reasoning behind this looks increasingly thin to me as we gain better knowledge of how the economy worked during the industrial revolution, it increasingly seems that capitalism is a misnomer and that higher incomes among the labor force and linked small scale investment was a larger driver of change than large scale investors and capitalists, including the bourgeoisie (incomes were higher for industrial workers than for artisans, the earlier assumption was that wages were driven down by people being driven off the land which the records don't back up).  This makes a lot of the classical assumptions questionable, the evidence increasingly seems to be that the important competition is that of new firms originated with small investors rather than the Schumpterian sense of competition for outsize returns by a few powerful firms and large investors.  The policy implication is that it is more important to favor labor and new capital formation and that capital shortages are exceedingly unlikely to exist in the real world. 

Separating capital income from labor income means that someone that gets a higher wage will face a comparable tax rate as someone that receives their income from capital.  In addition, a successful wage earner will have an incentive to invest in capital as well since this would be taxed on a separate schedule (and vice versa).  It would also mean that large concentrations of capital face higher marginal rates advantaging hungry new start ups (to some small degree).

That's all I have time for.  I have no doubt there are many complications, there are some big problems with being able to label one form of income another.  However, these problems would mostly exist for new firm start-ups still operating as sole proprietors, not for very high incomes.  Some shrinking of existing brackets would also be necessary since most high earners are currently being taxed on both labor and capital income under current income taxes.  As a separate issue, current tax rules with their myriad deductions would likely interact poorly with this which would require trimming some of these deductions (which we need to do anyway, but it's a separate topic).  Of course, more narrowly we could just make the cap gains tax progressive, but I have a big problem with favoring cap gains over dividends.  There are also some housing issues that I'm aware of.

Anyway, this is a half thought through idea but multiple lines of evidence are converging to make me think that our current system is fairly ruinous from a long term economic standpoint.  Capital needs to be taxed at much higher rates than it is today but it also seems important to encourage capital formation among lower incomes and among people who are currently primarily invested in labor.  The current system disadvantages groups such as doctors and other professionals too much relative to groups like bankers, separating income into two separate schedules would eliminate many of the disparities in current tax rates between nominally equal income groups.

Has Our Work Ethic Changed?

I just can't help but respond to a rather silly post I saw on CNN.  Looking at aggregate data, I see absolutely no sign that Americans have lost their work ethic.  It is true that hours worked per worker have declined by about 100 hours since 1950, from around 1900 to around 1800, but the difference isn't that large and likely primarily reflects better labor conditions.  (OECD data, dangit, it doesn't retain the changes I made to the chart, you'll need to alter the fields yourself to see back to 1950)  Furthermore, labor participation peaked in the late 1990s, labor force participation data shows quite clearly that the state of the economy is the primary determinant of the work ethic, rather than the other way around.    Better economy, means more people work for longer hours.  The poor are particularly sensitive to this.

Looking at other data, it is complete bullshit that young people have lost their labor ethic compared to the past.  Labor force participation among the 16 to 24 year old age group has increased from 59.9% in 1950 (and 56.4% in 1960) to 65.9% in 1998 (these numbers fluctuate with opportunities for higher education as well, so are rather variable). (BLS data)

Now, it is probably true that poor kids have less opportunities to make money when young.  But this is largely because they're poor, I doubt kids in housing projects get much in the way of allowance so parents can hardly require them to do chores for money (they may of course still require you do chores, but historically, something that separates capitalist societies from pre-capitalist societies is that in capitalist societies you get something from your work, in pre-capitalist societies you work but get nothing, teaching kids to work for the sake of working, while perhaps good for teaching them to maintain a household, doesn't reinforce capitalistic market habits any more than did the labor requirements that many pre-capitalist societies that never developed capitalist markets did, there's a difference between forcing people to work for whatever you deign to give them and teaching them the benefits of work, a distinction that I think is often lost in debates regarding work ethic).  If you're in the projects, there isn't anyone with the cash to pay you 5 bucks to shovel or mow a lawn/driveway (or a yard or driveway in most cases).  So there's not much you can do to promote work unless you first raise incomes, which isn't what I think Gingrich is talking about.

Behind all this rhetoric, I see nothing but an elitist attitude that people should accept what we're damn well willing to give them. Statements like this:

Whenever I write about young people and the jobs they won't do, I hear from dozens of employers with stories of their own. The common theme in all those e-mails is that we've been too soft on our kids and haven't demanded enough from them, something we hardly notice because we've allowed illegal immigrants to pick up the slack.

Have been recorded in countless variations since Sumer.  They're all bullshit, kids these days are no worse than they were before, there are a lot of indications that they are better, harder working, and more entrepreneurial.  What has disappeared is the institutions that used to exist to justify bad behavior, 50 years ago a teenager that got knocked up would have simply been married off, today it's recognized as a social problem we won't paper over by marrying them.  Kids these days work, and work hard, kids in poor neighborhoods don't have the same good influences but they never did have them.  A kid living in a 1950s era poor rural village wouldn't have had any better influences than a kid in today's housing project, but out their in the sticks they would have been out of sight and out of mind.  The only thing that is different is poverty, and its work ethic crushing effects on people, is more visible than 50 years ago.  Moral exhortation won't do a damn thing, no matter how many anecdotes are collected advocating for firmness, because the reality isn't that things were once better, the reality is that we are more aware of the problems.  Gingrich's statements on the subject aren't some bold revelation, they're tired, worn statements of an out of touch elitist trying to dismiss real social problems as the flaws of individuals.  It's based on not understanding our history and glorifying a past that never happened while simultaneously denigrating our own times which have revealed the problem, not caused it.

There's nothing bold about these statements, they do nothing but reinforce people's prejudices while doing nothing to point towards a solution.  They distract us from the real problems we face and provide easy answers that require us to do nothing as individuals, it's all in the hands of someone else to change, usually the poor and politically weak, while justifying our own success as due to our own inner moral goodness (well, I don't hire illegal immigrants to rake my leaves, I make my kid mow the lawn for his allowance, etc. so I've already done my part and don't have to give a damn about those lazy poor kids whose parents have gone and ruined them).  The fact that variables such as work force participation can and do vary with the economy and that it differs with social programs does show that Gingrich's attitude is nothing but self-justifying.  We can do something to change these factors, they just involve us doing something rather than sitting on our hands because I have done what I could and leave it up to someone else to do the rest.

Some Examples of Why Income Immobility is Persistent

The NY Times has a nice article on using home equity loans to start a business.  I don't have much to add, except that this shows just how much of an advantage it is to having assets to leverage.  Some potential entrepreneurs have ideas that can be started with little money, most don't.  If someone has entrepreneurial talent, but no assets, they wouldn't be able to do what these people do.

The entrepreneurship angle is a fairly small part of this, educational issues are probably far larger, but it is worth giving some examples of some concrete ways that income inequality and mobility trends tend to be self-reinforcing.  Growth in income inequality is likely to accelerate over time if market forces are left to do their work, eventually lowering growth as we move further away from a meritocratic system where the person with an idea can start a new business as they will be increasingly unable to compete with the favorable access to credit of someone with greater existing assets.  This is why these issues are so important.

This is How They Lie to You: Paul Ryan Edition Pt. 4

First, thing I'd like to mention is that I skipped substantial parts of page three of Ryan's report that I think are deceptive. This is because it is addressed more fully under the section "The Impact of Government Policy on Inequality." Rather than addressing the same facts twice I will address it all at once.

The second thing I want to bring up before moving forward are some of the implications of the change of age distribution on inequality. As I had said before, this is largely irrelevant to the inequality discussion since there should be a more or less constant number of households at various points in the income distribution meaning that the movement up or down of individual households is irrelevant to aggregate changes in income inequality (meaning that we should expect roughly proportional numbers of people to be at each stage of the life cycle during any given snapshot so increases/decreases in inequality indicate that something is happening aside from normal life cycle changes since we expect the distribution of individuals at each stage of the life cycle to be roughly constant). Now, since these proportions are not precisely similar over time, largely due to the boomers, some portion of the increase in inequality is due to this (it needs to be noted however, that the demographic shift has been larger in most other countries so the relative portion of change in inequality due to demographic shifts should be lower than the US than in other developed nations, though non-zero).

Think about this for a minute, however. The argument is that a larger portion of individuals in the US is at a later stage of the life cycle and thus wealthier. As people age, they have higher assets and income making comparisons between the top and bottom quintiles more uneven since a greater portion of the top quintile will be older (this says nothing about the 1% however, far more than 1% of the population has always been in their top earning years so this segment shouldn't change). Fair enough, but shouldn't this also mean that the median income earner should be older and closer to their peak income years?

Here's an implication of Ryan's suggestion that is not properly put into context. He addresses the fact that part of the explanation for increased income inequality is age, however, this argument necessarily implies that part of the growth in median incomes is due to age since the median income earner is closer to their peak income years. I couldn't find data for the years in questions with a quick search, this particular data I've never needed before, but what I did find with a quick look is that between 1990 and 2000 median age increased from 32.9 years to 35.3 and to 36.9 years today. The already dismal growth rate in median income for the period from 1979 to 2007 appears even worse when you take into account that, just as the increase in income inequality is in some small part due to shifting demographics, the growth of median income is in some small part due to shifting demographics as well.*

This is How They Lie to You: Paul Ryan Edition Pt. 3

Sorry about the long delay getting this post up.  The holidays took up more time than I expected and I had some projects that needed to get done that were somewhat higher priority than the blog.  Hopefully I'll be able to push through the analysis of this report over the next few days so I can move onto other topics.  Even though I'm now discussing a report that has sunk beneath the headlines for more than a week, I still believe a detailed analysis of it is useful, perhaps even necessary.

To continue from where I left off,

In attempting to draw conclusions from the CBO study, particularly in terms of how it might inform policy prescriptions, it is useful to contextualize the analysis, acknowledging the limitations that the CBO placed on the scope of its study, as well as alternative interpretations of similar data. Recent commentary on this issue 0ften draws sharply divergent conclusions based upon legitimate differences regarding how to frame the challenge. Proper context can help advance a more informed debate on how society can best secure the natural rights of all citizens to freely pursue their happiness.

 Love the sentiments, however, I feel that Ryan obscures the context rather than casts light on it.  This sham reasonableness is a characteristic of some of the most reactionary writing of our time, such as the widely discredited Losing Ground and The Bell Curve by Charles Murray.  It's easy to convince people of good intention by stating it, repeatedly, even if the data presented shows extremely biased analysis.  That's the problem with technical language, it strips away the verbal cues we usually use to assess the honesty/dishonesty of an argument making us suckers for charts, graphs, and arguments presented reasonably, even when the argument being made is far from reasonable.

So let me explain why this argument is unreasonable.

The CBO took static snapshots of the income distribution at two different points in time, in this case 1979 and 2007. In examining these snapshots, it is clear that real income has grown significantly more for those at the upper end of the distribution than for those at the lower end over the past 30 years.

Yet the CBO concedes that the dynamism of the American economy is not properly captured by this analytical approach. It is not the case that individual households remained fixed in the income distribution over this period. The CBO readily points this out: The study “does not reflect the experience of particular households. Individual households may have moved up or down the income scale if their income rose or fell more than the average for their initial group.”

This is an important distinction, as considerable empirical evidence has made clear that there is a significant amount of movement across income quintiles over time – in other words, there is a lot of income mobility in the U.S. economy. A person working his or her way through college in a relatively low-paying job in year one, for instance, may have climbed into a much higher earnings level by year five. Comparing the low-income point in year one with that same low-income point in year five does not speak to this particular individual’s experience, because the individual has moved up over that time. As the Federal Reserve Bank of St. Louis puts it, since “incomes are not constant over time, the same households do not necessarily remain in the same income quintiles. Thus, comparing income quintiles from different years is a proverbial apples-to-oranges comparison because the households compared are at different stages in their earnings profile.”2

This point doesn't deserve much discussion.  It's obvious that a poor college kid at one point in time might be a rich hedge-fund employee five years later.  The way this is presented it sounds really useless, the snapshot doesn't capture any dynamism because a poor household one year might be next year's rich household.

But, while there is a grain of truth here I'll get to in a bit, this is ultimately deceptive.  While an individual household may progress that's largely irrelevant, this year's college graduate is replaced by a next year's freshman.  While individual households will move, they have always done so.  If every poor person were a college Freshman, I would agree there is no problem.  But this simply isn't the case, there are a lot of poor 30 somethings as well, more than there are college Freshman that are going to be bankers after they graduate.

Of course, there is a grain of truth.  The age distribution has shifted and this has contributed to income inequality to some degree.  This portion we shouldn't worry about, but it's not that big a piece of the puzzle.  Here is an animation of changes in the age distribution since 1950 (this is from Calculated Risk and goes out till 2050 since it was created for a completely different purpose, but since health care is the usual reason people make these graphs it's too time consuming to find one made specifically for my purpose here that wouldn't include the extra years).  What is deceptive here is that the Commission makes a big deal out of this factor while it's a small contributor.  Also, it needs to be noted that other countries have faced far greater changes in their age distribution than the US (Japan comes to mind) without comparable increases in inequality.  While a legitimate piece of the puzzle, it's a really small one not worth the wordcount given to it in the Commission's report.

While household income mobility is high in the United States, other studies have attempted to gauge economic mobility by looking at a different measurement. Rather than looking at the movement of individuals or households over time, these studies measure the likelihood that a child will do better than his or her parents and then compare these statistics among developed countries. According to one such study by the Economic Mobility Project, by this measurement, economic mobility is higher in other developed nations than it is in the United States.

Lets look at what a more academic paper has to say on this (Beller and Hout 2006)*:

Although the United States occupies a middle ground in international comparisons of occupational mobility, its ranking in terms of income mobility is lower. Both the United States and Great Britain have significantly less economic mobility than Canada, Finland, Sweden, Norway, and possibly Germany; and the United States may be a less economically mobile society than Great Britain. Much of the higher intergenerational elasticity in the United States is due to greater income immobility at the top and bottom of the earnings distribution; the mobility of middle earners looks more similar to that in the other countries.

Eh, I'm out of time to work on this today.  Will pick this topic up tomorrow.

*Beller, Emily and Hout, Michael. Intergenerational Social Mobility: The United States in Comparative Perspective.   The Future of Children. Vol. 16. No.2 2006.

This is How They Lie to You: Paul Ryan Edition Pt. 2

The introduction has little wrong with it, but I will touch briefly on two key points that I disagree with.  The reasons why will be argued more fully with data when I come to them in the report.

The question for policymakers is not how best to redistribute a shrinking economic pie. The focus ought to be on increasing living standards, expanding economic opportunity, and promoting upward mobility for all.

This displays rules of propaganda two and three, discrediting the opposition by a parody and manipulating the consensus values of the target audience.  No one in American politics is discussing redistributing a shrinking economic pie, there are disagreements over the causes of growth and over how to share the burden of expenses that have been democratically agreed upon.  This statement radically manipulates the opposition's position into something distinctly unAmerican and portrays them as opposed to the universal values of better living standards, opportunity, and upward mobility while portraying Ryan and the Budget Committee as its champions.  My disagreement with Ryan is that I think his proposals degrade all three of these, not that I believe there is a shrinking economic pie to cut up.  It is also true that expenses simply are a pie that needs to be distributed, our debt isn't going to go away by wishing it would so that particular pie does need to be shared out, confusing this with wanting to share out the economic pie, rather than the debt pie, is just transparently manipulative.

My second issue with the first page is this:

Conventional wisdom on government’s role in inequality often has it backwards: tax reforms have resulted in a more progressive federal income tax; government transfer payments have become less progressive (due in large part to growing entitlement payments to wealthier seniors).

 Explaining what is manipulative about this will take some length, I'll get into it in more detail in the relevant sections of the report.  It will become apparent as we proceed that much of the increased progressivity of the tax code is due to shifting anti-poverty measures from other departments to the IRS, this has also made transfers less progressive as the more progressive transfers are the ones that have been shifted to the IRS.  I don't really understand why shifting government assistance from Health and Human Services to the IRS should be understood as having changed the overall progressivity of American transfer programs, it is simply pedantic hair splitting meant to score political points.

What the Story of the Four Little PIGS Tells Us about the Welfare State

I often hear that the European debt crisis is an example of the evils of government spending and the welfare state.  However, something shared by at least three of these little PIGS (I don't know about Portugal) is that all had fairly rough transitions to democracy and retain some powerful clientelist features.  A recent Economist article reminded me of these features, which to be completely honest, I've been waiting for an excuse to blog about.

Italy, especially, has been used for a comparative case of a remarkably poorly functioning public sector and state spending that bears the form of rents more than it does characteristic welfare state features (Greece is probably an even starker example of this, but for various reasons, it is less frequently used for comparisons).  In all three of these countries, and perhaps Portugal, state spending serves largely to create political support for the existing regime and to support the legitimacy of the state.  These features largely date from the transition to democracy from their autocratic regimes, it was necessary to win over powerful constituencies that otherwise posed significant threats to the democratic transition.  While this was likely a necessary aspect of their transition, unfortunately none of these states managed to unwind these features while they had the freedom to do so.

It is undeniable that state spending used for clientelistic purposes is extremely damaging, the situation in Europe only confirms this.  However, it is a huge stretch to generalize from these cases to the idea that all state spending is unsustainable or a negative risk.  The main lesson to be drawn is that most mature democracies don't look anything like this, in most democracies most state spending is widely shared with its skewness being towards the poor generally, not towards specific privileged groups.  Attempts to say that all state spending leads to clientelism or to buying support from beneficiaries runs aground on the fact that benefits in states such as France, Germany, or Sweden are widely shared while other states, like Greece or Italy, have far more of their spending going to privileged groups and in particular highly paid and pensioned public employees.

The lesson here is about particularism and clientelism vs the welfare state, not one about spending vs. austerity.  Particularistic spending and benefits tends to lead towards imbalances and a higher possibility of economic stagnation (Spain certainly took off for a while despite these problems, if the crisis had been delayed for another decade or two things may have been very different), broad based policy and spending tends to be far more effective.

On top of this, of course, are the usual labor and business rigidities that plague Europe.  But this is shared across Europe, what is different in the experiences has a lot to do with the relative maturity of the democracies, their ability to rely on broad based legitimacy for their governments as opposed to particularistic interest groups, and the method they use to disburse state spending, broad based benefits vs. jobs.

This theme is worth developing further, I see it brought up far too much despite being a variable that occurs a lot in the political science literature regarding Italy especially.