Mankiw's Taxes

| Sun Oct. 10, 2010 2:19 PM EDT

Greg Mankiw admits that he could afford to pay higher tax rates, but says that higher rates do affect his incentives to take on more work:

I could go so far as to say I am almost completely sated. One reason is that I don’t aspire for much more than a typical upper-middle-class lifestyle....I don’t want to move to a bigger house or buy that Ferrari, but I hope to put some money aside for my three children. They will never lead lives of leisure, but I hope they won’t have to struggle to find down payments to buy their own homes or to send their kids to college.

[Explanation of how $1,000 in income from a writing assignment grows to $10,000 over thirty years without taxes, but only to $1,700 with Obama-level taxes.]

Then, when my children inherit the money, the estate tax will kick in. The marginal estate tax rate is scheduled to go as high as 55 percent next year, but Congress may reduce it a bit. Most likely, when that $1,700 enters my estate, my kids will get, at most, $1,000 of it....By contrast, without the tax increases advocated by the Obama administration, the numbers would look quite different. I would face a lower income tax rate, a lower Medicare tax rate, and no deduction phaseout or estate tax. Taking that writing assignment would yield my kids about $2,000. I would have twice the incentive to keep working.

Do you see the card he palmed? Basically, the effect of letting the Bush cuts expire is so tiny that the only way to make it noticeable is to compound it over 30 years, which reduces the eventual payout of his writing assignment from $2,000 to $1,700. (And even that's probably overstated, since it assumes Mankiw pays all his taxes at their full statutory rate, which virtually no one does.) The rest of the reduction down to $1,000 comes solely from the estate tax. But even on the heroic assumption that you should take this year's zero rate as the baseline for comparison, the estate tax has an exemption of several million dollars. Unless Mankiw leaves his kids a helluva lot more than they need for a down payment on a house, they won't pay a dime of estate tax.

This is why the tax posse has such a habit of wildly overstating things. If they don't, there's no there there. It turns out that the effect of letting the Bush tax cuts on the rich expire is so minuscule that the only way to make it look sensational is to pick a scenario in which you (a) overstate effective tax rates, (b) compound those tax rates over 30 years, (c) slash the final number nearly in half by ignoring the estate tax exemption, and (d) use this year's highly unusual zero rate as your baseline. It's a virtuoso performance.

UPDATE: I should make something clear before I start getting emails about this. If you believe that taxes affect incentives — and I do — then you should also believe that small changes in tax rates affect incentives in small ways. I believe that too. My problem isn't with the idea that higher taxes will cause Mankiw to work less, it's with his final conclusion about the effect of the lower Bush rates on guys like him: "I would have twice the incentive to keep working."

But aside from the fact that Mankiw plays fast and loose with the actual tax laws, this is only true if (a) you're motivated solely by how much money you leave your children, and (b) you care about income 30 years in the future as much as you do about income right now. This doesn't describe any actual human beings, and I don't think it describes Mankiw. (I doubt very much that he doubled his production of outside writing after the Bush tax cuts went into effect.) If he'd laid out the incentives honestly — a small tax increase might reduce his incentive to write misleading op-eds by a small amount — that would have been OK. But that's not what he did.