Taxing the Rich

Riffing off a Karl Smith post about whether higher taxes destroy the incentive to work (answer: probably not, and the economic literature backs him up), Ezra Klein says:

Republicans argue — and there’s some evidence to back them up — that the rich are more sensitive to tax rates than the middle class or the poor....It’s why they worry much less about extending unemployment benefits than about protecting the rich from tax increases. Both policies make people poorer. But future economic growth doesn’t depend on the poor. It depends on the rich.

The problem is that there’s not much evidence backing this view.

I got into an email conversation with a conservative blogger about this last week, and among other things he said that the research on ETI had persuaded him that raising tax rates on the rich was bad for the economy. ETI stands for elasticity of taxable income, and it's a measure of how much income goes down when tax rates go up. I didn't pursue the conversation because I'm hardly an expert in the ETI literature, but I thought it was an odd thing to hang his hat on because what little I do know suggests that higher tax rates have very little effect on the economy.

So here's what I know. Last year I read a review of ETI research written by Emmanuel Saez, Joel Slemrod, and Seth Giertz. I'm not familiar with Giertz, but both Saez and Slemrod are pretty honest guys, so I figured their paper would provide an evenhanded look at what the ETI research indicates. Their conclusions were far from rosy. First, they suggested that the ETI literature of the past two decades varies so widely that it can't really be considered very reliable yet. Second, they make clear that incomes can decline for several reasons, and most of the reported income drops in the wake of tax increases are related to tax fiddling, not actual economic deterioration. From the paper:

While there are no truly convincing estimates of the long-run elasticity, the best available estimates range from 0.12 to 0.40. At the approximate midpoint of this rate — an ETI of 0.25 — the marginal excess burden per dollar of federal income tax revenue raised of 0.195 for an across-the-board proportional tax increase, and 0.339 for a tax increase focused on the top one percent of income earners.

....While there is compelling U.S. evidence of strong behavioral responses to taxation at the upper end of the distribution around the main tax reform episodes since 1980, in all cases those responses [are related to] timing and avoidance. In contrast, there is no compelling evidence to date of real economic responses to tax rates....If behavioral responses to taxation are large in the current tax system, the best policy response would not be to lower tax rates, but instead broaden the tax base and eliminate avoidance opportunities to lower the size of behavioral responses.

In other words, when taxes go up on the rich, they do report lower incomes. But that's mostly because they're fiddling with the tax code to report lower incomes, not because they're actually earning any less. If that's the case, we can draw a few conclusions:

  • We should reduce high-end tax loopholes so that the rich have fewer options for moving income around solely to optimize their taxes.
  • If we do that, modest increases in marginal rates on the rich will have very little impact on their taxable income.
  • And even if we don't, this sort of tax avoidance presents us with nothing worse than a mechanical issue of properly estimating tax receipts. Aside from the small inefficiency of paying tax accountants for lots of useless work, raising tax rates doesn't have a negative effect on the economy and has little or no effect on the actual incomes of the rich.

This all makes sense to me. After all, we've already run a sort of destruction test on this. During the 50s, top marginal rates were around 90%, and if high tax rates on the rich harm the economy then the tax rates of the 50s should have literally brought the United States to its knees. But even with heroic efforts, you can't make the case that those tax rates were anything more than a tiny drag on the economy. And if 90% rates produced only a tiny drag, then the effect of moving from, say, 35% to 40% would be literally too small to measure. Conservatives may claim to believe that they oppose higher tax rates on the rich because they'd be a disaster for the economy, but the evidence suggests something far less: namely that it would be a minor disaster for the rich. The rest of the economy would do just fine.

Front page image: alancleaver_2000/Flickr.

Chart of the Day: Arctic Sea Ice

From the Arctic Sea Ice Blog, this chart shows the extent of (what else) Arctic sea ice by month since 1979, with trend lines drawn in. On current trends, the Arctic will be entirely ice-free in September by about 2016, and will be ice-free year-round by the early 2030s. Probably nothing to worry about, though. Who needs ice, anyway?

Obama's Yawn-Inducing Outrage

Today President Obama stunned the world by saying this:

The borders of Israel and Palestine should be based on the 1967 lines with mutually agreed swaps, so that secure and recognized borders are established for both states.

The New York Times reports that Israeli prime minister Benjamin Netanyahu "reacted icily." The American right wing, by contrast, has been sent into a near frenzy. You'd think it was the end of the world.

This is one of the reasons why the Israel-Palestine issue is so difficult to deal with for those of us who haven't followed its every nuance for the past 30 years. I mean, this has been the basis of every peace negotiation in the Middle East for the past three decades, hasn't it? Most recently it was the basis of Wye River, Camp David, and Taba. Whether it was stated in precisely that way or not, every proposed deal has involved two states, with borders to be negotiated based on the facts on the ground that Israel has so assiduously built up since 1967. In other words, "the 1967 lines with mutually agreed swaps."

And yet, for some reason, actually saying what's been obvious for decades sends everyone into a tizzy. All because of some minuscule change in wording that, to ordinary ears, means nothing.

Somebody help me out here. Pretend I'm five years old and you have to explain things in words of one syllable. Why is Obama's formulation worthy of anything more than a yawn, let alone widespread outrage?

The Laws of Economics

Ezra Klein highlights this interesting passage from Tim Harford about the problems that the Great Collapse exposed in the economics profession:

In terms of how economics needs to change in light of the crisis, where I would put my emphasis is not so much in behavioural economics, though I have no problem with it — it’s a very interesting area and it’s producing really important insights — but I think it’s more about engaging with the world, and the institutions of the world as it is. Economists got too used to reasoning in fairly abstract ways, without looking at the details of what was actually going on. If, as an economist, you’d looked at the way sub-prime loans were being sold, and the kinds of contracts that were being written and the financial instruments that were being created, you don’t need any mysterious appeal to psychology to explain the disaster. You just need to have been paying attention. That’s not to write off behavioural economics — but it’s just not true that behavioural economics was the single thing that was missing, that if only we’d had it, there would have been no crisis.

I think this is an interesting insight, but I'd make it more broadly. One of the interesting things about economics as a science is that its basic laws change all the time. This is quite unlike, say, physics, where the applications change but the basic laws of the universe don't.1 But the laws of economics are just fundamentally different in a barter economy vs. a money economy vs. a banking economy vs. a fiat money economy vs. a credit economy etc. etc. Keynes' great opus on unemployment literally couldn't have been written a century or two before 1936 because unemployment wasn't even a well-defined concept in the pre-industrial age.

So here's my guess: in the past, we could at least take solace in the fact that the basic structure of the economy didn't change very fast. But now it does. And the changes in the financial sector over the past few decades — which are part cause and part effect of the globalization and computerization of finance — have cumulatively produced enough quantitative change in the structure of the economy that it's finally become a qualitative change, one that I'm not sure the economics profession has entirely grasped yet. Long story short, the laws that govern the economy of 2011 are fundamentally different than the laws of only 20 or 30 years ago. And Harford is right: understanding how the financial sector has changed, and how that's changed the basic functioning of the economy, is really important. The question is whether modern economists are smart enough to figure out what the new laws are before the economy has changed on them yet again.

IMPORTANT DISCLAIMER: I am not an economist. I might be completely full of hooey about this. But then again, maybe not.

1New physical laws are discovered periodically, of course, but those laws have always been in operation. We just didn't know it. Conversely, once you get beyond supply and demand, many of the laws of economics actually change as the nature of the economy changes.

Goodwin Liu is a smart, accomplished, liberal constitutional lawyer who's been nominated for a seat on the 9th Circuit Court. Lots of conservatives support him, but his confirmation looks increasingly unlikely regardless. Yesterday Adam Serwer tried to figure out why Republicans are so hellbent on blocking his nomination:

The real reason Republicans are trying to block Liu is this: Because of his youth (he’s 39), intelligence and outlook, he’d be a tempting choice the next time a spot opens up on the Supreme Court.

But I think Adam's take today is much closer to the truth:

Senate Republicans appear poised to filibuster the nomination of Goodwin Liu to the 9th Circuit Court of appeals, and they’ve settled on their reason why: Liu was awful mean to Justice Samuel Alito. As the Legal Times reports, Senators Lindsey Graham, John McCain, and Johnny Isakson all cited Liu’s testimony against Alito’s nomination as a reason for blocking him.

Yep. Liu is plenty liberal, which gives Republicans cover for voting against him. But honestly, it's mostly pique that's driving this. Here's conservative Jonathan Adler writing about Liu over a year ago:

I believe Senate Republicans are likely to oppose Prof. Liu for multiple reasons. First, Prof. Liu Chairs the Board of Directors the American Constitution Society for Law and Policy. This is not the sort of thing that should be disqualifying for a federal judgship, to be sure. Yet Senate Democrats firecely opposed, and ultimately blocked, confirmation of Peter Keisler to the U.S. Court of Appeals for the D.C. Circuit, largely because he was a co-founder of the Federalist Society for Law and Public Policy Studies (where he is also now Chairman of the Board).

Second, Prof. Liu was an outspoken critic of President Bush’s nomination of Samuel Alito to the Supreme Court. He co-authored an ACS report critical of Judge Alito’s record on death penalty cases and, more importantly, testified against then-Judge Alito’s confirmation to the Supreme Court. In his testimony, Prof. Liu argued that Senators should consider a nominee’s “judicial philosophy” and suggested that Judge Alito should fail such a test. According to Prof. Liu, then-Judge Alito was “at the margin, not the mainstream,” and that the America envisioned by his record on the bench “is not the America we know. Nor is it the America we aspire to be.” I suspect Senate Republicans will remember this testimony when considering Prof. Liu’s nomination.

Judicial nominations have spun out of control over the past couple of decades, and there's blame to go around on this. Conservatives have never forgiven liberals for the Bork/Ginsburg/Thomas trifecta of the late 80s and early 90s. Liberals continue to seethe over Orrin Hatch's transparent abuse of the blue slip rules in the aughts. Both sides are convinced that the other is dedicated to nominating extremists to the bench.

I don't know what the answer is. As a matter of policy, I believe that presidential nominations should get considerable deference. Conservative presidents are going to nominate conservative judges and liberal presidents are going to nominate liberal judges, and both sides should accept that. But there's always a but, and in this case it's whether there's genuinely a line that separates the merely ideological from the recklessly extreme. There probably is, but I've never heard anyone explicate it in an actually usable way. Maybe some nice bipartisan commission ought to take a crack at it.

Tom Coburn Is Angry at Tom Coburn

Sen. Tom Coburn is angry that the Senate can't seem to make any progress on deficit reduction. "The lack of leadership and initiative in the Senate is appalling," he says. Then this:

For the past several months I have been meeting with a small group of senators from both parties, informally known as the Gang of Six, that was designed to force the idle — not gridlocked — Senate, and then the House and the president, to enact a long-term deficit-reduction package. Our talks reached an impasse this week when, in my view, it became clear we would not be able to produce a balanced, specific and comprehensive deal that would improve on, and in some ways meet, the standard set by the Bowles-Simpson plan.

OK, let me get this straight. A group of six — six! — senators meeting together intensively for months can't manage to agree on a deficit reduction plan. And this is mostly because of Coburn himself, who walked out when the other five wouldn't agree to his ever-shifting list of demands. And yet, Coburn wants us to believe that even though six senators can't manage to agree on a plan, a hundred senators can. Despite the fact that, as usual, it will be Coburn himself throwing bombs from the sidelines if anyone tries.

Chutzpah, baby! Or something.

Throwing the Tea Party Under the Bus

Nick Carey reports that Wall Street wants the debt ceiling raised but the tea party movement doesn't:

That leaves [John] Boehner stuck between the Tea Party and a hard place. If he pushes too hard on cuts, that will rattle the Republican Party's powerful Wall Street wing, potentially roiling the markets and unsettling the broader electorate.

But backing down will also hurt him. "After accusations he didn't do enough in the budget battle, Boehner has to have something real to take back to conservatives or he's in trouble," said James McCormick, a professor of political science at Iowa State University. "He's boxed in between two components of the Republican Party. Obama knows that and is not under the same pressure."

If the Republicans falter, the search for establishment targets will kick into a higher gear — with freshmen, or those elected in 2010 seen as the easiest to unseat as they are new. "The Tea Party will almost certainly primary those they want to get rid of," said Larry Sabato, a politics professor at the University of Virginia. "They are not out to rebuild the Republican Party. They are out to take over the Republican Party and make it more like the Tea Party."

"If it takes some Republican defeats along the way to make that happen, then that is what they'll do," he added.

This scares Jon Chait, but frankly, I'm going to need more than the opinion of a couple of university professors to get my blood pressure up. They're not saying anything here that a thousand bloggers haven't already said before.

In any case, I actually see this as a bigger problem for the tea party than it is for Boehner. Don't get me wrong: it's a huge pain in the ass for Boehner because, in the end, he'll have to defy the tea partiers and do what Wall Street wants — which, on the bright side, also happens to be the right thing to do. In the longer term, though, this is just another sign of the tea party wearing out its welcome. It was a handy force for rousing the voters in the 2010 election, but there's only so much idiocy that even Republicans can put up with. Talk radio is one thing. Fox News is one thing. For the most part, they talk big but don't actually demand that politicians commit suicide. Tea partiers, conversely, do want them to commit suicide, and if they get their way the only real result is going to be more Democrats in Congress and the reelection of Barack Obama. The adults in the party understand this perfectly well, and they're going to throw the tea partiers under the bus if it looks like they're seriously screwing things up for GOP hopes next year.

So, yeah, Boehner is going to take this down to the wire. He's going to try to extort some spending cuts out of the White House. He might as well do what he can to appease the tea partiers, after all. But in the end, he'll vote to raise the debt ceiling, he'll get enough Republican votes to make it stick, and the Republican establishment is going to finally decide it's tired of the tea party if they make too much trouble about it. They already (arguably) lost a chance to take control of the Senate in 2010 because of the tea party, and they're not going to take that chance again in 2012. Either the tea partiers start playing ball with the millionaires or they're history. The history of the Republican Party is crystal clear on this point.

How To Improve Auto Mileage

Stuart Staniford reprinted a chart today showing the improvement in gas mileage of American cars since World War II. He's not happy with the progress we've made:

You can see that fuel economy drifted up slowly from the forties to the early seventies, barely accelerated at all in response to the first oil shock in 1973, then took off upwards after the second oil shock in 1979, improving several percent per year through the eighties. Then it went into gradual drift again in the early nineties.

It seems abundantly clear that the US is going to have to improve its fuel economy at a faster rate in the future to cope with rapid increases in emerging market demand in an oil constrained world. It would have been better if people had done this proactively. However, it appears that it's going to take a bigger, meaner, oil shock to get people moving in the right direction.

But was it really the oil shock of 1979 that prompted a big increase in auto efficiency? Here's a look at the chart, but with a chart of oil prices overlaid on top of it:

Certainly the price of oil has an effect on consumer behavior, but it really doesn't seem to be the prime motivator here. In 1973 the price of oil skyrockets, but mileage goes nowhere. In 1979 there's another shock and mileage goes up. Then in 1985 oil prices plummet but mileage keeps going up. Finally, in 2003, oil prices go up again but mileage doesn't react at all. (And it continued not to react even when prices continued to rise for the next five years.)

There's something else that explains this chart much better: the introduction of CAFE mileage standards. They take effect in 1978 and within a couple of years you see the first real spike in average mileage. CAFE standards keep rising until around 1987, and for a few years after that mileage keeps going up while new cars continue to replace old pre-CAFE cars. Then mileage plateaus. In every single year outside the CAFE era, absolutely nothing happens: mileage drifts ever so slightly upward and that's it.

Price signals do matter — which is why a carbon tax or a cap-and-trade system would help reduce fossil fuel usage — but for something like gasoline they need to be large and persistent to really have any effect. That's why I like to think of them as similar to a tailwind: nice to have, but not always the prime motivating force. If you really want something to happen, sometimes you still need good old command-and-control regulation. Luckily, between 2011 and 2016 CAFE standards are finally set to go up again. High gas prices will help motivate people to buy high mileage cars, but it's CAFE standards that are going to make the real difference.

Attention Class of 2007: Change Jobs Now!

Here's an interesting factlet about recent college graduates:

While young people who have weathered a tough job market may shy from risks during their careers, the best way to nullify an unlucky graduation date is to change jobs when you can, says Till von Wachter, an economist at Columbia.

“If you don’t move within five years of graduating, for some reason you get stuck where you are. That’s just an empirical finding,” Mr. von Wachter said.

That was a close call. I stayed at my first job after graduation for three years. Another two years and I would have been trapped forever. I never realized just how close I was cutting things.

How Not to Fix Medicare

"You can’t save Medicare by raising taxes," says Ezra Klein:

The problem with health-care costs is that they rise faster than wages, GDP or most anything else. That’s why balancing Medicare and Medicaid’s books through straight cost-shifting, as Ryan does, entails such savage cuts in care, and why balancing their books through straight tax increases, as Egan suggests, would be such a disaster. You wouldn’t just need to raise taxes. You’d need to raise them again and again and again, because every tax increase would soon be outpaced by Medicare’s growth.

This is true. You can, if you want, save Social Security by raising taxes. That's because the cost of Social Security is projected to rise for a couple of decades and then plateau at 6% of GDP forever, so one option for saving it is to simply raise payroll taxes to 6% of GDP. Problem solved. You can also save discretionary programs by raising taxes. That's because discretionary spending has been pretty flat for decades, is projected to remain pretty flat in the decades to come, and can be funded by simply raising enough money to cover that cost. You might not want to do it this way, but it could be done.

But Medicare is different. Its cost trajectory is so steep that it's impossible to keep raising taxes forever to cover it. At some point, you have to take serious steps to level out those costs. That level will certainly be higher than it is today, since in the future there will be more elderly people to take care of, but it can't be too much higher.

So how do we rein in that cost growth? Paul Ryan says: don't bother. Just refuse to pay those rising bills and tell the elderly they're on their own. It's up to them to buy insurance, and if it's too expensive because the Ryancare voucher is too small, that's tough. See you on the other side.

That's really not a serious solution. We need something instead that genuinely has an effect on healthcare costs. Something that reduces the amount we pay doctors, hospitals, and insurance companies. Something that provides incentives for difficult end-of-life decisions. Something that makes credible tradeoffs between the cost of new treatments and the likely benefits. And something that gives taxpayers and patients alike a reason to care about all this.

There are both liberal and conservative ideas that can help us with this. Unfortunately, we're not quite grown up enough yet to really start talking about them. Maybe someday.