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May 22, 2006

The Washington Post on Taxes

Via Brad Delong this editorial on taxes, productivity and inequality from the Washington Post. Somewhat disingenuous:

In a speech Thursday, Mr. Lazear contended that "low taxes are consistent with rising federal revenues, which helps bring the deficit down." This deliberately implies that low taxes cause a rise in federal revenue, even though they don't.

Really? If the statement had been "lower taxes" are consistent with rising federal revenues then the implication would indeed be there. We might expect there to be some level of taxation which maximises growth (Not even I would assume that zero tax, and therefore zero government, would provide this, and there’s very few who think that 100% tax, the complete submersion of the entire economy into the government, would either.) and thus maximises growth in federal revenues. The point here is whose definition of "low" are we going to use? 90% tax rates are unlikely to grow the economy (and thus revenues) and nor are 1%.

Last year one of Mr. Lazear's predecessors as chairman of President Bush's Council of Economic Advisers, N. Gregory Mankiw of Harvard University, examined whether tax cuts pay for themselves: In other words, do they boost work incentives enough to generate sufficient extra growth that government revenue ends up higher than it would have been without tax cuts? Mr. Mankiw concluded that this "dynamic" effect is way too small to justify Mr. Lazear's message. Tax cuts cause falls in federal revenue, and implying the opposite is irresponsible.

That isn’t quite what Mankiw’s research found. Rather, that at the rates that taxes have been and then have been cut to, the effect on incentives was such that some portion of the revenue loss was made up by greater activity but not 100%. And that it very much depended upon which tax and what the rates were.

The point is that the Laffer Curve really does exist: and that it is also a curve. We can at any time be to the right or the left of the peak. Different taxes, at different rates, will indeed be such. So to say that always tax cuts will increase revenue is just as absurd as the statement the WaPo makes above, that they never will.

Here in the UK in the late 70s we had a top income tax rate of 83% and a surcharge on "unearned" income (dividends, interest etc) of 15%, leading to a top rate of 98%. Cutting both of those to the 60% (then to 40%) as Margaret Thatcher did: well, perhaps people with more ability at tracking numbers through the Treasury site would like to tell me whether this did in fact increase revenues?

Mr. Lazear also stated that "higher productivity translates directly into higher wages -- even over the relatively short run." But one of his own charts showed how wages of production workers have lagged behind productivity gains for nearly all of the past 50 years and how this gap has grown wider in the past five years. In a recent paper titled "Where did the Productivity Growth Go?" Robert J. Gordon of Northwestern University reports that between 1966 and 2001, everyone in the bottom 90 percent of the income distribution saw wages grow more slowly than productivity and that fully half the gains from extra productivity went to the richest tenth.

Most odd. Higher productivity translates into higher wages is the claim and this is refuted by the statement that for 90% of the people wages grew with productivity rises? I can see the point they’re trying to make, that 100% of the productivity rise did not go to wages and that this is a bad thing but that doesn’t refute Lazear’s point that as productivity rises so do wages.

Which, when you think about it, it is reasonably sensible that some portion of productivity gains will go to the suppliers of capital (those 10%?). If they didn’t benefit from the new efficiencies being created by the use of their capital why would they bother to offer it for use?

"To further investment in human capital, it is necessary that the progressivity of the tax system not become too pronounced," he said; in other words, inequality usefully boosts the incentive to get an education. To illustrate the dangers of equality, Mr. Lazear cited Eastern Europe circa 1990, when "highly skilled individuals chose to drive taxis for tourists."

It is true that equal wages dampen work incentives, but the invocation of communist Czechoslovakia or Poland is far-fetched. In the late 1980s, the Gini coefficient, a standard measure of inequality, averaged around 24 points in the Soviet bloc; the contemporary United States, with a Gini score of about 40, is far less equal. Does Mr. Lazear honestly believe the United States is anywhere close to a situation in which engineers or doctors forsake their professions to act as tour guides? Or is he scraping around for an argument -- any argument -- to play down justified concerns about rising inequality?

I’d love to see where those Gini numbers come from for the Soviet block. To measure a society where it was your position in The Party that decided your access to housing, education, goods and so on by purely monetary measures of income seems most most odd. Having lived a number of years in immediate post-Soviet Russia I would be extraordinarily surprised if the place had actually had a Gini coefficient that low. Measured purely by the wage gap, perhaps, but that wasn’t a useful measure of anything at all in a world of special stores....the ones actually with meat in them being reserved for Party members for example.

Further, we don’t actually have to go to equal wages, or even equal post tax and benefit incomes, for the progressivity of the system to be damaging. Where you have marginal rates of 70% (say, Sweden?) plus a heavy VAT (a further 20% odd?) then why would the neurosurgeon, just to take an example, work the extra hours to pay someone to come and paint his house? As he’s actually only getting 10% of the extra earned, he’s likely to stay home and paint his own house: even the most incompetent amateur house painter is unlikely to be 10 times less efficient than a professional.

But do we actually regard that as an increase in the wealth of our society? That a highly trained professional doesn’t do what he’s trained for and instead does something of vastly lower productivity? We certainly wouldn’t regard it as sensible the other way round, that the house painter is doing the neurosurgery now would we?

As I say, a somewhat disingenuous piece from the WaPo there. Almost worthy of one of Brad Delong’s "Why oh why can’t we have a better press corps" tags.

May 22, 2006 in Economics | Permalink


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"Mr. Lazear also stated that "higher productivity translates directly into higher wages -- even over the relatively short run." But one of his own charts showed how wages of production workers have lagged behind productivity gains for nearly all of the past 50 years"

It depends how you define relatively short run - if it means a few years then there is no inconsitency. One would expect pay increases to follow productivity increases since (a) you don't know the productivity increases will work until they have been done (b) it is only once the product has sold that the extra profits exist for distribution (c) it is only once profits have been made that employers have the incentive to attract new workers/incentivise old ones.

Posted by: Neil Craig | May 22, 2006 12:27:54 PM

The EU provides an instructive laboratory. On the evidence, it depends on several factors as to whether countries with relatively high tax burdens in the EU have better performing economies than those with lower tax burdens.

The recent study: Globalisation and the reform of the European social models, prepared by André Sapir for the think-tank Bruegel and presented at the ECOFIN Informal Meeting in Manchester on 9 September 2005 argued that there is not one European social model, but rather four - the Nordic, Anglo-Saxon, Mediterranean and the Continental:

• The Nordic model (welfare state, high level of social protection, high level of taxation, extensive intervention in the labour market, mostly in the form of job-seeking incentives)
• The Anglo-Saxon system (more limited collective provision of social protection merely to cushion the impact of events that would lead to poverty)
• The continental model (provision of social assistance through public insurance-based systems; limited role of the market in the provision of social assistance)
• The Mediterranean social welfare system (high legal employment protection; lower levels of unemployment benefits; spending concentrated on pensions)


Andre Sapir's paper on: Globalisation and the Reform of European Social Models, is here:

Posted by: Bob B | May 22, 2006 12:51:55 PM

"Where you have marginal rates of 70% (say, Sweden?) plus a heavy VAT (a further 20% odd?) then why would the neurosurgeon, just to take an example, work the extra hours to pay someone to come and paint his house? As he’s actually only getting 10% of the extra earned..."

VAT isn't levied on gross income, but on most expenditure, which itself is spent out of the 30% net left after income tax. Thus, your neurosurgeon would retain at least 24%, not 10%.

Tim adds: True and thanks for the correction. My bad.

So are neurosurgeons 5 times worse at painting houses than professionals?

Posted by: RichardR | May 22, 2006 1:46:34 PM

I really don't think this is how people make decisions on employing painters. No-one earning £1000 below the higher-rate threshold gets a £2,000 pay rise and thinks 'bloody hell those painters have become expensive'.

Posted by: Matthew | May 22, 2006 2:58:48 PM

Not sure I'd want a neurosurgeon who's working til he drops just to get more money in, either way.

Also, I'd be surprised if neurosurgeons, one of the most prestigious and highly paid professions in existence, get only just enough money to scrape by on their normal working day, and have to work extra hours for luxuries such as redecorating anywhere outside of Cuba...

Posted by: Dr Maybe | May 22, 2006 3:47:31 PM

I read somewhere (sorry, can't find the cite) that the wage differential in the Soviet Union between a construction worker and a foreman was higher than in the US or UK.

Posted by: David Gillies | May 22, 2006 5:51:58 PM

They may not make the decision to employ a painter in exactly those terms, but if you are sitting on your porch and you notice that the outside paintwork is looking a bit worse for wear, your thought processes are : Mmmmh. Ineed to get the outside of the house done.

The next thought is usually: "what's the easiest way to do this?"

The obvious choices being: Do it yourself, get a painter or leave it for another season.

The decision is then based entirely on how badly you want to have new paint and how lazy you are. But if nearly everything you earn goes to the state the economic decision is made for you because: a) you don't have the dosh to pay the painter (you may not even have enough to buy paint) and b) the painter is already living high on the dole thanks to the generous welfare system your taxes are funding.

By the way, Tim. Does the WaPo specify the time frame for their argument? It may well be true that in the short term lowering tax rates doesn't increase revenues sufficiently to cver the loss to the state. But very few people keep their extra cash on the spare bed just so they can get naked and roll in it each night. The money not handed over to the taxman would typically get spent on new cars, speed boats, investments, whatever. That extra cash would surely stimulate the economy and therefore increase revenues in the longer term.

Or maybe I'm a simple mining engineer and therefore unable to understand the difficult stuff.


Tim adds: Mankiw’s paper (BTW, he’s one of the good guys) which they discuss does indeed. I think it’s a 4 or 5 year horizon he uses (but can’t remember exactly). For example, on a capital gains tax cut 50% of the lost revenue gets made up by higher growth. One income, 17% (again, from memory).

Use googleblogsearch to find the Greg Mankiw blog.

Posted by: The Remittance Man | May 22, 2006 6:52:09 PM


I see I need to do some serious catching up with all this economics stuff.


Posted by: The Remittance Man | May 22, 2006 8:19:39 PM

I think your reply was slightly tongue-in-cheek, but in case it wasn't:

1) Marginal tax rates can't make you poorer, just less richer.
2) Painters actually tend to be quite well paid, and the Welfare State not really a barrier to market entry.

Posted by: Matthew | May 23, 2006 10:02:58 AM


Marginally tongue in cheek. But taking your points seriously:

1) A good attempt at guilt reversal semantics but it falls on one basic point; both "poorer" and "less richer" mean the same thing - the individual in question has less money than he/she would otherwise have.

2) Since painting the outside of a house is within the skills of most people, hiring a painter can be considered a luxury for all but a few who cannot do the job. But if the state's generous welfare provisions vacuum most of the spare cash from people's pockets, there would be little money sloshing around for luxuries, like painters. Thus with a low demand for their services there would be very little incentive for anyone to become a painter. So actually, the Welfare State couldbe seen as a barrier to entry into the painting and decorating trade, just not in the way you mean.


Posted by: The Remittance Man | May 23, 2006 10:34:06 AM

'Mr. Lazear also stated that "higher productivity translates directly into higher wages -- even over the relatively short run." '

Is Mr Delong fair in assessing the words "directly translates" as meaning a one to one relationship?

Tim adds: Not sure. I’d say we were both being a little propagandistic in our terminology there.

Posted by: B's Freak | May 23, 2006 4:32:37 PM