Economical arithmetic*

If I distinguish strictly money and financial securities from real factors of production, then the only income-generating usefulness of money/financial-assets is as insurance. The financial sector consists of financial intermediaries, who carry on what the intermediaries will always claim are arbitrage opportunities in a carry trade, or borrowing short and lending long, in one form or another. Their general claim to delivering economic value is to economize on the costs and shortcomings of accumulating and holding money as insurance.

To support a large financial sector requires that a large part of the rest of population both “need” this insurance and pay dearly for it. So, we must have payday lenders in place of community banks and thrift institutions. We must replace non-profit and mutual associations with for-profit organizations in every aspect of the economy, from education (where proprietary institutions are growing rapidly) to electronic-merchant-transactions (where the Visa/MC system was converted from a non-profit condominium into a for-profit entity and immediately began hiking the merchant transaction fees). We must destroy foreclose on homes, dissolve pensions, and steal Social Security, to make room for the financial sector. We must complain that the minimum wage and pitiful unemployment compensation is responsible for high unemployment; we must never, ever complain that the wages of CEOs and Hedge Fund Managers are unaffordably high.

Would a reduction in the bonuses bankers pay to themselves (seven billion pounds in December 2010 in the UK), ceteris paribus, count as part of the “unthinkable ” contraction of the financial sector referred to? Or would it causally generate such an “unthinkable” contraction, even if it amounted, say, to 3.5 billion pounds in the case mentioned?
The Thatcher revolution amounted to “thinking the unthinkable”, according to some of its supporters. So “thinking the unthinkable” does not appear to be always, necessarily and intrinsically, out of order, or ineffective.

#1 “those who are making huge sums, are doing so because they make proportionately larger contributions”
Unfortunately the logic has become circular, as making large sums has effectively become the sole measure of worth of one’s contributions.

“Roughly speaking, the share of US national income going to the top 1 per cent of the income distribution has risen from 15 to 25 per cent over the past decade, mostly because of the growth in size and profitability of the financial sector.”

Well, maybe. And yet this:

http://www.williams.edu/Economics/bakija/BakijaHeimJobsIncomeGrowthTopEarners.pdf

(Table 2) tells us that financial professions, including management, are only 14% of that top 1%. Up from 8% ish in 1979, true, but that’s not quite the same as saying that the entire 10% of GDP movement over that time period has been going to the finance sector. “Medical”‘s moved from near 17% to just under 16% of that top 1% over that time period and while we can all have a good shout about what this shows us about the US health insurance/medical system, it’s very difficult indeed to argue that this sector, still larger than finance, has had its share of GDP boosted by the changes in finance over that period.

(The paper has lots of interesting tables looking at professions in top 0.1% and so on as well. Well worth having a look.)

@2

I agree to your comment in general, but I disagree to this sentence:
the only income-generating usefulness of money/financial-assets is as insurance.
Usually financial assets are the counterpart of some sort of debt, hence carry interest; in other words financial assets are a form of capital in the marxist sense of being “money that generates other money” instead that “money accumulated in order to be spent on consumption”.
Often many economic theories take for granted that individuals only accumulate money in order to buy someting (now or later), but in reality the sheer accumulation of money (or financial assets) is productive for the guy who accumulates, so that point of view is quite wrong IMHO.

Isn’t the Tobin tax a concrete proposal for (partly) doing what you propose. If so, it seems that it is not as unthinkable as their reactions might suggest. Their differential reactions on Tobin (I know most would be against but I guess none would find it unthinkable) and what you have said would be a case of “Ahh, but if it is for charity then …”.

But really, if you would Tobin tax and use the proceeds of this tax not so much for development of developing nations but to plug the hole in the domestic budget isn’t that then exactly the type of thing you propose?

And, after all, whether you Tobin tax and use that tax to ensure 0.7 GDP of developed countries is available for developing countries instead or explicitly budget 0.7 GDP via domestic taxes is – at least for developing countries – exactly the same (except maybe for the incentive effects).

In any case, the general argument is equally applicable to senior managers as to the financial sector – the measures needed to effectively tax these groups heavily would be likely to entail big changes to the way the economy is run, essentially reversing much of the change of the past three decades.

I think the biggest benefit to a 90% marginal tax rate for the top 0.1% of earners is that we would see a return to partnership structures on Wall Street. It is the only way to defer compensation and avoid some tax incidence. I believe this would be quite helpful for the stability of those banks. Less gambling with public money and all. I don’t think it’s in our near future, however. We seem to have developed a marxist interpretation of free market economics. The purpose and consequence of the free market is to reward people according to their social contribution (according to some perverted version of a labor theory of value). Never mind that there has never been an economic theory advanced that can actually defend this proposition, much less that our economy is actually a free market one.

“In this very careful and rigorous paper, here is a “scream it from the rooftops” result:

‘…we find that a one percent increase in the net of tax share is associated with an 0.7 percent reduction in incomes earned by people in the top 0.1 percent of the income distribution, which would imply that if we were to raise top marginal tax rates further on these taxpayers, the increase in deadweight loss would be substantially larger than the increase in revenue raised [emphasis added]. However, we find essentially no evidence at all of any responsiveness of people below the top 0.1 percent…’

Better stock up on those cough drops.”

I missed something. I got the dead weight loss at 15 billion at .07% which is less than 30 billion.

Say finance is responsible for taking 100% of all 18%. You close your eyes and pretend no dead weight losses exist.

Effective rates are already probably about 30%. You look to raise that to 55%. Be extremely un realistic ignore all incentives and pretend you will get an additional 25% of 2.16 trillion.

That is 500 billion. You are left with a 700 billion gap.

Squeezing finance is really only going to get you 10% – 20%(20% is way too high) or so of the gap before you consider what is politically possible.

But is weird that it is unthinkable.

we find that a one percent increase in the net of tax share is associated with an 0.7 percent reduction in incomes earned by people in the top 0.1 percent of the income distribution, which would imply that if we were to raise top marginal tax rates further on these taxpayers, the increase in deadweight loss would be substantially larger than the increase in revenue raised

Wait, what? Reducing the income “earned by” people in the top 0.1 percent means that that income becomes earned by someone else, it doesn’t just vanish into thin air. (The scare quotes are important because of the moral definition of “earned”, which is often not appropriate at that income level.)

The income of the top 0.1 percent comes primarily from the gap between their underlings’ productivity and wages, so either the gap itself has to shrink (i.e. higher real wages), or more of it has to go to some combination of middle managers or shareholders. So where’s the deadweight loss coming from?

The thing you have to bear in mind when the lords and masters of our society threaten to “go Galt” is that they only THINK they’re carrying the rest of society on their backs — the reality is exactly the reverse. At best they steer the company’s work in a more productive direction — a task which is itself useless unless someone then *does* the work — and very often they fail to measure up to even the most basic standards of competence or honesty and take home princely compensation anyway.

Shrinking the prize at the top of the corporate pyramid (scheme) might reduce the intensity of the competition to reach the top — but there’s no reason to think that therefore less competent people, on average, would win. (There’s some reason to think that more honest people would win: individual competitors may or may consider it worth risking a prison term for fraud to pull in the big bucks, much less so to pull in the medium-sized bucks. Thus, taking the big bucks off the table shrinks the incentive to cheat.)

“and not many doctors make it into this group: it’s essentially top managers and financial professionals.”

Well, yes, but they have a table with the top 0.1%. 42% execs (not much change of the time period) 18% financial execs (up from 11%), 7% lawyers, 6% medical…..

OK, I guess you can say “essentially” is 60% but I’d say that is stretching it. “A majority” possibly even most, yes….

“In any case, the general argument is equally applicable to senior managers as to the financial sector – the measures needed to effectively tax these groups heavily”

But that’s not what you said up top:

“More precisely, it would necessitate a big contraction of the financial sector.”

While I can see the pluses (and minuses) of both ideas they’re certainly not the same idea.

“Wait, what? Reducing the income “earned by” people in the top 0.1 percent means that that income becomes earned by someone else, it doesn’t just vanish into thin air.”

No, sadly, it doesn’t. “Deadweight” costs mean eaxactly that, that income, that wealth, disappears, as we’ve economic activity that doesn’t take place under these new tax rates which would have under the old.

It can still be a good idea: there are deadweight costs to the outlawing of the hiring of hit men and losing that economic activity is just fine with me. But deadweight does mean it vanishes in a puff of smoke, not that it’s just reallocated. That’s why we use the word, not reallocate.

The income of the top 0.1 percent comes primarily from the gap between their underlings’ productivity and wages, so either the gap itself has to shrink (i.e. higher real wages), or more of it has to go to some combination of middle managers or shareholders. So where’s the deadweight loss coming from?

I completely agree with your take on this, but I think the argument is something along the lines of: the reduced income in the top 0.1% represents those people working less so that economic activity is reduced. It’s not necessarily as simple as them paying their line level employees better because their taxes went up. While they may be working less, my feeling is that what they are calling ‘work’ does not necessarily or even frequently create as much value as the income they are able to extract from the system. Whether you consider this to be a loss or not depends highly on your interpretation of what is going on.

“No, sadly, it doesn’t. “Deadweight” costs mean eaxactly that, that income, that wealth, disappears, as we’ve economic activity that doesn’t take place under these new tax rates which would have under the old.”

That is true only if you believe the wealth is currently being used in the most productive manner possible, which I don’t. Every dollar going to “compensate” financial gurus on Wall Street would be better spent improving rail infrastructure or investing in industrial capital, or creating more spots at medical training facilities.

@21, thanks, but the methodology seems odd there. Why do they count corporate income taxes as household income (see Notes below the table)? How is it possible that the total income rate (31.2%) is higher than the rates for (what seem to be) major independent parts of it: individual income rate is 19.7% and capital income rate is 9.9%?

the reduced income in the top 0.1% represents those people working less so that economic activity is reduced.

That doesn’t make sense; their work is not the type of work that produces, or constitutes, economic activity.

If the production workers at a widget factory work 10% fewer hours, they will probably make 10% fewer widgets. But if the president of the company works 10% fewer hours, widget output might rise, fall, or do anything else — there’s no necessary connection, because the president doesn’t make any widgets.

*If* the president’s fewer hours worked cause the company to miss out on that big contract, then widget production at that plant will indeed fall — but widget production at a competitor’s plant will rise by an equivalent amount. Who gets the contract is a matter of distribution, not a matter of production. From a whole-economy perspective most sales activity is completely unproductive (and the president’s attempts to secure business-to-business contracts are essentially a form of sales).

The executive’s primary skills are climbing the corporate ladder (or he wouldn’t be there) and siphoning more money into his own pockets (or this thread wouldn’t be here discussing the phenomenon it is discussing). Both are distributive activities, not productive ones, so cutting back on them doesn’t cause a loss of aggregate production. The mean value over alternative executive is zero or very near (practically by definition), so even having him quit entirely has little effect.

(This doesn’t apply to doctors, lawyers, and entertainers, who do have underlings, but also do productive work of their own that complements the underlings’ work to produce the valuable total product. But as already discussed, they’re not a large part of the phenomenon discussed on this thread.)

I’m not saying it’s wrong, it’s just that it’s not clear to me what it all means; the presentation seems odd.

Well, the document itself says that their treatment of capital income is controversial. If (I’m not sure this is what they do, but if it is) I own X% of the stock of a corporation, and they count X% of the corporate profit as my income and X% of the corporate tax as my tax, then I disagree that this what we normally understand as income and tax. Corporation is a separate entity.

Here:
http://www.timesonline.co.uk/tol/money/tax/article1996735.ece

Speaking at a $4,600-a-seat fundraiser in New York for Senator Hillary Clinton, Mr Buffett, who is worth an estimated $52 billion (£26 billion), said: “The 400 of us [here] pay a lower part of our income in taxes than our receptionists do, or our cleaning ladies, for that matter. If you’re in the luckiest 1 per cent of humanity, you owe it to the rest of humanity to think about the other 99 per cent.”

Mr Buffett said that he was taxed at 17.7 per cent on the $46 million he made last year, without trying to avoid paying higher taxes, while his secretary, who earned $60,000, was taxed at 30 per cent.

And this:
http://www.examiner.com/business-ethics-in-seattle/400-richest-americans-also-pay-the-lowest-taxes

…the effective income tax rate of these 400 individuals fell to an all-time low of 16.62% of income. That is down from the average 17.17% income tax rate they paid in 2006. The new low rate is lower than the usual effective income tax rate paid by the average American worker.

According to the Tax Foundation, tax payers in between the 95th to 99th percentile of income (those earning between $255,000 and $451,000) paid Uncle Sam an effective income tax rate of 17.52%.

This is more like it.

Given that only people, not legal structures, can end up paying taxes this is reasonable.

How is this a given? Corporate taxes are paid by corporations, legal entities.

We are talking about the wealth or income that is (or is not) created as a result of our tax or regulatory system.

But that depends on the theory that behavior changes in response to the tax result in a loss. That’s not necessarily the case unless you assume ridiculously strong forms of EMH, and in the case of executives, I’m arguing that it’s not even contingently the case; the main “function” of executives is the executive exclusion principle: each office can contain only one officeholder. Holding the office entitles the officeholder to considerable wealth, but actually contributing something useful to the overall work of the corporation is not required, and even when it does occur, is no more likely from one executive than from another, so substituting a new executive for another who has decided to work on his golf game rather than continue paying the taxman has no net effect.

P.S. Also, IIRC the deadweight loss is a gain when the tax is Pigouvian, because the tax-induced behavioral shift reduces the externality. That’s the point of, e.g., carbon taxes. A number of social effects of high Gini coefficient, including for example political corruption, crime, and ressentiment, could reasonably be described as negative externalities of economic inequality; doesn’t it follow that a tax on economic inequality is Pigouvian and, to the extent inequality declines in response to the tax at all, the deadweight “loss” is actually a gain?

Tim, corporate income was taxed, then the corporation paid dividends to the Buffetts, different accounting entity, and they were taxed, naturally. This is the same as you paying a part of your, already taxed income, to, say, your gardener, who is then taxed again. Every transaction resets the counter.

“A number of social effects of high Gini coefficient, including for example political corruption, crime, and ressentiment,”

Singapore has lots of political corruption and crime? Who knew? The US has more political corruption then Italy or Greece? I’d say that your social effects of a high Gini coefficient aren’t all that correlated.

The job of the manager is to make sure they are producing the right widgets and finding ways to get the line level workers to produce more widgets than they would under worse management.

The person who finds ways is a professional, technologist of some sort. I think Chris is quite right about the role of the executives; what they do is things like mergers and acquisitions, spin-offs, layoffs, branding, etc. The gadgets are produced just the same.

The person who finds ways is a professional, technologist of some sort. I think Chris is quite right about the role of the executives; what they do is things like mergers and acquisitions, spin-offs, layoffs, branding, etc. The gadgets are produced just the same.

Managers are responsible for a whole slew of activities, some of which you name. But all the things you name may or may not create value depending on the situation. The end result is more or better widgets being made if the right decisions are made. The idea is that a good executive will make better decisions. I think it is a little extreme to argue that executives contribute nothing to productivity and certainly unnecessary to deal with deadweight loss type arguments.

Henri Vieuxtemps,

Fair enough it was confusing.

Not sure about Warren Buffet’s tax rate but-

Here we go. Scroll down to the bottom of table 5 for the top .1%.

http://www.cbo.gov/ftpdocs/98xx/doc9884/12-23-EffectiveTaxRates_Letter.pdf

Imputed earnings/taxes looks to be the key.

Even if we subtract imputed earnings /taxes we get a rate of 20%. Which makes sense because 15% is the lowest tax rate on all this income.

I think we need the break down on imputed taxes. I think you would agree that for a sole ownership S corporation it is fair to say the sole owner paid the employeer share of payroll taxes etc. Right?

On the other hand if I own .01% of Megacorp is it right to say that I paid .01% of Megacorp’s corporate taxes?

Hmmm.

In the case of Buffet I think it would be fair to say he paid x% of the taxes.

Buffett is talking about the taxes that he pays upon his dividends. But those dividends have already beent taxed at 35% before they are paid to him.

That is, before they start to constitute a form of income?

the Federal Govt does take donations. Warren ain’t made one as yet.

Whenever anyone says this, it sounds moronic. You can’t avoid that.

The wages of the American middle class are going to fall until American workers can compete with a worker in Mumbai, India. And the only way for that to happen is for American workers to live like workers in Mumbai—in huts with dirt floors and no running water and no electricity.
_________________________________

That’s ridiculous–productivity of a 99-IQ American is way higher than that of an 81-IQ Indian. See “A Farewell to Alms” for more data about productivity problems in Indian manufacturing.

Fair point: but nothing to do with deadweight costs. When we’re talking about such we absolutely are not talking about alternative uses of wealth (or income) that currently exists. We are talking about the wealth or income that is (or is not) created as a result of our tax or regulatory system.

Either we are or the point is irrelevant.

Any realistic “deadweight” calculation involves an aggregation problem and is meaningless without some consideration of what is done with the wealth. Otherwise how do you know whether it is better to have a high or low number for the GDP style statistic that the elementary calculation applies to?

NotSure claimed “That’s ridiculous—productivity of a 99-IQ American is way higher than that of an 81-IQ Indian. See “A Farewell to Alms” for more data about productivity problems in Indian manufacturing.”

Your statement is provably false and demonstrably ignorant. Of the dozen top-grade programmers identified by Microsoft as “plus five best of the best,” basically the superstars of their entire organization, all are located in India. Not one of their superstar programmers is an American.

Third world PhDs are eating our lunch, and for a tenth the cost of American experts. IQ doesn’t suddenly drop when you leave the borders of the United States, despite any racist claims to the contrary.

“In the years ahead, sizable numbers of skilled, reasonably well-educated middle-income workers in service-sector jobs long considered safe from foreign trade—accounting, law, financial and risk management, health care and information technology, to name a few—could be facing layoffs or serious wage pressure as developing nations perform increasingly sophisticated offshore work.”

Source: “Europe: The Big Squeeze,” Newsweek International Edition, 30 May 2010.

Take a look at this graph anomalous manufacturing capacity shrinkage since the year 2000:
http://economistsview.typepad.com/timduy/2010/07/anomalous-capacity-shrinkage.html

“U.S. firms have no intention of adding net new capacity, planning instead to source any excess demand from overseas. This implies that the manufacturing recovery will not be a net positive to US growth. It also implies that the trade deficit will widen further and that the challenge of global imbalances will remain unresolved. The rise of Dollar assets abroad will with either force a fall in the US dollar which would then create more incentive for export and import-competing industries or, more likely, encourage the accumulation of reserve assets among foreign central banks.
“In short, I continue to worry that policymakers are ignoring the possibility that increasing reliance on external production to satisfy US demand has contributed significantly to the jobless recoveries we have seen this decade. Something is very different this decade. I think it is a mistake to write off this decade’s shift in manufacturing as simply a repeat of the agricultural experience. At least agricultural output continued to rise as its relative employment importance fell. The capacity numbers are telling us the same can not be said of manufacturing any longer. And in the past, the relative decline in manufacturing jobs was matched by a more than corresponding increase in service sector jobs. No longer the case; job growth is flat for a decade.”

Meanwhile, take a look at this IBM patent on a system for rapidly transferring knowledge from expert workers to younger (foreign) employees in third world sweatshops:

“Today’s computers are smaller and thousands of times more powerful than the ones we worked with during the AI boom, but the problem is still one of programming — getting knowledge into the system in an efficient and usable manner. For that matter, it is hard to envision computers other than robots performing many of these workplace functions, and robots aren’t ready. The better solution then, according to a just-published IBM patent filing (US29228426A1), might be to find a way to suck knowledge out of the experts then inject it into younger, stronger, cheaper employees, possibly even in other countries.
“IBM’s proposed Platform for Capturing Knowledge describes how to use an imersive gaming environment to transfer expert knowledge held by employees “aged 50 and older” to 18-25 year-old trainees who find manuals “difficult to read and understand.”
“IBM also discusses how its invention could be made available for customers’ use in return for “payment from the customer(s) under a subscription and/or fee agreement.”
“What we’re talking about, then, is a possible revolution in workplace training, one where a lifetime of experience would ideally be sucked from the mind of an experienced worker to be injected into a trainee and then the older worker discarded.
“There are several thoughts that came to mind as I read this patent application. Could IBM really be serious about such a plan? Then I imagined how enthusiastically the idea must have been received at IBM intergalactic HQ in Armonk. What a great idea! Transfer knowledge from old to young, American to Argentinian, or even just hold it in machine storage for later use, disposing of the expert in the meantime.”

Source: Robert X. Cringley, “Logan’s Run,” September 2009:
http://www.cringely.com/2009/09/logans-run/

Then take a look at this graph of what Americans are spending their money on during this recession:
http://innovationandgrowth.wordpress.com/2010/08/09/where-americans-are-spending-more/

“Could there be a clearer—and perhaps more heart-rending—picture of an economy in deep, systemic, structural decline? Probably not.
“What people are spending more on, in relative terms, as incomes dwindle—what they’re substituting spending for, as budgets decline in real terms—are the most basic of necessities.
“Oh, and goods for which monopoly power allows incumbents to reap fat profits, sans meaningful innovation of any kind (hi, telcos).
“Needless to say, consumption patterns like these bode (very) ill for the next decade—because they fail to support a single one of the structural changes (new industries, new institutions, new markets, the
localization of capital flows, risk sharing, etc) necessary to spark the rebirth of prosperity. Instead, they point to a Ponziconomy—where people and societies run harder and harder, only to move backwards.
“It’s a vicious circle, a bad equilibrium, a game of musical chairs—a masquerade of wealth creation. Except the masks are coming off.”

Source: Umair Haque, “The State of the Ponziconomy,” August 2010:
http://www.bubblegeneration.com/2010/08/state-of-ponziconomy.html

This article sums it all up:

“The real issue with US economic policy today is that no one in a position of power actually has a clue how to address the structural issues in the US economy. Either that, or they willingly ignore the obvious for the sake of career risk, choosing instead to take a “wack a mole” approach to handling economic issues: applying the same solution (spend money) to every problem that raises its head.
“The fact of the matter is that the US economy, on a structural basis, is BROKEN. Starting in the early ‘70s, we outsourced our manufacturing and began shifting to a services economy (particularly financial services). We also outsourced our wealth to Asia, OPEC, and Wall Street.
“Because of this, the average American has seen his income dramatically in the last 30 years. This is obvious to anyone with a functioning brain. Forty years ago one parent worked and people got by. Today both parents work (if they can find jobs) and still can’t have a decent quality life.
“THESE are the items that matter for economic growth: jobs and income. If you want people to have money for them to spend and consequently boost economic growth, they need to have decent jobs that pay them well.”

Source: “The Only Things That Matter…and No One Talks About,” 12 August 2010:
http://www.zerohedge.com/article/only-things-matter%E2%80%A6-and-no-one-talks-about

“Fair point: but nothing to do with deadweight costs. When we’re talking about such we absolutely are not talking about alternative uses of wealth (or income) that currently exists. We are talking about the wealth or income that is (or is not) created as a result of our tax or regulatory system.”

Tim this does not make any sense. If wealth is used to do something more productive then logically no “deadweight loss” has occurred. For example what if some investment banker is paid 1.5 million as opposed to 5.0 million and the 3.5 million difference is invested in improving transit to an undeserved community allowing hundreds of people to find better employment. These hundreds of people then create 50 million extra dollars of wealth. Where is the deadweight loss?

Someguy, the tax burden of corporate taxes is hard to determine (but widely studied), and it is far from clear that it is mostly carried by investors.

Look at it this way: if a company wants to attract capital, it has to make likely a certain stream of future payments for every dollar invested. A company raising money by issueing shares is competing with bonds and foreign stocks, so the amount of dividend it has to pay to attract share-buyers is determined by how much investors can get elsewhere.

So companies do not slash dividends by 35% if they have to pay 35% corporate tax. if they did that, they simply couldn’t raise capital by issueing stock. Instead, they also have to make a higher before-tax profit, by raising prices and cutting wages. keep in mind that their domestic competitors face the same situation, so competition will not make wage-cutting and price raising impossible.

Of course, yield on other investments go down if people flock to them, so investors as a whole (those holding stock and also the others) end up geting less money as result of corporate taxes. But that amount is not enough to cover the entire tax, some of that tax money comes from others than investors

A corporate tax is in some way divided among investors, consumers and wage-earners. Roughly speaking, the division depends on the elasticity of the supply of those groups with respect to the tax. In other words, how easy those groups can escape the tax. If they can easily escape, companies cannot reduce the after-tax money flow going to them.

Clearly, wage-earners cannot easily work abroad for a foreign company that doesn’t pay corporate taxes, they can only decide to work less. Although they still need income.

For many products, especially services, consumers cannot move to foreign buying either. So if all companies in such a sector see a tax increase, they can simply increase prices. But companies in international markets face competition from competitiors who do not face the tax increase, so they cannot raise prices as easily. You can see this effect clearly in the corporate tax level of the US: it is much higher than in smaller countries, because a relatively large share of its companies are domestic-oriented.

Sadly, investors can most easily escape without any downside. Investing abroad is hardly less attractive than investing at home, and they can invest in other things than stock. So they are in fact the group that carries least of corporate taxes, although the exact amount is under dispute. Of course, they do pay for them as consumers.

“The wages of the American middle class are going to fall until American workers can compete with a worker in Mumbai, India. And the only way for that to happen is for American workers to live like workers in Mumbai—in huts with dirt floors and no running water and no electricity.”

No: as Paul Krugman has pointed out. Average wages in an economy are determined by average productivity in that economy. And as and when Chinese workers are, on average, as productive as American, then they’ll be paid like Americans. And the adjustment will be Chinese wages upwards. As long as, as Marx himself pointed out, there are competing capitalists competing with each other to make those higher profits available from the higher productivity of labour.

As to deadweight: the very definition of deadweight is that the economic activity vanishes in a puff of smoke.

“As to deadweight: the very definition of deadweight is that the economic activity vanishes in a puff of smoke.”

And if no economic activity vanishes than nothing is lost and no deadweight loss occurs.
Also you might find this enlightening:
http://news.bbc.co.uk/2/hi/8410489.stm

Apparently high paid bankers destroy about 7 pounds of wealth for every pound they are paid. I would argue the term deadweight loss would better be applied to any wage that these leaches receive.

Zamfir ,

Very good. Thanks.

In which direction does private capital flow?

Can consumers and workers substitute goods and jobs produced by corporations?

What is the coporate tax rate of possible capital destinations?

Looks complicated. The true incidence seems pretty hard to pin down.

The entire burden probably does not fall capital owners. But I would guess that at the very least a large chunk does.

Add some significant chunk to 23.27 and call that the effective rate of taxation on the top 1% I will split the difference and gladly call the effective tax rate 27%.

He operates Berkshire and he is paid salary for doing it; IIRC it’s $100K/yr, a decent wage.

Other than that, by owning its shares, he has certain relationships with the corporate entity, but people have relationships with their parents as well. They may benefit from corporate taxes being cut, and they may benefit from their parents’ taxes being cut. My point is that this fact doesn’t justify treating someone’s (or something’s) taxes as their own.

I’ve forgotten the details of how they came to this remarkable conclusion, sorry, but the a useful rule of thumb with the new economics foundation is to simply assume that they’re entirely and completely barking mad.

Funny, that’s exactly how I deal with your comments.

(And dsquared has won this thread, hands down.)

Ha-Joon Chang, writing in the Guardian

[…] Of course, if pay restraints and higher taxes continue, some bankers will move abroad and weaken the British banking industry. But that may not necessarily be a bad thing. I would not go as far as Paul Volcker, the former chairman of the Federal Reserve board and the current chairman of the economic recovery advisory board, in declaring that the only socially useful financial innovation in the last few decades has been the ATM. But it is true that during this period the banks in London have been engaged in activities that are socially unproductive or even harmful, as revealed by the 2008 financial crisis. Losing some of these activities may not be a bad thing.

Those who find it plausible that Warren Buffet’s monetary interests in Berkshire Hathaway are limited to his yearly 100K salary should conclude that capital owners pay none of the tax incidence of corporate profits.

Those who don’t find this plausible should consider that perhaps capital owners pay at least some of the tax incidence of corporate profits.

You’re ignoring the argument already raised upthread that the tax is passed on to consumers and/or workers because those groups have less bargaining power than the corporation, and therefore, doesn’t actually cut into profitability.

the tax is passed on to consumers and/or workers because those groups have less bargaining power than the corporation

I haven’t read any studies, but I don’t find this very convincing, I must say. Corporations will suppress the wages and maximize the prices as much as they can with or without the corporate tax, and regardless of its rate. And the suggestion that the investors will move from stocks to bonds sounds weak too: once they do, interest rates will fall, and stocks become attractive again. Am I wrong?

Tim Worstall ,

“Tax incidence : a reasonable (ie, CBO, so relatively non partisan) estimate is that currently in the USD capital (shareholders) pay 30% of the corporate income tax, workers in the form of lower wages, 70%.”

That is interesting. If they used that formula to calculate the imputed tax of the top 1% in the below link then effective tax rates on the top 1% are probably very close to their 31% number.

http://www.cbo.gov/ftpdocs/98xx/doc9884/12-23-EffectiveTaxRates_Letter.pdf

As Dean Baker has pointed out, a housing crash of this magnitude, whatever happened to the financial sector, falling over, going bust, imploding or not, is going to create a recession.

But the housing crash came from the housing bubble, and the housing bubble came from loose mortgage underwriting, and loose mortgage underwriting came from securitization, and securitization came from the financiers. So they can’t use the housing crash as an excuse; it was the instrument by which they wrecked the economy, not an exogenous economic act of God.

chris ,

“But the housing crash came from the housing bubble, and the housing bubble came from loose mortgage underwriting, and loose mortgage underwriting came from securitization, and securitization came from the financiers. ”

I don’t think that is quite right close but not right.

Low interest rates created the bubble not loose mortgage underwriting. Once the bubble was up and running loose mortgage underwriting jumped in with both feet and created a disaster.

http://www.investopedia.com/articles/07/subprime-blame.asp#12947731213882&close

http://www.nytimes.com/imagepages/2006/08/26/weekinreview/27leon_graph2.html

http://www.realestatedecline.com/housingbubblecharts.htm

http://mortgage-x.com/trends.htm

Substance McGravitas,

“Regarding the role of policy makers: if they made no law against jumping off bridges are they then responsible for the bridge-jumpers?”

Suppose the government gave out free banannas. People started piling them on their roofs.

http://www.marginalrevolution.com/marginalrevolution/2008/12/market-failure.html

Should the government continue giving out free banannas? Are they in any way culpable when roofs start collapsing?

You can’t jump off a bridge with someone else’s body, but if you could, then there damn well should be a law against it. The financial bridge-jumpers risked their shareholders’ money in addition to (or instead of) their own. Driving your car off a bridge while you have passengers in it would be a better analogy — and yes, it would be a serious failure of policy to fail to ban that.

What I’m interested in is whether or not it’s a libertarian position that policy-makers bear responsibility for individual ridiculous speculations.

I can’t think of any way that securitization would have affected the FHA lending guidelines, which permitted no-down-payment loans.

Suppose you come up with a great idea for how to make a loan to someone who will have no possibility of repaying it if they don’t refinance within the first two years, and you’re planning to hold that loan to maturity. Do you make the loan?

Now suppose you can make the same loan, but conceal the likelihood of default by not asking for any proof of the borrower’s stated income and assets (and encouraging them to lie), and then sell the loan to someone else within those first two years. *Now* do you make the loan?

Ninja loans were useful to loan originators because they could take their commission and run before the teaser rate expired and the borrower went into *entirely predictable* default.

In theory, if you had a steady relationship with one loan underwriter, you could originate bad loans for them anyway, for the higher commissions in the short run; but then you’d be destroying the business relationship that kept your company in business. Securitization lets you transfer your risk to faceless strangers and find a limitless supply of new marks to unload your toxic loans on. Well, it seemed limitless for a while.

Loose underwriting guidelines were well-intentioned public policy, not random stupidity
Sure, if regulatory capture is your idea of “well-intentioned public policy”. The idea that the Bush Administration FHA might have been acting independently of what the industry wanted, let alone against them, is pretty funny. Even if the move to laxer FHA standards was as important as the ability to walk away from the loan and the risk of default, it was about 99% likely to have come from industry pressure anyway.

Tim, 87, I mostly agree with your analysis of the effects of corporate taxation. Except for the part where you suggest (if I understand correctly) that in a small (eg Sweden-size, 10 million people) closed economy its burden falls significantly on the workers. Could you explain that, please.

It seems to me, even if this is a 10-people economy with 2 genuinely competing entrepreneurs, the burden is still fully on the capital. How does introduction of corporate income tax allow them to lower wages and/or to raise prices?

“I do not doubt that mistakes were made and that damage was done: …”

Thanks

“Tim, 87, I mostly agree with your analysis of the effects of corporate taxation. Except for the part where you suggest (if I understand correctly) that in a small (eg Sweden-size, 10 million people) closed economy its burden falls significantly on the workers. Could you explain that, please.”

In a closed economy, where capital cannot leave, nor capital come in, then this whole thing of the “world return” to capital isn’t an issue. Decisions to invest elsewhere won’t happen as a result of tax rates because you can’t invest elsewhere.

It is only if capital can move outside the taxing jurisdiction that the economic burden can shift to the workers. Or alternatively, only if foreign capital will be dissuaded from entering as a result of the local taxation.

With me so far?

So how much the burden is shifted to the workers will depend rather upon the mobility of capital. It will also depend upon how large the taxing economy is relative to the world economy (for is one country which is 50% of the world economy raiases it’s capital taxation rate then the global average taxation of capital has gone up considerably, if the economy which is 0.5%, not so much).

So if you’ve a small economy (Sweden) then more of the burden shifts to your workers as a result of the second. Further, because you’re in the EU and there absolute freedom of movement of capital, you also shift more to the workers for reason 1.

The US is of course a vastly larger economy (so less of point 2) and they don’t have the same mobility of capital (for example, a US domiciled company would find it almost impossible, short of liquidation, to change domicile. A Swedish one just files a bit of paperwork).

Just rereading you: you say Sweden is a closed economy? But it isn’t, it’s one of the most open: thus my point.

Tim, I thought you said that in a small and closed economy (not Sweden, but Sweden-sized) the burden will fall, in part, on workers – because of the size of this economy. So, I misunderstood. Now I see that you’re saying that (ceteris paribus) open small economies are likely to suffer more than open large economies. That makes sense, I suppose. The important point is (and I’m not sure whether Zamfir would agree with it or not) that in a closed, isolated economy corporate taxes would have no effect on workers or consumers, they are paid by capital alone.

“that in a closed, isolated economy corporate taxes would have no effect on workers or consumers, they are paid by capital alone.”

That’s the way the theory goes.

[aeiou] Amongst those one-percenters we have all kinds of people, from job-creating entrepreneurs, inventors, traders, doctors, top-flight engineers, all the way down the productivity spectrum to tenured, superannuated and self-important economist-bloggers.

If we’re looking to increase taxes on the least-productive of the high-income bracket, I know where I would start…

Tim Worstall: “Average wages in an economy are determined by average productivity in that economy.”

You’ve made this claim before. I’m curious as to where you got the idea and what reason you have for thinking it is true. Not that it would surprise me if there are lots of respectable models in which some such relationship holds, but I’ve never seen anyone else make that particular claim.

Average wages might be limited by average productivity (they can only grow faster than it if something else is shrinking) but they’re not determined by it. Frex, they could grow more slowly than productivity if the labour share of income was falling. Or the average might do something weird if the distribution of income was changing rapidly – if the skewness between the mean and median was shifting.

There’s a difference between a defining and a limiting factor – the trees do not grow up to the sky, but height < alt(sky) isn't a useful predictor of tree size.

dsquared: I was trying to think the whole thing through and arrive at something like what you wrote. Fortunately you just put it better than I ever could. Thank you.

[aeiou] Isn’t quiggin one of those federation fellows on $250K+ a year? That probably puts him in the top 1% in Australia.

The morons on the Democrat side of the aisle were largely responsible for the financial crash. Last I checked, most of those guys have no chance of making more than their relatively paltry congressional salary (unlike most republicans who actually have something to contribute to society outside of politics).

Geez, libertarian, you’re making Worstall sound actually intelligent.

At any rate, in the light of Worstall’s claims that banks deserved their returns due to their efficiency in international capital allocation, feast on this morsel:

” The dirty secret of the credit crisis is that the relentless pursuit of “innovation” meant there was virtually no equity, no cushion for losses anywhere behind the massive creation of risky debt. Arcane, illiquid securities were rated superduper AAA and, with their true risks misunderstood and masked, required only minuscule reserves. Their illiquidity and complexity also meant their accounting value could be finessed. The same instruments, their intricacies overlooked, would soon become raw material for more leverage as they became accepted as collateral for further borrowing, whether via commercial paper or repos.

But even then, the bankers still needed real assets, real borrowers. Investment bankers screamed at mortgage lenders to find them more product, and still, it was not enough.

But credit default swaps solved this problem. Once a CDS on low-grade subprime was sufficiently liquid, synthetic borrowers could stand in the place of subprime borrowers, paying when the borrowers paid and winning a reward when real borrowers could pay no longer. The buyers of CDS were synthetic borrowers that made synthetic CDOs possible. With CDS, supply was no longer bound by earthly constraints on the number of subprime borrowers, but could ascend skyward, as long as there were short sellers willing to be synthetic borrowers and insurers who, tempted by fees, would volunteer to be synthetic lenders, standing atop their own edifice of risks, oblivious to its precariousness.

Institution after institution was bled dry. Yet economists and central bankers applauded the wondrous innovations, seeing increased liquidity and more efficient loan intermedation, ignoring the unhealthy condition of the industry.

The firms that had been silently drained of capital and tied together in shadowy counterparty links teetered, fell, and looked certain to perish. There was one last capital reserve to tap, U.S. taxpayers, to revive the financial system and make the innovators whole. Widespread anger turned into sullen resignation as the public realized its opposition to the looting was futile.

The authorities now claim they will find ways to solve the problems of opacity, leverage, and moral hazard.

But opacity, leverage, and moral hazard are not accidental byproducts of otherwise salutary innovations; they are the direct intent of the innovations. No one was at the major capital markets firms was celebrated for creating markets to connect borrowers and savers transparently and with low risk. After all, efficient markets produce minimal profits. They were instead rewarded for making sure no one, the regulators, the press, the community at large, could see and understand what they were doing.”

The important point is (and I’m not sure whether Zamfir would agree with it or not) that in a closed, isolated economy corporate taxes would have no effect on workers or consumers, they are paid by capital alone.
Zamfir doesn’t agree entirely :) In a simple model, the cost of the tax is determined by the elasticity of supply of different factors of production and the elasticity of demand of different types of consumers. Less-elastic suppliers and consumers would pay a relatively larger share.

Thing is, in a closed economy those elasticities are mostly determined by a choice to participate in the economic action (working, buying, lending, letting land to businesses), or refraining from them. But in an open economy, there is also the choice between participating in the local economy, or in another country.

Both in an open and in a closed economy, the cost of the tax would be distributed over all participants in some way. But some economic activities move easier abroad than others, so in a more open economy those will see a reduced share compared to what they would bear in a closed economy.

This is true for corporate taxes, but also for the tax system as a whole. By shear necessity, countries have to concentrate their taxes more on activities that are tied more strongly to their area of jurisdiction.

The morons on the Democrat side of the aisle were largely responsible for the financial crash.

Nice to see you move from questionable assertions to plain lies. Typical glibertarian.

Well, the problem of course is that these guys weren’t doing much intermediation- they were mostly running a casino in which they bet huge amounts of other people’s money while raking off plenty for themselves from each bet, win or lose.

That might well be true, but there is a real question why people gave them that money in the first place. The reason casinos don’t wreck the economy is that most people fully realize that they shouldn’t gamble their pensions in them.

It’s a question that really bothers me. The whole deck of cards the financial sector built before the crisis (and the one they might well be building again now) could only exist because people outside of that sector handed them large sums of money, and control over large parts of other sectors. And they still do, to largely the same people and organizations.

People might not be perfect, but they are not stupid either. And most financial institutes are not Microsoft-level monopolies either. People hand over the cash because they genuinely think it’s the best thing to do.

People hand over the cash because they genuinely think it’s the best thing to do.

Well, no, I think a lot of people hand over the cash because their pensions have been taken away (by essentially the same people who are salivating over relieving them of their cash) and they’re told it’s the only way they’ll be able to eat something other than dog food when they get old and put out to pasture.

For clarification, could somebody explain what Megacorp could legally do with its profits if it doesn’t distribute them in dividends. For example, if they are used for capital investment or paid to management as bonuses, would they still be taxable profits?

If the profits are distributed to management as bonuses, the bonuses would be wages; the profits would go down by the bonuses paid.

If the profits were used for capital investments, one would hope that the value of the company would increase by the amount of the investment (at least), leading to an increase in the value of the stockholder’s share.

It’s also implicit in Baumol’s Cost Disease. The very thing which makes services more expensive over time compared to manufactures is that wages move in step with average productivity, while productivity in services rises more slowly than in manufacturing.

I think this is precisely wrong. The reason the price of manufactured goods drops is that productivity in those industries increases relatively rapidly, and wages *don’t* increase in step with productivity. If they did, the cost to produce the item wouldn’t decrease and neither would its price. (Cost of labor per unit of output = number of units of labor needed per unit of output x wage. That first factor is the reciprocal of productivity.) The price of services doesn’t drop because the number of units of labor needed to produce them doesn’t drop (i.e. productivity doesn’t rise), which makes them more expensive by comparison.

A parallel phenomenon occurs for prestige goods that reject technological assistance to productivity for “authenticity”: handcrafted goods instead of factory-made, organic foods, food cooked from scratch in small amounts instead of processed in large batches, live performing arts instead of recorded, etc. Those goods are more expensive than their technology-assisted counterparts primarily because of the higher labor inputs required per unit productivity (AFAIK, it doesn’t take more wood to make a handcrafted chair than a factory-made one, but it *does* take a lot more worker-time), which in turn is what makes them status symbols.

@123: If they’re paid out as bonuses/wages, they stop being profit (by the definition of profit).

Some comments on the alleged contributions of bankers to the economy, from the Naked Capicalism blog:

“Barclays’ Bob Diamond to Non-Bankers: Drop Dead ”

http://www.nakedcapitalism.com/2011/01/barclays-bob-diamond-to-non-bankers-drop-dead.html