Economical arithmetic*

by John Quiggin on January 9, 2011

I’m at the American Economic Association meeting in Denver, and just attended a panel of the great and serious discussing the US budget deficit. The numbers are pretty impressive – on current projections, US government expenditure (properly measured) is likely to be around 25 per cent of national income (around 3 trillion/year) and the default budget deficit is around 10 per cent of national income. While current and former CBO directors went over the usual options, it struck me that I had seen those numbers before.

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. As I’ve argued before, this payment to the top percentile can be seen as a kind of tax paid by the population as a whole for the benefits of living in the kind of economy that has developed over the past few decades of financialisation. (Please check irony alerts before responding!)

Clearly, any attempt to claw back some of this money to fill the budget hole would have what economists call “incentive effects”. More precisely, it would necessitate a big contraction of the financial sector. Judging by the reaction of the assembled experts when I raised this point (all declined to respond), this is literally unthinkable.

  • I’m alluding to Richard Feynmann’s joke that, in view of the size of budgets, we should talk about “economical” rather than “astronomical” numbers.

{ 127 comments }

1

Omega Centauri 01.09.11 at 7:49 pm

(all declined to respond), this is literally unthinkable.

It seems we have capture on at least two fronts. The first I will call opportunity capture, i.e. members of the economic profession know they have an opportunity to feast at the financialist table. Secondarily (or arguably primarily), we have ideological capture, the widespread notion that those who are making huge sums, are doing so because they make proportionately larger contributions

2

Bruce Wilder 01.09.11 at 7:57 pm

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.

3

Barry 01.09.11 at 8:06 pm

IIRC, the Bohr theory of scientific progress was summed up as ‘science advances one tombstone at a time’ (ie., that many senior scientists in a field don’t accept new ideas, but die off, and are replaced by people trained under the new ideas).

I don’t expect economics to proceed at even this glacial pace because the Big Money is against that, and there’s been no sign that economics has enough institutional integrity to buck the Big Money (although it’d be fun to see).

4

Herminio Martins 01.09.11 at 8:13 pm

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.

5

Wrye 01.09.11 at 10:39 pm

To what extent is this a US, rather than worldwide , problem? I suppose I’m wondering, if the phenomenon is currently somewhat limited to the US, is it likely to spread?

6

Sev 01.10.11 at 12:57 am

#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.

7

liberal 01.10.11 at 1:43 am

mostly because of the growth in size and profitability of the financial sector

I’d be interested in more details on that. Do you have cites?

8

Tim Worstall 01.10.11 at 9:59 am

“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.)

9

Henri Vieuxtemps 01.10.11 at 10:09 am

@8: Table 2, with “excluding capital gains” in the title. Why exclude the capital gains, or any other category of income, for that matter?

10

Random lurker 01.10.11 at 11:16 am

@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.

11

John Quiggin 01.10.11 at 1:03 pm

As we’ve discussed before, the *growth* in the share of the top 1 per cent has flowed mainly to the top 0.1 per cent, and not many doctors make it into this group: it’s essentially top managers and financial professionals. To quote a study cited by Tyler Cowen “financial market asset prices, corporate governance, entrepreneurship, and income shifting across corporate and personal tax bases may be especially important in explaining the dramatic rise in top income shares.”

http://www.marginalrevolution.com/marginalrevolution/2010/12/the-newest-and-best-data-on-income-inequality.html

That’s from 2005, and financial sector rewards have risen since then – they are only a little bit below the 2007 peak now

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.

12

Guido Nius 01.10.11 at 2:37 pm

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).

13

chris 01.10.11 at 3:06 pm

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.

Sign me up — provided we don’t have to reverse three decades of technological improvement and the associated productivity gains. In the US at least, the pre-Reagan economy is clearly preferable to the post-Reagan one for almost everyone. I suspect the same is true for the UK and Thatcher, mutatis mutandis.

14

mpowell 01.10.11 at 3:07 pm


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.

15

y81 01.10.11 at 3:30 pm

I am very skeptical about interpreting the income numbers reported by the top 0.1% for tax purposes as anything other than artifactual, determined primarily by marginal rates. People at that level–as a handmaiden to that class I know whereof I speak–have substantial control over the income tax reporting, realization and classification of their incomes. So while I don’t dispute that the income earned by the top 1% has definitely risen, I don’t think we have the tools to determine how much of that has flowed to the top 0.1%.

16

someguy 01.10.11 at 4:17 pm

“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.

17

Jim Harrison 01.10.11 at 5:13 pm

Income and wealth distribution isn’t the only problem with “unthinkable” solutions. In the last era of extreme inequality in the United States, the creation of enormous fortunes went along with the development of productive industries, a economy that was the wonder and sometime terror of the world. In that era, the Goulds and Morgans were smaller players than the Carnegies and Rockefellers. Most of our zillionaires aren’t building squat and even the ones who are developing new industries are sitting on the piles of cash instead of plowing it back into economy. Under these circumstances, one could be perfectly content with even extreme inequality and be unhappy. The problem isn’t just how to reduce inequality. The problem is how to encourage, mandate, or simply force force American business to build things and provide services?

18

chris 01.10.11 at 5:21 pm

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.)

19

Henri Vieuxtemps 01.10.11 at 5:48 pm

Effective rates are already probably about 30%.

Nah, probably about 15% or less. Most of their income is taxed as capital gains, plus various other tricks, deferred compensation, corporate perks that aren’t taxed at all.

20

Tim Worstall 01.10.11 at 5:50 pm

“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.

21

someguy 01.10.11 at 5:59 pm

Henri Vieuxtemps,

According to the Congressional Budget Office it looks like it was 31.2% in 2005.

http://www.cbo.gov/ftpdocs/88xx/doc8885/12-11-HistoricalTaxRates.pdf

22

mpowell 01.10.11 at 6:05 pm


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.

23

John Quiggin 01.10.11 at 6:11 pm

What mpowell said. Among other things, the claim that these guys are now producing 25 per cent of US national income requires you to accept
(i) miserable productivity performance on the part of the rest of us
(ii) as regards top managers and finance types a degree of belief in the efficient markets hypothesis only explicable by Upton Sinclair’s famous remark on the topic

24

MPAVictoria 01.10.11 at 6:14 pm

“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.

25

Barry 01.10.11 at 6:43 pm

Adding on – we’ve seen that these guy have produce miserable economic and productivity growth, and smashed the world for a multi-trillion dollar hit. After which they immediately went back to their old tricks.

26

Henri Vieuxtemps 01.10.11 at 6:58 pm

@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%?

27

Sagredo 01.10.11 at 7:16 pm

Hello,

How sensitive is incentive to actual dollar amounts? Does the excitement come from having 100000 times as much as the mean wealth, or from being in the top 0.1%?

Also, why is there no faction, movement or party in the United States specifically focused on increasing income tax?

28

chris 01.10.11 at 7:36 pm

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.)

29

someguy 01.10.11 at 8:11 pm

“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 individual components of the tax rate add up to .1% less than the total. I am going to say the .1% difference is rounding.

“Why do they count corporate income taxes as household income (see Notes below the table)? “

Not really sure off the top my head but what difference would it make?

This CBO data seems to be a generally accepted data set. Take a look at the link below.
You can see that the respected progessive economist and blogger Lance Kentworthy using the same data set to question how progessive the US tax system is.

http://lanekenworthy.net/2009/01/05/how-progressive-are-our-taxes/

30

Henri Vieuxtemps 01.10.11 at 8:31 pm

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.

31

someguy 01.10.11 at 8:40 pm

Henri Vieuxtemps ,

I didn’t like it myself.

But we agree our best estimate of the effective tax rate of the top 1% is about 30%.

32

Henri Vieuxtemps 01.10.11 at 8:50 pm

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.

33

Tim Worstall 01.10.11 at 8:57 pm

“Why do they count corporate income taxes as household income (see Notes below the table)? ”

They don’t. They count corporate taxes as being paid by households. Given that only people, not legal structures, can end up paying taxes this is reasonable.

“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.”

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.

JQ being the house economist can tell you more about this than I can….

34

Henri Vieuxtemps 01.10.11 at 9:19 pm

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.

35

Tim Worstall 01.10.11 at 9:44 pm

Yes, lovely Henri. And Buffett was…ummm, being economical with the truth. I personally would say lying through his teeth but that’s another matter.

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.

Now I, years ago, wrote a piece for WhaleCentralStation pointing out that the Federal Govt does take donations. Warren ain’t made one as yet.

36

chris 01.10.11 at 9:49 pm

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?

37

chris 01.10.11 at 9:56 pm

Now I, years ago, wrote a piece for WhaleCentralStation pointing out that the Federal Govt does take donations. Warren ain’t made one as yet.

Oh, come on, this is obviously silly. There’s a huge difference between saying “Group X, which includes me, should pay more to the government for these services we all benefit from” and “I’m going to pay more to the government despite the fact that other similarly situated people are not doing so.” Unilateral action can’t solve a collective action problem, that’s why it’s called a *collective* action problem.

Warren will pay up (probably without complaint, or at least without much complaint) when everyone else similarly situated is also paying up. They’re not, so there’s no reason he should either. The whole point of taxes is to have groups of people pay them according to uniform rules, so that people don’t put themselves at a competitive disadvantage by supporting common goals disproportionately and lose out w.r.t. free-riders.

38

Henri Vieuxtemps 01.10.11 at 9:58 pm

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.

39

mpowell 01.10.11 at 9:59 pm


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.

Okay, I’m only responding here for the purpose of clarity, but I think you are thinking about this the wrong way. Ideally a manager and even a financial type still contributes something. If your workers are all producing the wrong type of widgets, that is wasted activity and it does happen in the real world. 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. And that doesn’t even have to be about pressure to work harder. Employees have different strengths and the same group of workers can produce more or less widgets if the individuals are assigned tasks more or less efficiently by their manager. The result is real productivity output increases that the manager is responsible for and you can see how there would be a temptation to reason that the more people a manager is responsible for, the more his delta productive is applied to a larger group of workers. And if he’s working harder, maybe he does a better job at this. Finance is similar, it’s about finding the best and most productive uses of capital. You may not like it, but there is certainly a story about how managers and finance types by doing their job better can contribute to increased economic production. Whether they are physically assembling widgets or not is really not relevant. The question is whether their contribution corresponds at all to their take home share of income, which I think is pretty obviously no.

40

Sebastian 01.10.11 at 10:01 pm

“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.

41

Watson Ladd 01.10.11 at 10:09 pm

No, the income vanishes with deadweight losses. If I don’t ride a bus that costs $10 because a tax raises the price to $15, the economic gains I would have had from taking that bus ride are not realized by anyone. (Assume it is worth $13 to me to get where I am going.)

42

Henri Vieuxtemps 01.10.11 at 10:21 pm

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.

43

Omega Centauri 01.10.11 at 10:29 pm

Regarding Chris, and mpowell above.

I think there are a few separable issues. One is what is the value of good management decisions, versus bad ones. Thats what mpowell is getting at. Obviously stuff like what gets made, and how to best organize it. Also what investments to make in either future productivity and/or new product design are made at these levels. So clearly the net effect of the quality of executive decisions is important.
But, then we have the issue of whether an incremental increase in executive pay leads to a commensurate increase in the value added by the decisions themselves? This is probably tougher to answer. We obviously have a pile of anecdotal cases where eggregiously bad decisions seemed to have been highly rewarded, but this doesn’t constitute proof that in some sort of net aggregate sense, that the same result follows.

44

mpowell 01.10.11 at 10:31 pm


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.

45

Henri Vieuxtemps 01.10.11 at 10:57 pm

Well, this is based on my real-life observations, at a software company. Most certainly at least the CEO and CFO were never involved in anything other than what I mentioned, plus daily bullshit sessions with Wall Street analysts, and a lot of golf-playing. But I seem to remember (though not 100% sure) that the R&D chief was also an executive, and he probably was involved; so yeah, I suppose you have a point there.

46

someguy 01.10.11 at 11:24 pm

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.

47

someguy 01.10.11 at 11:27 pm

Uh yeah also what mpowell said over sight and decision making are real important.

48

Cryptic ned 01.11.11 at 12:12 am

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.

49

mclaren 01.11.11 at 12:53 am

Jim Harrison asserts “The problem is how to encourage, mandate, or simply force force American business to build things and provide services?”

A classic example of “not getting it.”

The top 1% make their billions precisely by exporting the manufacture of goods and the provision of services overseas. When IBM fires 9,000 of its workers and replaces ‘em with third world PhDs who work for 1/10 the cost, IBM’s stock skyrockets and the CEO of IBM makes hundreds of millions in bonuses.

It’s called “global wage arbitrage.” The American middle class is being destroyed by shipping all its jobs overseas. Soon we’ll be a nation of dog groomers and xerox clerks, with no engineers and no roboticists and no programmers and no architects and no surgeons. The surgeons will be replaced by robots made in China run by software programmed in India in hospitals designed in Singapore built by guest workers on H1B visas from Taiwan.

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.

50

NotSure 01.11.11 at 1:05 am

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.

51

john c. halasz 01.11.11 at 1:49 am

#34:

“But those dividends have already beent taxed at 35% before they are paid to him.”

If you really think that major U.S. based “public” corporations pay an effective tax rate of 35%, I’ve got some prime real estate over the East River to sell you. There was a econ paper about “dark matter”, the supposed ability of U.S. corporations to generate large returns abroad and the inability of foreign corporations to generate any significant returns in the U.S., a few years back. Brad Setser put paid to it, by simply asking why foreign corporations would want to commit to expensive long-run real investments in the U.S. with all the difficulties and uncertainties involved, when they could get better returns simply by holding 10 year T-bonds. The obvious answer is that they wouldn’t. The “dark matter” effect is almost entirely due to tax arbitrage effects. Look up the share of the U.S. corporate income tax receipts as % of total income tax receipts from 1945-present. That’ll give you the clue that you’re so obviously lacking.

52

bunbury 01.11.11 at 1:52 am

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?

53

someguy 01.11.11 at 2:09 am

Henri Vieuxtemps,

Here is the IRS data which would not include imputed taxes.

http://www.taxfoundation.org/news/show/250.html

The average rate for the top 1% is 23.27%. 2008.

And thinking about it a little it makes sense to include imputed taxes.

If Megacorp suddenly doesn’t have to pay corporate taxes that amount is either distributed in dividends or retained in which case we would expect the value of Megacorp to rise by about that amount. Either way the taxes represent earnings lost by the owners.

Let’s say the top 1 percent of income earners were arguing for the repeal of the corporate tax rate. Would you feel that they were doing so in order to promote the abstract good of corporations or would you be amendable to the idea that they were doing so in order to increase their own income?

The more firm your belief they would be doing so in order to increase their own income the more firm should be your belief that imputed taxes are paid by owners.

Anyway from 23.27 to 48.27 or more correctly from 31.2 to 56.2 [And that is just the federal rate. Local and state taxes are missing] is a very big jump and even if you could realize the full 25% in increased revenues you would only be talking about 500 billion out of 1.2 trillion.

Closing the gap will require higher taxes from just about anyone who pays federal taxes.

54

mclaren 01.11.11 at 2:12 am

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

55

geo 01.11.11 at 2:23 am

Tim @34:

From the Washington Post, 6/27/07: http://www.washingtonpost.com/wp-dyn/content/article/2007/06/27/AR2007062700097.html.

Buffett cited himself, the third-richest person in the world, as an example. Last year, Buffett said, he was taxed at 17.7 percent on his taxable income of more than $46 million. His receptionist was taxed at about 30 percent

56

MPAVictoria 01.11.11 at 3:49 am

“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?

57

someguy 01.11.11 at 4:42 am

geo,

Warren is ignoring his imputed taxes. When investing he doesn’t make the same mistake.

58

Zamfir 01.11.11 at 7:39 am

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.

59

Henri Vieuxtemps 01.11.11 at 8:08 am

Someguy, but the shareholders don’t own the business, they choose to place a full-fledged legal and accounting entity between themselves and the business. They do it for a reason, to avoid liability; the downside is that the entity (naturally) is taxed. Buffett is free to own his businesses outright, but he (and most other billionaires) chooses not to.

Let’s say the top 1 percent of income earners were arguing for the repeal of the corporate tax rate. Would you feel that they were doing so in order to promote the abstract good of corporations or would you be amendable to the idea that they were doing so in order to increase their own income?

Of course they are doing it in order to increase their own income. But they might also argue, in a hope to increase their income at some point, for repeal of, say, their parents individual income taxes; nevertheless, it wouldn’t be reasonable to count their parents’ taxes as their own.

60

Tim Worstall 01.11.11 at 10:50 am

“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.

61

chris 01.11.11 at 2:15 pm

So clearly the net effect of the quality of executive decisions is important.

In the sense that you shouldn’t make managerial decisions with a Magic 8 Ball, maybe. But 50s-era managers made managerial decisions on 50s-era managerial salaries and I don’t think you can back up a claim that corporations in the 50s were systematically less well managed than today (if anything the reverse seems to be true, with a degree of risk-seeking that is pretty much insane by any objective standard). The main discernible difference between a reasonably competent manager and today’s celebrity executives (aside from the paycheck) is precisely that culture of risk-seeking that has destroyed or badly damaged several formerly healthy corporations. (You could make the same comparison between American corporate executives and those in other countries.)

Modern corporations (and, therefore, their shareholders) are getting pretty much nothing from the increase in executive pay, so it seems rather relevant that the executives as a class are setting their own pay and shareholders are basically frozen out of the governance of the corporations they “own”.

It doesn’t take $100 million a year to find someone who can read a report on the last quarter’s sales and set production targets accordingly. To the extent that that’s a valuable skill, it’s not what American executive salaries are actually buying.

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.

The profits don’t just come from the productivity of labor; they come from the productivity *minus cost* of labor. Cost of labor is, after all, a cost, not a profit. If a worker in Advanced Country A produces $20 worth of goods per hour, but expects $10/hr in pay and benefits, and a worker in Developing Country B produces $15 worth of goods per hour, but expects only $3/hr in pay (after factoring in unpaid overtime) and no benefits, then it’s time to build the next factory in Country B. It’s not hard to guess where A’s wages are going as a consequence. Their productivity is too expensive to be profitable to use.

62

MPAVictoria 01.11.11 at 2:23 pm

“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.

63

dsquared 01.11.11 at 2:25 pm

“Being paid” is not an activity.

64

someguy 01.11.11 at 3:40 pm

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%.

65

someguy 01.11.11 at 3:49 pm

Henri Vieuxtemps ,

We don’t own shares in our parents. Buffet owns and operates Berkshire. That is why I choose him as the example. The connection between shareholder gains and corporate profits is very messy and imperfect but extremely real.

66

Henri Vieuxtemps 01.11.11 at 4:20 pm

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.

67

Tim Worstall 01.11.11 at 4:27 pm

“Apparently high paid bankers destroy about 7 pounds of wealth for every pound they are paid. “

Umm, yes, I knew I recognised that number. The new economics foundation again.

“The research, carried out by think tank the New Economics Foundation, says hospital cleaners create £10 of value for every £1 they are paid.

It claims bankers are a drain on the country because of the damage they caused to the global economy.

They reportedly destroy £7 of value for every £1 they earn. Meanwhile, senior advertising executives are said to “create stress”. “

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 simpy assume that they’re entirely and completely barking mad.

68

Steve LaBonne 01.11.11 at 4:29 pm

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.)

69

MPAVictoria 01.11.11 at 4:38 pm

Tim do you really find it that hard to believe that investment bankers have destroyed a great deal of wealth in the last couple years? I for one am amazed that it is only 7 pounds for every pound they received in compensation.

70

engels 01.11.11 at 4:42 pm

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.

71

someguy 01.11.11 at 4:46 pm

Henri Vieuxtemps,

“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.”

Excellent. I think we have arrived at the crux of the disagreement.

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.

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chris 01.11.11 at 5:07 pm

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.

73

Tim Worstall 01.11.11 at 5:22 pm

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%.

As to the nef thing, their report us here:

http://www.neweconomics.org/sites/neweconomics.org/files/A_Bit_Rich.pdf

“Factors in value created:
1 Average annual contribution of the City to UK economic activity, as measured by gross value added
2 Tax contributions to the Exchequer
3 Jobs provided in the wholesale finance sector.
Factors in value destroyed:
1 The cost of the current financial crisis in terms of loss to UK gross domestic product and economic capacity
2 The cost of that crisis in terms of the negative impact on the public finances.”

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. So loading all of the cost of the recession onto the wholesale bankers of the City (and not even in part onto policy makers say, or even the retail banking system which originated the mortgages and yes, they do distinguish betwee nthe City and this retail financial system) is, umm, entirely and completely barking mad.

74

Henri Vieuxtemps 01.11.11 at 5:27 pm

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?

75

someguy 01.11.11 at 5:45 pm

chris,

No I didn’t.

And here is a CBO study that asks all the same questions I did though with an extremely higher level of expertise and depth.

[I stole the corporate tax rate in other countries question from it.]

http://www.cbo.gov/ftpdocs/115xx/doc11519/05-2010-Working_Paper-Corp_Tax_Incidence-Review_of_Gen_Eq_Estimates.pdf

76

someguy 01.11.11 at 5:50 pm

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

77

MPAVictoria 01.11.11 at 5:58 pm

I have to notice Tim that you failed to actually answer my question. I will repeat: Do you doubt that highly compensated investment bankers have done significant damage to the worlds economy in recent years while being richly compensated?

78

chris 01.11.11 at 6:48 pm

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.

79

Substance McGravitas 01.11.11 at 6:56 pm

So loading all of the cost of the recession onto the wholesale bankers of the City (and not even in part onto policy makers say, or even the retail banking system which originated the mortgages and yes, they do distinguish betwee nthe City and this retail financial system) is, umm, entirely and completely barking mad.

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

80

someguy 01.11.11 at 7:28 pm

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?

81

SamChevre 01.11.11 at 9:13 pm

But the housing crash came from the housing bubble,
True

and the housing bubble came from loose mortgage underwriting,
Partly true; loose mortgage underwriting and low interest rates contributed, but steadily rising house prices since 1980 were also significantly important.

and loose mortgage underwriting came from securitization,
Ahhh–no; not even close. I can’t think of any way that securitization would have affected the FHA lending guidelines, which permitted no-down-payment loans. Loose underwriting guidelines were well-intentioned public policy, not random stupidity. (If you are including FHA/FNMA/FHLMC and Barney Frank in “securitization”, this might be true.)

and securitization came from the financiers.
Yes, and was enthusisticly supported by banking regulators as a way of controlling bank risk, and was enthusiastically propped up by the GSE’s.

82

chris 01.11.11 at 9:31 pm

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.

83

chris 01.11.11 at 9:33 pm

In fact, an even more precise analogy would be driving your *taxi* off a bridge, when the passengers have hired you to get them to their destinations, and entrusted themselves to your driving skill for that purpose.

84

Substance McGravitas 01.11.11 at 9:34 pm

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

85

Jac 01.11.11 at 10:49 pm

It is often heard that some superstar banker X must be paid insane amount of money because he is so super skilled and super productive. Is there any solid empirical evidence that, say 10 less intelligent but also less self-interested economists (surely there must be 10 of those?) wouldn’t outperform superstar banker X? The 10 combine their work for a lower total pay than what X demands. Which of these two alternative yields a better total outcome for the bank? Then repeat the same experiment with 100 non-economists forming a coop that serve to replace the work of superbanker X. Again, would X outperform the 100?

86

Chris 01.12.11 at 6:03 am

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.

87

Tim Worstall 01.12.11 at 9:46 am

“Do you doubt that highly compensated investment bankers have done significant damage to the worlds economy in recent years while being richly compensated?”

Yes, I doubt this.

I do not doubt that mistakes were made and that damage was done: the doubt is in whether it was exclusively, majority or even largely caused by bankers and or their pay (for example, at least some blame has to go to central banks for the interest rate policy which fed the property boom(s)).

And looking at it from my UK based perspective, I doubt it even more. “The City” isn’t just about the UK market: indeed, much of The City has almost nothing at all to do with the domestic economy. It’s the stock market/bond market/foreign exchange market to the world: and as you can see, an awful lot of the world is growing very well thank you, aided and abetted by an efficient capital allocation mechanism: The City.

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

That’s not the mechanism. Assume a relatively open economy, one in which capital is free to move in or out (note, in a closed economy, capital/the shareholders will be carrying the economic burden of corporate taxation: the extent to which they do not is a function of how small relative to world and how open the economy is. Thus, for example, the burden of Swedish corporation tax will fall more on the Swedish workers than the burden of the US one will on US workers).

There is a risk adjusted world return to capital. Raising the tax on that return to capital in one jurisdiction will mean less capital flowing in to be invested there, more capital flowing out to be invested elsewhere. Less capital being added to labour in an economy leads to lower productivity of that labour and average wages in an economy are determined by average productivity in that economy.

Thus less capital investment as a result of taxation of the returns to capital will lead to lower wages. Tghus we can say that the economic burden of corporate (or capital) taxation will fall on the workers in the form of lower wages. Some of it at least.

There is, of course, huge debate about how important this is. The mechanism not so much.

There are two solutions: don’t allow capital to move. Or have one single taxation rate globally for returns to capital. Neither are likely to happen soon.

88

Henri Vieuxtemps 01.12.11 at 10:31 am

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?

89

NomadUK 01.12.11 at 12:38 pm

That’s ridiculous—productivity of a 99-IQ American is way higher than that of an 81-IQ Indian.

Sweet Jesus, who left the cages open?

90

Barry 01.12.11 at 12:46 pm

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

Thanks

91

Zamfir 01.12.11 at 1:41 pm

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?

Be careful not to confuse the results of an introduction of a corporate tax with the long run effects of having a constant corporate tax.

Suppose the government introduces a lasting corporate tax out of the blue, without expectations from anyone,. That’s bad for people who currently hold stock or bonds. In the short run, it will lead to lower dividends and thus lower stock prices, and in the case of bonds, the companies are now less likely to have enough income to keep the terms. So people who provided capital to companies before the tax will suffer a one-time loss that they won’t recoup.

But companies need new capital. When that happens, they’ll have to negotiate again. If potential providers of capital can easily invest in some country without the new corporate tax, they can demand terms that give them the same kind of expected returns in the country with the tax. That means extra interest on the bonds to counteract the lower income stream, and they’ll pay lower prices for newly issued stock than for identical stock in an identical company abroad.

So it might well be the case that the one-off loss to investors pays for for most of the tax in its first years. But the long run equilibrium is much more favourable to investors, if they can easily invest abroad.

For comparison, think about labour income taxes. It doesn’t matter much whether you pay them from your gross income, or the company pays them before they hand you income. If the company has to pay, gross incomes will simply be set lower while net incomes stay roughly the same.

But right at the introduction of the tax it matters a lot, because people have fixed contracts that determine their gross income. Only over time will the contracts change to reflect the new situation.

92

Tim Worstall 01.12.11 at 1:41 pm

“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.

93

MPAVictoria 01.12.11 at 2:40 pm

Tim read what I wrote not what you think I wrote. I did not write that the pay the investment bankers were getting is what caused the damage. I wrote that the bankers were being richly compensated while acting in a manner which caused significant damage to the world’s economy. We would all have been much better off if we had chosen to pay these “supermen” less and they had gone Galt as a a result. Any money given to these thieves is too much.

94

Henri Vieuxtemps 01.12.11 at 3:59 pm

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.

95

someguy 01.12.11 at 4:29 pm

Henri Vieuxtemps,

Neat trick. Capital pays the tax but the tax is not paid by the owners of capital.

You can simutaneously call for a higher tax on capital and castigated capital owners for not paying their fair share of taxes.

Good one.

96

Tim Worstall 01.12.11 at 4:37 pm

“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.

97

dsquared 01.12.11 at 4:59 pm

It does seem to me that Tim is in a bit of a double-bind here. If the argument is that the financial crisis and housing bubble would have happened with or without the bankers, then it’s hard to see how there would be much deadweight loss from a tax, because ex hypothesi their activities weren’t making a difference. If on the other hand we’re making the argument that the bankers are responsible for a load of economic activity which wouldn’t otherwise occur (ie, if there was more of a tax wedge, they would reduce the amount of banking they did), then it does seem relevant to inquire into the results of that economic activity.

The argument you need to make, Tim, is that the financial crisis was not only the result of impersonal economic forces outside the control of individual financiers, but that the bankers actually made things better, and that if they hadn’t been working all hours of the day and night structuring CDOs, the crisis would have been much worse. Best of British luck with that one.

98

libertarian 01.12.11 at 5:05 pm

mngst ths n-prcntrs w hv ll knds f ppl, frm jb-crtng ntrprnrs, nvntrs, trdrs, dctrs, tp-flght ngnrs, ll th wy dwn th prdctvty spctrm t tnrd, sprnntd nd slf-mprtnt cnmst-blggrs.

f w’r lkng t ncrs txs n th lst-prdctv f th hgh-ncm brckt, knw whr wld strt…

99

Henri Vieuxtemps 01.12.11 at 5:15 pm

Someguy, no tricks; as a shareholder you don’t own capital, you own shares in the corporation that owns capital, capital it generated by selling stock.

100

Kevin Donoghue 01.12.11 at 5:16 pm

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.

101

Kevin Donoghue 01.12.11 at 5:42 pm

Having consulted Google, I’m pretty sure that the source of what we may call Worstall’s Law is this remark by Paul Krugman:

“Any difference in the rates of growth of productivity and compensation would necessarily show up as a fall in labor’s share of national income — and as everyone who is even slightly familiar with the numbers knows, the share of compensation in U.S. national income has been quite stable in recent decades….”

But there’s quite a leap from that to the alleged Law.

102

Alex 01.12.11 at 6:12 pm

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.

103

Henri Vieuxtemps 01.12.11 at 6:46 pm

I imagine – again, assuming isolated and competitive economy – increase of avg productivity may not translate into higher avg wages, but then (due to competitiveness) it’ll translate into lower prices which produces the same effect.

104

MPAVictoria 01.12.11 at 7:46 pm

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.

105

Steve LaBonne 01.12.11 at 8:44 pm

Nice try, libertarian @98, but 1) you’re not going to find professors even close to the top 1% on their salaries; they’d have to have a lucrative consulting business on the side, which I might be tempted to be snide about but you, on your alleged principles, can’t be; and 2) the people who are responsible for crashing the world financial system are largely in the top 0.1%, which is a whole different ballgame.

106

libertarian 01.13.11 at 2:04 am

sn’t qggn n f ths fdrtn fllws n $250K+ yr? Tht prbbly pts hm n th tp 1% n strl.

Th mrns n th Dmcrt sd f th sl wr lrgly rspnsbl fr th fnncl crsh. Lst chckd, mst f ths gys hv n chnc f mkng mr thn thr rltvly pltry cngrssnl slry (nlk mst rpblcns wh ctlly hv smthng t cntrbt t scty tsd f pltcs).

107

Frank Ch. Eigler 01.13.11 at 3:27 am

any attempt to claw back some of this money

By definition, you can’t claw the money back if it didn’t come from you in the first place.

108

john c. halasz 01.13.11 at 4:31 am

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.”

109

Tim Worstall 01.13.11 at 8:27 am

“I’m curious as to where you got the idea and what reason you have for thinking it is true.”

Certainly one of the sources is that Krugman essay.

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.

It’s not a law of course: just an observation.

“If the argument is that the financial crisis and housing bubble would have happened with or without the bankers, then it’s hard to see how there would be much deadweight loss from a tax, because ex hypothesi their activities weren’t making a difference.”

But that isn’t my claim at all.

I’ve made several different points above:

1) Looking at both top 1% and top 0.1% taxpayers, it isn’t true that financiers are anywhere near the majority of them and are therefore the expansion of the finance sector is not the cause of the rise in inequality. Thus, contra John Q’s original suggestion, shrinking the finance sector won’t (necessarily) lead to a reduction in said inequality.

2) Deadweight costs are deadweight costs. If there are deadweight costs associated with a particular tax then this does not lead to incomes being reassigned, the very word “deadweight” means that the economic activity never happens and thus the income (s) don’t exist.

3) Corporate taxation is, dependent upon size and openness of the economy in which it is levied, bourne to a greater or lesser extent by workers in the form of lower wages rather than by capital in reduced returns.

None of those strike me as being controversial in any manner. The latter two are simply statements of economic orthodoxy aren’t they?

As to taxing the financial sector I’ve not said we should or we shouldn’t, nor whether shrinking (or expanding) it would be a good idea.

I have muttered along the lines that while we can indeed see that a part of the highly paid finance industry has led to most undesirable costs, the mortgage origination and bundling part, that’s not the be all and end all of the highly paid finance industry and other parts of that highly paid finance industry have been doing desirable things. Further, that the highly paid finance industry isn’t solely and uniquely responsible for those undesirable costs in the mortgage industry.

But that’s as far as I’ve gone there.

110

Zamfir 01.13.11 at 9:11 am

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.

111

Zamfir 01.13.11 at 9:16 am

Small addition: groups like “workers” and “investors” are of course not monolithic entities. The effect can differ within such groups.

112

Steve LaBonne 01.13.11 at 1:17 pm

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.

113

Tim Wilkinson 01.13.11 at 1:42 pm

Tim Worstall

I am very worried about all the huge deadweight ‘losses’ that arise in every area of the oeconomy due to absence of subsidies. This far outweighs the deadweight loss that arises from positive-valued taxation. (Obviously we ignore the fiscal side of things because we are only looking at cases of deadweight loss.)

But the matter of deadweight loss is far from straightforward here (i.e. in relation to financial ‘intermediation’, rather than, say export of stock-trading facilities), because, as dd points out, being paid is not an activity – or more precisely, because it is not a measure of value added. The NEF’s figures on the plus (gross value added) side of the ledger, taken from the OECD/NAO whoever, are basically just made up.

But then perhaps this point should simply be rejected as paradoxical.

114

John Quiggin 01.13.11 at 1:54 pm

Apologies for libertarian – he’s a sockpuppeteer and chronic troll who has followed me here from my Oz blog, which he infested under many different nyms. Readers here may recall, him as the same guy who claimed to have a PhD in stats but couldn’t explain statistical significance.

I’ll disemvowel the comments in this thread, and permanently block him from now on.

115

Steve LaBonne 01.13.11 at 1:56 pm

Re 112- 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.

116

Zamfir 01.13.11 at 2:52 pm

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.

117

chris 01.13.11 at 4:35 pm

f there are deadweight costs associated with a particular tax then this does not lead to incomes being reassigned, the very word “deadweight” means that the economic activity never happens and thus the income (s) don’t exist.

Fair enough, but then you can’t simply assume that any particular tax will have a deadweight effect; you have to *prove* that it will destroy (and not merely shift) economic activity. The presence or absence, let alone magnitude, of deadweight effect of a given tax (as a policy matter to be considered in real economies) is an empirical question that can’t be decided by reference to idealized toy universes.

I’ve already asserted that any particular manager going Galt will generally cause a reallocation and not a deadweight (because their successor will be approximately equally talented; they’re not really Atlas, just some guy filling a chair), and in fact the evidence appears to show no effect of executive “talent” on much of anything; so anyone asserting higher marginal income taxes -> revolt of the genius managers -> economic ruin has a slight problem with their causality chain and had better dig up some evidence to repair it. (Or, in other words, the plot of _Atlas Shrugged_ is not a realistic scenario that should be used as the basis for policymaking decisions.)

Actually, I’m not sure even the first link of that causality chain works, because an income tax increase doesn’t change the rank order of incomes, therefore status-motivated people would retain the same outcome in the sense that mattered to them (even aside from emotional investment — does anyone really expect Steve Jobs to walk away from Apple over the expectation of making less money than he counterfactually could have made? But Jobs is precisely the kind of executive where it’s most plausible that he actually could be adding value to the company and not just a chair-filler). Does anyone in the higher tiers of the manager class really obtain substantial *non-positional* utility from their marginal income dollar?

118

NomadUK 01.13.11 at 4:52 pm

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.

119

piglet 01.13.11 at 6:02 pm

If Megacorp suddenly doesn’t have to pay corporate taxes that amount is either distributed in dividends or retained in which case we would expect the value of Megacorp to rise by about that amount. Either way the taxes represent earnings lost by the owners.

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? Methinks that someguys argument only makes sense if there is an automatism profits-corporate tax=stockholder income. I don’t think this is the case but don’t know for sure.

120

SamChevre 01.13.11 at 7:03 pm

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.

121

Walt 01.13.11 at 7:47 pm

piglet, corporations invest profits that they don’t pay out in dividends. They can invest internally by building factories or whatever, but they can also invest by buying stock in other companies, Treasury bonds, etc. They frequently hold some of it in “cash”, which includes things that are close substitutes for cash, such as short-term bonds.

122

chris 01.13.11 at 7:51 pm

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

piglet 01.13.11 at 8:32 pm

120, 121: You are saying that corporate profits can be either invested or paid out as dividends but not paid as bonuses/wages to employees. That’s what I wanted to clarify. Not that it was very important.

124

chris 01.13.11 at 10:28 pm

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

125

Henri Vieuxtemps 01.13.11 at 10:41 pm

Corporations can do other things, buy shares back from shareholders, for example. They live.

126

Barry 01.14.11 at 12:50 am

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

127

someguy 01.14.11 at 5:05 pm

Ok. Sure. When Megacorp pays taxes the incidence doesn’t fall on individuals.

If we cut the employeer’s portion of the SS Tax Megacorp wouldn’t have to pay that in wages.

In which case we can use this table. For better look at federal tax burdens we can add in about 7.5% for any one below about 1%.

http://www.taxfoundation.org/news/show/250.html

But I have a much better idea, If individuals don’t actually bear the tax burden when we tax Megacorp. Why don’t we just raise all our revenues by taxing Megacorp?

We can raise the corporate tax rate up to say 50% and we can make employeer’s pay 100% of the SS tax plus we could add on say 5%.

piglet,

Just IMO.

Because Megacorp isn’t necessarily some perfect profit maximizng machine they might pay more in wages. But because Megacorp is mostly trying to maximize profits they probably won’t be paying all that much more than the market clearing wage.

[If CEOs are profit maximizing then they would only be able to take about the same % they currently take. Which still means mostly capital owners benefit.]

They will either wisely or unwisely re-invest the extra cash or pay it out .

Buying back stock boosts the stock price which benefits stock/capital owners.

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