Links: June 2009
June 30, 2009Did Blair and Brown fail on inequality?
June 1, 2009In a Financial Times op-ed, Matthew Engel says
This month, it was revealed that the UK’s Gini coefficient, measuring inequality between rich and poor, had reached its highest level on record — after the longest period of Labour government ever. You do not have to be a Labour voter to wonder what, then, has been the point of it all.
I wouldn’t want to offer a full-scale defense of the Labour governments’ strategy (see ch. 11 of this book for my views), but there is a reasonable response to this particular challenge. Inequality of market incomes has been increasing almost everywhere. Arguably, it has risen less, and government has done more to mitigate its impact, under Labour than would have been the case under the Conservatives. It’s impossible to know that for certain, of course, but the following data on inflation-adjusted income growth during the most recent periods of Conservative and Labour rule are consistent with this assertion.

Economic crisis primer
May 27, 2009Larry Mishel at the Economic Policy Institute has a helpful primer on the economic downturn and what lies ahead. Well worth a look.
How does the U.S. labor market compare now?
May 26, 2009In a new CEPR report, John Schmitt, Hye Jin Rho, and Shawn Fremstad note that while the U.S. unemployment rate had been lower than those of many rich European countries in the 1980s and 1990s, it now has caught up to and surpassed most of them. In March of this year our unemployment rate was tied for fourth-highest among the major OECD nations. This, they say, “has turned the case for the U.S. model almost entirely on its head.” (Floyd Norris in the New York Times and John Quiggin at Crooked Timber have also picked up this story.)
I’m sympathetic to the conclusion, but I’d prefer it to be based on a different measure of labor market performance.
The unemployment rate is calculated as the number of people looking for work but without a job (unemployed) divided by the number of people either employed or unemployed. Its weakness is that it takes no account of people who aren’t seeking work because they doubt they could find a satisfactory job or have given up trying. The U.S. Bureau of Labor Statistics has broader unemployment measures that try to incorporate this, but there aren’t cross-nationally comparable data for those measures.
If our interest is in an economy’s success in creating jobs, a better indicator for cross-country comparison is the employment rate: the share of working-age people (age 15 to 64 is the standard) that are employed. The following chart shows employment rates for the two most recent business-cycle peak years: 2000 and 2007. The U.S. is one of just a few nations in which the employment rate declined during this period, though it’s in the middle of the pack rather than at the bottom.

What’s happened since then? Employment rates aren’t updated as regularly as unemployment rates, so recent trends are more difficult to judge. The data below are the best I can do at the moment. They show percentage change in the number (not share) of people employed from the fourth quarter of 2007 to the fourth quarter of 2008, and for a few countries to the first quarter of 2009. Our economy has lost more jobs — 4.5%, or about 6.5 million jobs — than most others.

The American labor market hasn’t been the worst at creating and maintaining jobs in the 2000s (though bear in mind that we’re talking here solely about the number of jobs, not their quality). Yet as Schmitt, Rho, and Fremstad rightly suggest, things have changed sharply relative to the 1980s and 1990s when our performance was near the top of the comparative heap.
Allocating talent productively
May 25, 2009A retiring hedge fund manager, interviewed by the New York Times‘ Joe Nocera, reflects that his business
was part of this huge trend toward the celebration of wealth. Hedge fund managers overearned. It just became too easy. There has been a massive misallocation of human resources. I have so many smart guys here who were making seven figures. And I think it is a fair question to ask: what would they have been doing in 1948 — going into the foreign service? If Obama does anything, the best thing he could do is change a generation’s values.
The point is right on. A significant portion (though not all) of the activity that’s yielded huge incomes in finance over the past several decades has been, in effect, little more than high-stakes gambling — betting on which way asset valuations will move, devising new instruments and techniques for doing so and for collecting fees on the transactions, and convincing investors to pony up more and more money to fund such bets. Even setting aside the danger this can pose to the real economy, it would be good if less of our collective intelligence and effort were dedicated to these sorts of pursuits.
Yet while changing values is a worthwhile aim, I doubt it’ll do the trick. What’s needed is to shift the incentives, via regulation and/or taxes.
Do schools make inequality worse?
May 21, 2009“Far from leaning against economic inequality, U.S. schools make it worse.” This sentiment, from a recent Clive Crook op-ed, expresses a view that’s commonplace on both the left and the right, and among both proponents and opponents of school reform.
It’s wrong. Americans do leave the schooling system more unequal in cognitive and noncognitive skills than when they enter it. Yet that inequality is less — probably much less — than it would be in the absence of schools. Schools don’t increase inequality; they just don’t do enough to overcome the inequality produced throughout childhood by differences in families, neighborhoods, peers, and other influences.
How do we know that? First, children are vastly unequal in ability when they enter the school system at age five or six. This is due partly to genetics and partly to environmental differences.
Second, we have evidence from the natural experiment that is summer vacation. During those three months out of school, the cognitive skills of children in lower socioeconomic status (SES) households tend to stall or actually regress. Kids in high-SES households fare much better during the summer, as they’re more likely to spend it engaged in stimulating activities. In his book Intelligence and How to Get It, cognitive psychologist Richard Nisbett concludes that “much, if not most, of the gap in academic achievement between lower- and higher-SES children, in fact, is due to the greater summer slump for lower-SES children” (p. 40).
Without schools this pattern would be magnified, and the gap in cognitive and noncognitive abilities at age 18 almost certainly would be much greater than it now is.
This by no means implies that our educational system is doing fine. It could and should do much better at helping children from disadvantaged environments. But saying it currently makes things worse suggests the situation is hopeless. Instead of promoting reform, that undercuts it.
Sublime Barça
April 26, 2009I grew up playing soccer and continue to enjoy the game, but my interest as a spectator has waxed and waned over the years. I’ve never been loyal to a particular team in a way that leads one to stay tuned even when times aren’t good, so my attentiveness hinges largely on the quality of the teams I’m able to watch. Two things have helped to rekindle it in recent years. One is television coverage of the English and Italian leagues via Fox Soccer Channel. The other is globalization. The European clubs (see the chart below) with the most money, and to some extent tradition, are able to lure the best players from all over the world — from Argentina to the Ivory Coast. The resulting concentration of talent makes these teams much more attractive to watch than was the case when many had only two or three foreign players. The combinations don’t always work; bloated egos and lack of chemistry sometimes get in the way. But on the whole, this has been a boon for fans with TV access and no allegiance to a club or country that’s been left behind by this process.
This year has been especially pleasurable, because Barcelona have a delightful team. Their front five — Lionel Messi (Argentina), Samuel Eto’o (Cameroon), Thierry Henry (France), Andrés Iniesta (Spain), and Xavi Hernández (Spain) — are a joy to watch. Messi has more skill on the ball than anyone since Diego Maradona and is probably the world’s best player at the moment. Eto’o, lightening quick with excellent touch around the goal, has scored 125 goals for Barcelona in the last five seasons. Henry has been one of the world’s top three forwards over the past decade; he’s slightly past his peak form, but still very good. Xavi and Iniesta are exquisite dribblers and passers whose talents and personalities seem ideally suited to bringing out the best in Messi, Eto’o, and Henry.
As one indicator this Barça team’s quality, here’s their goal difference — average goals scored minus goals allowed — this year compared to that of the nine other clubs that dominate European and world club soccer. (Since 1990, these teams have won 14 of the 19 Champions League tournaments, including 10 of the last 11. One of them will win it again this year, as all four semifinalists are among this group.) I’ve included both regular league and Champions League matches.

If you’ve been tempted by soccer but found it boring, consider watching Barcelona play in the Champions League semifinals this Tuesday and next Wednesday (April 28 and May 6). The matches will be shown on ESPN2 at 2:45pm eastern time. I can’t guarantee it’ll be worth your time; at this stage of major competitions (the Champions League is soccer’s biggest aside from the World Cup), teams often play cautiously. But I’d advise against waiting. The style and flair of this team come along very rarely, and all it takes is a juicy offer from another club or an injury to one of the key players to destroy it.
I should say that I wouldn’t bet on Barcelona winning the Champions League this season. They’re a bit suspect defensively, and in any case in soccer, as in many sports, the most attractive team doesn’t always come out on top. But for at least some fans, the outcome is a secondary consideration when you’re able to see what Pelé once called “the beautiful game” played so beautifully.
How to pay for inequality reduction: follow-up
April 20, 2009One way to make some progress in reducing income inequality is to significantly increase redistributive transfers and public services. I’ve suggested that it will be difficult to fund that solely by heightening taxes on those at the top of the income distribution. Robert Waldmann asks, quite reasonably: Where’s the math?
Here’s an answer. I’ll use numbers for 2006, since that’s the most recent year for which we have good income and tax data from the Congressional Budget Office.
Suppose we need to increase tax revenues’ share of GDP by 5 percentage points. As the following chart shows, that would still leave us near the bottom among the world’s rich countries. But if the money were used well, it would be a notable advance.

GDP in 2006 was approximately $13 trillion; 5% of that is $0.65 trillion ($650 billion). President Obama has pledged to not increase taxes for the bottom 95% of Americans, so let’s presume the added revenue will come from the top 5%. In 2006 this group, 5.9 million households, had an average pretax income of $564,200. Their total pretax income was thus $3.3 trillion. The $0.65 trillion needed in order to boost tax revenues by 5% of GDP amounts to 20% of that $3.3 trillion in income. Thus, the effective tax rate (taxes paid as a share of pretax income) on the incomes of the top 5% of households would need to be increased by 20 percentage points.
The following chart shows the effective federal tax rate on the top 5% of households going back to 1960. The data from Piketty and Saez begin in 1960; the CBO data begin in 1979. I use the federal rate not only because data are available, but also because these taxes — mainly individual and corporate income — are the ones most likely to enhance the progressivity of the tax system (also included are payroll and excise taxes).

Incomes are higher in the top 1%, so what if we focused on that group? In 2006 the average pretax income among those 1.1 million households was $1,743,700. Their total income was thus $1.9 trillion. The effective federal tax rate on this group would have to be raised by 34 percentage points in order to increase tax revenues by $0.65 trillion, or 5% of GDP. Here’s what that would look like in historical context.

Whether desirable or not, increases of this magnitude strike me as unlikely. It’s worth thinking about additional potential sources of revenue.
Let me emphasize that my aim isn’t to discourage increases in taxation of the richest. I favor doing that. Rather, it’s to encourage the American left to think beyond heightened tax progressivity when considering strategies for inequality reduction.
Note: I’ve corrected an error in the earlier version of this post.
Reducing inequality: how to pay for it
April 17, 2009The Labour Party returned to power in the U.K. in 1997 based in part on a pledge by Tony Blair and Gordon Brown not to raise taxes’ share of the British economy. In his 2008 presidential campaign, Barack Obama promised to reduce taxes for the bottom 95% of Americans. In both instances this commitment succeeded in insulating the progressive candidate from what had become the right’s most powerful electoral club: stoking fear of tax increases by the left.
But while it may be smart electoral politics, committing not to increase taxes’ share of GDP, as Blair did, or to lower taxes for most of the population, as Obama has done, makes it difficult for a government to make much headway in addressing income inequality. Obama has some leeway; the economic crisis has necessitated increases in government spending that can justifiably excuse some backtracking on his campaign pledge. Fully consistent with his promise, he should increase the tax rate on high-end incomes (beyond simply letting the Bush reductions expire). Two other progressive tax reforms are worth pursuing, though they would affect some in the bottom 95%. One is to reduce or end the homeownership subsidy. More than 80% of the $160 billion in foregone revenues from the deduction for mortgage interest and property tax payments goes to households in the top income quintile. The other is to introduce a modest tax on financial transactions.
But should the focus be confined to steps that make the tax system more progressive? Many on the left view heightened progressivity as the key to inequality reduction. Yet in the United States and other rich countries the tax system overall, including taxes of all types and at all levels of government, is essentially flat; households throughout the income distribution pay roughly similar shares of their market income in taxes. As the following chart shows, inequality reduction is achieved not through taxation but with government transfers (and services).

Taxes help to reduce inequality mainly via their quantity rather than their progressivity. The greater the tax revenues, the more government is able to boost incomes and living standards of those in the lower half of the distribution with transfers and services.

Moderate or high levels of tax revenue can’t come solely from higher rates or new taxes on the rich; the math simply doesn’t work. To significantly increase spending on transfers and/or services, President Obama and/or his successors will need to increase taxes on the middle class. One way to do this would be via a federal consumption tax, such as a value-added tax (VAT). We have state and local consumption (sales) taxes, but we raise less money from consumption taxes than any other rich country. Consumption taxes are regressive, and for that reason they’re often dismissed by the American left. But they can be tweaked to limit the degree of regressivity. And if the money is put to progressive use, the benefits may outweigh this drawback.
Reducing inequality: what to do about the top 1%
April 17, 2009In my view, raising and indexing the minimum wage, enhancing the Earned Income Tax Credit, and expanding and improving public services ought to be our top priorities for boosting the incomes and living standards of Americans in the lower half of the income distribution. What about the other component of rising inequality: soaring incomes of those in the top 1%?
It’s tempting to want to intervene directly in markets to reverse this trend. One way to do so is to legislate some sort of pay cap — a maximum wage, if you will. I don’t think this is the right way to go. If the value-added by particular individuals — a CEO, financial innovator, top athlete, movie star, or what have you — is sufficient to merit pay above the cap, firms will figure out ways to get around it, for instance by providing non-monetary perks or deferring pay.
Stricter regulation of the financial sector is another possibility. This is a good idea, though mainly to prevent a repeat of the current economic downturn. If doing so has the indirect effect of reducing enormous payouts to financial players, so much the better.
The simplest and best strategy is to let markets largely determine high-end earnings and incomes and use the tax system to redistribute (more here and here). We should increase the top income tax rate and/or add one or more new rates for those with very high incomes.
This would help to reduce income inequality. And it follows logically from the rationale for progressive taxation: the higher your income, the larger the share of it you can afford to pay in taxes. Since high-end pretax incomes have risen sharply in recent decades, those at the top can afford to pay a greater share of those incomes in taxes than they did in the past. So far they haven’t had to do so, as the following data on the top 0.01% of households (about 10,000 households) indicate. This group’s average inflation-adjusted pretax income soared from $7 million in 1979 to $35 million in 2005, but the share of that income they paid in taxes didn’t increase.

What’s the proper effective tax rate on top incomes? It’s the rate that is consistent with fairness norms and produces the most tax revenue without (significantly) reducing work, investment, and innovation. I don’t know what that rate is. Maybe it’s 40%. Perhaps it’s 50% or 60%. It could conceivably be even higher. Figuring this out requires policy adjustment and monitoring.

