Links

Why Give Corporations a Tax Break - Laura Tyson - Project Syndicate
Corporate Profitability - Economist's View
Fed Watch: The Recovery is Real - Tim Duy - Economist's View
China's Hidden Debt Risk - Zhang Monan - Project Syndicate
One Investment That Can Reduce Our Long-Term Debt - Mark Thoma - The Fiscal Times

Income Inequality and What You Can Do About It.

Income inequality is very much in the news recently and I wanted to explore some reasons for it. In looking at the reasons we will find possible cures.

I. Savings Rates

It’s been observed in the academic literature that those with higher incomes generally have higher savings rates for a variety of reasons. The chart below illustrates this.

Inequality itself reinforces this. Having more people in the lower income percentages decreases the overall savings rate.

http://www.nakedcapitalism.com/2010/03/high-income-disparity-leads-to-low-savings-rates.html

 

II. Taxes

When you add local, state, and federal taxes together, total taxes seem to be progressive until you get to around the 60-80% of high income earners. Then it flattens out and someone in the top 1% on average pays about as much as a percentage of their income in taxes (if not less) as those in the upper 40%.

Source: Institute on Taxation and Economic Policy Tax Model, April 2012

 

III. Risk Aversion

In my professional career I’ve noticed that people who don’t have much if any experience with investing are much less likely to do it at all. They are certainly less willing to take risk whether it’s in regards to investments, human capital, or professionally. More educated individuals are also more likely to be risk takers.[i] Riley and Chow (1992) found risk aversion to be a function of age, education, wealth and income.[ii]

 

What to Do About It.

So you add up savings rates, tax non-progressivity, and risk aversion and we can only expect a high level of inequality. All of these factors are interrelated: income, education, savings rates, taxes, risk aversion. Those with higher education will generally have higher incomes, higher savings rates, and be less risk averse etc.

So what you can do to combat inequality (aside from any political stuff) is pretty simple: (1) increase your savings rate somehow, (2) Try to keep your taxes low by saving in 401(k)s, IRAs, and qualified dividends and capital gains rates, etc, and (3) take some (calculated) risks whether it be in human capital, investments, or professionally.

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[i] Shaw, Kathryn L. An Empirical Analysis of Risk Aversion and Income Growth. Journal of Labor Economics, 1996, vol 14, no. 4

[ii] Chow, K. Victor and Willaim B. Riley Jr. Asset Allocation and Individual Risk Aversion. Financial Analysts Journal. November-December 1992.

A Few Links

The Dirt on Plastic Waste - Marino Xanthos - Project Syndicate
'The Sordid History of Cap-and-Trade' - Schmalensee & Stavins - Economist's View
Our Public Lands (Part 3.1) - Sportsmen in Virginia - Tom Sadler - Dispatches From the Middle River - about how outdoor recreation is an economic powerhouse.

Mark Zandi's "5 Reasons for Optimism"

Had the pleasure of hearing Mark Zandi, Chief Economist of Moody's Analytics, at The National Economists Club. He outlines 5 reasons why he is optimistic about the US economy.

1) The De-leveraging process if over. Corporate balance sheets are very strong and corporations are starting to re-lever. Banking core capital ratios also a strong 9.2% Households have also de-levered and delinquency rates are at the lowest in decades.

2) Housing. Mark thinks housing will take off in 2013 and housing starts will jump from 850k to 1.75MM over the next few years. He mentioned that supply side constrains may impede this.

3) US Businesses competitive. Productivity is up and unit labor costs are down.

4) Fiscal Progress. Sees the Debt/GDP ratio stabilizing.

5) Threats are less threatening. Mentioned threats were Iran and oil prices and interest rates rising faster than expected. He was concerned about income and wealth distribution.

Enterprise, Energy, and Climate: A Conservative's Approach

I had the pleasure of meeting and hearing Bob Inglis, former SC Rep and Executive Director of the Energy & Enterprise Initiative the other day at a lecture he gave. He presented his 3 point plan, which by the way, made him popularly called the Al Gore of the Republican Party. An outline of the plan:

1. Change what we tax from current income to emissions. We want more income and less emissions...so why are we taxing income and not emissions.
2. Eliminate all subsidies for all fuels.
3. Attach all costs to all fuels. (Account for all externalities).

Most conservatives these days seem to be against any sort of carbon tax. So how does this fit into a conservative ideology?

Accountability: The energy sector is one in which profits are privatized but the costs are socialized. You might not view climate change as being real, however the health cost associated with pollution from the creation of energy are quantifiable. In economics this is called a negative externality (there are positive ones as well). And in order for resources and capital to be allocated most efficiently, all costs of production need to be included in the price consumers pay. So the typical way of dealing with this is levying a tax equal to the cost society at large is paying. Inglis says this should be a rattling issues amongst social issue conservatives.

Liberty. Changing to a consumption tax allows energy producers to choose their own tax rate which is a value near and dear to conservatives in favor of the flat sales tax approach.

Budget Neutral: This one for fiscal conservatives. A carbon tax would be coupled with a decrease in one of the income taxes. Inglis' choice is the payroll tax due to the progressivity problem of lowering income tax rates but he said he'd be for a deal either way. The problem with this is that conservatives will view it as simply another revenue stream for the government which will increase all taxes over time. Grover Norquist suggested he eliminate a tax entirely to get around this problem.

National Defense conservatives should be happy with it as lowering our dependence on foreign oil would make us safer. The military cost of protecting our supply lines of oil would also be included in those externalities mentioned above.

The tax would be increase every year up to a threshold to give a steady stream of revenue as production substitutes away from carbon intensive production. It would also be border adjustable (the tax would be removed on exports and imposed on imports).

The problem of course is that implicit in this is the acceptance that climate change is real...so conservatives will have to change their minds.

Another problem I see is that free market conservatives have a hard time accepting, or at least reconciling, the concept of the externality (and the need to correct for it) with free enterprise. Some may say this is just more government involvement. In my mind, however, you can't have real free enterprise without correcting for externalities. Not correcting for the externality is essentially a subsidy. In this case correcting for the externality creates a playing field that is fairer for both producer and consumer. Fairer for the producer in that we won't be subsidizing dirty energy. Fairer for the consumer in that as emissions go down, illnesses and premature deaths caused by pollution would decrease and the subsidization of those health care costs would decrease.

But as Inglis suggests, perhaps the greatest argument for placing a price on carbon is reasonable risk avoidance. Liability insurance companies hire actuaries. The actuaries listen to scientists...carefully. In many ways the federal government is just a large insurance company and it should do the same.

Bob Inglis, US Rep (R-SC4 1993-1999, 2005-2011) was voted out by a Tea Party candidate, targeted for his energy bill summarized above and his vote for the TARP program. He said if he had to do it again, he would still have voted for TARP.

Marginal Tax Rates and Unemployment

This is an interesting article by Joshua A. Cuevas from Counterpunch

                “Unemploymentand Marginal Tax Rates”

When the top marginal tax rates are compared to unemployment rates for the same year, one year later, two years later, and three years later, nearly identical results emerge. Not only is there a negative relationship in each case, with low tax rates correlating with high unemployment and vice versa, the magnitude of each relationship is nearly identical. So between 1948 and 2011, there appears to be a clear and consistent relationship between top marginal tax rates and the unemployment rate. And since unemployment rates cannot dictate tax rates, any influence must go in the opposite direction, with tax rates influencing the unemployment rates. Because we are dealing with correlations, there is a possibility that a third variable or more variables are also at play, particularly in a dynamic as complex as the U.S. economy. Indeed, it is almost a certainty that other factors are involved. But the unmistakable and highly uniform pattern revealed in the analyses reported here would lead us to believe that the relationship between top marginal tax rates and unemployment is in fact present, even if other factors are also involved.

What we can say with absolute confidence, though, is that there is no evidence here that low tax rates are associated with low unemployment, and by extension, a healthy economy. Similarly, there is no evidence that high tax rates are associated with high unemployment, and by proxy a weak economy. There is simply no empirical basis to make those claims based on this historical data. In fact, everything we see here suggests that just the opposite is true. Low marginal tax rates do not appear to be beneficial to employment rates, and if they are in fact detrimental to employment rates one would be hard pressed to make the case that they are helpful to the economy. In the most basic terms, a healthy economy is one in which the vast majority of citizens who want to work can find that work.

If one were to accept the common contention these days that we must wait until we again have a strong economy before we are able to collect the tax revenues needed to adequately fund public sector services, the data simply does not support that claim. These numbers tell a far different story. They instead suggest that while tax rates remain at historical lows we will continue to have a weak economy and high unemployment. There is no data to suggest that by keeping top marginal tax rates low it will improve the economy or decrease unemployment. For those who insist on low taxes at all costs, it would be worthwhile for them to look at the numbers and realize that pursuing low marginal tax rates, and gutting education and other social services in the process, is not the answer to a weak economy. It may be one of the causes of it, and certainly appears to be a prime factor in the equation. If we continue on the trajectory that we as a country have been on for more than 30 years of demanding lower and lower tax rates in the hopes that it will keep money in our pockets and food on the table, the data tells us we are more likely to have empty pockets and less on the table.

 

So let’s think about the intuition behind this. How could higher tax rates theoretically encourage employment? If tax rates are higher, the opportunity cost of hiring someone is smaller, and therefore, a higher top marginal tax rate may encourage hiring, not discourage it as popularly thought.

Let’s say a business person is deciding whether or not to hire someone or just do the work themselves. Hypothetically we will assume this business owner makes $300,000 per year. Let’s assume their tax rate is 25%.

If they pay someone $40,000/year the opportunity cost is salary - salary*tax rates = $30,000. This is what the employer would have netted after taxes had he not hired someone.

Now let’s assume tax rates are 40%. The opportunity cost then would be salary – salary*tax rates = $24,000, which is much lower than $30,000.

This is basically the same intuition behind IRA contributions rising when tax rates rise as well.

Two Good Posts

One from Economist's View:
'The Outlook Has Already Improved'

And another from Paul Krugman's NY Times blog:
"Against Willful Denseness, The Gods Themselves Content In Vain"