Mankiw defends the 1 percent

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Mankiw defends the 1 percent

Jurriaan Bendien
Gregory Mankiw explicitly makes the case for the very wealthy 1 percent in a forthcoming essay:
http://gregmankiw.blogspot.nl/2013/06/defending-one-percent.html (he seems to have a mirror site in NL from gregmankiw.blogspot.com/ 

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Re: Mankiw defends the 1 percent

Eugene Coyle
Clicking on the link Mankiw provides brings up a black screen for me.  Is there something I can do to see the essay?


On Jun 16, 2013, at 8:10 AM, "Jurriaan Bendien" <[hidden email]> wrote:

> Gregory Mankiw explicitly makes the case for the very wealthy 1 percent in a forthcoming essay:
> http://gregmankiw.blogspot.nl/2013/06/defending-one-percent.html (he seems to have a mirror site in NL from gregmankiw.blogspot.com/
> _______________________________________________
> pen-l mailing list
> [hidden email]
> https://lists.csuchico.edu/mailman/listinfo/pen-l

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Re: Mankiw defends the 1 percent

Carrol Cox
I get a huge list of cites but no text except a brief Who am I paragraph.

Carrol

> -----Original Message-----
> From: [hidden email] [mailto:pen-l-
> [hidden email]] On Behalf Of Coyle Eugene
> Sent: Sunday, June 16, 2013 10:20 AM
> To: Progressive Economics
> Subject: Re: [Pen-l] Mankiw defends the 1 percent
>
> Clicking on the link Mankiw provides brings up a black screen for me.  Is
there
> something I can do to see the essay?
>
>
> On Jun 16, 2013, at 8:10 AM, "Jurriaan Bendien"
> <[hidden email]> wrote:
>
> > Gregory Mankiw explicitly makes the case for the very wealthy 1 percent
in

> a forthcoming essay:
> > http://gregmankiw.blogspot.nl/2013/06/defending-one-percent.html (he
> seems to have a mirror site in NL from gregmankiw.blogspot.com/
> > _______________________________________________
> > pen-l mailing list
> > [hidden email]
> > https://lists.csuchico.edu/mailman/listinfo/pen-l
>
> _______________________________________________
> pen-l mailing list
> [hidden email]
> https://lists.csuchico.edu/mailman/listinfo/pen-l


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Re: Mankiw defends the 1 percent

Jim Devine
Defending the One Percent

N. Gregory Mankiw
June 7, 2013

Forthcoming, Journal of Economic Perspectives

N. Gregory Mankiw is the Robert M. Beren Professor of Economics,
Harvard University,
Cambridge, Massachusetts. His e-mail address is [hidden email].
I am grateful to David Autor, Nathaniel Hilger, Chang-Tai Hseih,
Steven Kaplan, Ulrike
Malmendier, Deborah Mankiw, Nicholas Mankiw, Lisa Mogilanski,
Alexander Sareyan,
Lawrence Summers, Timothy Taylor, Jane Tufts, and Matthew Weinzierl
for helpful comments
and discussion.


Imagine a society with perfect economic equality. Perhaps out of sheer
coincidence, the
supply and demand for different types of labor happen to produce an
equilibrium in which
everyone earns exactly the same income. As a result, no one worries
about the gap between the
rich and poor, and no one debates to what extent public policy should
make income
redistribution a priority. Because people earn the value of their
marginal product, everyone is
fully incentivized to provide the efficient amount of effort. The
government is still needed to
provide public goods, such as national defense, but those are financed
with a lump-sum tax.
There is no need for taxes that would distort incentives, such as an
income tax, because they
would be strictly worse for everyone. The society enjoys not only
perfect equality but also
perfect efficiency.

Then, one day, this egalitarian utopia is disturbed by an entrepreneur
with an idea for a
new product. Think of the entrepreneur as Steve Jobs as he develops
the iPod, J.K. Rowling as
she writes her Harry Potter books, or Steven Spielberg as he directs
his blockbuster movies.
When the entrepreneur’s product is introduced, everyone in society
wants to buy it. They each
part with, say, $100. The transaction is a voluntary exchange, so it
must make both the buyer
and the seller better off. But because there are many buyers and only
one seller, the distribution
of economic well-being is now vastly unequal. The new product makes
the entrepreneur much
richer than everyone else.

The society now faces a new set of questions: How should the entrepreneurial
disturbance in this formerly egalitarian outcome alter public policy?
Should public policy remain
the same, because the situation was initially acceptable and the
entrepreneur improved it for
everyone? Or should government policymakers deplore the resulting
inequality and use their
powers to tax and transfer to spread the gains more equally?


In my view, this thought experiment captures, in an extreme and
stylized way, what has
happened to US society over the past several decades. Since the 1970s,
average incomes have
grown, but the growth has not been uniform across the income
distribution. The incomes at the
top, especially in the top 1 percent, have grown much faster than
average. These high earners
have made significant economic contributions, but they have also
reaped large gains. The
question for public policy is what, if anything, to do about it.

This development is one of the largest challenges facing the body
politic. A few numbers
illustrate the magnitude of the issue. The best data we have on the
upper tail of the income
distribution come from Piketty and Saez’s (2003, with updates)
tabulations of individual tax
returns. (Even these numbers, though, are subject to some controversy:
the tax code changes
over time, altering the incentives to receive and report compensation
in alternative forms.)
According to their numbers, the share of income, excluding capital
gains, earned by the top 1
percent rose from 7.7 percent in 1973 to 17.4 percent in 2010. Even
more striking is the share
earned by the top 0.01 percent—an elite group that, in 2010, had a
membership requirement of
annual income exceeding $5.9 million. This group’s share of total
income rose from 0.5 percent
in 1973 to 3.3 percent in 2010. These numbers are not easily ignored.
Indeed, they in no small
part motivated the Occupy movement, and they have led to calls from
policymakers on the left to
make the tax code more progressive.

At the outset, it is worth noting that addressing the issue of rising
inequality necessarily
involves not just economics but also a healthy dose of political
philosophy. We economists
must recognize not only the limits of what we know about inequality’s
causes, but also the limits
on the ability of our discipline to prescribe policy responses.
Economists who discuss policy
responses to increasing inequality are often playing the role of
amateur political philosopher (and,  admittedly, I will do so in this
essay). Given the topic, that is perhaps inevitable. But it is
useful to keep when we are writing as economists and when we are
venturing beyond the
boundaries of our professional expertise.

Is Inequality Inefficient?

It is tempting for economists who abhor inequality to suggest that the
issue involves not
just inequality per se, but also economic inefficiency. Discussion of
inequality necessarily
involves our social and political values, but if inequality also
entails inefficiency, those
normative judgments are more easily agreed upon. The Pareto criterion
is the clearest case: If
we can make some people better off without making anyone worse off,
who could possibly
object? Yet for the question at hand, this criterion does not take us
very far. As far as I know,
no one has proposed any credible policy intervention to deal with
rising inequality that will make
everyone, including those at the very top, better off.

More common is the claim that inequality is inefficient in the sense
of shrinking the size
of the economic pie. (That is, inefficiency is being viewed through
the lens of the Kaldor-Hicks
criterion.) If the top 1 percent is earning an extra $1 in some way
that reduces the incomes of the
middle class and the poor by $2, then many people will see that as a
social problem worth
addressing. For example, suppose the rising income share of the top 1
percent were largely
attributable to successful rent-seeking. Imagine that the government
were to favor its political
allies by granting them monopoly power over certain products,
favorable regulations, or
restrictions on trade. Such a policy would likely lead to both
inequality and inefficiency.
Economists of all stripes would deplore it. I certainly would.

Joseph Stiglitz’s (2012) book, The Price of Inequality, spends many
pages trying to
convince the reader that such rent-seeking is a primary driving force
behind the growing incomes
of the rich. This essay is not the place for a book review, but I can
report that I was not
convinced. Stiglitz’s narrative relies more on exhortation and
anecdote than on systematic
evidence. There is no good reason to believe that rent-seeking by the
rich is more pervasive
today than it was in the 1970s, when the income share of the top 1
percent was much lower than
it is today.

I am more persuaded by the thesis advanced by Claudia Goldin and
Lawrence Katz (2008)
in their book The Race between Education and Technology. Goldin and
Katz argue that skill-
biased technological change continually increases the demand for
skilled labor. By itself, this
force tends to increase the earnings gap between skilled and unskilled
workers, thereby
increasing inequality. Society can offset the effect of this demand
shift by increasing the supply
of skilled labor at an even faster pace, as it did in the 1950s and
1960s. In this case, the earnings
gap need not rise and, indeed, can even decline, as in fact occurred.
But when the pace of
educational advance slows down, as it did in the 1970s, the increasing
demand for skilled labor
will naturally cause inequality to rise. The story of rising
inequality, therefore, is not primarily
about politics and rent-seeking but rather about supply and demand.

To be sure, Goldin and Katz focus their work on the broad changes in
inequality, not on
the incomes of the top 1 percent in particular. But it is natural to
suspect that similar forces are
at work. The income share of the top 1 percent exhibits a U-shaped
pattern: falling from the
1950s to the 1970s, and rising from the 1970s to the present. The
earnings differentials between
skilled and unskilled workers studied by Goldin and Katz follow a
similar U-shaped pattern. If
Goldin and Katz are right that the broad changes in inequality have
driven by the interaction
between technology and education, rather than changes in rent-seeking
through the political
process, then it would seem an unlikely coincidence that the parallel
changes at the top have
been driven by something entirely different. Rather, it seems that
changes in technology have
allowed a small number of highly educated and exceptionally talented
individuals to command
superstar incomes in ways that were not possible a generation ago.
Erik Brynjolfsson and
Andrew McAfee (2011) advance this thesis forcefully in their book Race
Against the Machine.
They write (p. 44), “Aided by digital technologies, entrepreneurs,
CEOs, entertainment stars, and
financial executives have been able to leverage their talents across
global markets and capture
reward that would have been unimaginable in earlier times.”

Nonetheless, to the extent that Stiglitz is right that inefficient
rent-seeking is a driving
force behind rising inequality, the appropriate policy response is to
address the root cause. It is
at best incomplete and at worst misleading to describe the situation
as simply “rising inequality,”
because inequality here is a symptom of a deeper problem. A
progressive system of taxes and
transfers might make the outcome more equal, but it would not address
the underlying
inefficiency. For example, if domestic firms are enriching themselves
at the expense of
consumers through quotas on imports (as is the case with some
agribusinesses), the solution to
the problem entails not a revision of the tax code but rather a change
in trade policy. I am
skeptical that such rent-seeking activities are the reason why
inequality has risen in recent
decades, but I would support attempts to reduce whatever rent-seeking
does occur.


An especially important and particularly difficult case is the finance
industry, where
many hefty compensation packages can be found. On the one hand, there
is no doubt that this
sector plays a crucial role. Those who work in commercial banks,
investment banks, hedge funds
and other financial firms are in charge of allocating capital and
risk, as well as providing
liquidity. They decide, in a decentralized and competitive way, which
firms and industries need
to shrink and which will be encouraged to grow. It makes sense that a
nation would allocate
many of its most talented and thus highly compensated individuals to
this activity. On the other
hand, some of what occurs in financial firms does smack of rent
seeking: when a high-frequency
trader figures out a way to respond to news a fraction of a second
faster than his competitor, his
vast personal reward may well exceed the social value of what he is
producing. Devising a legal
and regulatory framework to ensure that we get the right kind and
amount of financial activity is
a difficult task. While the solution may well affect the degree of
equality and the incomes of the
1 percent, the issue is primarily one of efficiency. A
well-functioning economy needs the correct
allocation of talent. The last thing we need is for the next Steve
Jobs to forgo Silicon Valley in
order to join the high-frequency traders on Wall Street. That is, we
shouldn’t be concerned about
the next Steve Jobs striking it rich, but we want to make sure he
strikes it rich in a socially
productive way.

Equality of Opportunity as a Desideratum

Closely related to the claim of inefficiency is concern about
inequality of opportunity.
Equality of opportunity is often viewed as a social goal in itself,
but economists recognize that
the failure to achieve such equality would normally lead to
inefficiency as well. If some
individuals are precluded from pursuing certain paths in life, then
they might be unable to
contribute fully to growing the economic pie. To be specific, if
children from poor families are
unable to continue their education because of financial constraints,
they do not accumulate the
optimal amount of human capital. The outcome from underinvestment in
education is both
unequal and inefficient.

Measuring the degree of equality of opportunity is difficult. In his
book, Stiglitz (2012)
proposes a metric: the intergenerational transmission of income. He
says (p. 18), “If America
were really a land of opportunity, the life chances of success—of,
say, winding up in the top 10
percent—of someone born to a poor or less educated family would be the
same as those of
someone born to a rich, well-educated, and well-connected family.” In
other words, under this
definition of equality of opportunity, people’s earnings would be
uncorrelated with those of their
parents. Needless to say, in the data, that is not at all the case,
which leads Stiglitz to conclude
that we are falling short of providing equal opportunity.

Yet the issue cannot be settled so easily, because the
intergenerational transmission of
income has many causes beyond unequal opportunity. In particular,
parents and children share
genes, a fact that would lead to intergenerational persistence in
income even in a world of equal
opportunities. IQ, for example, has been widely studied, and it has a
large degree of heritability.
Smart parents are more likely to have smart children, and their
greater intelligence will be
reflected, on average, in higher incomes. Of course, IQ is only one
dimension of talent, but it is
easy to believe that other dimensions, such as self-control, ability
to focus, and interpersonal
skills, have a degree of genetic heritability as well.

This is not to say that we live in a world of genetic determinism, for
surely we do not.
But it would be a mistake to go to the other extreme and presume no
genetic transmission of
economic outcomes. A recent survey of the small but growing field of
genoeconomics by
Benjamin et al. (2012) reports, “Twin studies suggest that economic
outcomes and preferences,
once corrected for measurement error, appear to be about as heritable
as many medical
conditions and personality traits.” Similarly, in his study of the
life outcomes of adopted
children, Sacerdote (2007) writes, “While educational attainment and
income are frequently the
focus of economic studies, these are among the outcomes least affected
by differences in family
environment.” (He reports that family background exerts a stronger
influence on social variables,
such as drinking behavior.) This evidence suggests that it is
implausible to interpret generational
persistence in income as simply a failure of society to provide equal
opportunities. Indeed,
Sacerdote estimates (in his Table 5) that while 33 percent of the
variance of family income is
explained by genetic heritability, only 11 percent is explained by the
family environment. The
remaining 56 percent includes environmental factors unrelated to
family. If this 11 percent
figure is approximately correct, it suggests that we are not far from
a plausible definition of
equality of opportunity—that is, being raised by the right family does
give a person a leg up in
life, but family environment accounts for only a small percentage of
the variation in economic
outcomes compared with genetic inheritance and environmental factors
unrelated to family.

To the extent that our society deviates from the ideal of equality of
opportunity, it is
probably best to focus our attention on the left tail of the income
distribution rather than on the
right tail. Poverty entails a variety of socioeconomic maladies, and
it is easy to believe that
children raised in such circumstances do not receive the right
investments in human capital. By
contrast, the educational and career opportunities available to
children of the top 1 percent are, I
believe, not very different from those available to the middle class.
My view here is shaped by
personal experience. I was raised in a middle-class family; neither of
my parents were college
graduates. My own children are being raised by parents with both more
money and more
education. Yet I do not see my children as having significantly better
opportunities than I had at
their age.

In the end, I am led to conclude that concern about income inequality,
and especially
growth in incomes of the top 1 percent, cannot be founded primarily on
concern about
inefficiency and inequality of opportunity. If the growing incomes of
the rich are to be a focus of
public policy, it must be because income inequality is a problem in
and of itself.

The Big Tradeoff

In the title of his celebrated 1975 book, Arthur Okun told us that the
“big tradeoff” that
society faces is between equality and efficiency. We can use the
government’s system and taxes
and transfers to move income from the rich to the poor, but that
system is a “leaky bucket.”
Some of the money is lost as it is moved. This leak should not stop us
from trying to redistribute,
Okun argued, because we value equality. But because we are also
concerned about efficiency,
the leak will stop us before we fully equalize economic resources.

The formal framework that modern economists use to address this issue
is that proposed
by Mirrlees (1971). In the standard Mirrlees model, individuals get
utility from consumption C
and disutility from providing work effort L. They differ only
according to their productivity W.
In the absence of government redistribution, each person’s consumption
would be WL. Those
with higher productivity would have higher consumption, higher
utility, and lower marginal
utility.

The government is then introduced as a benevolent social planner with
the goal of
maximizing total utility in society (or, sometimes, a more general
social welfare function that
could depend nonlinearly on individual utilities). The social planner
wants to move economic
resources from those with high productivity and low marginal utility
to those with lower
productivity and higher marginal utility. Yet this redistribution is
hard to accomplish, because
the government is assumed to be unable to observe productivity W;
instead, it observes only
income WL, the product of productivity and effort. If it redistributes
income too much, high
productivity individuals will start to act as if they are low
productivity individuals. Public
policymakers are thus forced to forgo the first-best egalitarian
outcome for a second-best
incentive-compatible solution. Like a government armed with Okun’s
leaky bucket, the
Mirrleesian social planner redistributes to some degree but also
allows some inequality to remain.

If this framework is adopted, then the debate over redistribution
turns to questions about
key parameters. In particular, optimal redistribution depends on the
degree to which work effort
responds to incentives. If the supply of effort is completely
inelastic, then the bucket has no leak,
and the social planner can reach the egalitarian outcome. If the
elasticity is small, the social
planner can come close. But if work effort responds substantially to
incentives, then the bucket
is more like a sieve, and the social planner should attempt little or
no redistribution. Thus, much
debate among economists about optimal redistribution centers on the
elasticity of labor supply.


Even if one is willing to accept the utilitarian premise of this
framework, there is good
reason to be suspect of particular numerical results that follow from
it. When researchers
implement the Mirrlees model, they typically assume, as Mirrlees did,
that all individuals have
the same preferences. People are assumed to differ only in their
productivity. For purposes of
illustrative theory, that assumption is fine, but it is also false.
Incomes differ in part because
people have different tastes regarding consumption, leisure, and job
attributes. Acknowledging
variation in preferences weakens the case for redistribution (Lockwood
and Weinzierl 2012).
For example, many economics professors could have pursued
higher-income career paths as
business economists, software engineers, or corporate lawyers. That
they chose to take some of
their compensation in the form of personal and intellectual freedom
rather than cold cash is a
personal lifestyle choice, not a reflection of innate productivity.
Those who made the opposite
choice may have done so because they get greater utility from income.
A utilitarian social
planner will want to allocate greater income to these individuals,
even apart from any incentive
effects.

Another problem with the Mirrlees framework as typically implemented
is that it takes a
simplistic approach to tax incidence. Any good introductory student of
economics knows that
when a good or service is taxed, the buyer and seller share the
burden. Yet in the Mirrlees
framework, when an individual’s labor income is taxed, only the seller
of the services is worse
off. In essence, the demand for labor services is assumed to be
infinitely elastic. A more general
set of assumptions would acknowledge that the burden of the tax is
spread more broadly to
buyers of those services (and perhaps to sellers of complementary
inputs as well). In this more
realistic setting, tax policy would be a less well-targeted tool for
redistributing economic wellbeing.

The harder and perhaps deeper question is whether the government’s
policy toward
redistribution is best viewed as being based on a benevolent social
planner with utilitarian
preferences. That is, did Okun and Mirrlees provide economists with
the right starting point for
thinking about this issue? I believe there are good reasons to doubt
this model from the get-go.

The Uneasy Case for Utilitarianism

For economists, the utilitarian approach to income distribution comes
naturally. After all,
utilitarians and economists share an intellectual tradition: early
utilitarians, such as John Stuart
Mill, were also among the early economists. Also, utilitarianism seems
to extend the
economist’s model of individual decision-making to the societal level.
Indeed, once one adopts
the political philosophy of utilitarianism, running a society becomes
yet another problem of
constrained optimization. Despite its natural appeal (to economists,
at least), the utilitarian
approach is fraught with problems.

One classic problem is the interpersonal comparability of utility. We
can infer an
individual’s utility function from the choices that individual makes
when facing varying prices
and levels of income. But from this revealed-preference perspective,
utility is not inherently
measurable, and it is impossible to compare utilities across people.
Perhaps advances in
neuroscience will someday lead to an objective measure of happiness,
but as of now, there is no
scientific way to establish whether the marginal dollar consumed by
one person produces more
or less utility than the marginal dollar consumed by a neighbor.


Another more concrete problem is the geographic scope of the analysis. Usually,
analyses of optimal income redistribution are conducted at the
national level. But there is
nothing inherent in utilitarianism that suggests such a limitation.
Some of the largest income
disparities are observed between nations. If a national system of
taxes and transfers is designed
to move resources from Palm Beach, Florida, to Detroit, Michigan,
shouldn’t a similar
international system move resources from the United States and Western
Europe to sub-Saharan
Africa? Many economists do support increased foreign aid, but as far
as I know, no one has
proposed marginal tax rates on rich nations as high as the marginal
tax rates imposed on rich
individuals. Our reluctance to apply utilitarianism at the global
level should give us pause when
applying it at the national level.

In a 2010 paper, Matthew Weinzierl and I emphasized another reason to
be wary of
utilitarianism: it recommends a greater use of “tags” than most people
feel comfortable with. As
Akerlof (1978) pointed out, if the social planner can observe
individual characteristics that are
correlated with productivity, then an optimal tax system should use
that information, in addition
to income, in determining an individual’s tax liability. The more the
tax system is based on such
fixed characteristics rather than income, the less it will distort
incentives. Weinzierl and I showed
that one such tag is height. Indeed, the correlation between height
and wages is sufficiently
strong that the optimal tax on height is quite large. Similarly,
according to the utilitarian calculus,
the tax system should also make a person’s tax liability a function of
race, gender, and perhaps
many other exogenous characteristics. Of course, few people would
embrace the idea of a height
tax, and Weinzierl and I did not offer it as a serious policy
proposal. Even fewer people would
be comfortable with a race-based income tax (although Alesina et al.,
2011, propose in earnest a
gender-based tax). Yet these implications cannot just be ignored. If
you take from a theory only
the conclusions you like and discard the rest, you are using the
theory as a drunkard uses a lamp
post—for support rather than illumination. If utilitarianism takes
policy in directions that most
people don’t like, then perhaps it is not a sound foundation for
thinking about redistribution and
public policy.

Finally, in thinking about whether the utilitarian model really
captures our moral
intuitions, it is worth thinking for a moment about the first-best
outcome for a utilitarian social
planner. Suppose, in contrast to the Mirrlees model, the social
planner could directly observe
productivity. In this case, the planner would not need to worry about
incentives, but could set
taxes and transfers based directly on productivity. The optimal policy
would equalize the
marginal utility of consumption across individuals; if the utility
function is assumed to be
additively separable in consumption and leisure, this means everyone
consumes the same amount.
But because some people are more productive than others, equalizing
leisure would not be
optimal. Instead, the social planner would require more productive
individuals to work more.
Thus, in the utilitarian first-best allocation, the more productive
members of society would work
more and consume the same as everyone else. In other words, in the
allocation that maximizes
society’s total utility, the less productive individuals would enjoy a
higher utility than the more
productive.

Is this really the outcome we would want society to achieve if it
could? A true utilitarian
would follow the logic of the model and say “yes.” Yet this outcome
does not strike me as the
ideal toward which we should aspire, and I suspect most people would
agree. Even young
children have an innate sense that merit should be rewarded
(Kanngiesser and Warneken
2012)—and I doubt it is only because they are worried about the
incentive effects of not doing so.
If I am right, then we need a model of optimal government taxes and
transfers that departs
significantly from conventional utilitarian social planning.

Listening to the Left

In recent years, the left side of the political spectrum has focused
much attention on the
rising incomes of the top 1 percent. This includes President Obama’s
proposals to raises taxes on
higher incomes, the Occupy Wall Street movement, and a rash of books
about economic
inequality. Even though I don’t share the left’s policy conclusions, I
find it is worthwhile to
listen carefully to their arguments to discern what set of
philosophical principles and empirical
claims underlie their concerns.

It is, I believe, hard to square the rhetoric of the left with the
economist’s standard
framework. Someone favoring greater redistribution along the lines of
Okun and Mirrlees would
argue as follows. “The rich earn higher incomes because they
contribute more to society than
others do. However, because of diminishing marginal utility, they
don’t get much value from
their last few dollars of consumption. So we should take some of their
income away and give it
to less productive members of society. While this policy would cause
the most productive
members to work less, shrinking the size of the economic pie, that is
a cost we should bear, to
some degree, to increase utility for society’s less productive citizens.”


Surely, that phrasing of the argument would not animate the Occupy
crowd! So let’s
consider the case that the left makes in favor of greater income
redistribution. There are three
broad classes of arguments.

The first is the suggestion that the tax system we now have is
regressive. Most famously,
during the presidential campaign of 2008, at a fund-raiser for Hillary
Clinton, the billionaire
investor Warren E. Buffett said that the rich were not paying enough.
Mr. Buffett used himself as
an example. He asserted that his taxes in the previous year equaled
only 17.7 percent of his
taxable income, while his receptionist paid about 30 percent of her
income in taxes (Tse 2007).
In 2011, President Obama proposed the “Buffett rule,” which would
require taxpayers with
income over a million dollars to pay at least 30 percent of their
income in federal income taxes.

There are, however, good reasons to be skeptical of Buffett’s
calculations. If his
receptionist was truly a middle-income taxpayer, then to get her tax
rate to 30 percent, he most
likely added the payroll tax to the income tax. Fair enough. But for
Buffett’s tax rate to be only
17.7 percent, most of his income was likely dividends and capital
gains, and his calculation had
to ignore the fact that this capital income was already taxed at the
corporate level. A complete
accounting requires aggregating not only all taxes on labor income but
also all taxes on capital
income.

The Congressional Budget Office (2012) does precisely that when it
calculates the
distribution of the federal tax burden—and it paints a very different
picture than did Buffett’s
anecdote. In 2009, the most recent year available, the poorest fifth
of the population, with
average annual income of $23,500, paid only 1.0 percent of its income
in federal taxes. The
middle fifth, with income of $64,300, paid 11.1 percent. And the top
fifth, with income of
$223,500, paid 23.2 percent. The richest 1 percent, with an average
income of $1,219,700, paid
28.9 percent of its income to the federal government. To be sure, some
taxpayers aggressively
plan to minimize taxes, and this may result in some individual cases
where those with high
incomes pay relatively little in federal taxes. But the CBO data make
clear that these cases are
the exceptions. As a general rule, the existing federal tax code is
highly progressive.

A second type of argument from the left is that the incomes of the
rich do not reflect their
contributions to society. In the standard competitive labor market, a
person’s earnings equal the
value of his or her marginal productivity. But there are various
reasons that real life might
deviate from this classical benchmark. If, for example, a person’s
high income results from
political rent-seeking rather than producing a valuable product, the
outcome is likely to be both
inefficient and widely viewed as inequitable. Steve Jobs getting rich
from producing the iPod
and Pixar movies does not produce much ire among the public. A Wall
Street executive
benefiting from a taxpayer-financed bailout does.

The key issue is the extent to which the high incomes of the top 1
percent reflect high
productivity rather than some market imperfection. This question is
one of positive economics,
but unfortunately not one that is easily answered. My own reading of
the evidence is that most of
the very wealthy get that way by making substantial economic
contributions, not by gaming the
system or taking advantage of some market failure or the political
process. Take the example of
pay for chief executive officers. Without doubt, CEOs are paid
handsomely, and their pay has
grown over time relative to that of the average worker. Commentators
on this phenomenon
sometimes suggest that this high pay reflects the failure of corporate
boards of directors to do
their job. Rather than representing shareholders, the argument goes,
boards are too cozy with the
CEOs and pay them more than they are worth to their organizations. Yet
this argument fails to
explain the behavior of closely-held corporations. A private equity
group with a controlling
interest in a firm does not face the alleged principal-agent problem
between shareholders and
boards, and yet these closely-held firms also pay their CEOs
handsomely. Indeed, Kaplan (2012)
reports that over the past three decades, executive pay in
closely-held firms has outpaced that in
public companies. Conqvist and Fahlenbrach (2012) find that when
public companies go private,
the CEOs tend to get paid more rather than less in both base salaries
and bonuses. In light of
these facts, the most natural explanation of high CEO pay is that the
value of a good CEO is
extraordinarily high (a conclusion that, incidentally, is consistent
with the model of CEO pay
proposed by Gabaix and Landier, 2008).

A third argument that the left uses to advocate greater taxation of
those with higher
incomes is that the rich benefit from the physical, legal, and social
infrastructure that government
provides and, therefore, should contribute to supporting it. As one
prominent example, President
Obama (2012) said in a speech, “If you were successful, somebody along
the line gave you some
help. There was a great teacher somewhere in your life. Somebody
helped to create this
unbelievable American system that we have that allowed you to thrive.
Somebody invested in
roads and bridges. If you’ve got a business -- you didn’t build that.
Somebody else made that
happen. The Internet didn’t get invented on its own. Government
research created the Internet so
that all the companies could make money off the Internet. The point is
that when we succeed,
we succeed because of our individual initiative, but also because we
do things together.”

In the language of traditional public finance, President Obama was
relying less on the
ability-to-pay principle and more on the benefits principle. That is,
higher taxation of the rich is
not being justified by the argument that their marginal utility of
consumption is low, as it is in
the frameworks of Okun and Mirrlees. Rather, higher taxation is being
justified by the claim that
the rich achieved their wealth in large measure because of the goods
and services the government
provides and therefore have a responsibility to finance those goods
and services.

This line of argument raises the empirical question of how large the benefit of
government infrastructure is. The average value is surely very high,
as lawless anarchy would
leave the rich (as well as most everyone else) much worse off. But
like other inputs into the
production process, government infrastructure should be valued at the
margin, where the
valuation harder to discern. As I pointed out earlier, the average
person in the top 1 percent pays
more than a quarter of income in federal taxes, and about a third if
state and local taxes are
included. Why isn’t that enough to compensate for the value of
government infrastructure?

A relevant fact here is that, over time, an increasing share of
government spending has
been for transfer payments, rather than for purchases of goods and
services. Government has
grown as a percentage of the economy not because it is providing more
and better roads, more
and better legal institutions, and more and better educational
systems. Rather, government has
increasingly used its power to tax to take from Peter to pay Paul.
Discussions of the benefits of
government services should not distract from this fundamental truth.

In the end, the left’s arguments for increased redistribution are
valid in principle but
dubious in practice. If the current tax system were regressive, or if
the incomes of the top 1
percent were much greater than their economic contributions, or if the
rich enjoyed government
services in excess of what they pay in taxes, then the case for
increasing the top tax rate would
indeed be strong. But there is no compelling reason to believe that
any of these premises holds
true.

The Need for an Alternative Philosophical Framework

A common thought experiment used to motivate income redistribution is
to imagine a
situation in which individuals are in an “original position” behind a
“veil of ignorance” (as in
Rawls, 1971). This original position occurs in a hypothetical time
before we are born, without
the knowledge of whether we will be lucky or unlucky, talented or less
talented, rich or poor. A
risk-averse person in such a position would want to buy insurance
against the possibility of being
born into a less fortunate station in life. In this view, governmental
income redistribution is an
enforcement of the social insurance contract to which people would
have voluntarily agreed in
this original position.

Yet take this logic a bit further. In this original position, people
would be concerned
about more than being born rich and poor. They would also be concerned
about health outcomes.
Consider kidneys, for example. Most people walk around with two
healthy kidneys, one of
which they do not need. A few people get kidney disease that leaves
them without a functioning
kidney, a condition that often cuts life short. A person in the
original position would surely sign
an insurance contract that guarantees him at least one working kidney.
That is, he would be
willing to risk being a kidney donor if he is lucky, in exchange for
the assurance of being a
transplant recipient if he is unlucky. Thus, the same logic of social
insurance that justifies
income redistribution similarly justifies government-mandated kidney donation.

No doubt, if such a policy were ever seriously considered, most people
would oppose it.
A person has a right to his own organs, they would argue, and a
thought experiment about an
original position behind a veil of ignorance does not vitiate that
right. But if that is the case, and I
believe it is, it undermines the thought experiment more generally. If
imagining a hypothetical
social insurance contract signed in an original position does not
supersede the right of a person to
his own organs, why should it supersede the right of a person to the
fruits of his own labor?

An alternative to the social insurance view of the income distribution
is what, in Mankiw
(2010), I called a “just deserts” perspective. According to this view,
people should receive
compensation congruent with their contributions. If the economy were
described by a classical
competitive equilibrium without any externalities or public goods,
then every individual would
earn the value of his or her own marginal product, and there would be
no need for government to
alter the resulting income distribution. The role of government arises
as the economy departs
from this classical benchmark. Pigovian taxes and subsidies are
necessary to correct externalities,
and progressive income taxes can be justified to finance public goods
based on the benefits
principle. Transfer payments to the poor have a role as well, because
fighting poverty can be
viewed as a public good (Thurow 1971).

This alternative perspective on the income distribution is a radical
departure from the
utilitarian perspective that has long influenced economists, including
Okun and Mirrlees. But it
is not entirely new. It harkens back about a century to the tradition
of “just taxation” suggested
by Knut Wicksell (1896, translated 1958) and Erik Lindahl (1919,
translated 1958). More
important, I believe it is more consistent with our innate moral
intuitions. Indeed, many of the
arguments of the left discussed earlier are easier to reconcile with
the just-deserts theory than
they are with utilitarianism. My disagreement with the left lies not
in the nature of their
arguments, but rather in the factual basis of their conclusions.

The political philosophy one adopts naturally influences the kind of
economic questions
that are relevant for determining optimal policy. The utilitarian
perspective leads to questions
such as: How rapidly does marginal utility of consumption decline?
What is the distribution of
productivity? How much do taxes influence work effort? The
just-deserts perspective focuses
instead on other questions: Do the high incomes of the top 1 percent
reflect extraordinary
productivity, or some type of market failure? How are the benefits of
public goods distributed
across the income distribution? I have my own conjectures about the
answers to these latter
questions, and I have suggested them throughout this essay, but I am
the first to admit that they
are tentative. Fortunately, these are positive questions to which
future economic research may
provide more definitive answers.

To highlight the difference between these approaches, consider how
each would address
the issue of the top tax rate. In particular, why shouldn’t we raise
the rate on high incomes to 75
percent, as France’s President Hollande has recently proposed, or to
91 percent, where it was
through much of the 1950s in the United States? A utilitarian social
planner would say that
perhaps we should and would refrain from doing so only if the adverse
incentive effects were too
great. From the just-deserts perspective, such confiscatory tax rates
are wrong, even ignoring any
incentive effects. By this view, using the force of government to
seize such a large share of the
fruits of someone else’s labor is unjust, even if the taking is
sanctioned by a majority of the
citizenry.

In the final analysis, we should not be surprised when opinions about income
redistribution vary. Economists can turn to empirical methods to
estimate key parameters, but no
amount of applied econometrics can bridge this philosophical divide. I
hope my ruminations in
this essay have convinced some readers to see the situation from a new
angle. But at the very
least, I trust that these thoughts offer a vivid reminder that
fundamentally normative conclusions
cannot rest on positive economics alone.

References

Akerlof, George. 1978. "The Economics of ‘Tagging’ as Applied to the
Optimal Income Tax,
Welfare Programs, and Manpower Planning," American Economic Review,
68(1): 8-19.

Alesina, Alberto, Andrea Ichin, and Loukas Karabarbounis,
2011."Gender-Based Taxation and
the Division of Family Chores," American Economic Journal: Economic
Policy, vol. 3(2): 1-40.

Benjamin, Daniel J., David Cesarini, Christopher F. Chabris, Edward L.
Glaeser, David I.
Laibson, Vilmundur Guðnason, Tamara B. Harris, Lenore J. Launer, Shaun
Purcell, Albert
Vernon Smith, Magnus Johannesson, Patrik K.E. Magnusson, Jonathan P.
Beauchamp, Nicholas

A. Christakis, Craig S. Atwood, Benjamin Hebert, Jeremy Freese, Robert
M. Hauser, Taissa S.
Hauser, Alexander Grankvist, Christina M. Hultman, and Paul
Lichtenstein (forthcoming).“The
Promises and Pitfalls of Genoeconomics.” Annual Review of Economics,
September 2012.
Brynjolfsson, Erik, and Andrew McAfee. 2011. Race Against the Machine.
Lexington, MA:
Digital Frontier Press.

Congressional Budget Office, The Distribution of Household Income and
Federal Taxes, 2008
and 2009, online report, 2012.

Conqvist, Henrik, and Rudiger Frahlenbrach. 2012. “CEO Contract
Design: How Do Strong
Principals Do It?” Swiss Finance Institute Research Paper No. 11-14.
Journal of Financial
Economics, forthcoming.

Gabaix, Xavier, and Augustin Landier, "Why Has CEO Pay Increased So
Much?", Quarterly
Journal of Economics, vol. 123(1), 2008: 49-100.

Goldin, Claudia, and Lawrence F. Katz. 2008. The Race between
Education and Technology.
Cambridge, MA: Harvard University Press.

Kanngiesser Patricia, and Felix Warneken. 2012. “Young Children
Consider Merit when Sharing
Resources with Others,” PLoS ONE 7(8): e43979.

Kaplan, Steven N. 2012. “Executive Compensation and Corporate
Governance in the U.S.:
Perceptions, Facts, and Challenges,” NBER Working Paper No. 18395.

Lindahl, Erik. 1958. “Just taxation--a positive solution.” In Richard
Musgrave and Alan Peacock,
editors, Classics in the Theory of Public Finance, Macmillan, London: 98–123.

Lockwood, Benjamin, and Matthew Weinzierl, “De Gustibus non est
Taxandum: Theory and
Evidence on Preference Heterogeneity and Redistribution,” Harvard
Business School Working
Paper, 2012.

Mankiw, N. Gregory, 2010. “Spreading the Wealth Around: Reflections
Inspired by Joe the
Plumber,” Eastern Economic Journal 36, 285–298.

Mankiw, N. Gregory, and Matthew Weinzierl. 2010. "The Optimal Taxation
of Height: A Case
Study of Utilitarian Income Redistribution." American Economic
Journal: Economic Policy, 2(1):
155–76.

Mirrlees, James A. 1971. "An Exploration in the Theory of Optimal
Income Taxation," Review
of Economic Studies 38(2): 175-208.

Obama, Barack. 2012. “Remarks by the President at a Campaign Event in
Roanoke, Virginia.”
July 13. http://www.whitehouse.gov/the-press-office/2012/07/13/remarks-president-campaignevent-
roanoke-virginia

Okun, Arthur, Equality and Efficiency: The Big Tradeoff, The Brookings
Institution, 1975.

Piketty, Thomas, and Emmanuel Saez, "Income Inequality in the United
States, 1913-1998"
Quarterly Journal of Economics, 118(1), 2003, 1-39, updated to 2010 on
Saez’s website.

Rawls, John. 1971. A Theory of Justice. Belknap Press.

Sacerdote, Bruce, “How Large are the Effects from Changes in Family
Environment? A Study
of Korean American Adoptees.” The Quarterly Journal of Economics
(2007) 122 (1): 119-157.

Stiglitz, Joseph. 2012. The Price of Inequality. W.W. Norton and Company.

Thurow, Lester. 1971. “The Income Distribution as a Pure Public Good,”
Quarterly Journal of
Economics 85(2): 327-336.

Tse, Tomoeh Murakami. 2007. “Buffett Slams Tax System Disparities,”
The Washington Post,
June 27.

Lockwood, Benjamin, and Matthew Weinzierl, “De Gustibus non est
Taxandum: Theory and
Evidence on Preference Heterogeneity and Redistribution,” Harvard
Business School Working
Paper, 2012.

Wicksell, Knut. 1958 “A New Principle of Just Taxation.” In Richard
Musgrave and Alan
Peacock, editors, Classics in the Theory of Public Finance, Macmillan,
London: 72-118.

--
Jim Devine /  "Segui il tuo corso, e lascia dir le genti." (Go your
own way and let people talk.) -- Karl, paraphrasing Dante.
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Re: Mankiw defends the 1 percent

Jim Devine
[maybe more readable]

Defending the One Percent

N. Gregory Mankiw  June 7, 2013

Forthcoming, Journal of Economic Perspectives

N. Gregory Mankiw is the Robert M. Beren Professor of Economics,
Harvard University,  Cambridge, Massachusetts. His e-mail address is
[hidden email].  I am grateful to David Autor, Nathaniel Hilger,
Chang-Tai Hseih, Steven Kaplan, Ulrike  Malmendier, Deborah Mankiw,
Nicholas Mankiw, Lisa Mogilanski, Alexander Sareyan,  Lawrence
Summers, Timothy Taylor, Jane Tufts, and Matthew Weinzierl for helpful
comments  and discussion.

Imagine a society with perfect economic equality. Perhaps out of sheer
coincidence, the  supply and demand for different types of labor
happen to produce an equilibrium in which  everyone earns exactly the
same income. As a result, no one worries about the gap between the
rich and poor, and no one debates to what extent public policy should
make income  redistribution a priority. Because people earn the value
of their marginal product, everyone is  fully incentivized to provide
the efficient amount of effort. The government is still needed to
provide public goods, such as national defense, but those are financed
with a lump-sum tax.  There is no need for taxes that would distort
incentives, such as an income tax, because they  would be strictly
worse for everyone. The society enjoys not only perfect equality but
also  perfect efficiency.

Then, one day, this egalitarian utopia is disturbed by an entrepreneur
with an idea for a  new product. Think of the entrepreneur as Steve
Jobs as he develops the iPod, J.K. Rowling as  she writes her Harry
Potter books, or Steven Spielberg as he directs his blockbuster
movies.  When the entrepreneur’s product is introduced, everyone in
society wants to buy it. They each  part with, say, $100. The
transaction is a voluntary exchange, so it must make both the buyer
and the seller better off. But because there are many buyers and only
one seller, the distribution  of economic well-being is now vastly
unequal. The new product makes the entrepreneur much  richer than
everyone else.

The society now faces a new set of questions: How should the
entrepreneurial  disturbance in this formerly egalitarian outcome
alter public policy? Should public policy remain  the same, because
the situation was initially acceptable and the entrepreneur improved
it for  everyone? Or should government policymakers deplore the
resulting inequality and use their  powers to tax and transfer to
spread the gains more equally?

In my view, this thought experiment captures, in an extreme and
stylized way, what has  happened to US society over the past several
decades. Since the 1970s, average incomes have  grown, but the growth
has not been uniform across the income distribution. The incomes at
the  top, especially in the top 1 percent, have grown much faster than
average. These high earners  have made significant economic
contributions, but they have also reaped large gains. The  question
for public policy is what, if anything, to do about it.

This development is one of the largest challenges facing the body
politic. A few numbers  illustrate the magnitude of the issue. The
best data we have on the upper tail of the income  distribution come
from Piketty and Saez’s (2003, with updates) tabulations of individual
tax  returns. (Even these numbers, though, are subject to some
controversy: the tax code changes  over time, altering the incentives
to receive and report compensation in alternative forms.)  According
to their numbers, the share of income, excluding capital gains, earned
by the top 1  percent rose from 7.7 percent in 1973 to 17.4 percent in
2010. Even more striking is the share  earned by the top 0.01
percent—an elite group that, in 2010, had a membership requirement of
annual income exceeding $5.9 million. This group’s share of total
income rose from 0.5 percent  in 1973 to 3.3 percent in 2010. These
numbers are not easily ignored. Indeed, they in no small  part
motivated the Occupy movement, and they have led to calls from
policymakers on the left to  make the tax code more progressive.

At the outset, it is worth noting that addressing the issue of rising
inequality necessarily  involves not just economics but also a healthy
dose of political philosophy. We economists  must recognize not only
the limits of what we know about inequality’s causes, but also the
limits  on the ability of our discipline to prescribe policy
responses. Economists who discuss policy  responses to increasing
inequality are often playing the role of amateur political philosopher
(and,  admittedly, I will do so in this essay). Given the topic, that
is perhaps inevitable. But it is  useful to keep when we are writing
as economists and when we are venturing beyond the  boundaries of our
professional expertise.

Is Inequality Inefficient?

It is tempting for economists who abhor inequality to suggest that the
issue involves not  just inequality per se, but also economic
inefficiency. Discussion of inequality necessarily  involves our
social and political values, but if inequality also entails
inefficiency, those  normative judgments are more easily agreed upon.
The Pareto criterion is the clearest case: If  we can make some people
better off without making anyone worse off, who could possibly
object? Yet for the question at hand, this criterion does not take us
very far. As far as I know,  no one has proposed any credible policy
intervention to deal with rising inequality that will make  everyone,
including those at the very top, better off.

More common is the claim that inequality is inefficient in the sense
of shrinking the size  of the economic pie. (That is, inefficiency is
being viewed through the lens of the Kaldor-Hicks  criterion.) If the
top 1 percent is earning an extra $1 in some way that reduces the
incomes of the  middle class and the poor by $2, then many people will
see that as a social problem worth  addressing. For example, suppose
the rising income share of the top 1 percent were largely
attributable to successful rent-seeking. Imagine that the government
were to favor its political  allies by granting them monopoly power
over certain products, favorable regulations, or  restrictions on
trade. Such a policy would likely lead to both inequality and
inefficiency.  Economists of all stripes would deplore it. I certainly
would.

Joseph Stiglitz’s (2012) book, The Price of Inequality, spends many
pages trying to  convince the reader that such rent-seeking is a
primary driving force behind the growing incomes  of the rich. This
essay is not the place for a book review, but I can report that I was
not  convinced. Stiglitz’s narrative relies more on exhortation and
anecdote than on systematic  evidence. There is no good reason to
believe that rent-seeking by the rich is more pervasive  today than it
was in the 1970s, when the income share of the top 1 percent was much
lower than  it is today.

I am more persuaded by the thesis advanced by Claudia Goldin and
Lawrence Katz (2008)  in their book The Race between Education and
Technology. Goldin and Katz argue that skill- biased technological
change continually increases the demand for skilled labor. By itself,
this  force tends to increase the earnings gap between skilled and
unskilled workers, thereby  increasing inequality. Society can offset
the effect of this demand shift by increasing the supply  of skilled
labor at an even faster pace, as it did in the 1950s and 1960s. In
this case, the earnings  gap need not rise and, indeed, can even
decline, as in fact occurred. But when the pace of  educational
advance slows down, as it did in the 1970s, the increasing demand for
skilled labor  will naturally cause inequality to rise. The story of
rising inequality, therefore, is not primarily  about politics and
rent-seeking but rather about supply and demand.

To be sure, Goldin and Katz focus their work on the broad changes in
inequality, not on  the incomes of the top 1 percent in particular.
But it is natural to suspect that similar forces are  at work. The
income share of the top 1 percent exhibits a U-shaped pattern: falling
from the  1950s to the 1970s, and rising from the 1970s to the
present. The earnings differentials between  skilled and unskilled
workers studied by Goldin and Katz follow a similar U-shaped pattern.
If  Goldin and Katz are right that the broad changes in inequality
have driven by the interaction  between technology and education,
rather than changes in rent-seeking through the political  process,
then it would seem an unlikely coincidence that the parallel changes
at the top have  been driven by something entirely different. Rather,
it seems that changes in technology have  allowed a small number of
highly educated and exceptionally talented individuals to command
superstar incomes in ways that were not possible a generation ago.
Erik Brynjolfsson and  Andrew McAfee (2011) advance this thesis
forcefully in their book Race Against the Machine.  They write (p.
44), “Aided by digital technologies, entrepreneurs, CEOs,
entertainment stars, and  financial executives have been able to
leverage their talents across global markets and capture  reward that
would have been unimaginable in earlier times.”

Nonetheless, to the extent that Stiglitz is right that inefficient
rent-seeking is a driving  force behind rising inequality, the
appropriate policy response is to address the root cause. It is  at
best incomplete and at worst misleading to describe the situation as
simply “rising inequality,”  because inequality here is a symptom of a
deeper problem. A progressive system of taxes and  transfers might
make the outcome more equal, but it would not address the underlying
inefficiency. For example, if domestic firms are enriching themselves
at the expense of  consumers through quotas on imports (as is the case
with some agribusinesses), the solution to  the problem entails not a
revision of the tax code but rather a change in trade policy. I am
skeptical that such rent-seeking activities are the reason why
inequality has risen in recent  decades, but I would support attempts
to reduce whatever rent-seeking does occur.

 An especially important and particularly difficult case is the
finance industry, where  many hefty compensation packages can be
found. On the one hand, there is no doubt that this  sector plays a
crucial role. Those who work in commercial banks, investment banks,
hedge funds  and other financial firms are in charge of allocating
capital and risk, as well as providing  liquidity. They decide, in a
decentralized and competitive way, which firms and industries need  to
shrink and which will be encouraged to grow. It makes sense that a
nation would allocate  many of its most talented and thus highly
compensated individuals to this activity. On the other  hand, some of
what occurs in financial firms does smack of rent seeking: when a
high-frequency  trader figures out a way to respond to news a fraction
of a second faster than his competitor, his  vast personal reward may
well exceed the social value of what he is producing. Devising a legal
 and regulatory framework to ensure that we get the right kind and
amount of financial activity is  a difficult task. While the solution
may well affect the degree of equality and the incomes of the  1
percent, the issue is primarily one of efficiency. A well-functioning
economy needs the correct  allocation of talent. The last thing we
need is for the next Steve Jobs to forgo Silicon Valley in  order to
join the high-frequency traders on Wall Street. That is, we shouldn’t
be concerned about  the next Steve Jobs striking it rich, but we want
to make sure he strikes it rich in a socially  productive way.

Equality of Opportunity as a Desideratum

Closely related to the claim of inefficiency is concern about
inequality of opportunity.  Equality of opportunity is often viewed as
a social goal in itself, but economists recognize that  the failure to
achieve such equality would normally lead to inefficiency as well. If
some  individuals are precluded from pursuing certain paths in life,
then they might be unable to  contribute fully to growing the economic
pie. To be specific, if children from poor families are  unable to
continue their education because of financial constraints, they do not
accumulate the  optimal amount of human capital. The outcome from
underinvestment in education is both  unequal and inefficient.

Measuring the degree of equality of opportunity is difficult. In his
book, Stiglitz (2012)  proposes a metric: the intergenerational
transmission of income. He says (p. 18), “If America  were really a
land of opportunity, the life chances of success—of, say, winding up
in the top 10  percent—of someone born to a poor or less educated
family would be the same as those of  someone born to a rich,
well-educated, and well-connected family.” In other words, under this
definition of equality of opportunity, people’s earnings would be
uncorrelated with those of their  parents. Needless to say, in the
data, that is not at all the case, which leads Stiglitz to conclude
that we are falling short of providing equal opportunity.

Yet the issue cannot be settled so easily, because the
intergenerational transmission of  income has many causes beyond
unequal opportunity. In particular, parents and children share  genes,
a fact that would lead to intergenerational persistence in income even
in a world of equal  opportunities. IQ, for example, has been widely
studied, and it has a large degree of heritability.  Smart parents are
more likely to have smart children, and their greater intelligence
will be  reflected, on average, in higher incomes. Of course, IQ is
only one dimension of talent, but it is  easy to believe that other
dimensions, such as self-control, ability to focus, and interpersonal
skills, have a degree of genetic heritability as well.

This is not to say that we live in a world of genetic determinism, for
surely we do not.  But it would be a mistake to go to the other
extreme and presume no genetic transmission of  economic outcomes. A
recent survey of the small but growing field of genoeconomics by
Benjamin et al. (2012) reports, “Twin studies suggest that economic
outcomes and preferences,  once corrected for measurement error,
appear to be about as heritable as many medical  conditions and
personality traits.” Similarly, in his study of the life outcomes of
adopted  children, Sacerdote (2007) writes, “While educational
attainment and income are frequently the  focus of economic studies,
these are among the outcomes least affected by differences in family
environment.” (He reports that family background exerts a stronger
influence on social variables,  such as drinking behavior.) This
evidence suggests that it is implausible to interpret generational
persistence in income as simply a failure of society to provide equal
opportunities. Indeed,  Sacerdote estimates (in his Table 5) that
while 33 percent of the variance of family income is  explained by
genetic heritability, only 11 percent is explained by the family
environment. The  remaining 56 percent includes environmental factors
unrelated to family. If this 11 percent  figure is approximately
correct, it suggests that we are not far from a plausible definition
of  equality of opportunity—that is, being raised by the right family
does give a person a leg up in  life, but family environment accounts
for only a small percentage of the variation in economic  outcomes
compared with genetic inheritance and environmental factors unrelated
to family.

To the extent that our society deviates from the ideal of equality of
opportunity, it is  probably best to focus our attention on the left
tail of the income distribution rather than on the  right tail.
Poverty entails a variety of socioeconomic maladies, and it is easy to
believe that  children raised in such circumstances do not receive the
right investments in human capital. By  contrast, the educational and
career opportunities available to children of the top 1 percent are, I
 believe, not very different from those available to the middle class.
My view here is shaped by  personal experience. I was raised in a
middle-class family; neither of my parents were college  graduates. My
own children are being raised by parents with both more money and more
 education. Yet I do not see my children as having significantly
better opportunities than I had at  their age.

In the end, I am led to conclude that concern about income inequality,
and especially  growth in incomes of the top 1 percent, cannot be
founded primarily on concern about  inefficiency and inequality of
opportunity. If the growing incomes of the rich are to be a focus of
public policy, it must be because income inequality is a problem in
and of itself.

The Big Tradeoff

In the title of his celebrated 1975 book, Arthur Okun told us that the
“big tradeoff” that  society faces is between equality and efficiency.
We can use the government’s system and taxes  and transfers to move
income from the rich to the poor, but that system is a “leaky bucket.”
 Some of the money is lost as it is moved. This leak should not stop
us from trying to redistribute,  Okun argued, because we value
equality. But because we are also concerned about efficiency,  the
leak will stop us before we fully equalize economic resources.

The formal framework that modern economists use to address this issue
is that proposed  by Mirrlees (1971). In the standard Mirrlees model,
individuals get utility from consumption C  and disutility from
providing work effort L. They differ only according to their
productivity W.  In the absence of government redistribution, each
person’s consumption would be WL. Those  with higher productivity
would have higher consumption, higher utility, and lower marginal
utility.

The government is then introduced as a benevolent social planner with
the goal of  maximizing total utility in society (or, sometimes, a
more general social welfare function that  could depend nonlinearly on
individual utilities). The social planner wants to move economic
resources from those with high productivity and low marginal utility
to those with lower  productivity and higher marginal utility. Yet
this redistribution is hard to accomplish, because  the government is
assumed to be unable to observe productivity W; instead, it observes
only  income WL, the product of productivity and effort. If it
redistributes income too much, high  productivity individuals will
start to act as if they are low productivity individuals. Public
policymakers are thus forced to forgo the first-best egalitarian
outcome for a second-best  incentive-compatible solution. Like a
government armed with Okun’s leaky bucket, the  Mirrleesian social
planner redistributes to some degree but also allows some inequality
to remain.

If this framework is adopted, then the debate over redistribution
turns to questions about  key parameters. In particular, optimal
redistribution depends on the degree to which work effort  responds to
incentives. If the supply of effort is completely inelastic, then the
bucket has no leak,  and the social planner can reach the egalitarian
outcome. If the elasticity is small, the social  planner can come
close. But if work effort responds substantially to incentives, then
the bucket  is more like a sieve, and the social planner should
attempt little or no redistribution. Thus, much  debate among
economists about optimal redistribution centers on the elasticity of
labor supply.

 Even if one is willing to accept the utilitarian premise of this
framework, there is good  reason to be suspect of particular numerical
results that follow from it. When researchers  implement the Mirrlees
model, they typically assume, as Mirrlees did, that all individuals
have  the same preferences. People are assumed to differ only in their
productivity. For purposes of  illustrative theory, that assumption is
fine, but it is also false. Incomes differ in part because  people
have different tastes regarding consumption, leisure, and job
attributes. Acknowledging  variation in preferences weakens the case
for redistribution (Lockwood and Weinzierl 2012).  For example, many
economics professors could have pursued higher-income career paths as
business economists, software engineers, or corporate lawyers. That
they chose to take some of  their compensation in the form of personal
and intellectual freedom rather than cold cash is a  personal
lifestyle choice, not a reflection of innate productivity. Those who
made the opposite  choice may have done so because they get greater
utility from income. A utilitarian social  planner will want to
allocate greater income to these individuals, even apart from any
incentive  effects.

Another problem with the Mirrlees framework as typically implemented
is that it takes a  simplistic approach to tax incidence. Any good
introductory student of economics knows that  when a good or service
is taxed, the buyer and seller share the burden. Yet in the Mirrlees
framework, when an individual’s labor income is taxed, only the seller
of the services is worse  off. In essence, the demand for labor
services is assumed to be infinitely elastic. A more general  set of
assumptions would acknowledge that the burden of the tax is spread
more broadly to  buyers of those services (and perhaps to sellers of
complementary inputs as well). In this more  realistic setting, tax
policy would be a less well-targeted tool for redistributing economic
wellbeing.


 The harder and perhaps deeper question is whether the government’s
policy toward  redistribution is best viewed as being based on a
benevolent social planner with utilitarian  preferences. That is, did
Okun and Mirrlees provide economists with the right starting point for
 thinking about this issue? I believe there are good reasons to doubt
this model from the get-go.

The Uneasy Case for Utilitarianism

For economists, the utilitarian approach to income distribution comes
naturally. After all,  utilitarians and economists share an
intellectual tradition: early utilitarians, such as John Stuart  Mill,
were also among the early economists. Also, utilitarianism seems to
extend the  economist’s model of individual decision-making to the
societal level. Indeed, once one adopts  the political philosophy of
utilitarianism, running a society becomes yet another problem of
constrained optimization. Despite its natural appeal (to economists,
at least), the utilitarian  approach is fraught with problems.

One classic problem is the interpersonal comparability of utility. We
can infer an  individual’s utility function from the choices that
individual makes when facing varying prices  and levels of income. But
from this revealed-preference perspective, utility is not inherently
measurable, and it is impossible to compare utilities across people.
Perhaps advances in  neuroscience will someday lead to an objective
measure of happiness, but as of now, there is no  scientific way to
establish whether the marginal dollar consumed by one person produces
more  or less utility than the marginal dollar consumed by a neighbor.


 Another more concrete problem is the geographic scope of the
analysis. Usually,  analyses of optimal income redistribution are
conducted at the national level. But there is  nothing inherent in
utilitarianism that suggests such a limitation. Some of the largest
income  disparities are observed between nations. If a national system
of taxes and transfers is designed  to move resources from Palm Beach,
Florida, to Detroit, Michigan, shouldn’t a similar  international
system move resources from the United States and Western Europe to
sub-Saharan  Africa? Many economists do support increased foreign aid,
but as far as I know, no one has  proposed marginal tax rates on rich
nations as high as the marginal tax rates imposed on rich
individuals. Our reluctance to apply utilitarianism at the global
level should give us pause when  applying it at the national level.

In a 2010 paper, Matthew Weinzierl and I emphasized another reason to
be wary of  utilitarianism: it recommends a greater use of “tags” than
most people feel comfortable with. As  Akerlof (1978) pointed out, if
the social planner can observe individual characteristics that are
correlated with productivity, then an optimal tax system should use
that information, in addition  to income, in determining an
individual’s tax liability. The more the tax system is based on such
fixed characteristics rather than income, the less it will distort
incentives. Weinzierl and I showed  that one such tag is height.
Indeed, the correlation between height and wages is sufficiently
strong that the optimal tax on height is quite large. Similarly,
according to the utilitarian calculus,  the tax system should also
make a person’s tax liability a function of race, gender, and perhaps
many other exogenous characteristics. Of course, few people would
embrace the idea of a height  tax, and Weinzierl and I did not offer
it as a serious policy proposal. Even fewer people would  be
comfortable with a race-based income tax (although Alesina et al.,
2011, propose in earnest a  gender-based tax). Yet these implications
cannot just be ignored. If you take from a theory only  the
conclusions you like and discard the rest, you are using the theory as
a drunkard uses a lamp  post—for support rather than illumination. If
utilitarianism takes policy in directions that most  people don’t
like, then perhaps it is not a sound foundation for thinking about
redistribution and  public policy.

Finally, in thinking about whether the utilitarian model really
captures our moral  intuitions, it is worth thinking for a moment
about the first-best outcome for a utilitarian social  planner.
Suppose, in contrast to the Mirrlees model, the social planner could
directly observe  productivity. In this case, the planner would not
need to worry about incentives, but could set  taxes and transfers
based directly on productivity. The optimal policy would equalize the
marginal utility of consumption across individuals; if the utility
function is assumed to be  additively separable in consumption and
leisure, this means everyone consumes the same amount.  But because
some people are more productive than others, equalizing leisure would
not be  optimal. Instead, the social planner would require more
productive individuals to work more.  Thus, in the utilitarian
first-best allocation, the more productive members of society would
work  more and consume the same as everyone else. In other words, in
the allocation that maximizes  society’s total utility, the less
productive individuals would enjoy a higher utility than the more
productive.

Is this really the outcome we would want society to achieve if it
could? A true utilitarian  would follow the logic of the model and say
“yes.” Yet this outcome does not strike me as the  ideal toward which
we should aspire, and I suspect most people would agree. Even young
children have an innate sense that merit should be rewarded
(Kanngiesser and Warneken  2012)—and I doubt it is only because they
are worried about the incentive effects of not doing so.


 If I am right, then we need a model of optimal government taxes and
transfers that departs  significantly from conventional utilitarian
social planning.

Listening to the Left

In recent years, the left side of the political spectrum has focused
much attention on the  rising incomes of the top 1 percent. This
includes President Obama’s proposals to raises taxes on  higher
incomes, the Occupy Wall Street movement, and a rash of books about
economic  inequality. Even though I don’t share the left’s policy
conclusions, I find it is worthwhile to  listen carefully to their
arguments to discern what set of philosophical principles and
empirical  claims underlie their concerns.

It is, I believe, hard to square the rhetoric of the left with the
economist’s standard  framework. Someone favoring greater
redistribution along the lines of Okun and Mirrlees would  argue as
follows. “The rich earn higher incomes because they contribute more to
society than  others do. However, because of diminishing marginal
utility, they don’t get much value from  their last few dollars of
consumption. So we should take some of their income away and give it
to less productive members of society. While this policy would cause
the most productive  members to work less, shrinking the size of the
economic pie, that is a cost we should bear, to  some degree, to
increase utility for society’s less productive citizens.”


Surely, that phrasing of the argument would not animate the Occupy
crowd! So let’s  consider the case that the left makes in favor of
greater income redistribution. There are three  broad classes of
arguments.

The first is the suggestion that the tax system we now have is
regressive. Most famously,  during the presidential campaign of 2008,
at a fund-raiser for Hillary Clinton, the billionaire  investor Warren
E. Buffett said that the rich were not paying enough. Mr. Buffett used
himself as  an example. He asserted that his taxes in the previous
year equaled only 17.7 percent of his  taxable income, while his
receptionist paid about 30 percent of her income in taxes (Tse 2007).
In 2011, President Obama proposed the “Buffett rule,” which would
require taxpayers with  income over a million dollars to pay at least
30 percent of their income in federal income taxes.

There are, however, good reasons to be skeptical of Buffett’s
calculations. If his  receptionist was truly a middle-income taxpayer,
then to get her tax rate to 30 percent, he most  likely added the
payroll tax to the income tax. Fair enough. But for Buffett’s tax rate
to be only 17.7 percent, most of his income was likely dividends and
capital gains, and his calculation had  to ignore the fact that this
capital income was already taxed at the corporate level. A complete
accounting requires aggregating not only all taxes on labor income but
also all taxes on capital  income.  The Congressional Budget Office
(2012) does precisely that when it calculates the  distribution of the
federal tax burden—and it paints a very different picture than did
Buffett’s  anecdote. In 2009, the most recent year available, the
poorest fifth of the population, with  average annual income of
$23,500, paid only 1.0 percent of its income in federal taxes. The
middle fifth, with income of $64,300, paid 11.1 percent. And the top
fifth, with income of  $223,500, paid 23.2 percent. The richest 1
percent, with an average income of $1,219,700, paid 28.9 percent of
its income to the federal government. To be sure, some taxpayers
aggressively  plan to minimize taxes, and this may result in some
individual cases where those with high  incomes pay relatively little
in federal taxes. But the CBO data make clear that these cases are
the exceptions. As a general rule, the existing federal tax code is
highly progressive.

A second type of argument from the left is that the incomes of the
rich do not reflect their  contributions to society. In the standard
competitive labor market, a person’s earnings equal the  value of his
or her marginal productivity. But there are various reasons that real
life might  deviate from this classical benchmark. If, for example, a
person’s high income results from  political rent-seeking rather than
producing a valuable product, the outcome is likely to be both
inefficient and widely viewed as inequitable. Steve Jobs getting rich
from producing the iPod  and Pixar movies does not produce much ire
among the public. A Wall Street executive  benefiting from a
taxpayer-financed bailout does.

The key issue is the extent to which the high incomes of the top 1
percent reflect high  productivity rather than some market
imperfection. This question is one of positive economics,  but
unfortunately not one that is easily answered. My own reading of the
evidence is that most of  the very wealthy get that way by making
substantial economic contributions, not by gaming the  system or
taking advantage of some market failure or the political process. Take
the example of  pay for chief executive officers. Without doubt, CEOs
are paid handsomely, and their pay has  grown over time relative to
that of the average worker. Commentators on this phenomenon  sometimes
suggest that this high pay reflects the failure of corporate boards of
directors to do  their job. Rather than representing shareholders, the
argument goes, boards are too cozy with the  CEOs and pay them more
than they are worth to their organizations. Yet this argument fails to
 explain the behavior of closely-held corporations. A private equity
group with a controlling  interest in a firm does not face the alleged
principal-agent problem between shareholders and  boards, and yet
these closely-held firms also pay their CEOs handsomely. Indeed,
Kaplan (2012)  reports that over the past three decades, executive pay
in closely-held firms has outpaced that in  public companies. Conqvist
and Fahlenbrach (2012) find that when public companies go private,
the CEOs tend to get paid more rather than less in both base salaries
and bonuses. In light of  these facts, the most natural explanation of
high CEO pay is that the value of a good CEO is  extraordinarily high
(a conclusion that, incidentally, is consistent with the model of CEO
pay  proposed by Gabaix and Landier, 2008).

A third argument that the left uses to advocate greater taxation of
those with higher  incomes is that the rich benefit from the physical,
legal, and social infrastructure that government  provides and,
therefore, should contribute to supporting it. As one prominent
example, President  Obama (2012) said in a speech, “If you were
successful, somebody along the line gave you some  help. There was a
great teacher somewhere in your life. Somebody helped to create this
unbelievable American system that we have that allowed you to thrive.
Somebody invested in  roads and bridges. If you’ve got a business --
you didn’t build that. Somebody else made that  happen. The Internet
didn’t get invented on its own. Government research created the
Internet so  that all the companies could make money off the Internet.
The point is that when we succeed,  we succeed because of our
individual initiative, but also because we do things together.”

In the language of traditional public finance, President Obama was
relying less on the  ability-to-pay principle and more on the benefits
principle. That is, higher taxation of the rich is  not being
justified by the argument that their marginal utility of consumption
is low, as it is in  the frameworks of Okun and Mirrlees. Rather,
higher taxation is being justified by the claim that  the rich
achieved their wealth in large measure because of the goods and
services the government  provides and therefore have a responsibility
to finance those goods and services.

This line of argument raises the empirical question of how large the
benefit of  government infrastructure is. The average value is surely
very high, as lawless anarchy would  leave the rich (as well as most
everyone else) much worse off. But like other inputs into the
production process, government infrastructure should be valued at the
margin, where the  valuation harder to discern. As I pointed out
earlier, the average person in the top 1 percent pays  more than a
quarter of income in federal taxes, and about a third if state and
local taxes are  included. Why isn’t that enough to compensate for the
value of government infrastructure?

A relevant fact here is that, over time, an increasing share of
government spending has  been for transfer payments, rather than for
purchases of goods and services. Government has  grown as a percentage
of the economy not because it is providing more and better roads, more
 and better legal institutions, and more and better educational
systems. Rather, government has  increasingly used its power to tax to
take from Peter to pay Paul. Discussions of the benefits of
government services should not distract from this fundamental truth.

In the end, the left’s arguments for increased redistribution are
valid in principle but  dubious in practice. If the current tax system
were regressive, or if the incomes of the top 1  percent were much
greater than their economic contributions, or if the rich enjoyed
government  services in excess of what they pay in taxes, then the
case for increasing the top tax rate would  indeed be strong. But
there is no compelling reason to believe that any of these premises
holds  true.

 The Need for an Alternative Philosophical Framework

A common thought experiment used to motivate income redistribution is
to imagine a  situation in which individuals are in an “original
position” behind a “veil of ignorance” (as in  Rawls, 1971). This
original position occurs in a hypothetical time before we are born,
without  the knowledge of whether we will be lucky or unlucky,
talented or less talented, rich or poor. A  risk-averse person in such
a position would want to buy insurance against the possibility of
being  born into a less fortunate station in life. In this view,
governmental income redistribution is an  enforcement of the social
insurance contract to which people would have voluntarily agreed in
this original position.

Yet take this logic a bit further. In this original position, people
would be concerned  about more than being born rich and poor. They
would also be concerned about health outcomes.  Consider kidneys, for
example. Most people walk around with two healthy kidneys, one of
which they do not need. A few people get kidney disease that leaves
them without a functioning  kidney, a condition that often cuts life
short. A person in the original position would surely sign  an
insurance contract that guarantees him at least one working kidney.
That is, he would be  willing to risk being a kidney donor if he is
lucky, in exchange for the assurance of being a  transplant recipient
if he is unlucky. Thus, the same logic of social insurance that
justifies  income redistribution similarly justifies
government-mandated kidney donation.

No doubt, if such a policy were ever seriously considered, most people
would oppose it.  A person has a right to his own organs, they would
argue, and a thought experiment about an  original position behind a
veil of ignorance does not vitiate that right. But if that is the
case, and I  believe it is, it undermines the thought experiment more
generally. If imagining a hypothetical  social insurance contract
signed in an original position does not supersede the right of a
person to  his own organs, why should it supersede the right of a
person to the fruits of his own labor?

An alternative to the social insurance view of the income distribution
is what, in Mankiw  (2010), I called a “just deserts” perspective.
According to this view, people should receive  compensation congruent
with their contributions. If the economy were described by a classical
 competitive equilibrium without any externalities or public goods,
then every individual would  earn the value of his or her own marginal
product, and there would be no need for government to  alter the
resulting income distribution. The role of government arises as the
economy departs  from this classical benchmark. Pigovian taxes and
subsidies are necessary to correct externalities,  and progressive
income taxes can be justified to finance public goods based on the
benefits  principle. Transfer payments to the poor have a role as
well, because fighting poverty can be  viewed as a public good (Thurow
1971).

This alternative perspective on the income distribution is a radical
departure from the  utilitarian perspective that has long influenced
economists, including Okun and Mirrlees. But it  is not entirely new.
It harkens back about a century to the tradition of “just taxation”
suggested  by Knut Wicksell (1896, translated 1958) and Erik Lindahl
(1919, translated 1958). More  important, I believe it is more
consistent with our innate moral intuitions. Indeed, many of the
arguments of the left discussed earlier are easier to reconcile with
the just-deserts theory than  they are with utilitarianism. My
disagreement with the left lies not in the nature of their  arguments,
but rather in the factual basis of their conclusions.

  The political philosophy one adopts naturally influences the kind of
economic questions  that are relevant for determining optimal policy.
The utilitarian perspective leads to questions  such as: How rapidly
does marginal utility of consumption decline? What is the distribution
of  productivity? How much do taxes influence work effort? The
just-deserts perspective focuses  instead on other questions: Do the
high incomes of the top 1 percent reflect extraordinary  productivity,
or some type of market failure? How are the benefits of public goods
distributed  across the income distribution? I have my own conjectures
about the answers to these latter  questions, and I have suggested
them throughout this essay, but I am the first to admit that they  are
tentative. Fortunately, these are positive questions to which future
economic research may  provide more definitive answers.

To highlight the difference between these approaches, consider how
each would address  the issue of the top tax rate. In particular, why
shouldn’t we raise the rate on high incomes to 75  percent, as
France’s President Hollande has recently proposed, or to 91 percent,
where it was  through much of the 1950s in the United States? A
utilitarian social planner would say that  perhaps we should and would
refrain from doing so only if the adverse incentive effects were too
great. From the just-deserts perspective, such confiscatory tax rates
are wrong, even ignoring any  incentive effects. By this view, using
the force of government to seize such a large share of the  fruits of
someone else’s labor is unjust, even if the taking is sanctioned by a
majority of the  citizenry.

In the final analysis, we should not be surprised when opinions about
income  redistribution vary. Economists can turn to empirical methods
to estimate key parameters, but no  amount of applied econometrics can
bridge this philosophical divide. I hope my ruminations in  this essay
have convinced some readers to see the situation from a new angle. But
at the very  least, I trust that these thoughts offer a vivid reminder
that fundamentally normative conclusions  cannot rest on positive
economics alone.


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States, 1913-1998"  Quarterly Journal of Economics, 118(1), 2003,
1-39, updated to 2010 on Saez’s website.

Rawls, John. 1971. A Theory of Justice. Belknap Press.

Sacerdote, Bruce, “How Large are the Effects from Changes in Family
Environment? A Study  of Korean American Adoptees.” The Quarterly
Journal of Economics (2007) 122 (1): 119-157.

Stiglitz, Joseph. 2012. The Price of Inequality. W.W. Norton and Company.

Thurow, Lester. 1971. “The Income Distribution as a Pure Public Good,”
Quarterly Journal of  Economics 85(2): 327-336.

Tse, Tomoeh Murakami. 2007. “Buffett Slams Tax System Disparities,”
The Washington Post,  June 27.

Lockwood, Benjamin, and Matthew Weinzierl, “De Gustibus non est
Taxandum: Theory and  Evidence on Preference Heterogeneity and
Redistribution,” Harvard Business School Working  Paper, 2012.

Wicksell, Knut. 1958 “A New Principle of Just Taxation.” In Richard
Musgrave and Alan  Peacock, editors, Classics in the Theory of Public
Finance, Macmillan, London: 72-118.

--
Jim Devine /  "Segui il tuo corso, e lascia dir le genti." (Go your
own way and let people talk.) -- Karl, paraphrasing Dante.
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Re: Mankiw defends the 1 percent

Tom Walker-4
In reply to this post by Jim Devine
Shorter Mankiw: 
 
I am skeptical that such rent-seeking activities are the reason why
inequality has risen in recent decades...


It makes sense that a nation would allocate many of its most talented and thus highly compensated individuals to this activity [finance].
 
-- 
Cheers,

Tom Walker (Sandwichman)

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2nd para contradicts the 1st in Mankiw defends the 1 percent

Eugene Coyle
In reply to this post by Jim Devine
Mankiw's 2nd paragraph contradicts the first.  In the first paragraph he has everything priced at Marginal Cost ("perfect efficiency") and in the second he has Harry Potter selling for $100 which is certainly above MC.  How are Steve Jobs and Speilberg getting away with this rent-seeking, which he later dismisses as rare in the US economy?

What trash Mankiw repeatedly spews out.  And he had help from 13 people, including Larry Summers!  Summers knows this is crap and has said as much in a paper.

Gene


On Jun 16, 2013, at 11:08 AM, Jim Devine <[hidden email]> wrote:

> Defending the One Percent
>
> N. Gregory Mankiw
> June 7, 2013
>
> Forthcoming, Journal of Economic Perspectives
>
> N. Gregory Mankiw is the Robert M. Beren Professor of Economics,
> Harvard University,
> Cambridge, Massachusetts. His e-mail address is [hidden email].
> I am grateful to David Autor, Nathaniel Hilger, Chang-Tai Hseih,
> Steven Kaplan, Ulrike
> Malmendier, Deborah Mankiw, Nicholas Mankiw, Lisa Mogilanski,
> Alexander Sareyan,
> Lawrence Summers, Timothy Taylor, Jane Tufts, and Matthew Weinzierl
> for helpful comments
> and discussion.
>
>
> Imagine a society with perfect economic equality. Perhaps out of sheer
> coincidence, the
> supply and demand for different types of labor happen to produce an
> equilibrium in which
> everyone earns exactly the same income. As a result, no one worries
> about the gap between the
> rich and poor, and no one debates to what extent public policy should
> make income
> redistribution a priority. Because people earn the value of their
> marginal product, everyone is
> fully incentivized to provide the efficient amount of effort. The
> government is still needed to
> provide public goods, such as national defense, but those are financed
> with a lump-sum tax.
> There is no need for taxes that would distort incentives, such as an
> income tax, because they
> would be strictly worse for everyone. The society enjoys not only
> perfect equality but also
> perfect efficiency.
>
> Then, one day, this egalitarian utopia is disturbed by an entrepreneur
> with an idea for a
> new product. Think of the entrepreneur as Steve Jobs as he develops
> the iPod, J.K. Rowling as
> she writes her Harry Potter books, or Steven Spielberg as he directs
> his blockbuster movies.
> When the entrepreneur’s product is introduced, everyone in society
> wants to buy it. They each
> part with, say, $100. The transaction is a voluntary exchange, so it
> must make both the buyer
> and the seller better off. But because there are many buyers and only
> one seller, the distribution
> of economic well-being is now vastly unequal. The new product makes
> the entrepreneur much
> richer than everyone else.
>
> The society now faces a new set of questions: How should the entrepreneurial
> disturbance in this formerly egalitarian outcome alter public policy?
> Should public policy remain
> the same, because the situation was initially acceptable and the
> entrepreneur improved it for
> everyone? Or should government policymakers deplore the resulting
> inequality and use their
> powers to tax and transfer to spread the gains more equally?
>
>
> In my view, this thought experiment captures, in an extreme and
> stylized way, what has
> happened to US society over the past several decades. Since the 1970s,
> average incomes have
> grown, but the growth has not been uniform across the income
> distribution. The incomes at the
> top, especially in the top 1 percent, have grown much faster than
> average. These high earners
> have made significant economic contributions, but they have also
> reaped large gains. The
> question for public policy is what, if anything, to do about it.
>
> This development is one of the largest challenges facing the body
> politic. A few numbers
> illustrate the magnitude of the issue. The best data we have on the
> upper tail of the income
> distribution come from Piketty and Saez’s (2003, with updates)
> tabulations of individual tax
> returns. (Even these numbers, though, are subject to some controversy:
> the tax code changes
> over time, altering the incentives to receive and report compensation
> in alternative forms.)
> According to their numbers, the share of income, excluding capital
> gains, earned by the top 1
> percent rose from 7.7 percent in 1973 to 17.4 percent in 2010. Even
> more striking is the share
> earned by the top 0.01 percent—an elite group that, in 2010, had a
> membership requirement of
> annual income exceeding $5.9 million. This group’s share of total
> income rose from 0.5 percent
> in 1973 to 3.3 percent in 2010. These numbers are not easily ignored.
> Indeed, they in no small
> part motivated the Occupy movement, and they have led to calls from
> policymakers on the left to
> make the tax code more progressive.
>
> At the outset, it is worth noting that addressing the issue of rising
> inequality necessarily
> involves not just economics but also a healthy dose of political
> philosophy. We economists
> must recognize not only the limits of what we know about inequality’s
> causes, but also the limits
> on the ability of our discipline to prescribe policy responses.
> Economists who discuss policy
> responses to increasing inequality are often playing the role of
> amateur political philosopher (and,  admittedly, I will do so in this
> essay). Given the topic, that is perhaps inevitable. But it is
> useful to keep when we are writing as economists and when we are
> venturing beyond the
> boundaries of our professional expertise.
>
> Is Inequality Inefficient?
>
> It is tempting for economists who abhor inequality to suggest that the
> issue involves not
> just inequality per se, but also economic inefficiency. Discussion of
> inequality necessarily
> involves our social and political values, but if inequality also
> entails inefficiency, those
> normative judgments are more easily agreed upon. The Pareto criterion
> is the clearest case: If
> we can make some people better off without making anyone worse off,
> who could possibly
> object? Yet for the question at hand, this criterion does not take us
> very far. As far as I know,
> no one has proposed any credible policy intervention to deal with
> rising inequality that will make
> everyone, including those at the very top, better off.
>
> More common is the claim that inequality is inefficient in the sense
> of shrinking the size
> of the economic pie. (That is, inefficiency is being viewed through
> the lens of the Kaldor-Hicks
> criterion.) If the top 1 percent is earning an extra $1 in some way
> that reduces the incomes of the
> middle class and the poor by $2, then many people will see that as a
> social problem worth
> addressing. For example, suppose the rising income share of the top 1
> percent were largely
> attributable to successful rent-seeking. Imagine that the government
> were to favor its political
> allies by granting them monopoly power over certain products,
> favorable regulations, or
> restrictions on trade. Such a policy would likely lead to both
> inequality and inefficiency.
> Economists of all stripes would deplore it. I certainly would.
>
> Joseph Stiglitz’s (2012) book, The Price of Inequality, spends many
> pages trying to
> convince the reader that such rent-seeking is a primary driving force
> behind the growing incomes
> of the rich. This essay is not the place for a book review, but I can
> report that I was not
> convinced. Stiglitz’s narrative relies more on exhortation and
> anecdote than on systematic
> evidence. There is no good reason to believe that rent-seeking by the
> rich is more pervasive
> today than it was in the 1970s, when the income share of the top 1
> percent was much lower than
> it is today.
>
> I am more persuaded by the thesis advanced by Claudia Goldin and
> Lawrence Katz (2008)
> in their book The Race between Education and Technology. Goldin and
> Katz argue that skill-
> biased technological change continually increases the demand for
> skilled labor. By itself, this
> force tends to increase the earnings gap between skilled and unskilled
> workers, thereby
> increasing inequality. Society can offset the effect of this demand
> shift by increasing the supply
> of skilled labor at an even faster pace, as it did in the 1950s and
> 1960s. In this case, the earnings
> gap need not rise and, indeed, can even decline, as in fact occurred.
> But when the pace of
> educational advance slows down, as it did in the 1970s, the increasing
> demand for skilled labor
> will naturally cause inequality to rise. The story of rising
> inequality, therefore, is not primarily
> about politics and rent-seeking but rather about supply and demand.
>
> To be sure, Goldin and Katz focus their work on the broad changes in
> inequality, not on
> the incomes of the top 1 percent in particular. But it is natural to
> suspect that similar forces are
> at work. The income share of the top 1 percent exhibits a U-shaped
> pattern: falling from the
> 1950s to the 1970s, and rising from the 1970s to the present. The
> earnings differentials between
> skilled and unskilled workers studied by Goldin and Katz follow a
> similar U-shaped pattern. If
> Goldin and Katz are right that the broad changes in inequality have
> driven by the interaction
> between technology and education, rather than changes in rent-seeking
> through the political
> process, then it would seem an unlikely coincidence that the parallel
> changes at the top have
> been driven by something entirely different. Rather, it seems that
> changes in technology have
> allowed a small number of highly educated and exceptionally talented
> individuals to command
> superstar incomes in ways that were not possible a generation ago.
> Erik Brynjolfsson and
> Andrew McAfee (2011) advance this thesis forcefully in their book Race
> Against the Machine.
> They write (p. 44), “Aided by digital technologies, entrepreneurs,
> CEOs, entertainment stars, and
> financial executives have been able to leverage their talents across
> global markets and capture
> reward that would have been unimaginable in earlier times.”
>
> Nonetheless, to the extent that Stiglitz is right that inefficient
> rent-seeking is a driving
> force behind rising inequality, the appropriate policy response is to
> address the root cause. It is
> at best incomplete and at worst misleading to describe the situation
> as simply “rising inequality,”
> because inequality here is a symptom of a deeper problem. A
> progressive system of taxes and
> transfers might make the outcome more equal, but it would not address
> the underlying
> inefficiency. For example, if domestic firms are enriching themselves
> at the expense of
> consumers through quotas on imports (as is the case with some
> agribusinesses), the solution to
> the problem entails not a revision of the tax code but rather a change
> in trade policy. I am
> skeptical that such rent-seeking activities are the reason why
> inequality has risen in recent
> decades, but I would support attempts to reduce whatever rent-seeking
> does occur.
>
>
> An especially important and particularly difficult case is the finance
> industry, where
> many hefty compensation packages can be found. On the one hand, there
> is no doubt that this
> sector plays a crucial role. Those who work in commercial banks,
> investment banks, hedge funds
> and other financial firms are in charge of allocating capital and
> risk, as well as providing
> liquidity. They decide, in a decentralized and competitive way, which
> firms and industries need
> to shrink and which will be encouraged to grow. It makes sense that a
> nation would allocate
> many of its most talented and thus highly compensated individuals to
> this activity. On the other
> hand, some of what occurs in financial firms does smack of rent
> seeking: when a high-frequency
> trader figures out a way to respond to news a fraction of a second
> faster than his competitor, his
> vast personal reward may well exceed the social value of what he is
> producing. Devising a legal
> and regulatory framework to ensure that we get the right kind and
> amount of financial activity is
> a difficult task. While the solution may well affect the degree of
> equality and the incomes of the
> 1 percent, the issue is primarily one of efficiency. A
> well-functioning economy needs the correct
> allocation of talent. The last thing we need is for the next Steve
> Jobs to forgo Silicon Valley in
> order to join the high-frequency traders on Wall Street. That is, we
> shouldn’t be concerned about
> the next Steve Jobs striking it rich, but we want to make sure he
> strikes it rich in a socially
> productive way.
>
> Equality of Opportunity as a Desideratum
>
> Closely related to the claim of inefficiency is concern about
> inequality of opportunity.
> Equality of opportunity is often viewed as a social goal in itself,
> but economists recognize that
> the failure to achieve such equality would normally lead to
> inefficiency as well. If some
> individuals are precluded from pursuing certain paths in life, then
> they might be unable to
> contribute fully to growing the economic pie. To be specific, if
> children from poor families are
> unable to continue their education because of financial constraints,
> they do not accumulate the
> optimal amount of human capital. The outcome from underinvestment in
> education is both
> unequal and inefficient.
>
> Measuring the degree of equality of opportunity is difficult. In his
> book, Stiglitz (2012)
> proposes a metric: the intergenerational transmission of income. He
> says (p. 18), “If America
> were really a land of opportunity, the life chances of success—of,
> say, winding up in the top 10
> percent—of someone born to a poor or less educated family would be the
> same as those of
> someone born to a rich, well-educated, and well-connected family.” In
> other words, under this
> definition of equality of opportunity, people’s earnings would be
> uncorrelated with those of their
> parents. Needless to say, in the data, that is not at all the case,
> which leads Stiglitz to conclude
> that we are falling short of providing equal opportunity.
>
> Yet the issue cannot be settled so easily, because the
> intergenerational transmission of
> income has many causes beyond unequal opportunity. In particular,
> parents and children share
> genes, a fact that would lead to intergenerational persistence in
> income even in a world of equal
> opportunities. IQ, for example, has been widely studied, and it has a
> large degree of heritability.
> Smart parents are more likely to have smart children, and their
> greater intelligence will be
> reflected, on average, in higher incomes. Of course, IQ is only one
> dimension of talent, but it is
> easy to believe that other dimensions, such as self-control, ability
> to focus, and interpersonal
> skills, have a degree of genetic heritability as well.
>
> This is not to say that we live in a world of genetic determinism, for
> surely we do not.
> But it would be a mistake to go to the other extreme and presume no
> genetic transmission of
> economic outcomes. A recent survey of the small but growing field of
> genoeconomics by
> Benjamin et al. (2012) reports, “Twin studies suggest that economic
> outcomes and preferences,
> once corrected for measurement error, appear to be about as heritable
> as many medical
> conditions and personality traits.” Similarly, in his study of the
> life outcomes of adopted
> children, Sacerdote (2007) writes, “While educational attainment and
> income are frequently the
> focus of economic studies, these are among the outcomes least affected
> by differences in family
> environment.” (He reports that family background exerts a stronger
> influence on social variables,
> such as drinking behavior.) This evidence suggests that it is
> implausible to interpret generational
> persistence in income as simply a failure of society to provide equal
> opportunities. Indeed,
> Sacerdote estimates (in his Table 5) that while 33 percent of the
> variance of family income is
> explained by genetic heritability, only 11 percent is explained by the
> family environment. The
> remaining 56 percent includes environmental factors unrelated to
> family. If this 11 percent
> figure is approximately correct, it suggests that we are not far from
> a plausible definition of
> equality of opportunity—that is, being raised by the right family does
> give a person a leg up in
> life, but family environment accounts for only a small percentage of
> the variation in economic
> outcomes compared with genetic inheritance and environmental factors
> unrelated to family.
>
> To the extent that our society deviates from the ideal of equality of
> opportunity, it is
> probably best to focus our attention on the left tail of the income
> distribution rather than on the
> right tail. Poverty entails a variety of socioeconomic maladies, and
> it is easy to believe that
> children raised in such circumstances do not receive the right
> investments in human capital. By
> contrast, the educational and career opportunities available to
> children of the top 1 percent are, I
> believe, not very different from those available to the middle class.
> My view here is shaped by
> personal experience. I was raised in a middle-class family; neither of
> my parents were college
> graduates. My own children are being raised by parents with both more
> money and more
> education. Yet I do not see my children as having significantly better
> opportunities than I had at
> their age.
>
> In the end, I am led to conclude that concern about income inequality,
> and especially
> growth in incomes of the top 1 percent, cannot be founded primarily on
> concern about
> inefficiency and inequality of opportunity. If the growing incomes of
> the rich are to be a focus of
> public policy, it must be because income inequality is a problem in
> and of itself.
>
> The Big Tradeoff
>
> In the title of his celebrated 1975 book, Arthur Okun told us that the
> “big tradeoff” that
> society faces is between equality and efficiency. We can use the
> government’s system and taxes
> and transfers to move income from the rich to the poor, but that
> system is a “leaky bucket.”
> Some of the money is lost as it is moved. This leak should not stop us
> from trying to redistribute,
> Okun argued, because we value equality. But because we are also
> concerned about efficiency,
> the leak will stop us before we fully equalize economic resources.
>
> The formal framework that modern economists use to address this issue
> is that proposed
> by Mirrlees (1971). In the standard Mirrlees model, individuals get
> utility from consumption C
> and disutility from providing work effort L. They differ only
> according to their productivity W.
> In the absence of government redistribution, each person’s consumption
> would be WL. Those
> with higher productivity would have higher consumption, higher
> utility, and lower marginal
> utility.
>
> The government is then introduced as a benevolent social planner with
> the goal of
> maximizing total utility in society (or, sometimes, a more general
> social welfare function that
> could depend nonlinearly on individual utilities). The social planner
> wants to move economic
> resources from those with high productivity and low marginal utility
> to those with lower
> productivity and higher marginal utility. Yet this redistribution is
> hard to accomplish, because
> the government is assumed to be unable to observe productivity W;
> instead, it observes only
> income WL, the product of productivity and effort. If it redistributes
> income too much, high
> productivity individuals will start to act as if they are low
> productivity individuals. Public
> policymakers are thus forced to forgo the first-best egalitarian
> outcome for a second-best
> incentive-compatible solution. Like a government armed with Okun’s
> leaky bucket, the
> Mirrleesian social planner redistributes to some degree but also
> allows some inequality to remain.
>
> If this framework is adopted, then the debate over redistribution
> turns to questions about
> key parameters. In particular, optimal redistribution depends on the
> degree to which work effort
> responds to incentives. If the supply of effort is completely
> inelastic, then the bucket has no leak,
> and the social planner can reach the egalitarian outcome. If the
> elasticity is small, the social
> planner can come close. But if work effort responds substantially to
> incentives, then the bucket
> is more like a sieve, and the social planner should attempt little or
> no redistribution. Thus, much
> debate among economists about optimal redistribution centers on the
> elasticity of labor supply.
>
>
> Even if one is willing to accept the utilitarian premise of this
> framework, there is good
> reason to be suspect of particular numerical results that follow from
> it. When researchers
> implement the Mirrlees model, they typically assume, as Mirrlees did,
> that all individuals have
> the same preferences. People are assumed to differ only in their
> productivity. For purposes of
> illustrative theory, that assumption is fine, but it is also false.
> Incomes differ in part because
> people have different tastes regarding consumption, leisure, and job
> attributes. Acknowledging
> variation in preferences weakens the case for redistribution (Lockwood
> and Weinzierl 2012).
> For example, many economics professors could have pursued
> higher-income career paths as
> business economists, software engineers, or corporate lawyers. That
> they chose to take some of
> their compensation in the form of personal and intellectual freedom
> rather than cold cash is a
> personal lifestyle choice, not a reflection of innate productivity.
> Those who made the opposite
> choice may have done so because they get greater utility from income.
> A utilitarian social
> planner will want to allocate greater income to these individuals,
> even apart from any incentive
> effects.
>
> Another problem with the Mirrlees framework as typically implemented
> is that it takes a
> simplistic approach to tax incidence. Any good introductory student of
> economics knows that
> when a good or service is taxed, the buyer and seller share the
> burden. Yet in the Mirrlees
> framework, when an individual’s labor income is taxed, only the seller
> of the services is worse
> off. In essence, the demand for labor services is assumed to be
> infinitely elastic. A more general
> set of assumptions would acknowledge that the burden of the tax is
> spread more broadly to
> buyers of those services (and perhaps to sellers of complementary
> inputs as well). In this more
> realistic setting, tax policy would be a less well-targeted tool for
> redistributing economic wellbeing.
>
> The harder and perhaps deeper question is whether the government’s
> policy toward
> redistribution is best viewed as being based on a benevolent social
> planner with utilitarian
> preferences. That is, did Okun and Mirrlees provide economists with
> the right starting point for
> thinking about this issue? I believe there are good reasons to doubt
> this model from the get-go.
>
> The Uneasy Case for Utilitarianism
>
> For economists, the utilitarian approach to income distribution comes
> naturally. After all,
> utilitarians and economists share an intellectual tradition: early
> utilitarians, such as John Stuart
> Mill, were also among the early economists. Also, utilitarianism seems
> to extend the
> economist’s model of individual decision-making to the societal level.
> Indeed, once one adopts
> the political philosophy of utilitarianism, running a society becomes
> yet another problem of
> constrained optimization. Despite its natural appeal (to economists,
> at least), the utilitarian
> approach is fraught with problems.
>
> One classic problem is the interpersonal comparability of utility. We
> can infer an
> individual’s utility function from the choices that individual makes
> when facing varying prices
> and levels of income. But from this revealed-preference perspective,
> utility is not inherently
> measurable, and it is impossible to compare utilities across people.
> Perhaps advances in
> neuroscience will someday lead to an objective measure of happiness,
> but as of now, there is no
> scientific way to establish whether the marginal dollar consumed by
> one person produces more
> or less utility than the marginal dollar consumed by a neighbor.
>
>
> Another more concrete problem is the geographic scope of the analysis. Usually,
> analyses of optimal income redistribution are conducted at the
> national level. But there is
> nothing inherent in utilitarianism that suggests such a limitation.
> Some of the largest income
> disparities are observed between nations. If a national system of
> taxes and transfers is designed
> to move resources from Palm Beach, Florida, to Detroit, Michigan,
> shouldn’t a similar
> international system move resources from the United States and Western
> Europe to sub-Saharan
> Africa? Many economists do support increased foreign aid, but as far
> as I know, no one has
> proposed marginal tax rates on rich nations as high as the marginal
> tax rates imposed on rich
> individuals. Our reluctance to apply utilitarianism at the global
> level should give us pause when
> applying it at the national level.
>
> In a 2010 paper, Matthew Weinzierl and I emphasized another reason to
> be wary of
> utilitarianism: it recommends a greater use of “tags” than most people
> feel comfortable with. As
> Akerlof (1978) pointed out, if the social planner can observe
> individual characteristics that are
> correlated with productivity, then an optimal tax system should use
> that information, in addition
> to income, in determining an individual’s tax liability. The more the
> tax system is based on such
> fixed characteristics rather than income, the less it will distort
> incentives. Weinzierl and I showed
> that one such tag is height. Indeed, the correlation between height
> and wages is sufficiently
> strong that the optimal tax on height is quite large. Similarly,
> according to the utilitarian calculus,
> the tax system should also make a person’s tax liability a function of
> race, gender, and perhaps
> many other exogenous characteristics. Of course, few people would
> embrace the idea of a height
> tax, and Weinzierl and I did not offer it as a serious policy
> proposal. Even fewer people would
> be comfortable with a race-based income tax (although Alesina et al.,
> 2011, propose in earnest a
> gender-based tax). Yet these implications cannot just be ignored. If
> you take from a theory only
> the conclusions you like and discard the rest, you are using the
> theory as a drunkard uses a lamp
> post—for support rather than illumination. If utilitarianism takes
> policy in directions that most
> people don’t like, then perhaps it is not a sound foundation for
> thinking about redistribution and
> public policy.
>
> Finally, in thinking about whether the utilitarian model really
> captures our moral
> intuitions, it is worth thinking for a moment about the first-best
> outcome for a utilitarian social
> planner. Suppose, in contrast to the Mirrlees model, the social
> planner could directly observe
> productivity. In this case, the planner would not need to worry about
> incentives, but could set
> taxes and transfers based directly on productivity. The optimal policy
> would equalize the
> marginal utility of consumption across individuals; if the utility
> function is assumed to be
> additively separable in consumption and leisure, this means everyone
> consumes the same amount.
> But because some people are more productive than others, equalizing
> leisure would not be
> optimal. Instead, the social planner would require more productive
> individuals to work more.
> Thus, in the utilitarian first-best allocation, the more productive
> members of society would work
> more and consume the same as everyone else. In other words, in the
> allocation that maximizes
> society’s total utility, the less productive individuals would enjoy a
> higher utility than the more
> productive.
>
> Is this really the outcome we would want society to achieve if it
> could? A true utilitarian
> would follow the logic of the model and say “yes.” Yet this outcome
> does not strike me as the
> ideal toward which we should aspire, and I suspect most people would
> agree. Even young
> children have an innate sense that merit should be rewarded
> (Kanngiesser and Warneken
> 2012)—and I doubt it is only because they are worried about the
> incentive effects of not doing so.
> If I am right, then we need a model of optimal government taxes and
> transfers that departs
> significantly from conventional utilitarian social planning.
>
> Listening to the Left
>
> In recent years, the left side of the political spectrum has focused
> much attention on the
> rising incomes of the top 1 percent. This includes President Obama’s
> proposals to raises taxes on
> higher incomes, the Occupy Wall Street movement, and a rash of books
> about economic
> inequality. Even though I don’t share the left’s policy conclusions, I
> find it is worthwhile to
> listen carefully to their arguments to discern what set of
> philosophical principles and empirical
> claims underlie their concerns.
>
> It is, I believe, hard to square the rhetoric of the left with the
> economist’s standard
> framework. Someone favoring greater redistribution along the lines of
> Okun and Mirrlees would
> argue as follows. “The rich earn higher incomes because they
> contribute more to society than
> others do. However, because of diminishing marginal utility, they
> don’t get much value from
> their last few dollars of consumption. So we should take some of their
> income away and give it
> to less productive members of society. While this policy would cause
> the most productive
> members to work less, shrinking the size of the economic pie, that is
> a cost we should bear, to
> some degree, to increase utility for society’s less productive citizens.”
>
>
> Surely, that phrasing of the argument would not animate the Occupy
> crowd! So let’s
> consider the case that the left makes in favor of greater income
> redistribution. There are three
> broad classes of arguments.
>
> The first is the suggestion that the tax system we now have is
> regressive. Most famously,
> during the presidential campaign of 2008, at a fund-raiser for Hillary
> Clinton, the billionaire
> investor Warren E. Buffett said that the rich were not paying enough.
> Mr. Buffett used himself as
> an example. He asserted that his taxes in the previous year equaled
> only 17.7 percent of his
> taxable income, while his receptionist paid about 30 percent of her
> income in taxes (Tse 2007).
> In 2011, President Obama proposed the “Buffett rule,” which would
> require taxpayers with
> income over a million dollars to pay at least 30 percent of their
> income in federal income taxes.
>
> There are, however, good reasons to be skeptical of Buffett’s
> calculations. If his
> receptionist was truly a middle-income taxpayer, then to get her tax
> rate to 30 percent, he most
> likely added the payroll tax to the income tax. Fair enough. But for
> Buffett’s tax rate to be only
> 17.7 percent, most of his income was likely dividends and capital
> gains, and his calculation had
> to ignore the fact that this capital income was already taxed at the
> corporate level. A complete
> accounting requires aggregating not only all taxes on labor income but
> also all taxes on capital
> income.
>
> The Congressional Budget Office (2012) does precisely that when it
> calculates the
> distribution of the federal tax burden—and it paints a very different
> picture than did Buffett’s
> anecdote. In 2009, the most recent year available, the poorest fifth
> of the population, with
> average annual income of $23,500, paid only 1.0 percent of its income
> in federal taxes. The
> middle fifth, with income of $64,300, paid 11.1 percent. And the top
> fifth, with income of
> $223,500, paid 23.2 percent. The richest 1 percent, with an average
> income of $1,219,700, paid
> 28.9 percent of its income to the federal government. To be sure, some
> taxpayers aggressively
> plan to minimize taxes, and this may result in some individual cases
> where those with high
> incomes pay relatively little in federal taxes. But the CBO data make
> clear that these cases are
> the exceptions. As a general rule, the existing federal tax code is
> highly progressive.
>
> A second type of argument from the left is that the incomes of the
> rich do not reflect their
> contributions to society. In the standard competitive labor market, a
> person’s earnings equal the
> value of his or her marginal productivity. But there are various
> reasons that real life might
> deviate from this classical benchmark. If, for example, a person’s
> high income results from
> political rent-seeking rather than producing a valuable product, the
> outcome is likely to be both
> inefficient and widely viewed as inequitable. Steve Jobs getting rich
> from producing the iPod
> and Pixar movies does not produce much ire among the public. A Wall
> Street executive
> benefiting from a taxpayer-financed bailout does.
>
> The key issue is the extent to which the high incomes of the top 1
> percent reflect high
> productivity rather than some market imperfection. This question is
> one of positive economics,
> but unfortunately not one that is easily answered. My own reading of
> the evidence is that most of
> the very wealthy get that way by making substantial economic
> contributions, not by gaming the
> system or taking advantage of some market failure or the political
> process. Take the example of
> pay for chief executive officers. Without doubt, CEOs are paid
> handsomely, and their pay has
> grown over time relative to that of the average worker. Commentators
> on this phenomenon
> sometimes suggest that this high pay reflects the failure of corporate
> boards of directors to do
> their job. Rather than representing shareholders, the argument goes,
> boards are too cozy with the
> CEOs and pay them more than they are worth to their organizations. Yet
> this argument fails to
> explain the behavior of closely-held corporations. A private equity
> group with a controlling
> interest in a firm does not face the alleged principal-agent problem
> between shareholders and
> boards, and yet these closely-held firms also pay their CEOs
> handsomely. Indeed, Kaplan (2012)
> reports that over the past three decades, executive pay in
> closely-held firms has outpaced that in
> public companies. Conqvist and Fahlenbrach (2012) find that when
> public companies go private,
> the CEOs tend to get paid more rather than less in both base salaries
> and bonuses. In light of
> these facts, the most natural explanation of high CEO pay is that the
> value of a good CEO is
> extraordinarily high (a conclusion that, incidentally, is consistent
> with the model of CEO pay
> proposed by Gabaix and Landier, 2008).
>
> A third argument that the left uses to advocate greater taxation of
> those with higher
> incomes is that the rich benefit from the physical, legal, and social
> infrastructure that government
> provides and, therefore, should contribute to supporting it. As one
> prominent example, President
> Obama (2012) said in a speech, “If you were successful, somebody along
> the line gave you some
> help. There was a great teacher somewhere in your life. Somebody
> helped to create this
> unbelievable American system that we have that allowed you to thrive.
> Somebody invested in
> roads and bridges. If you’ve got a business -- you didn’t build that.
> Somebody else made that
> happen. The Internet didn’t get invented on its own. Government
> research created the Internet so
> that all the companies could make money off the Internet. The point is
> that when we succeed,
> we succeed because of our individual initiative, but also because we
> do things together.”
>
> In the language of traditional public finance, President Obama was
> relying less on the
> ability-to-pay principle and more on the benefits principle. That is,
> higher taxation of the rich is
> not being justified by the argument that their marginal utility of
> consumption is low, as it is in
> the frameworks of Okun and Mirrlees. Rather, higher taxation is being
> justified by the claim that
> the rich achieved their wealth in large measure because of the goods
> and services the government
> provides and therefore have a responsibility to finance those goods
> and services.
>
> This line of argument raises the empirical question of how large the benefit of
> government infrastructure is. The average value is surely very high,
> as lawless anarchy would
> leave the rich (as well as most everyone else) much worse off. But
> like other inputs into the
> production process, government infrastructure should be valued at the
> margin, where the
> valuation harder to discern. As I pointed out earlier, the average
> person in the top 1 percent pays
> more than a quarter of income in federal taxes, and about a third if
> state and local taxes are
> included. Why isn’t that enough to compensate for the value of
> government infrastructure?
>
> A relevant fact here is that, over time, an increasing share of
> government spending has
> been for transfer payments, rather than for purchases of goods and
> services. Government has
> grown as a percentage of the economy not because it is providing more
> and better roads, more
> and better legal institutions, and more and better educational
> systems. Rather, government has
> increasingly used its power to tax to take from Peter to pay Paul.
> Discussions of the benefits of
> government services should not distract from this fundamental truth.
>
> In the end, the left’s arguments for increased redistribution are
> valid in principle but
> dubious in practice. If the current tax system were regressive, or if
> the incomes of the top 1
> percent were much greater than their economic contributions, or if the
> rich enjoyed government
> services in excess of what they pay in taxes, then the case for
> increasing the top tax rate would
> indeed be strong. But there is no compelling reason to believe that
> any of these premises holds
> true.
>
> The Need for an Alternative Philosophical Framework
>
> A common thought experiment used to motivate income redistribution is
> to imagine a
> situation in which individuals are in an “original position” behind a
> “veil of ignorance” (as in
> Rawls, 1971). This original position occurs in a hypothetical time
> before we are born, without
> the knowledge of whether we will be lucky or unlucky, talented or less
> talented, rich or poor. A
> risk-averse person in such a position would want to buy insurance
> against the possibility of being
> born into a less fortunate station in life. In this view, governmental
> income redistribution is an
> enforcement of the social insurance contract to which people would
> have voluntarily agreed in
> this original position.
>
> Yet take this logic a bit further. In this original position, people
> would be concerned
> about more than being born rich and poor. They would also be concerned
> about health outcomes.
> Consider kidneys, for example. Most people walk around with two
> healthy kidneys, one of
> which they do not need. A few people get kidney disease that leaves
> them without a functioning
> kidney, a condition that often cuts life short. A person in the
> original position would surely sign
> an insurance contract that guarantees him at least one working kidney.
> That is, he would be
> willing to risk being a kidney donor if he is lucky, in exchange for
> the assurance of being a
> transplant recipient if he is unlucky. Thus, the same logic of social
> insurance that justifies
> income redistribution similarly justifies government-mandated kidney donation.
>
> No doubt, if such a policy were ever seriously considered, most people
> would oppose it.
> A person has a right to his own organs, they would argue, and a
> thought experiment about an
> original position behind a veil of ignorance does not vitiate that
> right. But if that is the case, and I
> believe it is, it undermines the thought experiment more generally. If
> imagining a hypothetical
> social insurance contract signed in an original position does not
> supersede the right of a person to
> his own organs, why should it supersede the right of a person to the
> fruits of his own labor?
>
> An alternative to the social insurance view of the income distribution
> is what, in Mankiw
> (2010), I called a “just deserts” perspective. According to this view,
> people should receive
> compensation congruent with their contributions. If the economy were
> described by a classical
> competitive equilibrium without any externalities or public goods,
> then every individual would
> earn the value of his or her own marginal product, and there would be
> no need for government to
> alter the resulting income distribution. The role of government arises
> as the economy departs
> from this classical benchmark. Pigovian taxes and subsidies are
> necessary to correct externalities,
> and progressive income taxes can be justified to finance public goods
> based on the benefits
> principle. Transfer payments to the poor have a role as well, because
> fighting poverty can be
> viewed as a public good (Thurow 1971).
>
> This alternative perspective on the income distribution is a radical
> departure from the
> utilitarian perspective that has long influenced economists, including
> Okun and Mirrlees. But it
> is not entirely new. It harkens back about a century to the tradition
> of “just taxation” suggested
> by Knut Wicksell (1896, translated 1958) and Erik Lindahl (1919,
> translated 1958). More
> important, I believe it is more consistent with our innate moral
> intuitions. Indeed, many of the
> arguments of the left discussed earlier are easier to reconcile with
> the just-deserts theory than
> they are with utilitarianism. My disagreement with the left lies not
> in the nature of their
> arguments, but rather in the factual basis of their conclusions.
>
> The political philosophy one adopts naturally influences the kind of
> economic questions
> that are relevant for determining optimal policy. The utilitarian
> perspective leads to questions
> such as: How rapidly does marginal utility of consumption decline?
> What is the distribution of
> productivity? How much do taxes influence work effort? The
> just-deserts perspective focuses
> instead on other questions: Do the high incomes of the top 1 percent
> reflect extraordinary
> productivity, or some type of market failure? How are the benefits of
> public goods distributed
> across the income distribution? I have my own conjectures about the
> answers to these latter
> questions, and I have suggested them throughout this essay, but I am
> the first to admit that they
> are tentative. Fortunately, these are positive questions to which
> future economic research may
> provide more definitive answers.
>
> To highlight the difference between these approaches, consider how
> each would address
> the issue of the top tax rate. In particular, why shouldn’t we raise
> the rate on high incomes to 75
> percent, as France’s President Hollande has recently proposed, or to
> 91 percent, where it was
> through much of the 1950s in the United States? A utilitarian social
> planner would say that
> perhaps we should and would refrain from doing so only if the adverse
> incentive effects were too
> great. From the just-deserts perspective, such confiscatory tax rates
> are wrong, even ignoring any
> incentive effects. By this view, using the force of government to
> seize such a large share of the
> fruits of someone else’s labor is unjust, even if the taking is
> sanctioned by a majority of the
> citizenry.
>
> In the final analysis, we should not be surprised when opinions about income
> redistribution vary. Economists can turn to empirical methods to
> estimate key parameters, but no
> amount of applied econometrics can bridge this philosophical divide. I
> hope my ruminations in
> this essay have convinced some readers to see the situation from a new
> angle. But at the very
> least, I trust that these thoughts offer a vivid reminder that
> fundamentally normative conclusions
> cannot rest on positive economics alone.
>
> References
>
> Akerlof, George. 1978. "The Economics of ‘Tagging’ as Applied to the
> Optimal Income Tax,
> Welfare Programs, and Manpower Planning," American Economic Review,
> 68(1): 8-19.
>
> Alesina, Alberto, Andrea Ichin, and Loukas Karabarbounis,
> 2011."Gender-Based Taxation and
> the Division of Family Chores," American Economic Journal: Economic
> Policy, vol. 3(2): 1-40.
>
> Benjamin, Daniel J., David Cesarini, Christopher F. Chabris, Edward L.
> Glaeser, David I.
> Laibson, Vilmundur Guðnason, Tamara B. Harris, Lenore J. Launer, Shaun
> Purcell, Albert
> Vernon Smith, Magnus Johannesson, Patrik K.E. Magnusson, Jonathan P.
> Beauchamp, Nicholas
>
> A. Christakis, Craig S. Atwood, Benjamin Hebert, Jeremy Freese, Robert
> M. Hauser, Taissa S.
> Hauser, Alexander Grankvist, Christina M. Hultman, and Paul
> Lichtenstein (forthcoming).“The
> Promises and Pitfalls of Genoeconomics.” Annual Review of Economics,
> September 2012.
> Brynjolfsson, Erik, and Andrew McAfee. 2011. Race Against the Machine.
> Lexington, MA:
> Digital Frontier Press.
>
> Congressional Budget Office, The Distribution of Household Income and
> Federal Taxes, 2008
> and 2009, online report, 2012.
>
> Conqvist, Henrik, and Rudiger Frahlenbrach. 2012. “CEO Contract
> Design: How Do Strong
> Principals Do It?” Swiss Finance Institute Research Paper No. 11-14.
> Journal of Financial
> Economics, forthcoming.
>
> Gabaix, Xavier, and Augustin Landier, "Why Has CEO Pay Increased So
> Much?", Quarterly
> Journal of Economics, vol. 123(1), 2008: 49-100.
>
> Goldin, Claudia, and Lawrence F. Katz. 2008. The Race between
> Education and Technology.
> Cambridge, MA: Harvard University Press.
>
> Kanngiesser Patricia, and Felix Warneken. 2012. “Young Children
> Consider Merit when Sharing
> Resources with Others,” PLoS ONE 7(8): e43979.
>
> Kaplan, Steven N. 2012. “Executive Compensation and Corporate
> Governance in the U.S.:
> Perceptions, Facts, and Challenges,” NBER Working Paper No. 18395.
>
> Lindahl, Erik. 1958. “Just taxation--a positive solution.” In Richard
> Musgrave and Alan Peacock,
> editors, Classics in the Theory of Public Finance, Macmillan, London: 98–123.
>
> Lockwood, Benjamin, and Matthew Weinzierl, “De Gustibus non est
> Taxandum: Theory and
> Evidence on Preference Heterogeneity and Redistribution,” Harvard
> Business School Working
> Paper, 2012.
>
> Mankiw, N. Gregory, 2010. “Spreading the Wealth Around: Reflections
> Inspired by Joe the
> Plumber,” Eastern Economic Journal 36, 285–298.
>
> Mankiw, N. Gregory, and Matthew Weinzierl. 2010. "The Optimal Taxation
> of Height: A Case
> Study of Utilitarian Income Redistribution." American Economic
> Journal: Economic Policy, 2(1):
> 155–76.
>
> Mirrlees, James A. 1971. "An Exploration in the Theory of Optimal
> Income Taxation," Review
> of Economic Studies 38(2): 175-208.
>
> Obama, Barack. 2012. “Remarks by the President at a Campaign Event in
> Roanoke, Virginia.”
> July 13. http://www.whitehouse.gov/the-press-office/2012/07/13/remarks-president-campaignevent-
> roanoke-virginia
>
> Okun, Arthur, Equality and Efficiency: The Big Tradeoff, The Brookings
> Institution, 1975.
>
> Piketty, Thomas, and Emmanuel Saez, "Income Inequality in the United
> States, 1913-1998"
> Quarterly Journal of Economics, 118(1), 2003, 1-39, updated to 2010 on
> Saez’s website.
>
> Rawls, John. 1971. A Theory of Justice. Belknap Press.
>
> Sacerdote, Bruce, “How Large are the Effects from Changes in Family
> Environment? A Study
> of Korean American Adoptees.” The Quarterly Journal of Economics
> (2007) 122 (1): 119-157.
>
> Stiglitz, Joseph. 2012. The Price of Inequality. W.W. Norton and Company.
>
> Thurow, Lester. 1971. “The Income Distribution as a Pure Public Good,”
> Quarterly Journal of
> Economics 85(2): 327-336.
>
> Tse, Tomoeh Murakami. 2007. “Buffett Slams Tax System Disparities,”
> The Washington Post,
> June 27.
>
> Lockwood, Benjamin, and Matthew Weinzierl, “De Gustibus non est
> Taxandum: Theory and
> Evidence on Preference Heterogeneity and Redistribution,” Harvard
> Business School Working
> Paper, 2012.
>
> Wicksell, Knut. 1958 “A New Principle of Just Taxation.” In Richard
> Musgrave and Alan
> Peacock, editors, Classics in the Theory of Public Finance, Macmillan,
> London: 72-118.
>
> --
> Jim Devine /  "Segui il tuo corso, e lascia dir le genti." (Go your
> own way and let people talk.) -- Karl, paraphrasing Dante.
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Re: Mankiw defends the 1 percent

Raghu Mudumbai
In reply to this post by Jim Devine
On Sun, Jun 16, 2013 at 1:14 PM, Jim Devine <[hidden email]> wrote:
Defending the One Percent

N. Gregory Mankiw  June 7, 2013


Rebutting Mankiw, from The Economist of all places..
-----------------------------snip
The 1 percent needs better defenders

[...]

So why does Mr Mankiw pick three figures from the entertainment and computer industries, where everyone knows the "superstar" phenomenon is strongest? Because if he used examples from other industries, it would be even more difficult to convince the reader that the immense rewards being reaped by those at the top had anything to do with their unique contributions to the economy. Last year the highest-paid chief executive in the country, at $131m, was a guy named John Hammergren, who runs a medical and pharmaceuticals business called McKesson. If he hadn't been running McKesson, some other guy would have been. If Michael Vascitelli ($64m) hadn't been running Vornado Realty Trust, somebody else would have. Perhaps those other guys wouldn't have been as good at their jobs; in that case, these firms would have lost market share to competitors. So what?

The social purpose of high executive pay is to create incentives for hard work to maximise profit. But these guys are being paid double what their predecessors were making in the 1980s, which was not exactly a period known for its stodgy egalitarianism. Are we seeing startlingly better corporate performance today than we were back then? Is there greater productive innovation in, say, medical technology or commercial real estate? Is our economy growing faster? Are general standards of living rising faster? No, no, no and no. What public interest is served by the fact that these CEOs, as a class, are earning a multiple of what their predecessors did a generation ago?

Mr Mankiw's analogy stacks the deck by making it appear as though great creative entrepreneurs create the consumer demand which leads to inequality. This is not how things work. Inequality is rising for structural reasons that have nothing to do with the social value produced by the labour of the top one percent of earners. If the government were to, for example, return top marginal tax rates to the levels that prevailed in the 1990s or the 1970s in order to compensate for the superstar effect, there is no reason to believe that the top one percent would produce any less value for society than they do now. Mr Spielberg would likely have worked just as hard at 1970s tax rates as he does at 2013 tax rates; indeed, he did so when he made "Jaws". Similarly, Mr Jobs worked very hard on the Apple 2e in the 1970s and on the iMac in the 1990s, and Ms Rowling worked quite hard on the Harry Potter series even though tax rates in Britain are much higher than those in America.

To avoid accusations that I'm just picking out an ill-thought-out analogy while ignoring Mr Mankiw's main thrust, I'll add a few more points.  Mr Mankiw argues that the calculus of progressive taxation is based on a confused utilitarianism. Whether high tax rates discourage productivity among the top one percent is the wrong question, he writes. Redistribution as such is misguided, he thinks, because we don't have any good way to measure the increased utility which redistribution aims to create for low earners: "there is no scientific way to establish whether the marginal dollar consumed by one person produces more or less utility than the marginal dollar consumed by a neighbor." This is strictly true, but I can't see how it's relevant in any normal society, where such compromises are made every time a law entitles citizens to equal treatment without trying to determine each person's exact individual preferences. And it's a particularly strange point to make in a paper called "Defending the 1 Per Cent". We can be pretty sure that a dollar is worth more to someone who earns $30,000 per year than to someone who earns $3 million.

Mr Mankiw's preferred alternative is a "just deserts" theory, in which people should retain the value of their labour beyond whatever is needed to provide public goods and compensate for externalities and market failures. "Confiscatory" tax rates, he says, should be avoided. This is one reasonable approach, but at the least, it suffers from the same calculation problem as the utilitarianism he derides: how much is a "confiscatory" tax rate, exactly, and according to whom?

But I think the worst weakness in the paper comes in Mr Mankiw's brief treatment of the Rawlsian justification for redistribution. Rawls's argument is that if people were asked what kind of society they'd want to be part of, without knowing whether they'd be rich or poor (ie behind the "veil of ignorance"), they would choose one where the rich paid taxes to fund social insurance for the poor. Mr Mankiw objects that this approach would also probably lead people to choose a society with mandatory organ donation, since they wouldn't know whether or not they'd need an organ. He thinks this a serious flaw in Rawls's argument:

If imagining a hypothetical social insurance contract signed in an original position does not supersede the right of a person to his own organs, why should it supersede the right of a person to the fruits of his own labor?

Why indeed? And how come when I break your window it's just vandalism, whereas when I break your nose it's assault? Because your rights over your own body are more fundamental than other kinds of property rights, that's why. If Mr Mankiw is looking to dismiss the Rawlsian social-insurance argument, he's going to need a better argument than this.




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Re: Mankiw defends the 1 percent

michael perelman-3
Go easy on Mankiw.  After all, he was the first to discover that the McDonalds workers should be included as part of manufacturing.


On Tue, Jun 18, 2013 at 12:34 PM, raghu <[hidden email]> wrote:
On Sun, Jun 16, 2013 at 1:14 PM, Jim Devine <[hidden email]> wrote:
Defending the One Percent

N. Gregory Mankiw  June 7, 2013


Rebutting Mankiw, from The Economist of all places..
-----------------------------snip
The 1 percent needs better defenders

[...]

So why does Mr Mankiw pick three figures from the entertainment and computer industries, where everyone knows the "superstar" phenomenon is strongest? Because if he used examples from other industries, it would be even more difficult to convince the reader that the immense rewards being reaped by those at the top had anything to do with their unique contributions to the economy. Last year the highest-paid chief executive in the country, at $131m, was a guy named John Hammergren, who runs a medical and pharmaceuticals business called McKesson. If he hadn't been running McKesson, some other guy would have been. If Michael Vascitelli ($64m) hadn't been running Vornado Realty Trust, somebody else would have. Perhaps those other guys wouldn't have been as good at their jobs; in that case, these firms would have lost market share to competitors. So what?

The social purpose of high executive pay is to create incentives for hard work to maximise profit. But these guys are being paid double what their predecessors were making in the 1980s, which was not exactly a period known for its stodgy egalitarianism. Are we seeing startlingly better corporate performance today than we were back then? Is there greater productive innovation in, say, medical technology or commercial real estate? Is our economy growing faster? Are general standards of living rising faster? No, no, no and no. What public interest is served by the fact that these CEOs, as a class, are earning a multiple of what their predecessors did a generation ago?

Mr Mankiw's analogy stacks the deck by making it appear as though great creative entrepreneurs create the consumer demand which leads to inequality. This is not how things work. Inequality is rising for structural reasons that have nothing to do with the social value produced by the labour of the top one percent of earners. If the government were to, for example, return top marginal tax rates to the levels that prevailed in the 1990s or the 1970s in order to compensate for the superstar effect, there is no reason to believe that the top one percent would produce any less value for society than they do now. Mr Spielberg would likely have worked just as hard at 1970s tax rates as he does at 2013 tax rates; indeed, he did so when he made "Jaws". Similarly, Mr Jobs worked very hard on the Apple 2e in the 1970s and on the iMac in the 1990s, and Ms Rowling worked quite hard on the Harry Potter series even though tax rates in Britain are much higher than those in America.

To avoid accusations that I'm just picking out an ill-thought-out analogy while ignoring Mr Mankiw's main thrust, I'll add a few more points.  Mr Mankiw argues that the calculus of progressive taxation is based on a confused utilitarianism. Whether high tax rates discourage productivity among the top one percent is the wrong question, he writes. Redistribution as such is misguided, he thinks, because we don't have any good way to measure the increased utility which redistribution aims to create for low earners: "there is no scientific way to establish whether the marginal dollar consumed by one person produces more or less utility than the marginal dollar consumed by a neighbor." This is strictly true, but I can't see how it's relevant in any normal society, where such compromises are made every time a law entitles citizens to equal treatment without trying to determine each person's exact individual preferences. And it's a particularly strange point to make in a paper called "Defending the 1 Per Cent". We can be pretty sure that a dollar is worth more to someone who earns $30,000 per year than to someone who earns $3 million.

Mr Mankiw's preferred alternative is a "just deserts" theory, in which people should retain the value of their labour beyond whatever is needed to provide public goods and compensate for externalities and market failures. "Confiscatory" tax rates, he says, should be avoided. This is one reasonable approach, but at the least, it suffers from the same calculation problem as the utilitarianism he derides: how much is a "confiscatory" tax rate, exactly, and according to whom?

But I think the worst weakness in the paper comes in Mr Mankiw's brief treatment of the Rawlsian justification for redistribution. Rawls's argument is that if people were asked what kind of society they'd want to be part of, without knowing whether they'd be rich or poor (ie behind the "veil of ignorance"), they would choose one where the rich paid taxes to fund social insurance for the poor. Mr Mankiw objects that this approach would also probably lead people to choose a society with mandatory organ donation, since they wouldn't know whether or not they'd need an organ. He thinks this a serious flaw in Rawls's argument:

If imagining a hypothetical social insurance contract signed in an original position does not supersede the right of a person to his own organs, why should it supersede the right of a person to the fruits of his own labor?

Why indeed? And how come when I break your window it's just vandalism, whereas when I break your nose it's assault? Because your rights over your own body are more fundamental than other kinds of property rights, that's why. If Mr Mankiw is looking to dismiss the Rawlsian social-insurance argument, he's going to need a better argument than this.




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Michael Perelman
Economics Department
California State University
Chico, CA
95929

530 898 5321
fax 530 898 5901
http://michaelperelman.wordpress.com

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