Wrong on the Evidence; Wrong on the Theory

August 29th, 2011 at 5:05 am

I was just listening to a debate on tax policy on the radio, riffing off of Warren Buffett’s great op-ed from last week on how the tax code “coddles the rich.”  The conservative—doesn’t matter who; he was just running the talking points—made these arguments: 1) the rich pay most of the federal income taxes; 2) If Buffett or anyone else wants to pay more taxes, they should go ahead and do so; 3) the rich create the jobs, the wealth, the gov’t revenue—if you tax them more, they’ll create less of all that.

#2 is just silly.

#1 is true, but the thing to remember, and a central point of Buffett’s piece, is that they’re actually paying a considerably smaller share of their income in federal taxes than a) they have in the past (see slide #4 here) and b) then lots of other people with a lot less income.  Buffett notes that his 17% effective tax rate is about half the average rate for the rest of the people in his office.

But it’s point #3 I’d like to rage about here for a second.  One of the themes I’ve consistently come back to on these pages is the extent to which advocates go way beyond the evidence in assigning huge behavior changes to even the slightest changes in the tax code.

But the thing I and others don’t mention enough is that in theory, there’s no reason to expect people to respond to higher tax rates by working less.  That is, they could just as easily decide to work harder to make up the loss in their after-tax income.

Microeconomics predicts two responses to higher taxes on the work effort of people.  Response A is that they work less, because the “price,” or opportunity cost, of non-work, just went down…you lose less if, once your after-tax wage has gone down, you work less.

But the other response (B) is that you work more to make up for the lost income.* And there’s no reason, a priori, to think response A dominates response B.  If anything, the literature, which tends to show small responses to tax changes, suggests the two responses offset each other.

In other words, we would be wholly (holy?) justified to argue that we need to raise taxes on upper income people so that they’ll work harder!

*Interestingly, conservatives often argue that B dominates among the poor—cut their income from say, reducing the benefits from a welfare program, and they’ll work harder.  That’s much the same argument as response B above.

 

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24 comments in reply to "Wrong on the Evidence; Wrong on the Theory"

  1. Mary Heintz says:

    Could you please address the assumption that wealthy people create jobs? This does not seem intuitive to me.


    • perplexed says:

      I too would love to hear what’s what’s behind this myth and how it goes completely unchallenged. In stead of explaining that jobs are created as demand increases and more jobs are demanded to satisfy this increase (because it takes more work to satisfy more demand), this “job creation” myth has taken hold of our public discourse to such an extent that even the president seems to have swallowed the bait “hook, line, & sinker. So now we have this “fairy tale” of the beneficiaries of the disastrous failure of our tax system now being painted as our “little fairly job creators” who are performing this very much needed function of “creating jobs,” kind of like an artist “creating” a masterpiece; how quaint & even noble of them to go around “creating jobs” for us peasants. Oh, where would ever be without the dear souls and their TBTF banks?

      What would happen if we put an end to this myth and explained that the real “job creators” are people with increased incomes and high propensities to consume those incomes instead of saving them? Where might that lead? To even higher levels of income & wealth concentration? I doubt it. So what’s keeping the myth going? Obviously republicans and their wealthy benefactors love this story, but why do progressives buy into this madness? Maybe they just love a good fairy tale, or is the mystery that entices them? Looks more like a tragedy to me.


  2. Robert says:

    Jared,

    The federal tax system is part of a multi-purpose national social and economic policy. One of the purposes of taxes is to express public policy for the distribution of wealth and income. Given the wealth and income inequality in America is arguably at its apex, is that not sufficient reason alone to close the inequality gap through a more equitable federal tax policy?


  3. urban legend says:

    Why waste time on these preternaturally stupid arguments other than to heap ridicule on them?


  4. Arun says:

    It seems more likely that the people who successfully create jobs eventually become wealthy. I don’t think that people with inherited wealth, for instance, are particularly above average in creating jobs.


    • perplexed says:

      Unless, of course, the people who really “created” the jobs were the consumers that demanded more goods from the oligopolists controlling that particular market. As demand increases, these oligopolists face a choice: hire more workers or do the extra work yourself. We know how that always ends up.

      So who really should get the credit for “creating” the jobs? Saying that it must be the oligopolists because they got wealthy in the process is like giving credit to roosters for the sun coming up in the morning. This is the same myth Keynes dispelled over 70 years ago when people tried to claim that extreme wealth concentration was somehow beneficial to society. It was a myth then, it’s a myth now.

      Once we recognize who the real job “creators” are, maybe we can figure out how to help them instead of supporting the oligarchs who are pulling in the opposite direction.


  5. Alessandro Rosa says:

    Here is another point which discredits their argument. In the decade that we have had these lower rates of taxes we have lost jobs. Unemployment is up and underemployment is out of control. So if lower taxes create jobs then why have we seen the exact opposite be the case?

    What we have seen is 1) an increase in the income gap 2) an increase of cash on the balance sheets 3) stock buybacks which uses money which could go to increasing workforce to increase the wealth and control of small blocs of investors 4) a continued importing of labor through outsourcing ever more well paying jobs to lower cost countries.

    What truly boggles the mind is how deluded the majority of the electorate is. The President’s message has been, we will increase taxes on the fewest people possible so that we can actually get money back into the hands of the majority of the people and yet they choose to believe the Republicans and Conservatives who are basically offering them a Feudal System with none of the benefits of Noblesse Oblige that those Aristocratic systems had in them.


  6. Jim Gonyea says:

    I like that point. The apologists for wealth use the argument that reducing government entitlements will cause people to work harder, but use the argument that the wealthy will only work harde if the government provides them entitlements. If the wealthy are really so lazy then maybe they should move on to something else and allow some one else into the corner office.


  7. Geoffrey Freedman says:

    If there is an obvious opportunity to make money, people with the resources will invest unless the tax structure is totally oppressive, and it is not.

    Over time, tax rates cannot be directly correlated to economic expansion or contraction. There are just too many factors to the economy to correlate directly to one of those elements.

    The last point made in this blog (about how the poor react to less services) indirectly addresses issues in attitudes conservatives have to those who earn less or work less than they do. There are moral, ethical, and issues of integrity that are implied in these statements which correlate directly to the desire to dismantle the New Deal structures.


  8. Jeff H says:

    Jared,

    Like most rhetoric number 3 (the job creators will stop creating jobs if we take away their sugar) is pure BS!

    It’s even worse than the nonsense of a few years ago, the “Death Panels” as what was in the health care bill was so much that one could go about telling lies and they were hard to smack down. Number 3 is not.

    Anyone, sorry, everyone that has ever run a business knows, if you know you are going to taxed X amount on your profits unless you invest them in a tax negative way, you will invest your profits.

    If you know that you can avoid those taxes you will go to Vegas with your money. (nothing against Vegas)

    Oh, and if I hear one more time that we need to eliminate loopholes and lower tax rates to make those eliminations neutral I’m going to throw up. We need both, less loopholes, and higher marginal rates.

    If not, why bother?


  9. Ted says:

    One of the things that bugs me about those who rant against taxing the “job makers” is that CEO pay is inflated to begin with. The value in CEO compensation (or professional athletes, for example) is not their purchasing power but in signaling. At some point the number is just an abstraction and you just want to get paid more than the next guy. So, I say, tax them.


  10. Larry says:

    I haven’t seen anyone actually put it this way, but the supply-side argument that if you give rich people more money, they’ll create more jobs seems directly opposed to the same party’s argument against welfare–that if you give poor people money, they WON’T bother working for a living.

    Rich people do things like build factories and hire workers in order TO make money. If you just GIVE them the money without requiring anything in exchange for it, then you’ve short-circuited the process. Why should they do all the hard stuff to make a profit if they’re just given the money?

    So the next time someone argues that rich people will create jobs if you just give them more money, you might respond by asserting that poor people will seek jobs if you just give them more welfare checks. And when they disagree, ask what’s the difference.


  11. Larry says:

    …and had I read to the end of your column before jumping in, I would have seen that you DID directly address the point I was making here.

    Sorry for doubting.


  12. Dan Furlano says:

    Can someone point to something within the last 10 years that conservatives were right about when discussing the economy?

    Inflation
    Solvency
    Socialism
    Bond Markets
    Devaluation
    Debt/debit issues
    Taxes
    Unemployment

    I am sure I missed a few.


  13. Dan Furlano says:

    BTW;

    I think liberals have been equally wrong but much less vocal.


  14. bestliberalwriting says:

    This is wrong even if it is correct:

    ” the rich create the jobs, the wealth, the gov’t revenue—if you tax them more, they’ll create less of all that.”

    Why?

    Because if the rich aren’t hungry for more, there are a plenty of people who are starving for success, and will fill the void and pick whatever fruit they can.

    This is a sham argument put forward by oligarchs who don’t believe in capitalism.


  15. Ebenezer Scrooge says:

    Where the conservatives are coming from, they are absolutely right that cutting the income of the poor will induce the poor to work harder. People on the edge of starvation value bread far more than leisure. At least the ones who survive.

    In other words, conservatives believe that the poor deserve the labor economics of concentration camps, or the Donner Party. I’m not exaggerating. Read John Holbo’s classic post, on the labor economics of a genuinely smart conservative, David Frum: http://examinedlife.typepad.com/johnbelle/2003/11/dead_right.html


  16. jonathan says:

    The “job creators” idea goes hand in hand with another ideological, not empirical point: that what the economy needs, what makes it most optimal, is more freedom. This isn’t true: businesses function under constraints, of all sorts. The ideology claims there is a difference between a restraint imposed by the EPA and one imposed by poorly trained workers, lack of access to capital, etc. They make this claim based on extremes that only apply to the US in the most dogmatic application: the comparison of regulation with societies which don’t allow private property, where the means of production are owned by the state, or with those which tread close to that line. We know the first category. The 2nd is countries which impose massive bureaucracy on purchasing or disposing of equipment, countries like how India used to be. The ideology then extends restriction to mean “any restriction by government”. That’s nonsense.

    If you look at economic history – not to mention the present – constraint imposed by government is the norm for successful economies. The same goes with incentives offered by government.

    But the ideology drives toward a purity, a non-existent, unachievable state. Same goes with the weird idea that states matter and the federal government doesn’t. Putting aside the ancient arguments and then the Civil War, why? Why are states the sacred essence of America? The claim is made, without evidence, that we only need the federal government for defense. If you’re ideologically pure, why even that?


  17. Earl Moreo says:

    You left out the most obvious one of all. Continue to work about as diligently as before, because it is a comfortable pace for the income available.

    While The amount of work one does when one’s income is primarily from one’s work is unlikely to put him in a significantly high tax bracket, People whose total income WOULD put them in such a bracket probably get quite a lot of thet income from sources that don’t result from the amount or quality of the work they do.

    So if you earn $250K a year as a stock broker, but earn $2.5 million a year in bonuses, dividends, interest, stock options, and other emoluments, the fact that we now put that amount from $1 million to $2 million in a 50% bracket, and take half of it, and put the income from $2 million to $3 million in a 55% bracket, taking $275,000 of that, you are unlikely to work less diligently for your $250 k, because the job defines you and you aren’t likely to walk out on it. More likely, if you don’t like forking over the $775 k to uncle Sam, you might decide to instead invest in something. Investing in income producing entities puts you back in the funding uncle Sam category, so you need to invest in businesses that grow. So you invest $1 million of otherwise income in the next Micro Soft and help grow the company.

    Thus, in the case of your deciding not to get paid quite as much, you help provide jobs that didn’t exist so they can pay uncle their fair share.


  18. joe says:

    Where are the jobs under the Bush tax rates?

    private sector jobs – Bush vs Carter

    Jan 1977 65.636 million
    Jan 1981 74.671 million

    9.035 million private sector jobs created/3.28% a year

    Jan 2005 110.718 million
    Jan 2009 110.981 million

    263,000 private sector jobs created/.059% a year


  19. JimZ. says:

    JOHN Kenneth Galbraith, identified one of the great doctrines of our age as a belief that the rich don’t work because they have too little money, while the poor don’t work because they have too much. That is, the rich need more money as an incentive and the poor need less money as an incentive.


  20. 21law says:

    I’d love to see a detailed response to Golub’s WSJ piece (responding to WARREN B) that is so often cited … http://online.wsj.com/article/SB10001424053111903639404576516724218259688.html


    • Jared Bernstein says:

      I’ll try…for now, the key is to focus on the effective tax rate–tax liability as a share of income…it’s 17% for Buffett, about twice that for his staff. No one’s disagreeing that we need to deliver efficient gov’t services, but Golub first needs to explain what’s fair about that tax structure.


      • 21law says:

        Thanks Jared, I’ll watch for the long version of your take-down of Golub, who seems to me quite a phony. E.G.-how has he been leading the charge for the reforms/system he longs for…or has he been – – as I suspect – – a Republican who never worked for (let alone insisted on) what he now says are his preconditions to going along w/ WARREN B.


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