The Laffer Curve Refuted

Mike Kimel at Angry Bear has several nice posts on the "Laffer Curve" that underlies much of conservative economic orthodoxy in this country. As you may know, Art Laffer famously claimed that at tax rates of 0 and 100%, you would get zero tax revenue, and that in between, there is an inverted U shaped curve, where taxes collected first increase as the tax rate goes up, then decrease as tax rates go higher still, back down to zero tax collected when the tax rate is 100%.

The Kimel post linked above was prompted by an economist at the American Enterprise Institute, Alan Viard, telling the New York Times that all economists know that when the top tax rate is 35%, cutting rates further will reduce tax revenue.

“The Reagan tax cuts, on the whole, reduced revenue,” he explains. “The Bush tax cuts clearly reduced revenue. There is no dispute among economists about that.”

Except, as Kimel points out, lots of conservative economists dispute this, including one who co-authored a paper with Viard! For his trouble, Kimel became the subject of a post at the AEI blog by James Pethokoukis, which started by completely misidentifying him and going downhill from there. For Kimel's enjoyable takedown of this post, see here.

All this led me back to an earlier post of Kimel's, where he makes an empirical estimate of the Laffer Curve, using U.S. data all the way back to 1929, the first year for which official U.S. data exists. I'll spare you the technical details (see Kimel's post), but here's the bottom line: Laffer got it exactly backward, with tax revenue initially falling as tax rates increase, then rising after a further increase in rates. Here is Kimel's estimate of the "true" Laffer curve:




Not only that, as one of Kimel's commenters, Robert Waldmann points out, we actually have experience with a country having a top marginal rate over 100%, Sweden in the 1970s. Contrary to Laffer, not only was tax revenue not equal to zero, in 1975, Sweden's tax revenue was 41.3% of gross domestic product! (OECD statistics, click on "data by theme," then "public sector, taxation, and market regulation," then "taxation," then "revenue statistics - OECD member countries," then "comparative tables") 21.2% was central government revenue, i.e. excluding subnational government and social security. Either way, a long way from zero.

Not to belabor the point, but Viard was right about tax revenue after President Bush's tax cuts. Here is the OECD data for the federal government, excluding Medicare, Medicaid and Social Security. First we see the effects of President Clinton's tax increase, then President Bush's tax cuts.

Year          Tax/GDP

1992          10.7%
1993          11.0%
1994          11.3%
1995          11.7%
1996          12.2%
1997          12.7%
1998          13.1%
1999          13.2%
2000          13.5%
2001          12.5%
2002          10.4%
2003            9.8%
2004          10.0%
2005          11.2%
2006          11.9%
2007          11.9%
2008          10.4%
2009            8.4%
2010            9.1%

Source: OECD, directions as above for Sweden

Before you supply-siders get too excited about the increase in 2006 and 2007 to 11.9%, remember that the higher Clinton tax rates brought in more revenue for five straight years, 1996-2000.

Though many journalists get it wrong, chessplayers like myself know that "refute" means to conclusively disprove. And the Laffer Curve stands refuted.

U.S. has 18th best unemployment benefits in OECD; also trails 13 non-OECD countries

Tim Vlandas at EU Welfare States flags some important recent International Monetary Fund data on the generosity of a number of countries' unemployment benefits. The metric used is the gross replacement rate (GRR) the ratio of unemployment benefits to a worker's previous wages. The United States gives, on average, a miserly 27.5% of previous wages in unemployment benefits, behind 17 OECD members, though ahead of 11 others (no data was given for OECD members Iceland, Luxembourg, Mexico, Slovak Republic, and Slovenia). Not only that, the U.S. falls behind 13 non-OECD members, including Algeria, Taiwan, and Ukraine, all of which have at least double the replacement rate of the U.S.

Why is this important? As Vlandas points out,

A high replacement rate...ensures that the negative effects of rising unemployment on aggregate demand are mitigated. It also prevents workers from falling into poverty when they lose their jobs.

 Furthermore, the generosity of unemployment insurance interacts with the state of other employment protections. As regular readers of this blog will recall, the United States has the absolute worst employment protections in the OECD, by a large margin compared to most other members. As commenter Norm Breyfogle rightly noted in response to that post, if your protection from both individual and mass firings are weak, you really need good unemployment insurance. As the data here show, however, U.S. workers are not well-protected with unemployment insurance.

I won't reproduce Vlandas' entire table, but I will highlight the leaders and some other significant countries.

Country          GRR          Overall rank          OECD rank

Netherlands     70%                  1                         1
Switzerland      68.7%               2                         2
Sweden           68.5%               3                         3
Portugal           65%                 4                          4
Spain               63.5%              5                          5
Norway            62.4%              6                          6
Algeria             61.2%              7                         N/A
Taiwan             60%                 8                         N/A
Ukraine            56%                 9                         N/A

All the above countries give at least twice as much as the United States' 27.5%

Canada            45.9%             17                         11
Germany          35.3%             23                         14
Japan               28.9%             30                         17
United States    27.5%             31                        18
United Kingdom 18.9%             46                        27

To compare it in another way, according to an IMF working paper (Figure 1, p. 21), the average GRR for high-income countries in 2005 was about 38%, compared to the United States' 27.5%. U.S. workers get relatively low unemployment benefits compared to other industrialized countries.

Moreover, as I showed in February, the length of unemployment is at its longest since record-keeping started in 1947. The following FRED graph gives both the mean and median length of unemployment, both of which hit double their previous record in the current jobs recession.

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Thus, in a country where employment protections are weaker than in any comparable nation, and which  is still just below postwar records for length of unemployment, we face the additional problem of low unemployment benefits, a factor which exerts an additional drag on growth.

Top 1% Reduced Taxes in Last 3 Years but Probably Gained Income Share

Citizens for Tax Justice came out with a nice report today showing that the overall U.S. tax system is just barely "progressive," which is to say that as your income goes up, so does your tax rate. While the federal income tax is progressive in this sense, many state and local taxes, such as sales and property taxes are regressive in that lower income people pay higher percentages of their income than do higher income people. The following table from CTJ makes this crystal clear:



As the right-hand portion of the table shows, as income rises federal taxes (individual and corporate income, estate tax, etc.) increase as a percentage of income, from 5.0% of income for the lowest 20% of earners to 21.1% for the top 1% of taxpayers. Meanwhile, state and local taxes move in exactly the opposite direction, from 12.3% of income for the lowest 20% to 7.9% for the top 1%. As CTJ further points out, for every income group the share of total taxes they pay is extremely close to their share of total income (in fact, the biggest difference is 1.7 percentage points).

We already knew, thanks to Emmanuel Saez, that in 2010, the top 1% got 93% of all income gains. With the new 2011 data, we find that the top 1% has continued to make out like gangbusters. As I reported in August, using data from the conservative Tax Foundation, in 2008 the top 1% earned 20.00% of all income. As we see in the table above, just three years later that has grown to 21.0%. Considering that the 2011 data is estimated, perhaps this change is not too significant. But what is really striking is that the top 1% paid only 21.1% of its income in all federal taxes in 2011, whereas in 2008 it paid at a rate of 23.27% for personal income tax alone. Since the top 1% gets an even more disproportionate share of corporate income and taxable estate income than it does of personal income, this is solid evidence that it's a real reduction we are seeing. I hate to sound like a broken record, but it's really true that there is one tax system for the 1% and another one for the rest of us.

America Shows No Increase in College Graduation Rates over the last 30 Years

Jared Bernstein (via Paul Krugman) highlights an amazing breakdown in the prospects for reducing economic inequality any time soon. Over the last 30 years, the U.S. has made no progress whatsoever in increasing college graduation rates. To be specific, 25-34 year olds in 2009 had a college degree rate of about 40%, almost exactly the same as for 55-64 year old baby boomers. In the meantime, other industrialized countries were racking up substantial gains, most spectacularly in the case of South Korea where a little over 10% of 55-64 year olds have college degrees, but more than 60% in the 25-34 age group do. If you want to understand how South Korea has gone from a poor developing country to an industrial powerhouse within our lifetimes, this is one big reason.

Here are the overall results for OECD and select non-OECD countries for the two periods:



As we can see, the U.S. has fallen from a tie for second with Canada among current OECD members (Russia is not a member) to 15th in the OECD. The big question is why this is happening. One major reason is rising college costs, which have far outstripped overall inflation.

	Tuition and Fees
	Private Nonprofit Four-Year	Public Four-Year	Public Two-Year
1980-81 to 1990-91	5.1%	4.2%	3.9%
1990-91 to 2000-01	2.6%	3.3%	3.2%
2000-01 to 2010-11	3.0%	5.6%	2.7%

Note: Average annual rate of growth of published prices in inflation-adjusted dollars over a 10-year period. For example, from 2000-01 to 2010-11, average published tuition and fees at private four-year colleges rose by an average of 3.0% per year beyond increases in the Consumer Price Index. See link above for further data on tuition and fees plus room and board.

View Notes and Sources

As we can see, the rate of cost increase for public four-year universities was the most rapid of all. One big reason for that, of course, is reduced state support of higher education. Citing State Higher Education Executive Officers, the National Conference of State Legislatures reports that state appropriations per student, at $6928 in fiscal year 2009, was more than $1000 below its FY 2001 peak, and lower in real terms "than in most years since FY 1980" (p. 1). As Bernstein argues, Pell grants are one way to offset this problem, and he points out that the Obama administration has strengthened the program. However, the Ryan budget would slash Pell grants, among many other programs, in order to fund a tax cut for millionaires of almost $400,000, per Bernstein.

As Alan Krueger noted in January, there is a strong relationship between higher inequality and lower social mobility. The OECD data show that the U.S. is making no progress on one of the most important tools for social mobility, college. If access to higher education in this country actually declines, as it is threatening to do, our inequality problem will become infinitely harder to solve.

Romney Gets Incoherent on Pre-Existing Conditions

Mitt Romney was on the Jay Leno Show last night (via @didkins4life) and gave a completely incoherent account of whether people with pre-existing conditions should be able to get insurance. As the author of Massachusetts' health insurance reform as Governor, he was able to articulate the free-rider problem of people waiting to get sick to get insurance--which is why Romneycare and the Affordable Care Act have an individual mandate.

But Romney stumbled badly when Leno asked him what should happen to people with pre-existing conditions. If they had had insurance before, Romney said they should be able to get it again. (Note, however, he says nothing about how long ago they'd had insurance.) But if they never had insurance before, Romney gave what was essentially a non-answer: a) You can't play games like that; b) "But you have to find rules that get people in that are playing by the rules.” That, of course, would be a mandate, but he can't bring himself to say it because of primary politics and, as Greg Sargent points out, perhaps his own beliefs as well.

The alternative, though, is to do nothing for the uninsured who get sick. Romney did not rule that out, but merely tried clumsily to finesse it. As Mark Thoma says,

If we could make people pay the full cost of this wager that they won't need insurance, i.e. if society could turn it's back and say you made your choice, now live (or die) with it, a mandate wouldn't be needed. But we can't (and I wouldn't want to live in a society that could).

 I wouldn't want to live in such a society, either, which is why we need universal coverage. Though I'd prefer single payer, right now the Affordable Care Act's individual mandate is as close as we are going to get. Romney's repudiation of it is as hilarious (and depressing) as that of the Heritage Foundation. As a result, his plans for the uninsured look distressingly like what Alan Grayson called the Republican health plan: 1) Don't get sick. 2) If you do get sick, die quickly.

The Best Data on Middle Class Decline (Updated)

The flurry of posts earlier this month on middle class decline (me, Lane Kenworthy, Matthew Yglesias, Kevin Drum) made me think some more about what the best way is to show what's happened since the peak of real wages in the early 1970s. While in my opinion there is no perfect measure, there are a lot of choices to be made, and I argue below why real wages for production and non-supervisory workers, with an adjustment for non-wage compensation, is the best single measure.

Choice 1: Household/family vs. individual

While we all live in households or families, over the past 40 years, there has been a decline in persons per household (see Kenworthy) and an increase in incomes per household as women's labor force participation has increased. The decline in persons per household means that a household needs less income than in the past to have a fixed per capita income. The increase in incomes per household has meant that households have had higher real income even as real individual income has fallen, as pointed out by commenter peggy_Boston in the comments thread of Drum's article. To my mind, this is partly causal; that is, because real wages have fallen, families have had to have more incomes in order to maintain their living standards. Indeed, falling real wages have forced families to run up high levels of debt, with non-mortgage debt reaching 1/3 of family income by 2005. Therefore, I think individual data is the right choice here.

Choice 2: Median income vs. production and non-supervisory workers' income

The median (middle value, with an equal number of observations above and below it)  has big advantages over the arithmetic mean in trying to show the typical situation in a distribution of values. It is especially useful for income distributions, where the presence of very high incomes means that the mean is much higher than the median. In fact, the literature on "decoupling" (see Kenworthy above) demonstrates just how much this is the case. But I think that "production and non-supervisory workers" captures our intuition about who is in the middle class even better than the median does. This series, in Table B-47 of the Economic Report of the President, is an average of the earnings of employed persons in private (non-government), non-agricultural jobs. It includes about 80% of the private workforce and 64% of the total non-agricultural workforce. Despite being an average, its exclusion of supervisory workers means that virtually all of the extremely high values that distort the mean of the entire workforce are eliminated. It is, essentially, the mean income of the bottom 80% of private workers. The biggest drawback to this dataset is that it does not include non-supervisory government workers, but I think that is outweighed by its broader coverage of the middle class than the pure median income (or middle quintile, as in Kenworthy's post).

For the counterargument, that changes in composition of production & non-supervisory workers can cause distortions that the median wage is not subject to, see Dean Baker (p. 9).

Choice 3: Weekly vs. hourly

Baker mentions hourly earnings rates in some cases. As I discussed in the comments section of my March 11 post, the decline in hours worked per week (from 36.9 hours in 1972 to 33.6 hours in 2011) suggests to me that we need weekly, not hourly, wages.

Choice 4: Which inflation data to believe?

Shortly after President Clinton's first election, I predicted to my students that, because his message of middle-class stagnation ("It's the economy, stupid") was dependent on how inflation was measured, that conservatives would soon attack the official Bureau of Labor Statistics inflation data. The issue is, if inflation is overstated, then the decline in real wages reported by the BLS could be overstated or even non-existent. Conversely, if BLS data understates inflation, then real wages have fallen even faster than shown in Table B-47.

Unfortunately, I did not publish this prediction, so you'll have to take my word for it that I predicted the attack on inflation data that culminated in the Boskin Commission in 1995. I always took this to be a political attack rather than a scientific one. My attitude has always been that trade theory (i.e., the Stolper-Samuelson Theorem; see Ronald Rogowski's great book Commerce and Coalitions for an explanation of this topic, which I intend to discuss in a later post) predicts that real wages in a relatively labor-scarce country like the United States will fall as trade expands, and the data shows that real wages indeed fell: so what reason do we have to question the data? In the end, though, the Commission concluded that inflation was being overstated by about 1.1 percentage points a year, and the BLS was mandated to adjust its methodology.

Barry Ritholtz takes an even more jaundiced view of the Boskin Commission than I do. Paul Krugman, on the other hand, is not convinced that inflation is now significantly underreported, citing the work of the Billion Prices Project. For the moment, I do not see reason enough to toss out the BLS data, despite the possibility that the Boskin Commission may have introduced distortions into it.

Choice 5: Wages vs. compensation

Martin Feldstein and other economists argue that it is not sufficient to look at wages alone, because the non-wage share of compensation has been growing over the past few decades. As I posted before, total employee compensation includes everyone from the CEO to the janitor, so it overlooks the fact that the top 1% have made almost all the gains from decades of economic growth. Nevertheless, it is clearly true that non-wage compensation has grown faster than wages, as we will see below. In fact, Yglesias suggests that the 2000s actually saw real compensation growth at the median, but it was all in the form of health insurance benefits. Of course, there is some debate over how much value actually comes from extra employer payments for health insurance, as Baker's paper (p. 10) details

A different way to factor in compensation that I had seen before on the Economic Policy Institute's website was explained to me in an email by Jared Bernstein and is documented in the footnote of his blog post here. It takes the ratio of total compensation to total wages, both of which are in National Income and Product Accounts Table 1.12 (you can set it to a wider range of years, as I did). Whereas he applies it to median wages, I apply it to Table B-47 and get the following results:

Year          Weekly Real Earnings     Comp/Wages     Weekly Compensation
                  (1982-84 dollars)                                     (1982-84 dollars)

1972          $341.83                         1.14                   $388.01
1975          $314.75                         1.16                   $366.63
1980          $290.86                         1.20                   $348.93
1985          $285.34                         1.22                   $347.10
1990          $271.12                         1.21                   $328.99
1995          $267.07                         1.22                   $326.23
2000          $284.79                         1.20                   $341.49
2005          $284.99                         1.24                   $352.87
2010          $297.67                         1.24                   $370.28
2011          $294.78                         1.24                   $365.77

Note: Last two columns rounded from spreadsheet calculations

Sources: Economic Report of the President 2012, Table B-47, National Income and Product Accounts, Table 1.12, and author's calculations

 By this measure, compensation in 2011 for most workers was still almost 6% below its 1972 peak. The advantage of this adjustment over Feldstein's procedure is it strips out the wage inequality of the compensation data, although there is still some overstatement based on inequalities in non-wage compensation. Still, I think this gives us our most accurate picture of what's happening to the bottom 80% of workers.

That is not to say that this is a perfect measure even with those caveats. It matters what is happening at the top, too. If high wage earners were seeing their income fall faster than middle-class workers, then inequality would be falling and we would probably object less to what would then look like the much-vaunted "shared sacrifice." But of course, as Kenworthy notes, the share of the top 1% more than doubled from 1979 to 2007, from 8% to 17%. With inequality rising as it is, we now seem to be in danger of a consequent sharp shift of political power to the 1%, as MIT economist Daron Acemoglu told Think Progress' Pat Garofolo.

I look forward to your comments, especially if I've gotten something wrong.


UPDATE: By way of comparison, here is Lane Kenworthy's chart.

 

In it, you can see that by either median family income or 3rd quintile household income, incomes started rising shortly after 1980, whereas in my table compensation-adjusted real wages continued to fall until 1995. You can also see the divergence in median family income and Q3 household income between 2000 and 2007, as noted by Yglesias. Whereas the increase is made up entirely of nonwage compensation in the Q3 household income series, in my table at the individual level we have an increase made up partly of wages and partly of nonwage compensation.

Apple Whines About Having to Pay Taxes

On Monday, Apple announced that it was going to start paying dividends to shareholders, and buy back $10 billion worth of stock. What caught many people's attention in the subsequent conference call, however, was the company's pointed statement that it would not be bringing back any of the cash it holds overseas, estimated at $64 billion, or over 64% of its current cash on hand.

The reason, as stated by Chief Financial Officer Peter Oppenheimer, is that it would have to pay taxes on this money if it were repatriated to the United States. Apple made the money, so it owes taxes on it just like you or I would. But because the money was earned overseas (though realistically, some of it probably got there through transfer pricing), it can defer paying taxes on it until the money comes home. Taxes deferred are taxes reduced due to the time value of money, but that's not enough for Apple. In good Mitt Romney fashion, Apple is working with other companies to try to get the tax laws changed in its favor.What they want, as Carl Franzen of TPM points out, is a "repatriation holiday" that will allow them to bring back the money at a greatly reduced tax rate, as in 2004. Franzen notes:

However, in that 2004 experiment, pharmaceutical companies were the largest beneficiaries and although $312 billion was brought back into the U.S. by some 800 companies, most of the money was spent on dividends and stock repurchases, as Bloomberg and the New York Times both reported, referring to numerous studies. In fact, some of the companies that benefited the most from the 2004 tax holiday ended up laying off employees.

 Today, despite having just gone through the worst economic crisis since the Great Depression, U.S. multinationals now have over three times as much overseas as was brought back in 2004, some $1 trillion, according to Franzen's article. Apple's action Monday suggests that more dividends and stock repurchases would be the order of the day once again if they got their way.

According to Justin Fox, the $64 billion is "sitting in Apple's overseas subsidiaries..." This almost certainly means it is in Ireland: According to Apple's 2011 Annual Report (Exhibit 21.1), it has only two "significant" subsidiaries outside the country (and one significant subsidiary in the U.S.), both of which are in Ireland. Apple, then, is simultaneously benefiting from Ireland's tax haven status and the deferral provisions of U.S. tax law.

What should be done? I agreed with Citizens for Tax Justice in January that not taxing worldwide corporate profits would give companies even more incentive to make their profits show up overseas than they do now. Fox notes a similar argument from tax attorney Edward D. Kleinbard, who says that ending the deferral provision is the right way to go. That way, companies' income would be taxed in the year it was earned, and multinationals would get no benefit relative to domestic companies that don't squirrel away their profits overseas. It would go a long way to ending our current situation where there is one tax law for the 1% and another one for the rest of us.