New French Book on Growing Inequality

It sounds like Thomas Piketty, who is French, has written an important book about the trends of distribution of wealth and income in 20th-21st century economies, primarily in developed economies.  The general story is that the “natural” rate of accumulation of capital is on the order of five-six percent per annum, while the natural rate of overall growth in GDP in advanced economies is 1-1.5 percent annually.   Thus, without major changes in political institutions, inherited private wealth will dominate the societies in advanced economies by virtue of the tendencies inherent in them.

I was alerted to Piketty by this column in the NYT:

Questions that will have to await reading of the book include the following.  (1) How independent is the rate at which private capital accumulates of political institutions?  That is, the implication is that capital will accumulate, over the long run, at five-six percent annually, when redistributive mechanisms are below some threshold.  What is the threshold?  (2) How independent are the rates of capital and GDP growth from the rate of population growth?  This second question is almost certainly not addressed in the book, but, in general, I think that macroeconomics should attempt to incorporate demographic analysis.  More generally, I speculate that those who are interested in reducing inequality of wealth and income should also be interested in reducing the human population, both within advanced economies of larger nation states and globally.

An introduction to the book by Piketty himself on French television can be seen here:

Doug Henwood, often indispensable

Everyone should listen to this edition of Doug Henwood’s “Behind the News” (March 13, 2010).

First, you will hear one of the best interviews I have heard about the financial crisis.  The first interviewee is a woman who has written a new book about the financial crisis, and who blogs at Naked Capitalism, under the pseudonym of Yves Smith.  She had experience in investment banking on Wall Street in the 1980’s and now works as a financial consultant.  Everything she says rings true to me.

The second interview is with economist Robert Poland and is also quite good.

What are Obama’s core economic beliefs?

This just in from John Judis at “The New Republic,” Obama’s sympathies are really with Wall Street, not with Main Street. But I object to Judis’s own gloss on the old chestnut of comparing very high compensation in the business world with the very high compensation of athletes and entertainers. Judis makes the wrong argument. His argument is that banking is not analogous to professional sports for various reasons. This might in principle be a reasonable argument, but I don’t think that it is. The better argument is to say that the very high salaries are not justified anywhere, not in business, not in professional sports, not in entertainment. That is my position. One has to rebut the whole presumption of payment according to product that undergirds the free-market ideology. “The market” makes all kinds of crazy distributive decisions. The people who happen to benefit most tend to benefit from particular regulatory constraints and barriers to entry that are the opposite of a free market.

I just heard Woody Allen say to Terry Gross on “Fresh Air” that he never understood why entertainers are paid so much compared to teachers, but he confesses that he has never protested about this fact, since he has profited greatly from it. In any event, one has to distinguish two claims from one another: (i) market prices are just; (ii) market prices are efficient, or Pareto-optimal, meaning that any change in market-determined prices would produce a lower GDP. A lot of people seem to believe (ii), without believing (i). Obama may be such a person. I believe neither (i) nor (ii). If we cut the after-tax income of the highest paid people in America, say anyone with over $1,000,000 in annual wage and salary income, by 50%, the people themselves would not suffer much, and the economy as a whole might benefit. It’s not as though people would stop working extremely hard to become movie stars, professional athletes, CEO’s, and investment bankers, if the compensation at the top of the competitive pyramid in these fields were cut in half. I don’t think it would affect the pool of people interested in these professions, except perhaps very marginally, and I don’t think it would affect the effort expended by the pool.

Judis’s article does raise a very troubling doubt about Obama’s principles, however, and I am certainly coming to call into question my enthusiasm for the man.

Doug Henwood Speaks for Me

in his introductory editorial for the edition of January 21, 2010. Those not familiar with Henwood should check him out. A leftist with a brain, who began adulthood as a graduate student of comparative literature at Yale. I don’t share his taste for punk rock, but his book about Wall Street is quite good. He is usually well worth listening to.

Mankiw on repealing the estate tax

Gregory Mankiw, Professor of Economics at Harvard and former Chairman of the Council of Economic Advisors under George W. Bush, gave a speech to the National Press Club in 2003 in which he advocated abolition of the estate tax.  This post provides my attempt to rebut his speech.  The post is organized to correspond to the organization of the speech.

1                    Incidence

“Under what circumstances would the estate tax actually fall only on the decedent? That would happen if the tax prompted the decedent to reduce his consumption during his lifetime, so that he could satisfy the tax obligation without diminishing the after-tax bequests left to his loved ones. In other words, the estate tax would have to reduce lifetime consumption and promote estate accumulation.”

What is the contrary to this proposition?  It is that the estate tax completely discourages capital and estate accumulation.  But this is clearly false, so the truth of the matter is somewhere in between these two extremes.  Taxpayers who are likely to have an estate sufficiently large to fall under the estate tax do not reduce consumption during their lifetimes as much as would be necessary to increase their estate by an amount sufficient to allow their heirs to inherit some amount X, net of the estate taxes.  But even stating the matter in this way highlights an analytical problem.  It is that it is implausible that most people have a specific net amount X that they want to bequeath.  One might visit an estate planner, learn that the current bequest, net of estate tax under then current law, would be either higher or lower than desired, and make an adjustment in one’s behavior accordingly.  But then again, one might well make no adjustment, and much might depend upon how close death actually seemed at the time.

It seems highly likely that behavior in this regard varies with the size of estates.  That is, it might be more important to someone to leave at least $1,000,000, net of taxes, to all of his or her children than to leave $10,000,000 to each.  But perhaps not.  This is obviously a matter for empirical research, but it does seem likely that beyond some amount of wealth it becomes increasingly less important to decedents to bequeath some precise amount of money.  On the other hand, it will often be of paramount importance that a bequest enable heirs to retain control of a business or other important asset, such as some particular real estate or artworks, after having paid the estate tax.

Mankiw places particular emphasis on the fact that the incidence of the estate tax is not upon the decedent alone.  But who would ever have thought that this was the case?  To the contrary, virtually everyone who has a large enough estate to be subject to the estate tax, and virtually all the heirs of such people, are aware that the tax is being levied upon the heirs, not upon the decedent.  So I find this portion of Mankiw’s argument incoherent.  Yes, the incidence of the tax is upon the decedent by statute.  But no one looks at the actual incidence of the tax in this way, everyone is looking at the net estate available to heirs.  It is only the tax rate which is determined by the estate and not by the economic situation of the heirs.

Mankiw is correct to say that heirs are often less wealthy than decedents, but this fact would tend to make the tax more progressive than if tax rates were based upon the situation of the heirs and not upon that of the estate.  One of the primary purposes of the tax is to reduce the amount of capital accumulation in a small number of hands.  Or, if people are to become wealthy, they should do so by the fruits of their own labor, not by virtue of the labor of their ancestors.

“What would happen if we allocated the estate tax burden to heirs rather than decedents?”

The tax would be somewhat less progressive than it is, as just noted.  That is, on balance, the incidence of the tax would fall more upon less wealthy people who might be in lower marginal tax brackets than is the estate.

“The flaws in the distributional analysis of the estate tax also apply to analyses of capital income taxation in general, including the corporate income tax and the taxation of capital gains and dividends under the individual income tax. The burden of these taxes is almost always assumed to fall on the owners of capital. The burden shifted to labor is generally ignored.”

Mankiw maintains that, insofar as the estate tax discourages accumulation of capital, it is actually in part a tax upon labor, since labor will be less productive than it would otherwise be for every theoretical increase in the overall capital stock.  This assumes that (i) all increases in capital stock lead to greater productivity of labor and (ii) the fruits of greater productivity of labor are distributed to labor.  There is probably some truth in this line of reasoning, but not as much as Mankiw would have us believe.  One has to ask oneself whether the estate tax has really led to a perceptible decline in America’s capital stock in the first instance, and, second, whether labor tends to receive a large percentage of increases in productivity, which are presumably distributed between capital and labor.

2              Revenue effects

“The estate tax encourages people to take avoidance actions, such as making gifts to their children. Since their children are almost always in lower tax brackets, these gifts reduce income tax collections. Repealing the estate tax would remove the incentive for such gifts and would thereby boost income tax revenues.”

Almost certainly true.  An empirical question.

“Consider the story of twin brothers – Spendthrift Sam and Frugal Frank. Each starts a dot-com after college and sells the business a few years later, accumulating a $10 million nest egg. Sam then lives the high life, enjoying expensive vacations and throwing lavish parties. Frank, meanwhile, lives more modestly. He keeps his fortune invested in the economy, where it finances capital accumulation, new technologies, and economic growth. He wants to leave most of his money to his children, grandchildren, nephews, and nieces.”

Mankiw goes on to argue that the government should not be penalizing the frugal brother, who is contributing to capital accumulation, more than the spendthrift brother.

But, in the first place, is it obvious that the government is penalizing the frugal brother more than the spendthrift, simply because there is an estate tax that will fall upon the frugal brother?  We have already established that the tax falls upon the heirs of the frugal brother, not upon the frugal brother himself, so there is a sense in which he is not being penalized at all.  Secondly, the spendthrift brother has presumably been paying higher income, sales, and property taxes than the frugal brother throughout their lifetimes.  It is just with respect to the estate tax itself that the frugal brother is penalized, relatively speaking, and even here, it is his heirs who are penalized directly, not he himself.  So this whole line of argument, of which Mankiw appears to be particularly proud, because he restates it in a blog post of 2006, is quite weak, in my opinion.

To make matters worse, nowhere in the course of this speech does Mankiw even mention the disincentive to work exerted upon heirs to estates by their inheritances.  There is presumably no easy way of measuring this effect, but it is an obvious effect that most people who have known trust-fund babies have observed.  How can we know how much capital accumulation is lost due to such disincentives?

Moreover, Mankiw would apparently have us believe that government revenues make no contribution to capital accumulation in the society.  That is, implicit in his argument is the idea that money bequeathed to heirs leads to capital accumulation, while money raised by the estate tax is simply spent.  But obviously, government also leads to capital accumulation, in the form of both infrastructure and human capital formation.  So one would have to make a very difficult comparison between capital formation by heirs in the private sector and capital formation by government.

3               Conclusion

“The estate tax unfairly punishes frugality, undermines economic growth, reduces real wages, and raises little, if any, federal revenue.”

It is not clear that the estate tax punishes frugality at all, let alone that it does so unfairly.  The estate tax punishes frugality, if the basis of comparison is a world in which there are no federal taxes.  Otherwise, it is not clear, at least not from Mankiw’s speech, that frugality is penalized relative to its opposite.  It is even less clear that this is so when one realizes that the government revenues which are raised due to this hypothetical tax on frugality do not vanish into the ether.  They are themselves used for economic purposes, a portion of which include capital accumulation.

It is not clear that the estate tax undermines economic growth.  This assertion rests on two assumptions:  (i) capital accumulation will be greater in the absence of the estate tax and (ii) capital will be more productive in private than in public hands.  Not taken into account is the disincentive to work and entrepreneurship implicit in large private inheritances.  Even if it could be demonstrated that capital accumulation would be greater in the absence of the estate tax, it is not obvious that other social goals should not override this fact.  In particular, the goal of establishing a more equal starting point for economic competition than is provided in a society in which there are large intergenerational transfers of wealth might override any abstract economic advantage conveyed by greater capital accumulation.

It is not clear that the estate tax reduces real wages.  This is true if all of Mankiw’s assumptions are true.  But while the productivity or labor did rise in the period 1985-2005, say, in America, real wages did not rise for many people.  So even were it the case that abolition of the estate tax would lead to greater overall capital accumulation, and hence to greater productivity of labor, it is not obvious that this would produce higher real wages.  And it would still remain to be proved that the two assumptions are true.

Mankiw says that the estate tax raises little, if any, federal revenue.  This is the only part of his argument which strikes me as very likely to be true.  We know it is true in an absolute sense, because this tax accounts for a very small portion of federal revenues.  Mankiw argues that the estate tax largely represents income tax revenues that would otherwise have been collected if, for example, people did not make tax-free gifts to beneficiaries in lower income tax brackets than their own.  This would have to be tested empirically.

The remarkable thing is that Mankiw nowhere addresses the main goal of the estate tax, which is to make a gesture towards the goal of equality of economic opportunity.  The entire point of the tax is to reduce somewhat the amount of wealth that can be inherited and that gives some people, namely heirs, a distinct advantage in economic competition.  Inherited wealth conveys economic advantages while, simultaneously, acting as a disincentive to entrepreneurship in the class of heirs.  It cannot be known what the effects of the estate tax upon economic growth and economic accumulation are, if comparison is made to a society in which there is no estate tax, or to a society in which estate taxes are confiscatory.  I think the truth is that most people think that the estate tax has relatively little effect upon any of the things that Mankiw says he is worried about, viz. frugality, capital accumulation, and real wages.  What it does do, in its current form, is to provide some symbolic evidence that America does not believe in the unbridled accumulation of capital in private hands based upon the accidents of birth.

There are two principal oddities in Mankiw’s argument in this speech.  The first is that he implies that the savings or frugality effect of the estate tax is negligible, that wealthy people do not reduce consumption at all in order to provide for the tax liability that will fall upon their heirs.  But this seems very unlikely to me.  It is difficult to know what effects the estate tax has upon the consumption and savings behavior of wealthy people, but it seems to me virtually certain that there is a large “frugality effect,” especially towards the lower end of the spectrum of estates that are subject to the tax.  Secondly, but relatedly, Mankiw completely ignores the disincentive to work of inheritances upon heirs.  So the entire exercise seems disingenuous, if not dishonest.

Bob Herbert – The US Economy on the brink

I like Bob Herbert.  He mostly speaks for me in this column about America’s sinking economic fortunes.  I’m not too sure what would be so awful if America were to be like Germany – I guess Herbert means that America would be consigned to lower average growth in GDP.  Herbert says that America’s economic problems have been made worse by trade agreements, but does not specify what he means.  But Herbert’s tone of urgency and concern strike me as apt, and the long list of major problems awaiting solution seems equally apt.

A propos of nothing, I much prefer the earnestness of Herbert to the monotonous light-heartedness of Gail Collins, who nevertheless must be quite smart and who has just published a book about the changed place of women in American society since 1960 that sounds like it is well worth reading.  But I find the tone of her columns insufferable.  If she wrote in that tone 1/3 of the time, I could abide it.

Back to Herbert and my hobby-horse of the moment, America’s outdated constitution, it occurs to me that if there were a major movement of complaint about the excessive powers of the senate and the overrepresentation of a small part of the US population that the senate represents, then senators might be moved to behave differently, even if the constitution cannot be changed.  Civics textbooks should be rewritten in such a way as to make it clear that the powers of the unrepresentative senate are unusual in a contemporary democratic state.

The state of the Union is bad, continued

I am a self-identified progressive.  My favorite economists in the public arena are Paul Krugman and Robert Reich.  But I am also a deficit hawk.  Today, I received an email from Nouriel Roubini’s consulting business that addresses America’s likely long-term fiscal deficit.  The picture is bleak.  This is the main reason that I think America’s political system is broken.  There is an inability or unwillingness to address major problems that are known to be problems.  America simply cannot afford to continue to fund its current military spending levels, which should be reduced for both economic and political reasons.  A combination of tax increases and spending reductions should be passed.  On the spending side, neither entitlements nor defense can be sacrosanct, but in Obama’s proposed spending freeze, both are exempt.

Here are representative quotations from the Roubini group’s email (I receive only the free email and am not a subscriber to the paid service).  “…The fiscal deficit is likely to remain near US$1 trillion and exceed 5.0% of GDP over the next decade (and trend higher thereafter). Near-term spending on fiscal stimulus and defense will remain high at least until 2011, as Obama’s proposed three-year freeze on discretionary spending excludes defense and entitlements…Obama simply lacks the political support to implement aggressive fiscal reforms. The Senate recently voted against Obama’s proposals on spending freezes and the establishment of a fiscal commission, whose role would be to send fiscal reform legislation to Congress that would have to be voted on or thrown out without the possibility of amendments. Moreover, if policymakers extend the 2001 and 2003 tax cuts beyond 2011, when they are scheduled to expire, the impact on the fiscal deficit and U.S. fiscal credibility would be immense. Washington has not signaled strong support for wider tax reforms, such as introducing a value-added tax (VAT)… Despite the ticking fiscal bomb, mid-term and presidential elections in November 2010 and 2012 respectively will further constrain political will to undertake necessary reforms.”

As I recently posted, I believe that the senate has outworn its usefulness as an institution in its present form and that this anachronism is a deficiency of the US Constitution.   Towards the end of a recent bloggingheadstv conversation between Brook Lindsey of the Cato Institute and Mark Schmitt of “The American Prospect,” Lindsey, a libertarian/conservative,  characterizes the view that there is a structural polticial problem preventing necessary action to address the long-term federal deficit as a progressive one, and it is a view that he does not share.

If this really is primarily a progressive view, that seems odd to me.  It was only about thirty years ago that conservatives were proposing a new constitutional convention.   It is not odd that people who are deeply frustrated with political events should look to constitutional reform.  But it is odd that progressives are at least as worried about America’s long-term fiscal deficit as conservatives, if not more so.

Frank Rich deserves Pulitzer, gets Ledocsian

This piece by Frank Rich in today’s NYT is one of the best political columns I have ever read. It’s about, surprise, surprise, the need to reregulate the financial industry. This is the big story that is being neglected by almost everyone.

I would never have guessed that this former NY drama critic would become a truly great political columnist.  In recognition of his contributions to the general welfare to date in his capacity as political columnist, Frank Rich is the first recipient of the coveted Ledocsian, a nonmonetary, purely verbal award conferred by me upon the recipient.   Thank you, Mr. Rich.  If you did not exist, we would have had to invent you.

Wishful thinking or disingenuousness on the left?

I have been very remiss in my blogging over the past several weeks, but one of my resolutions for 2010 will be to make blog entries on a much more regular basis.  I have been counseled to make shorter blog posts, and I expect to take this advice in 2010.

On the year-in-review edition of “Left, Right, and Center,” Tony Blankley and Matt Miller, representing the right and the center, respectively, both said that they feared a secular trend of reduction in US wage levels due to foreign competition.  Robert Scheer, representing the left, demurred, saying that he thought the US continues to have good long-term economic prospects.


Scheer’s professed optimism on this point bothered me quite a bit, insofar as it might represent either naïvete or disingenousness on the left.  I was also bothered, and continue to be bothered, by assertions, such as that made repeatedly by Al Gore during his unsuccessful bid for the presidency, that there is no conflict between environmentalism and economic growth.  It does seem to me that US wages will be under downside pressure due to a worldwide overabundance of labor for the foreseeable future, and I remember thinking that this would be the case forty years ago, when I attended a conference of labor leaders at Penn State University.

Bob Herbert on youth unemployment

Good column by Bob Herbert in today’s NYT about the problem of youth unemployment in the US.

I have a niece who is a recent graduate from a very good (non-Ivy, not Berkeley) university who is working part-time in a Whole Foods kind of store.  France has been experiencing this youth unemployment problem for years, and it’s a very serious problem.  I saw a recent round-table discussion on CNN International with various US executives, the most talkative of whom was a financial genius named Fink, but Jack Welch was there, the current CEO of Pimco was there, the female head of Ogilvy and Mather was there.  They were talking about the financial crisis and its aftermath.  They were supposed to come up with ideas about how to get economic growth going again, but it was not a fertile plain for such ideas.  One often hears that America should learn to make things again, but one rarely hears what it should make, apart from electric cars and their accompanying batteries and solar panels.  A better traditional car is often mentioned also.  What one also never hears discussed is the distinct possibility that there is simply an international overabundance of labor – there are too many people, too many to provide professional jobs for all the people with professional qualifications.  I found this CNN round-table somewhat depressing.  While the executives were not stupid, apart from one Republican neanderthal with a shaved head, they did not strike one as profound thinkers either.  The guy from Pimco was not bad.

I want to give props to David Frum also.  On a recent edition of bloggingheadstv, Frum more than once referred to the problem that the US would likely have absorbing the most recent cohort of 18-24 year-olds into its workforce.   There are lots of people in this cohort, he says, who have very poor skills.  I am inclined to believe both parts of the hypothesis, viz. that there are a lot of kids with low skill levels and that it will be difficult for them to find jobs.  But Frum could have added the corollary discussed by Herbert in this column:  it’s also a very difficult environment for skilled young people.  In short, the US could be facing a very serious structural youth employment problem, comparable to the problem that France has had for years.  And, if this is so, it’s not a problem of French overregulation of the labor market, although that is presumably a contributing factor.

It is disappointing that one rarely hears economists discussing things like this.  Questions like this tend to devolve to sociologists and journalists.