Social norms and macro labor supply estimates

Krugman has suggested that Ryan Avent and I look at the literature on labor supply elasticities.  Or perhaps, as Ambrosini suggests, just the half of that literature with which he agrees:

Today he says that Sumner and Avant should read the literature on macro vs micro labor supply elasticities. Well, ok, he says they should only read half of that literature. Over the last decade, Prescott has been doing a lot of work showing that differences in taxes explain differences in employment and hours worked between Europe and the US. I think his Nobel speech was about this.

The micro people threw fits though because their estimates of the response of labor supply to tax changes is much less extreme than Prescott’s finding suggest. They basically find labor supply curves are vertical. This would mean that taxes simply can’t have an effect on labor supply.

For a while, these guys had me convinced because, in general, micro/labor types do a much better job of identification and I trust their estimates more than I trust macro estimates. More recently, however,  macro people1 have been making the case that the “labor supply elasticity” estimated by the micro people is different from the “labor supply elasticity” the macro people estimate. The difference isn’t due to statistical methodology, we were just calling two different things the same thing.

Of course, its the macro elasticity that matters for tax policy, though. Prescott’s work (and not the paper that PK links to) is the place to go for understanding differences between Europe and the US. He says that difference is due to differences in tax and transfer policies.

I haven’t studied the recent literature in this field, although of course I was aware of the Prescott study.  But if Ambrosini is right I feel much less ignorant than I feared.  Back in the 1970s at Chicago we were taught that you needed to use income compensated supply and demand curves when examining tax policy.  I just assumed that everyone knew that when government collected taxes, the money was injected back into the economy through various means.  I guess this insight only recently reached certain segments of the profession.  Now of course the progressives that favor high taxes can always argue that the government expenditures go to activities that are so worthless that society is impoverished.  In that case people keep working hard for the same reason Bangladeshis work hard.  But I’m going to assume they don’t want to make that argument. 

This is from the Alesina, Glaeser and Sacerdote paper recommended by Krugman, which argues that institutional factors such as unions, and not taxes, explain the big difference in hours worked between the US and Europe:   

 
 

In a recent, provocative paper Prescott (2004) argues that “virtually all of the large differences between U.S. labor supply and those of Germany and France are due to differences in tax systems.” Prescott calibrates a dynamic model of investment and labor supply; and shows that under what appear to be reasonable assumptions about parameter values, all of the difference between the U.S. and the major European countries can be explained by different marginal tax rates. Indeed the marginal income tax rate differences between the U.S. and Europe were much smaller in the 1970s, when labor supply differences were much smaller. Prescott’s view is supported by the statistical evidence of Davis and Henreksson (2004) who use a panel of richer countries and find large labor supply responses to higher tax rates.
 
But Prescott’s argument that taxes explain U.S./Europe differences relies critically on assumptions that ensure an elasticity of labor supply that is hard to reconcile with most standard estimates of labor supply elasticities. In the case of male labor supply, we are not aware of any within-country estimates of labor supply elasticities that are even in the same ball park as those used in the Prescott’s calibration. For women, estimated labor supply elasticities are much closer to those used by Prescott (his assumptions still veer toward the upper limit of available estimates); however the reduction of hours worked is by no means a women-only phenomenon. Female labor force participation shows an increasing trend in most European countries since 1973 even though the U.S. shows an even faster growth of female participation; this is a case where the effect of marginal tax rates may indeed be very important. Prescott himself is well aware of this discrepancy between the traditionally estimated elasticities from “micro” evidence and the “macro” elasticity needed for his calibration exercise to work, but he offers little explanation of why the “micro” elasticities are wrong.
 
This paper examines two different hypotheses for the mismatch between macro and micro labor supply estimates. The same hypotheses also offer us different theories of the differences in hours worked between the U.S. and Europe. First, we consider the possibility that the macro-estimates are right in this context and the micro-estimates are misleading. Micro-estimates may be statistically correct, but they are inappropriate because they consider only the direct impact of taxation. One indirect effect of taxation is the government transfers that it funds. These transfers create an income effect that might induce lower work hours. This is one reason why Prescott’s elasticities are so high, but there is little evidence suggesting income elasticities of the level that his work assumes.  

My first reaction is that Ambrosini is right.  They write as if Prescott’s income-compensated labor supply estimates were some sort of novel innovation.  Again, the substitution effect is the only first order effect from tax changes.    My second reaction is to wonder whether micro estimates are particularly useful for macro analysis.  They talk about studies showing that labor supply doesn’t respond much to changes in unearned income.  But here’s my problem with those sorts of micro estimates; labor supply is partly influenced by all sorts of societal norms, which are ultimately determined (in the long run) by incentives such as MTRs.  Here are a few societal norms:

1.  The standard 40 hour work week.

2.  The standard retirement age of 65.

3.  Attitudes toward working mothers.

4.  The number of legal holidays.

5.  Attitudes toward young people who are indefinitely unemployed and living on the dole.

I once lived in England, and was shocked at how casually young Englishmen I knew would accept long term unemployment.  Now all of this might seem very unChicago-like.  But I am not saying that tax rates don’t affect labor supply, rather I am saying that the effects are probably mediated through quite complex mechanisms, some of which involve collective choice.  Go back to the unearned income example.  If a factory worker at GM inherits money from his aunt, and starts earning interest income, how easily can he go to GM and ask to be shifted from a 40 hour work week to a 35 hour work week?  And yet if every factory worker at GM had such good fortune, perhaps they’d ask their union to negotiate shorter hours.

If societal norms change slowly (partly because of “first-mover” problems), then I could imagine that countries with more collective bargaining might be able to more quickly move to the regulatory structure that is now optimal in light of higher tax rates.  This might involve changes in the standard retirement age, the number of official holidays, and/or the number of weekly hours worked at which overtime pay kicks in. This doesn’t mean taxes are not ultimately responsible for these collective decisions, just that an econometric study might not identify taxes as the proximate cause of changes in labor supply.  

But even if I am wrong and if the true causal factor is unions and other institutional structures, and not tax rates, does this really help the progressives’ argument regarding US fiscal policy?  I don’t see how, unless they can identify low union membership countries with very high tax rates and very high levels of hours worked.  But where are those examples? 

At first glance it seems more “scientific’” to try to isolate the effects of each causal variable, and to try to figure out what happens if we raise taxes and hold everything else constant.  But on closer inspection it isn’t clear that there is anything scientific about this approach.  Indeed I can imagine four possible interpretations for the AGS findings, only one of which supports the progressive agenda:

1.  The regressions suffer from an identification problem due to the social norms issue I mentioned, as well as other factors.

2.  Taxes are caused by the institutional factors that are associated with the Western European economic model.  And these are in turn caused by cultural differences, making it impossible to implement the economic model in the US.

3.  Institutional factors cause hours worked, and culture does not prevent the US from adopting the institutional structure of Western Europe.  But taxes are endogenous, and reflect the same forces that lead to things like strong unions.

4.  Taxes and institutional structure are both exogenous, and both can be determined independently. 

Case two we can’t adopt the European model for cultural reasons.  Case three says we can adopt the European model, but it is all or nothing.  Either we go whole hog into the European model that the progressives like, and suffer a big drop in GDP per capita, or we stick with our current model.  In that case the European model as a whole doesn’t produce significantly more tax revenue (PPP) per capita than the US model.  That’s the implication of Prescott’s work, and that would also be the implication of AGS’s study.  Only in case 4 do we get the policy implication that high tax rates in the US would not significantly reduce hours worked. 

Obviously it is possible to argue that we can have our cake and eat it too.  It’s theoretically possible that we could have high tax rates and continue to have high levels of hours worked.  But where are the successful examples of such a model?  Where are the countries that have European tax rates and US levels of productivity and hours worked?  If there are no such examples among the 200 countries in the world, then it is hardly “scientific” to claim we can choose such a model as casually as picking an item off a menu.  The truly scientific approach would be to assume everything is endogenous.

As I said in my first post on this issue, I think it might make more sense to view the entire progressive policy regime as a single choice:

Why is per capita GDP in Western Europe so much lower than in the US?  Mankiw seems to imply that high tax rates may be one of the reasons.  I don’t know if that’s the answer, but if it’s not my hunch is that the factors that would explain the difference are other government policies that the left tends to favor (strong unions, higher minimum wages, more regulation, generous unemployment insurance, etc.) 

Do we buy into the European model or not?  If we do, let’s not kid ourselves that we can avoid a big hit to GDP/person.

In contrast, I do have an ideal real world model in mind:  Singapore.  

BTW, Ryan Avent criticized me for cherry-picking Singapore as an example of a rich, low tax economy.  He pointed out that there are also rich metro areas in Western Europe, and I agree that that is a very good counter-argument.  But take a look at the astounding data on hours worked that commenter “mbk” sent me:

Labor productivity, GDP per hour worked in k$:

US 54.9
France 53.4
Germany 50.7
Singapore 25.0

That’s indeed because of k hours worked per employed person and year:

US 1.77
France 1.55
Germany 1.43
Singapore 2.45

(note 1 Japan is at 1.79 contrary to popular perception)
(note 2 re: Singapore I wouldn’t be surprised if family business work were to not even fully enter into the true hours worked by young and old on evenings and weekends)
(note 3 yes this means Singaporeans work almost twice as many hours as Europeans, and I’d assume a higher % of the population is in the workforce as well)
(note 4 this squares well with my anecdotal perception that everyone in Singapore works all the time)

Singapore productivity may be a bit higher than estimated—his data uses a fairly conservative PPP adjustment.  I have seen estimates where Singapore’s GDP per capita already exceeds the US.  But the hours worked is the real eye-opener.  Singaporeans, who face even lower taxes than Americans and Japanese, work far more hours each year.  And mbk also suggests a higher percentage of people may be working.  So even if one discounts the high income of Singapore as reflecting its status as a city-state, the hours worked provides strong evidence that the ultra-low taxes have an impact.  I doubt whether people work anywhere near that long in Paris, Frankfort or Milan.  And I’ll bet you’d also find extremely high hours worked in Hong Kong, the other developed country with tax rates far below US levels. 

[BTW, I know that there are developing countries with low tax/GDP ratios, but as I argued elsewhere they are "developing" for a reason.  They have all sorts of hidden implicit MTRs that discourage work effort.]

In another post I pointed out that Singapore was still growing faster than other developed countries.  Mbk’s data suggests why—they still haven’t caught up to the developed world in per capita productivity.  When they do, they will probably have extremely high per capita GDP.  And Singapore already has universal health care, despite the low tax rates.  One more piece of evidence that forced saving is a much more efficient way to finance social insurance than taxes.

I still have an open mind on the question of taxes and work effort.  But I tend not to put too much weight on dueling econometric studies.  Call me a luddite, but in my view it’s hard to beat the following:

1.  Find the best natural experiments you can.

2.  Get the appropriate descriptive statistics.

3.  Carefully think through the implications of various theories.

I almost never see conclusions reached this way overturned with fancy pants econometric studies.  But I often see the reverse.  I see sloppy thinking about the implications of theory.  I see people “disproving” the Quantity Theory by testing whether nominal income and money are cointegrated.  I see people testing the AS/AD model using unit root tests.  And I see people applying micro studies of labor supply elasticity to aggregate tax changes.  None of these tests are theoretically appropriate.

It might be fun to discuss counterexamples in the comment section.  What are the theoretical models that cannot be demonstrated with the judicious use of descriptive statistics?  Are there any?

PS.  Mankiw reached the same conclusion that I did:

There is a literature about how and why the European workforce differs from the American workforce—specifically, why Europeans enjoy spending more time at the café than Americans do and why we work harder than they do. There are many hypotheses out there. Olivier Blanchard says that it stems from cultural tastes (Blanchard, 2004): Europeans have more joie de vivre than Americans, and therefore, they want to enjoy their high productivity by spending more time enjoying leisure. My colleagues Alberto Alesina and Ed Glaeser say that it is the presence and scope of powerful labor unions in Europe that have negotiated shorter work weeks, more vacation days, and so on. But Ed Prescott tells us it is the high tax rates in Europe (Prescott, 2004), and I actually find this argument the most compelling.  

PPS.  It was a busy Easter so this post was rushed.  I will post updates to correct the errors that people will inevitably find.

HT:  Marcus


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25 Responses to “Social norms and macro labor supply estimates”

  1. Gravatar of Stuart Stuart
    4. April 2010 at 15:49

    you may be interested in this conference where Alesina discussed his work in light of the tax argument:
    http://www.aei.org/event/1146#doc

    note also in particular his comments about Krugman!
    http://www.aei.org/EMStaticPage/1146?page=Summary

  2. Gravatar of Thorfinn Thorfinn
    4. April 2010 at 21:48

    Here’s an interesting point from Stuart’s link:

    There is strong evidence that Americans have more capital intensive home production. For instance, they are more likely to have washing machines, and are less likely to have to go to the laundromat. In fact, a person under the poverty line in the United States has more of these consumer durables than the average Frenchman–therefore they have more leisure, since they are more efficient at home production.

    So even if the European outcome is the result of a different cultural treatment of work; they still don’t get more leisure. Bad for your theory, however, is this point:

    On the U.S. state level, there is no relationship between hours and taxes

    I’d like to see more research on this. Here in NYC, female labor force participation is very low; presumably in part due to huge MTRs.

  3. Gravatar of Will Ambrosini Will Ambrosini
    4. April 2010 at 21:49

    Rafael left a link to these (http://obs.rc.fas.harvard.edu/chetty/bounds_opt_slides.pdf) Raj Chetty lecture slides on this issue. Seems to be a definitive review and reconciliation of the recent literature. Start at slide 70 if you’re short on time.

  4. Gravatar of Tim Worstall Tim Worstall
    5. April 2010 at 00:19

    Speaking to just this point:

    “I once lived in England, and was shocked at how casually young Englishmen I knew would accept long term unemployment.”

    Richard Layard is one of the UK economists who has worked on long term unemployment. Part of the explanation:

    http://cep.lse.ac.uk/pubs/download/occasional/OP015.pdf

    “The rationale for welfare-to-work is simple. If you pay people to be inactive, there
    will be more inactivity. So you should pay them instead for being active – for either working
    or training to improve their employability.
    The evidence for the first proposition is everywhere around us. For example, Europe
    has a notorious unemployment problem. But if you break down unemployment into shortterm
    (under a year) and long-term, you find that short-term unemployment is almost the same
    in Europe as in the U.S. – around 4% of the workforce. But in Europe there are another 4%
    who have been out of work for over a year, compared with almost none in the United States.
    The most obvious explanation for this is that in the U.S. unemployment benefits run out after
    6 months, while in most of Europe they continue for many years or indefinitely.
    The position is illustrated in Figure 1. The vertical axis shows how long it is possible
    to draw unemployment benefit, and the horizontal axis shows how long people are actually
    unemployed, as measured by the percentage of unemployed who are out of work for over a
    year. The association is close, and it remains close even when we allow statistically for all
    other possible factors affecting the duration of unemployment.1″

    Now it’s possible to over egg this argument just as any other in economics. But this point would suggest that, for example, Ryan Avent’s recent noting of the way in which US unemployment has changed quite considerably in its duration recently (the proportion of unemployed who are long term rather than short term unemployed has risen strongly)might have something to do with the roughly quadrupling of time eligibility for unemployment benefits from 6 months to near two years.

    That is, that the US is alreasdy becoming more like Europe and not in a good way.

  5. Gravatar of Doc Merlin Doc Merlin
    5. April 2010 at 00:47

    “I’d like to see more research on this. Here in NYC, female labor force participation is very low; presumably in part due to huge MTRs.”

    There was some research that pointed towards easy access to driving and good roads as the determinant of female labor force participation. They found that the cities were the highest percent of public transport over road transportation also had the lowest female labor force participation.
    So, it could be government /spending/ not taxes which causes the lower working hours in europe and such

  6. Gravatar of aslak aslak
    5. April 2010 at 02:27

    Speaking as a European, I know that for me personally the reason I don’t work longer hours is union and overall labor market regulations but the plural of anecdote is not data etc.

    Here’s a question though – as I understand it the reason high tax rates is supposed to lower work hours is that they reduce the marginal rate of return on hours worked – less pay per hour means fewer hours worked. However, if this were true shouldn’t this work across countries as well – the richer the country, the higher the hourly pays and the more hours people work. I.e., there should be a correlation between after-tax hourly income and hours worked across countries. Is there any such research out there?

  7. Gravatar of aslak aslak
    5. April 2010 at 02:51

    Maybe I should explain exactly why I don’t work more hours. I think this one are where economic methodology fails because just running the numbers through an econometric model fails to capture some of the legal and social realities. So let’s take my example. I happen to be Norwegian (professional with office job) but most European countries have somewhat similar regulations.

    Norway has a 37.5 hour workweek. Now, personally I’d like to work more hours, both because I’m young and single and because by law overtime hours are paid at least 40% more than regular hours (at my job i get 50% more). There are also legal limits as to how many overtime hours you can work but that’s another issue. Now, this makes it very lucrative to work overtime and people tend to take the hours you can get but it also makes it very expensive for the employer. Therefore, instead of overtime, I get flextime, i.e. if I work long hours to finish something I get to take the equivalent time off later. This is a very common solution. Also, by law I have the right to five weeks of vacation in addition to various holidays – in practice including flextime there I end up getting 7-8 weeks of in total.

    Now, in other companies it is a lot easier to get overtime hours and in those cases people do work more. Anyway, my point is that it’s not the case that high tax rates causes to want to work less – but labor market regulations make it hard to work more even if you want to since it really is very lucrative.

  8. Gravatar of scott sumner scott sumner
    5. April 2010 at 04:37

    Stuart, I found this quote by Alesina to be perplexing:

    “Also, the implication of Steve Davis’s argument is that if taxes went down in France, there would be fewer vacation time in France–that there would be two weeks of vacation instead of six. I just do not see this happening–it is too much engrained in the culture.”

    And yet in his paper he argues exactly the opposite, that culture cannot explain the long vacations in France, as they worked just as hard as Americans in the 1960s. In my view the problem is that culture changes as economic incentives change.

    Thorfinn, That’s an interesting point about state variation. I suppose that taxes tend to be higher in more liberal states. On the other hand those are also the states that have cultures more accepting of working moms. So I suppose the two effects may offset each other. I wonder what the data in Washington state looks like? (A liberal state culturally, with no income tax.)

    Thanks Will, My basic argument is that these effects occur very slowly over time, and are mediated through changes in social norms. Thus micro studies of things like the 1986 tax bill might have trouble identifying long run elasticities. On the other hand cross-sectional studies of various countries would pick up long run effects.

    Tim, I completely agree, but two further points:

    I think that the effects of these incentives is greater over time. At first people tend to conform to the cultural norms about labor force participation. But over time it becomes more socially acceptable for a young man to remain unemployed for a long period. And this occurs precisely because more young men are remaining unemployed over a longer period. One of these papers mentioned that in Italy people tend to graduate from college at age 28. In American you’d be considered a deadbeat if you hung around that long. Unless, of course, everyone else was doing the same.

    The good news about unemployment comp is that it should go back to 26 weeks in the future (I hope) so the high unemployment ought not become structural, as in Europe.

    Doc Merlin, That may be another factor.

    aslak, The point I would emphasize is that taxes may be causal factors behind those other regulations that you mention. Also, personal introspection is a very poor way of estimating elasticities. If you ask every single smoker whether an extra one cent a pack tax on cigarettes would cause them to smoke less, they’ll all say no. But we know (from econometric studies) that it does cause people to quit. People respond more to price and tax incentives than they think they do.

  9. Gravatar of Doc Merlin Doc Merlin
    5. April 2010 at 04:57

    “And yet in his paper he argues exactly the opposite, that culture cannot explain the long vacations in France, as they worked just as hard as Americans in the 1960s. In my view the problem is that culture changes as economic incentives change.”

    I find myself in complete agreement with this point. Culture sort of form itself from a lot of things, one of which is the microeconomic incentives people have.

  10. Gravatar of Steve Steve
    5. April 2010 at 04:59

    Dear Scott,

    I have moved here with my comments, mostly because they are unrelated to anything what you write at the moment anyway.

    I was wondering about the time, when the Fed ended the stagflation of the 1970s, how would your NGDP policy have affected the economy during that time? Wasn’t the inflation-reducing efforts by Volcker harmful to the US economy at the time? Did it have to be that way?

    Best, S

  11. Gravatar of Mark A. Sadowski Mark A. Sadowski
    5. April 2010 at 05:10

    When we first started discussing Mankiw’s blog entry (how ever many posts back) I mentioned income elasticity of labor supply as an explanation of why taxes may not matter. I think this quote addresses the issue quite well:

    From the Alesina-Glaeser peper:
    “Micro-estimates may be statistically correct, but they are inappropriate because they consider only the direct impact of taxation. One indirect effect of taxation is the government transfers that it funds. These transfers create an income effect that might induce lower work hours. This is one reason why Prescott’s elasticities are so high, but there is little evidence suggesting income elasticities of the level that his work assumes.”

    The micro estimates of the elasticity are quite low and in fact zero to negative for very high income people. (This is intuitive because of the decreasing marginal benefit of income. Everybody, no matter how well paid, still only gets 24 hours in a day.) Thus those estimates imply taxes have little effect on hours worked. Alesina-Glaeser raise one explanation of why the micro estimates differ from the macro alludes to another issue: government transfers. I think this should (if it has not already) be evaluated separately at the micro level. It might explain some of the difference but I suspect not very much.

    Despite the fact I’m a macro person I still trust the micro research on this much more than Prescott. There are many reasons why people choose to work fewer hours, only one of which might be higher taxes.

  12. Gravatar of mbk mbk
    5. April 2010 at 07:28

    Honestly I think that empirical correlations aren’t very useful without an a priori hypothesis that makes some testable predictions. There are just too many factors that could lead to the same data. In any case to look for a single cause for the difference in working hours of “Europe” vs the US vs say Singapore, is probably hopeless.

    On the hypothesis side, I am a bit confused. Why would higher tax rates per se present an incentive for working fewer hours?

    - A strictly proportional income tax (flat tax) would simply be a proportional cost reducing net hourly wages. As a result if anything you’d expect people to work longer to make up for lower hourly income. The tax would be neutral towards working hours at best.

    - But income taxes are usually progressive. This might indeed discourage labour from working longer, since the net income suffers diminishing returns now. But counterexample, personal income tax is progressive in Singapore as well, going through steps of 0%, 3.5%, 5.5%, etc, up to 20%. True, the absolute income tax rates are low, and according to Singstat data 2007, of ca. 2.7 Mio employed in Singapore (resident and non resident) only about 850 k were even taxable. But the tax is still progressive, and Singaporeans are still working much longer hours than Americans or Europeans.

    - Mankiw had a post some time ago where he claimed that US labor suffers from _negative_ returns for the lowest towards mid-low incomes – from memory you had to jump the US$30000 hurdle before your returns from increased income became positive again (something to do with allowable relief claims, direct subsidies, and progressive rates). Now that kind of tax structure – and not the absolute tax level! – would indeed strongly discourage people from working longer hours but as we know, it doesn’t deter Americans from doing so anyway.

    - The only tax regime that would positively spur people on to longer working hours would be a fixed lump sum tax per worker (analogous to the “ship the good apples out” principle, a.k.a. the Alchian-Allen conjecture that fixed charges on goods favor the higher priced goods).

    The one thing that could indeed lead to lower reported working hours due to high (conventional, proportional) taxation in Europe is actually under-reporting. Anybody familiar with continental Europe labour habits will tell you that unreported (“black”) labour is rampant in many high labor cost countries. Professionals will clock in their standard hours for the company, and then either the company will have them work undeclared longer hours for cash, or more typically they will moonlight on their own account, sometimes with company tools. This is standard procedure in many highly developed Western European economies, and a much more realistic possibility than the coy assumption of increased “household productivity” in the reported Stiglitz paper. Estimates, from memory, range up to 20% of GDP additional unreported production in some European countries. Whether it works to explain away the total working hour difference, I doubt it.

    I see this labour intensity and productivity issue from the comparative advantage angle:

    - Income tax is a cost that drives down net wages on the worker’s side. It is not a direct cost to the company. So an increase in tax is neutral to the company cost and negative to the worker’s income. To increase income the worker can either work longer hours or move up the value chain, and increase his productivity (skills, education, job type). So high tax rates should either increase labour productivity due to skills upgrading, or possibly increase working hours in spite of progressive taxation.

    - Mandatory vacations however should have the opposite effect: they increase company unit labour cost (and hourly worker’s wages) while leaving the worker’s total wage as it is in the first order. In this case it is the company now that has a disproportional incentive to increase worker’s productivity. Aslak’s mention of high pay overtime being worse for a company than giving away free time off-season is an additional special case where the vacation time increases unit labour cost less than the overtime I presume.

    So, both high taxes and mandatory vacations taken together should increase productivity for the employed (while increasing unemployment due to losses of marginal employment). In my understanding neither can really explain low working hours per se except for the mandate of long vacations, by definition.

  13. Gravatar of OGT OGT
    5. April 2010 at 07:42

    That long work week may explain why Singaporeans report themselves to be so horribly miserable compared to other countries with similar incomes according to the cross national Gallup survey. Interestingly, thriving is positively correlated with being Nordic, not so much with being French or German, and definitely not with being Asian.

    The first chart linked below makes the GDP/Thriving connection:

    http://www.creativeclass.com/creative_class/2010/03/31/why-nations-struggle-or-thrive/

  14. Gravatar of mbk mbk
    5. April 2010 at 09:04

    OGT, the Singaporean happiness gap – who knows why… Again, so many confounding factors, it’s hard to pin it down. The Swiss also work a lot. An interesting tidbit I found is that community centered (read, East Asian, Confucian value system) cultures seem to fare more badly in well being scores, compared to individualist cultures. This also shows in your Gallup graphs, with Hong Kong, Japan, Korea et al, also faring badly. Apparently there is a large literature on the subject, and the current opinion is that the context dependent multiple views of identity in these cultures leads to less consistent self esteem, and high dependency on evaluation by others.

  15. Gravatar of D. Watson D. Watson
    5. April 2010 at 09:42

    On state data – it’s always possible that marginal effects are quite small, but larger effects are economically meaningful. 1 – If social/work norms prevent people changing their labor productivity much, the relatively small differences between state tax rates will not mean much compared to the large differences between European countries and the US. 2 – There could be a framing effects that people concentrate on their federal tax rates without pondering the added state burden, but that’s a behavioral argument I can’t prove. 3 – There could be industry effects, with different industries dominating in different states endogenously depending on the work/tax culture.

  16. Gravatar of OGT OGT
    5. April 2010 at 13:22

    mbk- I noticed that about other Asian countries as well, interesting to hear that this finding is consistent with other research. I was approximately half serious about Singapore’s relatively poor performance in self reported life satisfaction being caused by working so much. Both results could plausibly stem from the community based Confucian culture.

    But, since economics does most of its cost-benefit analysis in terms of GDP growth, looking at a measure like hours worked that is a strong covariant with GDP calls out for some other measure of well being to be considered. Otherwise I could read Sumner’s post and propose leisure tax on every hour spent away from one’s place of employment as a measure to increase your well being, as measured by GDP.

  17. Gravatar of Jim Glass Jim Glass
    5. April 2010 at 13:29

    “And yet in his paper he argues exactly the opposite, that culture cannot explain the long vacations in France, as they worked just as hard as Americans in the 1960s.

    “In my view the problem is that culture changes as economic incentives change.”

    The late, great Daniel Patrick Moynihan used the say that as far as societal behavior is concerned, the great conservative insight is that culture matters more than political policy, and the great liberal insight is that political policy can change culture.

  18. Gravatar of scott sumner scott sumner
    6. April 2010 at 05:16

    Doc Merlin, Yes, and many people overlook that fact. Culture doesn’t just change for no reason. People face different incentives, begin to adjust their behavior, and then the new behavior gradually becomes culturally accepted.

    Steve, There is an argument that reducing inflation might be less painful if there were an explicit NGDP target, level targeting. The Fed intended to reduce inflation gradually, but overshoot their target on the downside because of a big fall in velocity (they were targeting money.) Under NGDP targeting, if V falls then you increase M. But I don’t want to kid you into thinking it would be painless, just slightly less painful than the actual procedure.

    Mark, I’m not sure you are following my point. I trust the micro estimates, it’s just that they are answering the wrong question. Micro research looks at how people respond to changes in wage rates. I agree that the response is small. But that is a completely different question from the effects of taxes at the macro level. There is a big difference between income compensated supply curves and ordinary supply curves.

    mbk, You said:

    “On the hypothesis side, I am a bit confused. Why would higher tax rates per se present an incentive for working fewer hours?

    - A strictly proportional income tax (flat tax) would simply be a proportional cost reducing net hourly wages. As a result if anything you’d expect people to work longer to make up for lower hourly income. The tax would be neutral towards working hours at best.”

    Again, This is confusing an ordinary labor supply curve with an income compensated labor supply curve. The first order effects of taxes is not to reduce income, it is to reduce the trade-off between work and leisure. If you are familiar with indifference curves, it would change the slope of the trade-off, but not shift the curve. Alternatively, if you think in terms of consumption, then goods become more expensive and leisure becomes cheaper, with no change in the overall size of the consumption bundle. This will make people choose more leisure and less goods. Which is exactly what we observe.

    You said:

    “Mankiw had a post some time ago where he claimed that US labor suffers from _negative_ returns for the lowest towards mid-low incomes – from memory you had to jump the US$30000 hurdle before your returns from increased income became positive again (something to do with allowable relief claims, direct subsidies, and progressive rates). Now that kind of tax structure – and not the absolute tax level! – would indeed strongly discourage people from working longer hours but as we know, it doesn’t deter Americans from doing so anyway.”

    Agreed, but my hunch is that this is even worse in Europe. In Europe there are benefits that go to people if and only if they do not work. That is not a separate issue from taxes, it is part of the tax system. Money collect by the government doesn’t just vanish, it goes back to the public. That’s why there is no first-order income effect.

    You said;

    “So high tax rates should either increase labour productivity due to skills upgrading, or possibly increase working hours in spite of progressive taxation.”

    Just the opposite. Taxes discourage the formation of any kind of capital, including human capital. That is because returns on capital are double taxed.

    OGT, I seem to recall that Singapore scores higher than other East Asian countries on happiness surveys. I did some research on this a while back and looked at 5 Asian countries.

    The Nordic countries do score highly, I believe the key factor is liberal values (meaning utilitarian values.) Countries with more liberal or idealistic values score higher on happiness surveys.

    mbk#2, I agree that culture is important in explaining the Asian/Western difference. Indeed it is not even clear whether there is actually a difference in happiness, all we know is they answer survey questions differently. But in America it is much more socially acceptable to brag about being happy than in Japan. So culture might even bias how people answer such questions.

    Jim Glass, That is a great quotation.

  19. Gravatar of Thorfinn Thorfinn
    6. April 2010 at 12:10

    There’s a new Alesina paper on this:

    http://www4.gsb.columbia.edu/null/download?&exclusive=filemgr.download&file_id=733408

    The argument is that cultures with strong family ties end up with tighter labor restrictions to curb firm monopsony power.

    It’s interesting because it raises another social norm pathway: families can teach their kids the value of mobility if labor markets clear up. The Nordic countries have very loose family ties.

  20. Gravatar of mbk mbk
    6. April 2010 at 21:54

    Scott, granted that second order effects of taxes will mix with first order effects, and in addition there is a multi way interplay between cultural values, economic incentives, and taxation. But the argument has little explanatory value for the question of whether incentives lead or follow culture, since historically, culture and taxation can go either way, forth and back. So which factor is leading then? Note also, the French first introduced mandatory 2 week vacations and the 40 hour work week in the 1930′s, they didn’t wait until the 1960′s, when they reportedly still worked as hard as Americans did (I have no data on this).

    As to the first order effect. You said “The first order effects of taxes is not to reduce income, it is to reduce the trade-off between work and leisure.” Somehow this does not feel right. It just assumes a bit too much elasticity – why would people in one and the same country ever work similar hours for vastly different wages? And if the decrease in income through taxation is not a first order effect – before compensation, if any – then what # order effect is it?

    Granted the work/time trade off changes instantly together with the change in net wage (assuming no compensation in the first order effect). I thought hard about indifference curves but wouldn’t taxes make you move along the time/money indifference curve, rather than change the slope of it? And, do indifference curves really solve this question? If time and money were largely poor substitues to each other to begin with, which can be the case for cultural reasons or because of rigid labour laws preventing people from working excess overtime, then moving on one axis of the indifference curve does not move you much on the other axis. Granted again, of course they are to some extent substitutes, but depending where on the curve you start off (possibly in an already asymptotic region) an income tax might not move you into a significantly different trade off spot. How do you explain why say Americans would work 40-60 hours/week for yearly incomes of 20,000 – 20,000,000 , comparing the banker with the plumber? Clearly both are very indifferent to time in their sweet spot and both are not indifferent to money. If incomes can span ranges of 100,000%, why would a 10-20% change in income tax be a macroeconomic game changer and lead to proportional changes in hours worked?

    Productivity: my basic assertion is that high labour cost on the employer side drives productivity, for obvious reasons of competitiveness, and resource trade-offs between capital and labour cost. Increased productivity as second order effect then balances out with hourly wage rates. On the labour side returns may be diminishing with progressive taxation, but as long as they are still positive and not declining dramatically (sufficiently inelastic demand for income) I can still see how people would work long and productively all the same. How else would you explain that high tax Germany could conceivably have lower working hours (1430h/y) and higher productivity (GDP $50.1/h worked) than much lower tax countries of similar culture such as Switzerland (1642h/y; GDP $ 44.7/h worked)? (OECD data this time) Take smaller European countries similar to Switzerland: Sweden, Belgium, Austria, all monstrously taxed, all higher productivity than Switzerland (same OECD table). And low tax, education intensive, and capital rich Singapore is far below them all in productivity. Somehow these explanatory models leave too many counterexamples and open questions.

    Thorfinn, the idea of bringing family ties into this is interesting, even in the absence of formal legislation people might give family ties higher utility value, to use that concept, than money.

  21. Gravatar of Steve Steve
    7. April 2010 at 01:32

    “But I don’t want to kid you into thinking it would be painless, just slightly less painful than the actual procedure.”

    Scott, I am not sure I understand why it should be painful at all. Inflation expectations were high, so a reduction in inflation led to shortfalls in AD, is that right? But with an explicit NGDP target, inflation expectations should have switched immediately, thus, leading to some sort of new equilibrium right away. Why is there any painful prodcedure at all?

  22. Gravatar of scott sumner scott sumner
    7. April 2010 at 05:08

    Thorfinn, That is a very interesting paper. The hypothesis seems plausible. I doubt, however, that existing regulations are optimal.

    I think that if you surveyed Mexicans they would also oppose neoliberal reforms, but they still come to the US in the millions, despite that fact that it breaks up families much more severely than moving to the next town in Mexico. They vote with their feet for a more neoliberal labor market. But I wouldn’t deny that there is some truth to the Alesina paper. BTW, I think monopsony power is overrated.

    mbk, You ask:

    “And if the decrease in income through taxation is not a first order effect – before compensation, if any – then what # order effect is it?”

    At the macro level an increase in taxes does not reduce income, unless people work less. But those who think labor supply is inelastic deny that people will work less. Hence there is no (macro) income effect in that case. Some individuals may see a loss of income, but for each person losing someone else is gaining–hence no net loss.

    You asked:

    “How do you explain why say Americans would work 40-60 hours/week for yearly incomes of 20,000 – 20,000,000 , comparing the banker with the plumber? Clearly both are very indifferent to time in their sweet spot and both are not indifferent to money. If incomes can span ranges of 100,000%, why would a 10-20% change in income tax be a macroeconomic game changer and lead to proportional changes in hours worked?”

    In this case you have both the substitution effect and the income effect, and they roughly cancel out. Suppose the plumber inherited $20,000,000, but could still only earn $20/hour working. How many hours would he work in that case? I say zero. That’s the income effect w/o the substitution effect.

    Steve, The problem is that the policy might not be credible, and thus wages may still be a bit sticky. I agree that if the policy were credible, and wages were completely flexible, then there should be no cost at all.

  23. Gravatar of Steve Steve
    7. April 2010 at 08:11

    “I agree that if the policy were credible, and wages were completely flexible, then there should be no cost at all.”

    Scott, thanks for your reply!

    Do wages really need to be that flexible? If inflation expectations came down (due to a credible Fed goal), and would decline from say, 10% to 4%, then wages can be sticky, they just should not rise as fast. Or is that the problem, that a wage profile is specified years in advance?!

  24. Gravatar of mbk mbk
    7. April 2010 at 08:22

    Scott, I finally see where you’re getting at on the macro side – “Some individuals may see a loss of income, but for each person losing someone else is gaining–hence no net loss.”. Fair enough. I wasn’t thinking in that direction at all, I was focused on the various long run effects on the micro side.

  25. Gravatar of ssumner ssumner
    8. April 2010 at 05:30

    Steve, Even wage growth can be sticky. Back in 1980 workers at car companies used to sign big three year contracts with something like 10% wage gains per year built in. This was in anticipation of continued double digit inflation.

    But I do agree that slowing wage growth is easier than outright cuts in wages.

    mbk, Yes, It’s a hard point to explain, at least hard for me.

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