Quick reply to Ryan Avent

Ryan Avent criticized my recent defense of Mankiw:

That tax rates are driving the disparity in incomes is belied by the very data presented in Mr Mankiw’s initial post. His computation uses four economies with per capita incomes clustered closely together: France, Germany, Britain, and Japan. But while per capita outputs in those countries are very similar, the revenue shares of GDP are wildly different, ranging from 46.1% for France to 27.4% for Japan. And of the four, Japan’s per capita income is the lowest.

At no time did I argue that tax rates drove the disparity between the incomes of all countries.  Indeed I cited the Congo and Afghanistan as examples of how that could not possibly be true in all cases.  I also contrasted Italy and France.  Rather I suggested that the disparity between Western Europe and the US might be largely driven by different tax rates.  I’m not the only one who has made that suggestion, Prescott has done studies that reached similar conclusions.  I seem to recall that when French tax rates were at US levels (about 50 years ago I believe) the French worked just as much as Americans.  If so, then this would seem to conflict with the argument that greater European leisure time reflects cultural differences. 

Ryan Avent continues:

Mr Sumner tries to get around that by saying that if it’s not taxes, well then it must be some other favoured policy of the left. And:

“Further evidence for this hypothesis is that the few developed countries that do have much lower tax rates than the US (Hong Kong and Singapore) now have much higher per capita GDPs (PPP) than Western Europe.  Yes, they are small and urban, but Western Europe is full of small countries of about 6 million people that have less than 5% of the population in farming.”

True. But Norway and Luxembourg are richer than Hong Kong, Singapore, and America, and they have higher tax takes as a share of output. It’s almost as if it’s foolish to just cherry pick pieces of data on revenues as a share of GDP versus per capita GDP in order to make a point.

Well if Singapore and HK are unrepresentative, then Norway and Luxembourg are even more unrepresentative.  Everyone knows that Norway is just Sweden with lots of oil.  Take away the oil and Norway would probably be no richer than Sweden and Denmark.  Oil extraction isn’t really “income,” it’s running down a stock of wealth.  And Luxembourg?  Why stop there?  Let’s include all the rich postage stamp countries–Bermuda, Liechtenstein, Monaco, etc.  Then check out the average tax rates in all those tax havens against the bigger countries.  The 4.5 and 7 million people of Singapore and Hong Kong puts them in the mix with Denmark, Norway, Switzerland, Finland, etc.  Luxembourg only has a few 100,000 people.  Maybe it’s a cultural difference, but Americans just don’t consider it a real country.   Having said all that, although Singapore and Hong Kong are better examples than the two cited by Avent, I’ll freely admit that they aren’t ideal examples—they have probably skimmed some highly talented people from their bigger neighbors.  (I’d guess Luxembourg has as well.)  My post suggested Mankiw had a defensible argument—not an airtight argument.

Avent continues:

But then Mr Sumner gets really deep into it, citing Texas the epitome of the American economic model and arguing that it is especially dynamic and successful based on the fact that its population has been growing rapidly while Americans have been moving away from “states with fiscal policies more to the liking of progressives like Yglesias and Krugman”. Certainly, Texas has its upsides. I noted earlier today that better regulation of mortgage lending helped the state avoid a debilitating wave of foreclosures (I suspect that both Mr Yglesias and Mr Krugman would approve of said regulation).

There are multiple problems with these arguments, but I’ll stick with just two of them. First, Americans are moving to Texas, but they’re also moving to lefty bastions like Boston and San Francisco, both of which enjoyed net domestic in-migration from 2008 to 2009, according to brand new Census figures. That’s right, they’re moving to what some refer to derisively as “Tax-achusetts”, even with the comprehensive health insurance coverage.

Boston is actually a lousy example as we have had a fairly stable population for decades, while Texas has been growing very fast.  Avent should have mentioned NYC, which has gained substantial population despite an even worse tax structure than Massachusetts.  I agree that if areas have outstanding amenities (like NYC and SF, and to a much lesser extent Boston) then they can extract rents from highly skilled people who appreciate their sophistication and the ability to interact with other highly skilled people.  But if you compare equals—an uninteresting manufacturing city in New York state and/or Massachusetts with an equally uninteresting manufacturing city in Texas—then it is very clear where people are moving.

Ryan Avent continues:

The second point is that Mr Sumner should familiarise himself with an important body of literature on housing markets and migration. I’ll just briefly quote real estate economist, Massachusetts resident, and conservative Ed Glaeser:

“In the last 50 years, population and incomes have increased steadily throughout much of the Sunbelt. This paper assesses the relative contributions of rising productivity, rising demand for Southern amenities and increases in housing supply to the growth of warm areas, using data on income, housing price and population growth. Before 1980, economic productivity increased significantly in warmer areas and drove the population growth in those places. Since 1980, productivity growth has been more modest, but housing supply growth has been enormous. We infer that new construction in warm regions represents a growth in supply, rather than demand, from the fact that prices are generally falling relative to the rest of the country. The relatively slow pace of housing price growth in the Sunbelt, relative to the rest of the country and relative to income growth, also implies that there has been no increase in the willingness to pay for sun-related amenities. As such, it seems that the growth of the Sunbelt has little to do with the sun.”

Neither does it have much to do with the brilliance of the Texan economic model. Rather, it seems that housing supply growth in places like Boston can’t keep up with high housing demand, which has led””just as economics predicts””to rapidly rising house prices. And rapidly rising house prices””just as economics predicts””ration population growth. Price sensitive households end up following housing supply growth, of which there is a great deal in the state of Texas. To put things simply, if there weren’t a high level of demand for housing in those oppressive Northeastern cities, then prices couldn’t be held at a level so much higher than those in Sunbelt states. But the price differential remains.

Yes, I am very familiar with Glaeser’s work, but Avent is responding to an argument I never made.  I was touting Texas, not the Sunbelt.  Texas isn’t just doing better than its neighbors (Oklahoma, Arkansas, Louisiana, Mississippi, New Mexico, etc), it is doing dramatically better.  And all those states I just mentioned are warm and have plenty of available land and very low housing prices.  They also have income taxes, something Texas lacks.

Ryan Avent concludes:

To summarise: it’s often unwise to cite a few misleading data points in defence of a sweeping argument about economic dynamism.

My focus was the supply-side effect of taxes; I freely admit that lots of other government policies affect growth, and that Texas has some of those other good policies.  I believe that bad non-tax policies partly explain Japan (along with a very inefficient tax system.)  Here’s my challenge to progressives (not necessarily Avent, I don’t know his views.)  Progressives tend to be skeptical of the supply-side argument that higher taxes sharply cut real GDP growth.  Let’s suppose the US raises its average tax rates to French levels (from .282 to .461.)  Without behavioral changes, that increase should raise tax revenue (PPP) from $13,097 to $21,410.  Out of the hundreds of countries in the world I want some progressive to find just one that is bigger than a postage stamp and doesn’t rely heavily on oil exports, and which raises even close to $21,410 per person.  I claim it can’t be done, and I claim the reason it can’t be done is that (unless one is blessed with large oil deposits) the Laffer curve peaks at a level much lower than $21,410 (for whatever year Mankiw used in his data.)  My hunch is that Denmark and Sweden are near the peak.  And I doubt the US would even be able to match their tax take.  Apart from taxes, those two countries actually have pretty efficient economic models.

HT:  Dilip.  I guess my reply wasn’t so “quick.”

Tags: Taxation

This entry was posted on April 02nd, 2010 and is filed under Fiscal policy, Misc., Supply-side economics. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response or Trackback from your own site.