You can’t redistribute income . . .

. . . but you can and should redistribute consumption.  Here’s Matt Yglesias discussing a recent post by John Quiggen:

John Quiggin makes the case that redistribution of income away from the top 1 percent is essentially the only thing that matters in American politics. After all, as Willie Sutton said, “that’s where the money is.”

I’m all for that, but I really do think it’s an unduly limited view of political life.

Income really is the Achilles heel of the progressive movement.  The income statistics simply don’t mean what progressives think they mean–something like “resources available for redistribution.”  If you want something closer to resources available, you’d use consumption, or wage income.  If you combine wage and capital income in the same aggregate, you are counting the same resources twice.  This is deeply counter-intuitive, yet all public finance economists understand this.  The policymakers in Nordic countries understand this.  But progressives don’t seem to understand this.  Even Paul Krugman, who must know better, keeps citing income distribution data, which is about as informative as examining the entrails of a chicken.

A rich guy with lots of income has three choices, consumption, savings/investment, and charity.  Let’s dispose of charity quickly.  Yes, we could redistribute the money Gates in spending on malaria in Africa, and give it to other Americans.  Would that be a gain?  I think everyone would say no.  On the other hand if a rich guy gives a lot of money to Princeton, to have his name on a building, perhaps that’s really a form of consumption.  I’m fine with treating it that way, if the tax authorities decide that’s the way to go.

But the real money here is obviously in the consumption/investment categories.  You can redistribute consumption from the top 1% and give it to average Americans working in a car factory, or a Walmart.  But it’s an illusion to think you can redistribute investment from the top 1%, so that average Americans can have a higher living standard.  Where do people think the car factory comes from?  Or the Walmart building?  BTW, this has nothing to do with trickle-down economics, a theory I reject.  This is simple accounting.  Money put into investment projects isn’t available to boost living standards for the lower classes, unless you don’t do those investment projects.

So what’s available to be redistributed?  Basically consumption (including a modest amount of vanity charity.)  And that’s it.  Now come back to me with the consumption distribution data, and let’s see what that looks like.  I predict that consumption inequality is far lower than income inequality.  And that consumption inequality is rising at a far slower rate than income inequality.  I’m not saying there’s no problem, but it’s way smaller than the progressives imagine, as the data they use is pure nonsense.  Consumption inequality is economic inequality.  Income inequality is . . . well it’s meaningless gobbletygoop.

This Will Wilkinson posts cites study after study supporting my consumption inequality claim.

I’m not trying to make an Ayn Randian argument here.  I favor 4 types of income redistribution, on utilitarian grounds:

1.  Education vouchers

2.  Catastrophic health insurance

3.  Government subsidy of HSAs for low income workers.

4.  Wage subsidies for low income workers, combined with abolition of minimum wages and occupational licensing.  Thus a single mom with two kids making $8 hour, might get a government subsidy of another $8 hour.  And someone making $16/hour might get a $4 hour subsidy.  But they have to be employed.  Have government jobs paying 1 cent per hour as a residual, for those claiming they can’t find a job.  Give them a $12/hour subsidy.

They would also get the other three subsidies discussed above.  As one’s income rose, one would get less and less of a HSA subsidy, but I’d probably make the education voucher and catastrophic insurance universal.  Importantly, I’d try to spend less on education than we do now.

You do all this redistribution with two consumption taxes; a VAT and a progressive payroll tax.  Plus perhaps some other taxes on efficiency grounds (carbon, land, etc.)  No personal or corporate income taxes, no forms to fill out.  K.I.S.S.

BTW, other than my quibble over “income,” I basically agree with the thrust of Yglesias’s post.

PS.  Oh, and get rid of the debt ceiling, for God’s sake.

Karl Smith, Matt Yglesias, and Greg Mankiw

Greg Mankiw linked to a post showing data for income inequality and tax progressivity.  Matt Yglesias argued that Mankiw is unreliable because the data he used is incomplete (income taxes only.  But actually it’s not just income taxes.)  Then Karl Smith presented the exact same data in the form of a graph rather than a table, and Yglesias praised Smith’s graph, while continuing to argue that Mankiw engaged in “malfeasance.”  I’m confused.  Here’s how Matt Yglesias interpreted the Smith chart:

 The rich pay a huge share of the total taxes in the United States because they have a huge share of the money.

But that’s not really what Karl Smith’s graph shows.  It’s not saying that if you make twice as much money you pay twice the taxes.  It shows something far more interesting, something that I was unaware of.  The graph shows that countries with more income inequality tend to adopt tax regimes with more progressivity.  I knew that was true between the US and Europe, but didn’t know it was also true within Europe.  That’s completely consistent with Mankiw’s (implied) claim that the US tax system is the most progressive.

PS.  The reason it shows progressivity related to inequality is that the line on Smith’s graph has a relatively flat slope.

Update:  On second thought  I may have erred in saying it was simply a function of the relatively flat slope; the intercept also matters.  Math isn’t my forte.

HT:  Commenter “example”

The marshmallow test

There are two kinds of people, those who eat one marshmallow, and those who eat two.  More specifically, The Economist reported:

FORTY years ago Walter Mischel, an American psychologist, conducted a famous experiment. He left a series of four-year-olds alone in a room with a marshmallow on the table. He told them that they could eat the marshmallow at once, or wait until he came back and get two marshmallows. Recreations of the experiment on YouTube show what happens next. Some eat the marshmallow immediately. Others try all kinds of strategies to leave the tempting treat alone.

Nothing surprising there. The astonishing part was the way that the four-year-olds’ ability to defer gratification was reflected over time in their lives. Those who waited longest scored higher in academic tests at school, were much less likely to drop out of university and earned substantially higher incomes than those who gobbled up the sweet straight away. Those who could not wait at all were far more likely, in later life, to have problems with drugs or alcohol.

I am a libertarian, but I am also a utilitarian, so I don’t really object to reasonable “nudge” policies like making the 401k plan the default option for new hires, or having banks warn people who rely too much on expensive overdrafts.

What bothers me is when I see attempts to redistribute wealth from the two marshmallow eaters to the one marshmallow eaters.  For instance, by the time I retire in 6 years I will have probably averaged about $80,000/year over my working life, which makes me comfortably upper middle class.  Because I am a two marshmallow personality, I’ve probably saved about half of that income.  So I’m doing fine.  Most Americans with similar incomes are one marshmallow types, and save something closer to 10% of their incomes.

What do we do if Social Security needs to be trimmed in order to balance the budget?  I hear lots of talk about cutting back on benefits for those who “don’t need it.”  That would be people like me.  Here’s why I don’t trust the Dems—I see them as the party of one marshmallow eaters.  They represent people who have less self-control.  I fear they will cut my benefits, but not cut the benefits of people who didn’t save for retirement.  I fear they will use “wealth” as the criterion to determine who is needy and who isn’t; not lifetime wage earnings.

In my view there is nothing egalitarian about redistributing income from two marshmallow eaters to one marshmallow eaters.  They’ve already had their fun when young, loading up their three car garages with all sorts of fun toys.  I’ve never even had a garage.

I’m not saying that the rich shouldn’t be the ones who accept cutbacks in Social Security to save the system, that is a defensible argument (although interestingly many progressives oppose the idea, hoping that Social Security doesn’t become seen as “welfare.”)  But if you are going to do means-testing, it should be on lifetime wage income, not wealth.  If they do that then I need not fear for my SS benefits, as most Americans who have averaged about $80,000 a year over their lifetime have not saved much, and would march on Washington if their SS benefits were cut back.

Update:  Commenter Edwin A pointed out that I shouldn’t have picked on the Dems.  I do think they are usually the one marshmallow party, but in this case many Dems oppose means-testing Social Security, and some conservatives support the idea.

If you are going to argue that people who make mistakes should be ostracized . . .

. . . it’s best not to make a serious mistake in your attack.  Here’s Matt Yglesias:

The answer is that the column labeled “Share of taxes of richest decile” is in fact the share of income taxes paid by the richest decile. The federal income tax in the United States does, in fact, have a progressive rate structure. Federal payroll taxes, state and local sales taxes, most excise taxes, and property taxes all have a regressive rate structure. So, yes, if you look exclusively at the most progressive element of the American tax code, it’s highly progressive. If you compound that exercise by mislabeling your chart, then you can mislead people. You might think it’s a little strange that Greg Mankiw, an economics professor, would mislead people by uncritically endorsing such a misleading chart but Mankiw believes that progressive taxation is immoral and should be opposed even if it enhances human welfare. Perhaps this same moral theory leads him to believe that misleading people about the subject is an act of justice. If so, then I’m not sure it’s really in the interests of Harvard (or the many universities that assign his textbook) to entrust him with the instruction of teenage economics students.

Now I’m not going to argue that the chart Mankiw links to is exactly correct, but it looks like it’s in the right ballpark.  And I could tell that Yglesias’ assertion about income taxes was wrong without even looking up the numbers.  The top 10% in America pay way over 45% of income taxes, at least as tax incidence is normally estimated.  (BTW, the assumption that the incidence of income taxes falls on the people who write out checks to the IRS seems crazy to me, but my fellow economists of the left and right don’t agree.)

It is common knowledge among progressive public finance experts like Peter Lindert that the European tax regimes are able to collect more revenue than ours (as a share of GDP, not in total) by having a more regressive tax system.  Mankiw’s link may not be exactly right, but the stylized facts are in the right ballpark.  Given that Yglesias is a fan of the European welfare state, I’m surprised he hasn’t read Lindert’s research.

Actually, what most surprised me was the very low share of income earned by the top 10% in Switzerland.  That can’t possibly be right, can it?

Yglesias’ strongest argument might be that tax plus transfers in Europe might be more progressive than taxes alone.

BTW, I agree with Yglesias that a progressive (consumption) tax system is desirable, and don’t really buy into Mankiw’s “just deserts” approach.  So this post has nothing to do with my ideology.  (Of course if I had been born as Greg Mankiw I might feel differently about the just deserts approach.)

To summarize, it’s still safe to use Mankiw’s text, but Cowen/Tabarrok is also excellent.   (Can’t afford to piss off any influential bloggers.)

Update:  Scott Winship sent me a post with some quite interesting graphs on income inequality.  (BTW, I don’t think income inequality is the best way to measure economic inequality–I prefer consumption inequality.  But income is what most people use.)

The rich, and the upwardly mobile

Matt Yglesias recently linked to a study by Cristobal Young and Charles Varner, which showed New Jersey’s “millionaire tax” (actually a half of millionaire tax) had little effect on migration.  Here’s the technique they used:

To further probe the impact of the new tax bracket, we develop a difference-in-difference estimator. For this, we exploit the fact that there is a plausible control group of high-income earners not subject to the new tax “” those earning $200,000 to $500,000 per year (Saez, Slemrod and Giertz, 2009). For this group, the new millionaire tax has no effect, and thus should have no impact on their migration patterns. In short, we use households in the 95th to 99th percentiles of the income distribution as a control group for households above the 99th percentile.

I don’t know how much effect the tax had, but I can’t have much confidence in the results of a paper that relies on assumption that 30-something doctors, lawyers, businessman, and entrepreneurs making $400,000/year would be indifferent to a tax increase on people making $500,000.  How many people do you know in that income bracket who don’t aspire to eventually earn even higher incomes?  Indeed, I’d expect the effect to be stronger for those making below $500,000, as they’d often be younger and not yet tied to a particular area (via kids in school, spouse with good job, etc.)

In my view taxes tend to have weak short run effects (as people are often settled in a particular area and don’t want to move), and stronger long run effects, as businesses deciding where to locate might choose areas with better fiscal regimes for their employees.  But many other factors also matter.

Places without many amenities cannot get away with high income taxes.  That’s one reason why lots more affluent people move to Texas than neighboring states with income taxes.  But state income taxes tend to be fairly low, and of course those lacking income taxes may have higher taxes in other areas.

In addition, some states have “captive” residents due to perceived amenities, such as California’s climate and NYC’s cultural attractions.  They can impose a 10% top rate and still hold on to many wealthy residents.  Indeed I plan to move to California in a few years, despite the fact that I much prefer Texas’s fiscal regime, and even more so its land use policies.

So the variations in state income taxes probably don’t have a major impact on population flows, but they may have a bigger impact than these studies suggest, especially in the long run.  My hunch is that states know this, and know that they can’t get aways with income taxes that are far outside the norm for other states with similar levels of amenities.  Indeed if tax regimes really didn’t matter, it would be pretty difficult to explain why New Hampshire’s population has grown much faster than any of the other New England states (even given the fact that it is slightly closer to Boston than the other New England states.)