Notes on redistribution

Some entrepreneurs and some libertarians (or “liberaltarians”) appear to be warming to redistribution and the welfare state. But there’s a reexamination happening in left-of-center policy circles, too. I offer no opinion on that conversation here, but want to clip together a few references…

The limits of redistribution

Franklin Foer on Elizabeth Warren and the future of the Democratic party:

Nor is Warren’s driving obsession wealth redistribution. That’s important politically, because many Americans simply don’t begrudge wealth, and “inequality” as a clarion call hasn’t stuck… Rather, Warren is most focused on the concept of fairness. A course she taught early in her career as a law professor, on contracts, got her thinking about the subject. (Fairness, after all, is a contract’s fundamental purpose.) A raw, moralistic conception of fairness—that people shouldn’t get screwed—would become the basis for her crusading. Although she shares Bernie Sanders’s contempt for Wall Street, she doesn’t share his democratic socialism. “I love markets—I believe in markets!” she told me. What drives her to rage is when bankers conspire with government regulators to subvert markets and rig the game. Over the years, she has claimed that it was a romantic view of capitalism that drew her to the Republican Party—and then the party’s infidelity to market principles drove her from it.

A lengthy piece in Democracy:

Suppose we raised marginal tax rates on the highest income households from 39.6 percent to 50 percent… the increase would raise taxes by an average of $6,464 for those in the 95-99th percentiles (those with average incomes of $321,000 in 2013). Households in the top 1 percent (with average incomes of $1.571 million in 2013) would pay an additional $110,968 and those in the top 0.1 percent an additional $568,617… Now imagine that all of the revenue collected from this change was distributed evenly to the bottom 20 percent. The total revenue raised is $95.6 billion and allows each household at the bottom to have an extra $2,650 in post-tax income.

Although not directly discussing redistribution, another relevant estimate comes from David Autor in Science:

Between 1979 and 2012, the share of all household income accruing to the top percentile of U.S. households rose from 10.0% to 22.5% (89). To get a sense of how much money that is, consider the conceptual experiment of redistributing the gains of the top 1% between 1979 and 2012 to the bottom 99% of households (10). How much would this redistribution raise household incomes of the bottom 99%? The answer is $7107 per household—a substantial gain, equal to 14% of the income of the median U.S. household in 2012. (I focus on the median because it reflects the earnings of the typical worker and thus excludes the earnings of the top 1%.)

He goes on to say that, in terms of total dollars, the rise in the college wage premium has been more significant:

This increase in the earnings gap between the typical college-educated and high school–educated household earnings levels is four times as large as the redistribution that has notionally occurred from the bottom 99% to the top 1% of households. What this simple calculation suggests is that the growth of skill differentials among the “other 99 percent” is arguably even more consequential than the rise of the 1% for the welfare of most citizens.

Here is Mike Konczal of the Roosevelt Institute on redistribution and its discontents:

A predominant Democratic view is that the economy is mostly fine; it’s just a matter of adjusting and correcting it to ensure everyone has access. Deeper, structural, changes are put to the side in favor of taxes, transfers, and behavioral nudges to help people out.

On trade, for example, the consistent Democratic narrative in 2016 was that we need to “compensate the losers” of trade. The phrasing alone tells us everything we need to know. Which voters want to be identified as losers? Democrats may mean something more abstract when they speak of “losers” in a globalized economy, but the language carries the connotation of personal blame.

But what role does individual agency play when global capital flows upend communities? And why are we treating the economy as a natural phenomenon — one whose consequences we simply must accept — when voters know it’s a series of laws, trade agreements, and businesses making decisions? If this is the best Democrats can offer, it’s not surprising workers aren’t interested.

It’s worth mentioning the Rewrite the Rules report from Roosevelt here, as well as the general idea of “predistribution” policy, coined by political scientist Jacob Hacker.

There is also a wave of backlash against tech titans’ endorsement of a universal basic income. Here is one good example from Helen Razer at Quartz:

Here’s the shameful secret not uttered in our favorite futurists’ TED-style presentations. The reason they adore UBI isn’t to do with their commitment to lift a growing underclass out of poverty; that’s just a bedtime story that helps the super-wealthy sleep. Instead, it’s more to permit spending on their goods by what remains of the American middle class. No one on a stagnant wage can currently buy the things that Musk—and the rest of Silicon Valley—wants to sell them. These billionaires champion a scheme whose prime result will be their profit.

The case for redistribution

Here is Matt Yglesias:

The solution to both facets of this problem is simple: taxes. Higher taxes on very high wages and higher taxes on investment income. Some of the revenue should go to the kind of earned income tax credit boost that Rep. Ro Khanna (D-CA) and Sen. Sherrod Brown (D-OH) have proposed, and some to create a universal child allowance of the sort that’s taken a huge bite out of poverty in foreign countries.

Here’s coverage of U.S. Representative Ro Khanna’s plan to dramatically increase the size of the earned income tax credit, in Vox and The Atlantic.

Here’s Dylan Matthews’ case for a basic income, and a study suggesting it would grow the economy.

This paper suggests redistribution from rich to poor has been the historical norm for the last hundred years, and this paper suggests it improves life satisfaction. That’s broadly consistent with the historical data presented here on “social spending” improving human well-being, which admittedly may not map well onto today’s debates between redistribution and “pre-distribution” policies.

State capitalism vs. the alternatives

Noah Smith has a nice column on state capitalism vs. democratic capitalism, and argues that it’s a battle of ideas akin to communism vs. capitalism. As he writes in the beginning:

The great experiment that Vladimir Lenin and Joseph Stalin began is over. And that experiment was a colossal failure. Market economies are necessary for getting rich.

The whole thing is in line with my post the other week about the case for capitalism and the mixed economy. Here’s a bit more from Smith:

Why are democratic countries turning to redistribution, while authoritarian powers seem to be reducing the role of government? One reason is that democracies tend to be richer, and wealthier nations simply have more money to spend on safety nets for their poorer citizens. It’s possible that as autocracies like China grow richer, their citizens will also demand generous welfare states — or even a transition to democracy.

But this isn’t written in stone. Many see Singapore as an authoritarian capitalist success story. The tiny nation is wealthier than almost any democratic nation, yet it remains a one-party state with low levels of government spending and a light regulatory touch. It seems possible that instead of following the path of the democratic-socialist nations, China and other post-communist countries will end up looking more like Singapore. They certainly seem to be aiming for something along those lines.

So although it’s too early to know for sure, it looks like a new division is replacing the old Cold War dichotomy of democratic capitalism versus authoritarian communism. In the new system, democratic-socialist countries will face off against authoritarian state-capitalist ones. It will be the Denmark model versus the Singapore model.

A generous welfare state is compatible with a dynamic, innovative economy

Two Brookings scholars have a great piece in Boston Review making the case that the safety net helps promote economic dynamism. And they make the case that the conventional wisdom is changing, even among some conservatives. And, sure enough, a few days later The New York Times ran an opinion piece by an entrepreneur advancing a similar argument, tied to the Trump tax proposals. (Silicon Valley entrepreneurs are actually quite open to redistribution.)

The Boston Review piece in particular is worth a read, and I’m grateful that they cite my writing on this subject. In light of their piece, I figured it’d be good to put a few things I’ve written on the subject in one place. Here’s the most extensive piece I’ve written on this, for The Atlantic. I have done a series of pieces for HBR: on health insurance, unemployment benefits, and college tuition. And I’ve posted a couple times here on the blog about others making similar arguments. Here’s one about Will Wilkinson, here’s one on Zuckerberg and a piece by Neil Irwin.

Between the Boston Review piece and my Atlantic piece, there are links to most of the relevant papers, and references to many of the key people making the argument.

Taxes and growth

Do lower taxes mean faster economic growth, as is so often claimed by conservatives? I mentioned this question in the context of corporate taxes recently:

Although in general low taxes do not necessarily increase growth, corporate taxes are considered “the most harmful type of tax for economic growth”, according to the OECDAnd researchhas found that decreases in the corporate tax rate spur investment, which in the U.S. has been surprisingly low in recent years.

I figured I’d post a few other resources here, along those lines. This is a review paper from Brookings on individual taxes and economic growth:

We find that, while there is no doubt that tax policy can influence economic choices, it is by no means obvious, on an ex ante basis, that tax rate cuts will ultimately lead to a larger economy in the long run. While rate cuts would raise the after-tax return to working, saving, and investing, they would also raise the after-tax income people receive from their current level of activities, which lessens their need to work, save, and invest. The first effect normally raises economic activity (through so-called substitution effects), while the second effect normally reduces it (through so-called income effects).

Here’s a Congressional Research Service report from 2012 that caused a lot of debate, and concluded that:

The results of the analysis suggest that changes over the past 65 years in the top marginal tax rate and the top capital gains tax rate do not appear correlated with economic growth. The reduction in the top tax rates appears to be uncorrelated with saving, investment, and productivity growth. The top tax rates appear to have little or no relation to the size of the economic pie.

You can read some coverage of that study here and here. And here’s an NPR fact check piece on the subject, which describes the Brookings piece mentioned above.

Here’s a survey of economists. They’re asked if, “A cut in federal income tax rates in the US right now would lead to higher GDP within five years than without the tax cut.” They’re divided between Yes and Uncertain, with only a few No’s.

And here’s a couple good pieces by Noah Smith. On individual taxes:

the best evidence that economists can muster shows that income taxes — i.e., what Republicans are always trying to cut — don’t hurt the economy very much. Microeconomic estimates of something called the Frisch elasticity of labor supply — or the amount that taxes discourage people from working — are very low. That means that income taxes do only a very little to discourage people from working. The one exception is tax cuts for the poor and working class, which really do seem to encourage more work effort. But for the upper-middle class and rich, who bear most of the tax burden and who are usually the prime beneficiaries of Republican tax cuts, the effect is very small.

And here he is on corporate taxes.

Eduardo Porter on taxes and growth, and an estimation of the optimal top tax bracket.

What’s the evidence on short-termism?

Here was my attempt to sum it all up with links a few months back, as the introduction to a Q&A with Steve Kaplan about a paper he had on the subject:

McKinsey’s Dominic Barton has made the case, as has BlackRock’s Larry Fink. Politicians like Hillary Clinton and Joe Biden have warned against short-termism, as have scholars at Brookings and the American Enterprise Institute. McKinsey has made its case empirically, finding evidence linking long-term management to superior financial performance. In 2015 Rotman’s Roger Martin reviewed the evidence on both sides here at HBR and explained why he believed short-termism is a problem.

But not everyone agrees.

Economist Larry Summers says, in response to the McKinsey data, that the jury’s still out. The Economist calls short-termism a “slippery idea” and a “distraction.” The New Yorker calls it a “myth.” And we’ve published many pieces here at HBR taking issue in one way or another with the standard short-termism critique.

In a recent paper, University of Chicago Booth economist Steven Kaplan makes his own case against worrying about short-termism.

Here’s a similar effort by Noah Smith, who makes the case that short-termism is, in fact, a problem:

Back in June, I reported on a research paper by Steven Kaplan of the University of Chicago’s Booth School of Business, saying that the threat of short-termism was either nonexistent or exaggerated. But I also argued that the reasons Kaplan gives have major caveats or are of questionable relevance.

Other research has shown important evidence on the negatives of short-termism. A 2010 paper by economists John Asker, Joan Farre-Mensa and Alexander Ljungqvist found that closely held companies tend to invest more than similar publicly listed companies, and also tend to be quicker to respond to new investment opportunities. And a 2007 paper by Rudiger Fahlenbrach found that companies run by founder-chief executive officers tend to invest more in both capital goods, and research and development — investments that are rewarded with higher stock prices over the long term.

The evidence that short-termism might be harmful continues to pile up. A 2014 paperby Stanford University’s Shai Bernstein finds that when companies go public and face pressure for quick results from investors, their best inventors tend to leave, and the ones who remain produce fewer patents. Though patenting is a poor measure of innovation at the industry-wide level (since one company’s patents can hinder innovation by other companies), it’s a good indicator of the effort a company is putting into research. Bernstein’s paper also shows that once companies go public, they plow less of their resources into far-sighted R&D investments.

Meanwhile, economists German Gutierrez and Thomas Philippon have a recent paper investigating the causes of low business investment. They find that the more public companies are owned by institutional investors, the less they tend to invest.

Posting this mostly so I have the links to all these bits of evidence together in one place.

More on how to think about economic models

I wrote recently about three different ways to think about economic models. Here are two more. John Gruber of MIT to his undergraduate micro students:

We’re going to be modeling individual and firm behavior. Now technically, as you know, a model is any description of the relationship between two or more economic variables.But the difference from your other courses– and I’m telling you right now, it’s going to be frustrating.I’m warning you in advance, is unlike the relationship between energy and mass, there is no law that tells you exactly how things relate.We’re going to build a series of models that is going to help us try to understand the way things relate. But this is not a real science. As much as we wish we were, we are not. We’re not a real science. We are a quasi-science, social science.What we’re trying to do with our models is make assumptions that negotiate the tension between, on the one hand, explaining real world phenomena, and on the other hand, being mathematically tractable.

Here’s the CORE economics textbook The Economy:

ECONOMIC MODELS

A good model has four attributes:

  • It is clear: It helps us better understand something important.
  • It predicts accurately: Its predictions are consistent with evidence.
  • It improves communication: It helps us to understand what we agree (and disagree) about.
  • It is useful: We can use it to find ways to improve how the economy works.