Category: Economic Stability

Today’s big U.S. economic trade-off isn’t equality or efficiency

Posted on by Bridget Ansel

This year marks the 40th anniversary of the publication of the late economist Arthur Okun’s book, “Equality and Efficiency: The Big Trade-Off.” Rereading Okun in 2015, however, feels about as relevant to my work as an economist as does reading Hilary Mantel’s “Wolf Hall,” about 16th century Britain. Both are interesting and enjoyable swings through the historical past–and I highly recommend them–but neither should be used as a roadmap for today’s policymakers.

Okun’s purpose in 1975 was to give political leaders guidelines for how to think about economic policy based on his understanding gleaned over the previous 40 or so years. In his view, policymakers face a trade-off between addressing economic inequality and promoting economic efficiency, which is to say, addressing inequality threatens the foundation for a competitive economy. He uses the idiom “we can’t have our cake and eat it too” to frame his fundamental concern, saying, “We can’t have our cake of market efficiency and share it equally.”

This question led him to steer social scientists toward a narrow focus on the whether and how of the “big trade-off.” He ends his book with this plea: “I do, however, hope to persuade others to share my views about the preconditions for optimization—a more focused public dialogue on the intensities of preferences for equality and a greater research effort by social scientists on the measurement of the leakages. In short, I am pleading for us all to face up to the tradeoff between equality and efficiency.”

Today’s policymakers might pick up Okun’s book as a roadmap for coping with today’s rising inequality. After all, his concern was when and how policymakers should tax the rich to give to the poor. As Okun put it then: “Because the bottom end of the income scale is at the top of my priority list, I shall concentrate largely on the tax-transfer options.” I would argue that this is not today’s question. Focusing on technocratic solutions for helping those at the bottom of the income ladder diverts our attention from what’s really going on in our economy and society today.

“The Big Trade-Off” examines a United States where “the relative distribution of family income has changed very little in the past generation,” and where Okun could argue that the most pressing question was how much equality was enough. Problem is, in the 40 years since Okun’s book was published, the gains of U.S. economic growth have not been shared as widely as they were in the post-war era that Okun examined. While our economy has grown and productivity has improved—that is, American workers produce more goods and services per hour worked—wages and incomes have failed to keep pace. The middle class has seen little growth and the bottom has seen no growth, while incomes at the top have exploded.

According to data from economists Emmanuel Saez at the University of California-Berkeley and Thomas Piketty at the Paris School of Economics, between 1976 and 2007 the bottom 90 percent saw their income grow by an annual rate of ¼ of 1 percent, adjusted for inflation, while the top 1 percent saw theirs grow by 4.4 percent. Put another way—and pulling forward to the most recent year of data—from 1975 to 2013, the top 10 percent of households have accrued 109 percent of all the income gained.

This wasn’t Okun’s economy. Between 1933 and 1975, the top 10 percent took home only 29 percent of the income gains. Certainly, that’s more than their equal share, but the bottom 90 percent did get 70 percent of the growth and saw their incomes rise at a pace of 3.9 percent per year.[i] Okun pondered a trade-off between equality and efficiency just when those at the top of the wealth and income ladder began hauling off all the gains of economic growth.

Our political discourse today is also strikingly different than in Okun’s time. In the era he lived in, there was broad agreement about the role of policy. It’s a world unrecognizable to those of us steeped in the severe partisanship of the Bush and Obama years. Okun could blithely write, “I do not know anyone today who would disagree, in principle, that every person, regardless of merit or ability to pay, should receive medical care and food in the face of serious illness or malnutrition” That is not America today, where lawmakers in Congress and in statehouses around the country push to cut spending on the Supplemental Nutrition Assistance Program and seek to limit the availability of Medicaid made available recently under the Affordable Care Act.

Okun was—as we all are—a product of his time. Specific economic and political realities led him to conclusions that are inapplicable to today’s economy. He argues that our society accepts more inequality in economic assets than sociopolitical assets. He boldly begins his book by saying, “American society proclaims the worth of every human being. All citizens are guaranteed equal justice and equal political rights.” That’s an audacious statement to make 40 years ago and remains so today.

I live on U Street, in Washington, DC, and over the past week protestors have marched through my neighborhood loudly proclaiming, “All lives matter. Black lives matter.” They are marching because citizen-documentarians across the nation have shown the sad truth of police brutality. To point to just one statistic: The unemployment rate for African Americans has held steady at twice the rate of whites for decades. This was true in 1975 and it’s true today.

It’s hard to reconcile today’s political reality with Okun’s bold beginning in “The Big Tradeoff.” Fundamentally, it comes down to whether the lack of economic inclusion for African Americans directly affects their political and social power. If we cannot separate economic and political rights as neatly as Okun does, there’s no other conclusion than that today’s policymakers should be wary—very wary—of taking this book as a roadmap.

Okun’s analysis leads him to dismiss the notion that those at the top can buy political and social power. In his view, we don’t need to worry about the power of those with money because the state has ample strictures in place to keep the “Howard Hughes’s”—who in his day was one of the richest men in the world—from controlling the political process. Of course, he was writing immediately after Watergate and a sense of optimism that campaign finance reform would be effective clearly shaped his thinking. He concluded that such regulation was far better than tax policy for curbing the power of the rich: “If the uses of fat checkbook in the political process can be tightly regulated, the plutocracy will lose much of its political punch.”

We cannot be so sanguine today. Thomas Piketty’s book “Capital in the 21st Century” soared to the top of the best-seller list no doubt because we are a nation looking for answers to what’s happened to our economy and our political system. U.S. economists haven’t been asking those questions or providing those answers in no small part to Okun’s dismissal of the notion that we need to focus on incomes (and power) at the top.

Indeed, Okun missed what would become the biggest question of our times. When Okun was writing, the typical CEO earned about 25 times the typical worker. How could he know that today, they earn nearly 300 times the typical worker? [ii] Given the era he lived in—long before the Supreme Court’s 2010 ruling in Citizens United v. Federal Election Commission that enabled unlimited campaign contributions by multimillionaires and billionaires—perhaps his conclusion was reasonable. Yet Okun’s thinking still dominates economic and political discourse. While policymakers argue whether government aid for the less fortunate in our society is more or less efficient for our economy, the big economic trend of the long-term of a growing gap in productivity and wages and the top income earners pulling further and further away from the rest are not thoroughly examined for their consequences on future U.S. economic growth. It’s taken the work of Piketty—and his many co-authors—to focus us on these larger questions. Piketty’s conclusion is that we need to take swift action, but so long as we remain trapped in Okun’s trade-off, we’re not having the right conversation.

Because Okun began from a premise that assumed that his status-quo economy would continue for the foreseeable future, he focused us on the wrong questions. He asked us to focus on society’s preferences for equality, rather than society’s preferences for a strong middle class. He asked researchers to focus on measuring the “leaky budget”—his term for what is lost to an economy when government tries to ease economic inequality—a technocratic focus that has not served us well. He dismissed the big questions and left us with technocratic debates over how much we should give the poor, rather than how strong and vital our middle class should be.

But, my critique goes deeper. It’s hard not to see Okun’s legacy as the problem rather than the solution. His view that we needn’t focus our energies thinking about the effects of rising top incomes and that the real problem was ensuring that we didn’t veer too far into ensuring equality steered us in the wrong direction. Had we not listened, would we be here today.

[i] Data are computations from the updated Excel files provided by Thomas Piketty and Emmanuel Saez, based on this research: Thomas Piketty and Emmanuel Saez, “Income Inequality in the United States, 1913–1998,” The Quarterly Journal of Economics 118, no. 1 (February 2003): 1–39.

[ii] “CEO Pay Continues to Rise as Typical Workers Are Paid Less,” Economic Policy Institute, accessed May 3, 2015, http://www.epi.org/publication/ceo-pay-continues-to-rise/.

Determining the optimal U.S. tax rate for higher earners

Posted on by Nick Bunker

There are two constants in life: death and arguments about the optimal top marginal tax rate. The proper level of income taxation in the United States has been a hotly contested topic since the creation of the first federal income tax more than a century ago. The debate over the optimal tax rate has only intensified in recent years, as income and wealth inequality in the United States increases while taxes on the rich decline. Policymakers need an empirical answer to the question of the optimal level of taxation on top incomes.

How exactly do economists calculate an optimal level? Until very recently, economic research sought to determine the optimal rate by using just one concept—the highest tax rate that would maximize the amount of revenue collected, bearing in mind the disincentive to work created by taxation. Yet the most cutting-edge evidence tells us that our current estimates of the optimal tax rate are inaccurate because they’re missing important additional pieces of information about the behavioral response to taxes.

View full PDF here alongside all endnotes

So what is the optimal tax rate for top incomes? In order to determine that rate, policymakers should instead consider the following three ways that top earners might respond to tax changes:

  • by varying the supply of their own labor (working less)
  • by shifting between different types of income (wages and capital) to avoid taxes
  • by bargaining for different compensation levels from their employers

 

In this brief, we examine these three possible responses to higher taxes among the wealthy—responses that economists call elasticities—as posited by economists Thomas Piketty of the Paris School of Economics, Emmanuel Saez at the University of California-Berkeley, and Stefanie Stantcheva of Harvard University. Cutting to the chase, the three authors find that the optimal rate of taxation is much higher when we consider the responses quantified by three different elasticities as compared to one elasticity.

The analysis by Piketty, Saez, and Stantcheva finds that the optimal top tax rate is 83 percent. In contrast, the optimal rate using only one elasticity is 57 percent, which in turn compares to the current higher marginal tax in the United States of 39.6 percent. While 83 percent seems like a very high number, the underlying analysis of the paper is persuasive. Yet, the real take-away is the way the three authors calculate the much higher tax rate, and the importance of top earners bargaining for their compensation in calculating the optimal rate. U.S. policymakers need to understand the more complex responses of high earners to different tax rates. This new understanding is important given the country’s rising economic inequality and the relationship this rising inequality has to economic growth.

What is an elasticity?

Economists often seek to examine how responsive one economic variable will be to a change in another: What is known as an elasticity. Often they’ll explore the elasticity of Variable A to Variable B, such as the elasticity of employment to changes in the minimum wage or the elasticity of work hours to increases in the marginal tax rate. The resulting calculation of that elasticity would tell you how responsive the one variable is to changes in another. The larger the magnitude of the number, the larger the change.

In the case of the employment and the minimum wage, think of an elasticity of -0.1. This would mean a 10 percent increase in the minimum wage would result in a 1 percent decline in the level of employment. Or consider the elasticity of work hours to increases in the marginal tax rate, which economists calculate at -0.2—meaning a 10 percent increase in the marginal tax rate would result in a 2 percent decline in hours worked.

Obviously, many variables are at play in the complex U.S. economy. This is why factoring in other elasticities is important for economists to explore and for policymakers to understand.

A new approach to the problem

In their paper “Optimal Taxation of Top Labor Incomes: A Tale of Three Elasticities,” economists Piketty, Saez, and Stantcheva overturn conventional wisdom on optimal taxation by introducing empirical tests of three key ways that taxes can affect the behavior of top earners. The authors argue that the optimal tax rate for top earners isn’t the result of just one kind of response to taxation, but rather three different kind of behavioral responses, or three elasticities.

When the authors calculate the optimal tax rate using only the criteria that the rate not reduce the amount of time top earners spend working, they find that the optimal top tax rate would be 57 percent. But the authors argue that using just one elasticity misses out on too much that’s going on with the behavior of top earners when tax rates are changed. Instead, we should consider three elasticities.

Elasticity 1: Labor supply response

The labor supply of top earners is economic parlance for the amount of time wealthy individuals will put into work instead of leisure. To find the elasticity of their working hours to the tax rate  they pay, the authors first calculate the “supply side” elasticity, which measures the sensitivity of the labor supply of top earners to changes in the top tax rate. As the tax rate increases, individuals start to re-evaluate the trade-off between working and earning more money and not working and enjoying leisure time. If top earners were to stop working then the reduction in the labor supply would not only reduce the amount of taxes collected but, more importantly, could be harmful to economic growth.

That’s why policymakers need to know how responsive to taxation top earners are when it comes to their willingness to work. If they are very responsive, then the optimal tax rate could be lower, all other things being equal. If they are less responsive, the rate could be higher.

The authors calculate this first elasticity by looking at how both the share of income going to top earners in the United States, and U.S. economic output (measured by gross domestic product per person) changed as the top tax rate changed. They find that as the top tax rate went down between 1960 and the end of 2012 the top 1 percent of earners were able to keep more of their income but the growth of GDP per capita didn’t increase. That means this first elasticity is pretty low, at most 0.2.

In short, top earners do not substantially vary their labor supply in response to tax rates.

Elasticity 2: Tax avoidance

Another way that top earners can respond to taxation is to change the kind of income they receive so that they can avoid a higher tax rate. If the tax rate on labor income increases then top earners might shift their income toward capital income that is taxed differently. A chief executive officer at a big corporation, for example, might get his compensation shifted from purely salary to include stock options, which when exercised are treated as capital income. This doesn’t mean the top earners are changing their behavior. Rather they are trying to shelter their money from taxation.

A higher elasticity, or responsiveness, means that an increase in the tax rate would make the earner very likely to change the kind of income they earn. A low elasticity means that an earner would not change her source of income based on changes in the tax rate. In a situation where this elasticity is high, top earners will simply shift all their income away from labor and toward capital—so a high tax on the labor income of top earners would yield little revenue.

To calculate this elasticity, the authors compare the trends in the share of labor income going to the top 1 percent to the trends in the share of income that includes capital gains. What they find is that the trends of the two data series are nearly identical. In fact, Piketty, Saez, and Stantcheva say their estimate for the second elasticity is 0. Top earners in the United States do not tend to shift their income sources in response to changes in the tax rates.

Elasticity 3: Executive compensation bargaining

Many top earners are corporate executives. According to one estimate, 41 percent of the top 0.1 percent of income earners are executives, managers, or supervisors. A growing body of research demonstrates that corporate CEOs and other members of the corporate “C suite” (chief financial officers, chief information officers, chief operating officers, and the like) are not  responsible for all the gains in the company’s economic performance for which they are compensated. In other words, a substantial share of top corporate executives’ earnings are comprised of funds from the firm that might otherwise go to other workers, investments in the firm, or to shareholders.

When tax rates are lower, executives have a stronger incentive to bargain for higher compensation. And since this compensation isn’t necessarily due to higher productivity, the struggle is zero-sum—if executives receive compensation for productivity gains they aren’t responsible for then funds that would go toward other ends get diverted. Piketty, Saez, and Stantcheva explain that a higher elasticity means that executives are more likely to bargain for higher pay when tax rates are lower and therefore receive funds that might go elsewhere within the firm.

In order to calculate this elasticity, the economists look at international data to determine the relationship between top tax rates and CEO pay. The data show that in countries with lower tax rates, CEOs have higher average incomes after accounting for the kinds of industries in which their companies compete. Piketty, Saez, and Stantcheva interpret this finding as the sign of a high third elasticity, which they calculate conservatively at 0.3 at the lowest. This would mean a higher tax rate on top earners would reduce what economists call rent-seeking—the taking of undue compensation—within the firm, potentially increasing wages for average workers.

Conclusion: The optimal rate?

The research presented in “Optimal Taxation of Top Labor Incomes: A Tale of Three Elasticities,” by economists Piketty, Saez, and Stantcheva, suggests that the conventional wisdom around optimal taxation rates for top earners is missing some nuance in how top earners respond to taxation. Including the bigger picture would seem to leave substantial room for an increase in rates on top earners. Piketty, Saez, and Stantcheva’s calculate that the optimal top tax rate comes out to 83 percent, once their three elasticities—labor supply, tax avoidance, and bargaining—are combined.

Compare that result to the result of 57 percent when economists only consider the overall elasticity of income to tax rates. This level is also much higher than the current top federal income tax rate of 39.6. This isn’t to say that our current top tax bracket should be raised to 83 percent tomorrow. Rather, this is the optimal rate for those at the very top of the income ladder. The top tax bracket would have to be changed in order to tax only those individuals or households at the very tippy top at this new 83 percent rate.

The results of this research also indicate that the rise in income inequality at the very top of the income spectrum was driven primarily by the decline in tax rates, which allowed top earners to get higher incomes without increasing the pace of economic growth. So the main take-away from latest research is clear: Tax rates in the United States on incomes at the very top could be much higher without affecting output growth and potentially boost wages for average workers.

Taxation and fairness in an era of high inequality

Posted on by Bridget Ansel

Heather Boushey, Executive Director and Chief Economist, Washington Center for Equitable Growth, testifying before the U.S. Senate Committee on Finance on “Fairness in Taxation.”

I would like to thank Chairman Hatch, Ranking Member Wyden, and the rest of the Committee for inviting me here today to testify.

My name is Heather Boushey and I am Executive Director and Chief Economist of the Washington Center for Equitable Growth. The center is a new project devoted to understanding what grows our economy, with a particular emphasis on understanding whether and how rising levels of economic inequality affect economic growth and stability.

I’m honored to be here today to discuss a very important topic: the relationship between fairness and taxation. Over the past several decades, economic inequality, on a variety of measures, has increased in the United States. The benefits of economic growth have flowed primarily to households and individuals at the top of the income and wealth ladders. We need to keep this fact in mind when we consider taxation and fairness in the years ahead.

There are three major conclusions from my testimony:

  • As inequality has increased, the tax code has not kept pace with this change. The tax code does less to reduce inequality than it did in the late 1970s
  • Efforts to reduce inequality are not in tension with economic growth. A variety of research shows that steps taken to reduce inequality do not significantly hinder economic growth
  • There are policy options that can make the tax code more progressive that will have broad benefits for everyone

The rest of my testimony will focus on documenting the rise in inequality, reviewing the academic research on the effects of taxation, and some thoughts about where policy should go forward.

Download the full pdf for a complete list of sources

The rise of inequality

Inequality, at least in the popular conversation about it, is talked about like it is a single phenomenon. Even the most widely used measure of inequality, the Gini coefficient, treats it as such. If the coefficient rises, we know that inequality has gone up. But what we don’t know is how exactly inequality has increased.

In short, the story of the past four decades when it comes to inequality is a rapid rise in incomes and wealth for those at the top, slower growth for the middle compared to earlier time periods, and stagnation, if not outright declines, for incomes at the bottom of the ladder.

According to data from Paris School of Economics professor Thomas Piketty and University of California-Berkeley economist Emmanuel Saez, the average pre-tax income of the top 1 percent grew by 178 percent from 1979 to 2012. Correspondingly, the top 1 percent’s share of pre-tax income has increased from 8 percent to 19 percent over the same time period.

At the same time, inequality of wealth has been rising as well. According to research by Saez and London School of Economics professor Gabriel Zucman, the share of wealth going to top 0.1 percent of households has increased to 22 percent in 2012 from roughly 7 percent in 1979. That’s a 3-times increase in the share of wealth held by the top 10 percent of the top 1 percent. The reason for this rise? The rich have a much higher savings rate than the rest of population and the increase income inequality appears to be calcifying into wealth inequality as the rich save their incomes.

According to data from the Congressional Budget Office, the pre-tax, pre-transfer income of the median U.S. household grew by an average of 0.9 percent a year from 1979 to 2007, the last year before the Great Recession. That growth rate is considerably slower than the 4.7 percent a year for the average income of the top 1 percent of households.

For those at the bottom, the reductions in poverty over the past several decades have been driven almost entirely by tax-and-transfer programs. This means that our anti-poverty programs are working to reduce material hardship. Whether they have reduced it enough is another question. But this research also raises concerns about how the labor market is working for those at the bottom of the ladder.

Another shift toward inequality has been the shift of income from labor income (salaries and wages) toward capital (business income and capital gains). This shift matters for inequality because the distribution of capital income is far more unequal than the distribution of labor income. Households at the bottom and the middle of the income ladder rely much more on labor as a source of income than capital. And capital income is concentrated much more at the top of the income ladder.

As these shifts in inequality occurred, the federal tax system was doing less to reduce inequality, though the federal tax system is still progressive. A quick look at Figure 1 below shows how much the top marginal tax rate for labor income has been declining since the early 1980s.

Figure 1

testimony-visuals-03

However as the top rate has decreased, the improved economic performance that we might expect given the conventional wisdom doesn’t show up in the data. Figure 2 shows no discernible relationship between employment growth and the level of the top marginal tax rate. If cutting taxes resulted in stronger employment growth then there would be a discernible pattern in the years between 1948 and 2014, represented by a green dot in Figure 2. There is no pattern.

Figure 2

testimony-visuals-02

The lack of any obvious relationship isn’t the case for just employment growth. Figure 3 below shows that there is no clear correlation between the growth in labor productivity, one of the key sources of long-run economic growth, and the top marginal tax rate.

Figure 3

testimony-visuals-01

A more in-depth treatment of the relationship between tax rates and macroeconomic growth can be found in a 2012 Congressional Research Service report by Thomas Hungerford.

Now it’s true that the federal income tax has become slightly more progressive by some measures. But more tax revenue has come from payroll taxes, which have become less progressive. And those at the top of the distribution are paying a large share of federal income taxation. According to Congressional Budget Office data, the top 1 percent of earners had 14.2 percent of federal tax liabilities in 1979. By 2011, that share increased to 24 percent.

Yet over that same time period, the top 1 percent’s share of pre-tax income increased from 8.9 percent to 14.6 percent. So if progressivity is measured by the distribution of taxes paid, then progressivity has gone up. But that measure doesn’t account for the rising inequality in the distribution of income. The result of inequality increasing as the tax system does less to reduce inequality (as a CBO report points out) is that the inequality of incomes after taxation has increased more than the inequality of income before taxation.

Why should we care about the rise in inequality? There’s an emerging consensus in economic research that high levels of inequality can threaten economic growth. My colleague Carter C. Price and I went through the research literature on the relationship between inequality and growth and found that research points toward a negative relationship. As inequality goes up, economic growth tends to go down. A recent paper by researchers at the International Monetary Fund further finds that redistribution does not necessarily hamper growth. The exact reason for this apparent relationship is unclear and my organization was founded to help better understand it. But the evidence as it stands is cause to seriously grapple with the negative effects of inequality.

Academic research on taxation

Given the rise in inequality, what can tax policy do about this trend? One potential concern about taxation is that in an effort to reduce inequality, it can reduce economic growth and cause more problems than were already there. An increase in labor taxation might cause some workers to work less or an increase in capital taxation might cause a reduction in savings, both of which are important for economic growth.

These assumptions are widely held by policymakers and economics commentators. And to a certain extent they are true. But the level of taxation at which these problems would occur is much higher than usually expected.

On the subject of income taxation, a body of new research shows that labor income taxes for those at the top of the income ladder have no adverse effect on economic growth. A paper by Nobel Laureate Peter Diamond and UC-Berkeley economist Emmanuel Saez reviewed the research literature on income taxation and finds that progressive taxation is well-supported by the research.

When it comes specifically to top rates, another paper by Saez along with Thomas Piketty and Harvard University’s Stefanie Stantcheva look at the underlying forces that determine what the optimal level of taxation could be. After accounting for a variety of factors, the three economists find that the top marginal rate could be as high as 83 percent without affecting economic growth. I wouldn’t take this paper as evidence that the United States could increase its top income rate to such a level. Rather, the result is instructive that tax rates could be significantly higher without major adverse effects.

Research also shows that reducing certain tax expenditures wouldn’t negatively affect the economy either. Research that shows tax incentives are often ineffective at incentivizing behavior. The tax code may provide a tax break for a certain behavior on the belief that this economic incentive will dramatically change behavior, but some work casts doubt on how much behavior is changed by these kind of incentives. Take, for example, Harvard economist Raj Chetty’s work on retirement savings decisions. He and his co-authors look at millions of data points on changes in retirement savings after a change in tax policy in Denmark. What they found is that 85 percent of workers were non-responsive to changes in tax incentives and savings rates didn’t decline. Of course, this result isn’t perfectly applicable to the U.S. situation. But its results are suggestive and should be considered in the U.S. policy situation.

New research also challenges the idea that capital taxation will invariably result in lower savings and consequently lower economic growth. Recent work that shows the long-held belief that capital income shouldn’t be taxed at all is flawed. A paper by Piketty and Saez shows the flaws with the famous Chamley-Judd assumptions. Chamley-Judd assumptions imply that savers have infinitely long-time horizons when thinking about saving for the future. If I care about the returns on my savings very, very far in the future, then a tax on savings would end up compounding to a point where the burden is immense. Taxing capital in this situation would drastically reduce savings. But Piketty and Saez show that this assumption doesn’t hold up under scrutiny. And a recent paper by Ludwig Straub and Ivàn Werning of the Massachusetts Institute of Technology show that the zero taxation result doesn’t even hold up within the Chamley-Judd framework.

There is also the assumption that reducing capital taxation will induce corporations into investing more. The reduction in taxation supposedly will increase the return to investment. But research by the University of California-Berkeley’s Danny Yagan finds that the 2003 dividend tax cut didn’t have any effect on investment or employee compensation. Yagan compares the investment behavior of public companies, which would were affected by the tax cut, with the behavior of privately held companies. What he found was that the public companies, which should have invested more due to the tax cut, didn’t invest more than similar privately held companies.

Another possible form of capital taxation is increased taxation of bequests and inheritances. A 2013 Econometrica article by Piketty and Saez argues that the optimal tax rate for inheritances for the United States may be as high as 60 percent. And that the rate would be even higher for those at the very top. In their paper a high inheritance tax is optimal if those bequeathing wealth are relatively unaffected by taxation, inheritances are very unequally distributed and society favors work over inheritance. And the United States fits this description, hence the high level of taxation found in their paper.

With this knowledge, what can we say about tax policy moving forward?

 Possible policy steps

So we know that inequality has risen in the United States over the past several decades. At the same time we have learned from research that there is more room to make the tax code more progressive to help reduce inequality. There are quite a few policies that could move the tax code in that direction.

There are many examples of changes that would be consistent with the literature. Two that are on the table right now would be eliminating the “stepped-up basis” for taxation of bequests and expanding the Child Tax Credit and making it permanent. A rather large loophole currently exists when it comes to the taxation of capital gains. When a person inherits, say, a large amount of stock holdings from a parent, the inheritor is only taxed on the gains made after they inherit the stocks. So if a parent bought a stock at $1 and it appreciates to $99 before the child receives the stock, then the child would only be taxed on the gains over $99. So the capital gains that occurred over the lifetime on that asset since it was first purchased aren’t taxed as income.

If we are concerned about the possibility of families passing along large estates to children and the potential damages that could have on the vitality of the economy, this seems like a loophole we should close. There are a variety of other ideas for taxation in this area, including eliminating the carried interest loophole, whereby hedge fund managers do not pay the ordinary income tax. David Kamin, a professor at New York University School of Law, outlines a menu of options for taxing the wealth of the very wealthy, including transfer taxes, raising the ordinary income tax rates or limiting deductions and exclusions.

But we can also do a variety of things at the low end of the income laddee. One example is the Child Tax Credit, which provides workers with children a tax credit of up to $1,000 per child in hopes of offsetting the costs of raising a child. The tax credit is currently partially refundable for a set percentage of income (15 percent) over a set threshold (currently $3,000). The value of the tax credit has been increased and the threshold decreased, both temporarily, in recent years. I recommend making these reforms permanent. Given the rising costs of child care and the incredibly important role of children and the development of their future talents for the future growth of the economy, giving parents more funds to help raise children makes sense.

Conclusion

The past four decades have been a period of high and rising inequality in the United States. Tax policy has an important role to play in the policy response to this major shift in our economy. It cannot, and should not, be policymakers’ sole response. But changes are needed.

Our economy currently isn’t creating prosperity that is broadly shared. And it hasn’t for a while. Today’s hearing is an important contribution to the conversation about how to get our economy on a track to creating shared prosperity for all Americans.

Obamacare and long-term U.S. economic competitiveness

Posted on by Bridget Ansel

The legal arguments before the U.S. Supreme Court this week in King vs. Burwell may well decide whether a key provision of the Affordable Care Act remains in effect for millions of Americans who now rely on Obamacare for affordable health insurance. But if this elite jury of nine judges is still out on the legal question before the court, the long-term economic consequences of uninsuring the many children now insured under the new health law are clear.

Several new research papers document the importance of early childhood health care for the least advantaged kids among us—on their future workforce productivity, their contributions to our national tax base, their educational attainment, and their declining use of government income supports. These robust findings mirror the results of research that I conducted with economists Sandra Decker of the National Center for Health Statistics and Wanchuan Lin of Peking University. We found that Medicaid coverage for children born between 1985 and 2005 resulted in a better health trajectory for those kids as they because adolescents and young adults, and thus improved their ability to be productive contributors to our economy.

What will happen if less-well-off kids today do not get the affordable health care they need to become successful contributors to our economy over the coming decades? Well, the best economic research shows that current government health care programs, including those recently expanded under Obamacare, already ensure many of these kids will be better and more productive citizens. So lets parse the data.

The first paper, by economists David Brown and Ithai Lurie of the U.S. Treasury Department, and economics professor Amanda Kowalski of Yale University finds that children who gained public health insurance in the 1980s and 1990s under the expanded Medicaid and the Children’s Health Insurance Program paid more in cumulative taxes by age 28, collected less in payments from the Earned Income Tax Credit, and (among the women in the group) attained higher cumulative wages. The three authors estimate that when these now young adults reach the age of 60 the federal government will have recouped at least 56 cents for each dollar spent on childhood health care.

The second paper, by economists Laura Wherry at the University of California-Los Angeles, Sarah Miller at the University of Michigan, Rober Kaestner at the University of Illinois, and Bruce Meyer at the University of Chicago, shows that providing public health insurance to low-income children results in fewer hospitalizations and emergency room visits in adolescence and adulthood. Their findings strongly suggest that substantial health care savings are in the cards for this group of Americans—a welcome boon as the U.S. economy struggles with reducing the cost of health care in our society.

The third paper, by economists Sarah Cohodes of Harvard University and Cornell University’s Samuel Kleiner, Michael Lovenheim, and Daniel Grossman, shows that better public health care among low-income children in the 1980s and 1990s resulted in higher graduation rates from high school and college for these kids, again indicating that the long-run economic benefits of public health insurance are substantial.

None of these studies examined the health of kids enrolled in public health programs due to Obamacare specifically—the program is too new for these kinds of long-term studies—but the further expansion of eligibility for low-income children through Medicaid and the Children’s Health Care Program is one of the things at stake in the Supreme Court’s oral arguments in King vs Burwell next week and the final decision sometime this summer.

What could happen should the Supreme Court decide in effect to shut down the federal health insurance exchange operating in 34 states without their own exchanges? Among the results could be more than 5 million enrollees in the joint state-federal Children’s Health Insurance Program without health insurance, estimates the Children’s Health Fund, a provider of mobile health care for homeless and low-income children. We already know the empirical long-term economic benefits of expanded health care for those least able to afford it—and can say with strong confidence that taking away health insurance for these five million now covered under Obamacare would harm our economy.

—Janet Currie is the Henry Putnam Professor of Economics and Public Affairs at Princeton University and directs the Program on Families and Children at the National Bureau of Economic Research. Her views expressed in this column are her own.

The links between institutions and shared growth

Posted on by Bridget Ansel

Increasing inequality in the United States and its relationship to economic growth is getting a lot of attention lately. It is now clear that sharply rising inequality is not necessary for good economic performance and, indeed, growing evidence suggests that high and rising inequality is harmful, especially if the mechanisms generating the rise in incomes at the top of the ladder contribute to stagnant and falling incomes for the rest of us.

What matters most for the vast majority of American households is not inequality per se. Rather, individuals are mainly concerned with generating a higher standard of living via better wages and employment outcomes. Too many households confront a labor market in which it is increasingly difficult to find living-wage jobs. Despite substantial national productivity growth in the last 30 years, the average pre-tax income for the bottom 90 percent of American households was lower in 2013 than in 1980, and the wage for full-time male college graduates has not grown since the late 1990s.

This wage stagnation stands in contrast to the years following World War II until the late 1970s, when worker compensation grew in line with labor productivity. It’s true that compensation-productivity gaps have also appeared in other rich countries, but with one crucial difference—outside the United States this gap has increased despite substantial growth in worker compensation. While U.S. manufacturing workers have suffered from technology and global competition, that‘s also the case for manufacturing workers in all rich countries. For example, I’ve shown that American manufacturing workers experienced a paltry 4 percent wage increase between 1980 and 2013 (after accounting for inflation) while manufacturing compensation increased by 42 percent in Germany, 43 percent in France, and 56 percent in Sweden.

Many argue that the United States makes up for poor compensation performance with strong employment growth. Yet over the past few decades, U.S. employment rates have not only been lower than that of many European countries, but also have fallen dramatically in recent years—especially for men. In addition, while U.S. employment and GDP grew in tandem between the late 1940s and the mid-1990s, a yawning gap has developed since then, with GDP continuing upwards and employment flattening, despite a growing population.

In short, since the 1980s, U.S. economic growth failed to produce enough jobs, and equally important, enough “decent jobs, ” which I defined as those paying adequate wages with adequate hours of work.  Through my research—funded in part by a 2014 grant from the Washington Center for Equitable Growth—I am seeking to uncover the conditions and mechanisms through which economic growth gets translated into a sufficient numbers of decent jobs. More specifically, I aim to identify the institutions and public policies that help explain best practices for the creation of decent jobs.

What happened to shared growth? Most economists continue to explain the explosion of earnings inequality with conventional supply-and-demand stories, in which worker compensation is believed to accurately reflect the contribution workers make to production. Thus, in this view, CEOs and financiers have received skyrocketing salaries, especially since the mid-1990s, because they are now contributing dramatically more to their firms and to the economy as a whole.

Similarly, the bottom 90 percent have seen stagnant and falling wages because they’ve fallen behind in the “race between education and technology.” The computerization of the workplace requires greater cognitive skills, but workers have not kept up, as indicated by the slowdown in college graduation rates. Assuming (nearly) perfectly competitive markets, the explosion in wage inequality in this view must reflect a similarly explosive increase in skill mismatch (too many low skill workers, too few high skill ones).

Such arguments leave little or no room for labor market institutions and public policies in determining changes in the distribution of earnings up and down the income ladder. An alternative view is that institutionally-driven bargaining power is a critical piece of the story, whether it is the noncompetitive “rents” earned by top managers and financiers, or the collapsing power of hourly wage employees. As Thomas Piketty argues in “Capital in the Twenty-First Century:”

In order to understand the dynamics of wage inequality we must introduce other factors, such as the institutions and rules that govern the operations of the labor market in each society [and explain] the diversity of wage distributions we observe in different countries at different times.

All rich countries face challenges from technology and globalization, but only the United States and the United Kingdom show inequality rising to extreme levels.

In order to understand wage inequality and unshared productivity growth in the United States, we must take a much closer look at the ways in which institutions affect labor market outcomes. In my forthcoming research, I will compare the United States with Canada, Australia, Germany, and France to answer questions such as:

  • How does the distribution and growth of decent jobs in these countries compare by economic sector, occupation, and demographic group?
  • To what extent can these outcomes be attributed to the effects of differing institutions across the five countries?

 

Underlying this research design is the view that institutions matter a great deal for market outcomes. The United States can do a better job of generating decent jobs, and a sensible first step is to learn from the experiences of other countries.

 

—David Howell is a professor of economics and public policy at The New School in New York City

 

The future of work in the second machine age is up to us

Posted on by Nick Bunker

“Big Thinkers” about the role of technology in the U.S. economy are roughly divided into two camps when it comes to the consequences of rapid technological change on the U.S. workforce. There is the techno-optimist view that better technology complements workers and hence benefits them by raising wages. And there’s the pessimistic view that better technology substitutes for workers and therefore displaces and harms them. A debate between the two views was probably what the organizers intended for an event last week hosted by The Brookings Institution’s Hamilton Project entitled “The Future of Work in the Age of the Machine.”

The impetus for the forum was the influential 2014 book “The Second Machine Age” by professors Erik Brynnjolfsson and Andrew McAfee at the Massachusetts Institute of Technology. The authors argue that increasingly “smart” technology displaces workers by reducing the range of tasks that require human ingenuity, and by enabling economic arrangements such as off-shoring that rely on instantaneous global communication and replicability. Brynnjolfsson and McAfee are clearly in the pessimists’ camp.

Until recently, economists were largely in the optimist camp. Sure, some jobs—think buggy whip manufacturers, typists, or travel agents—might disappear, but others would arise to take their place. In the long run, increased productivity would benefit everyone in the form of higher wages.

Yet the debate last week actually highlighted a third position. If either the techno-optimists or the techno-pessimists are right, then we should see a major positive impact on worker productivity. But it just isn’t there in the data. If anything, the rate of technological change in the United States has decreased since at least 2003, specifically in the technology sectors widely thought to be most innovative.

In contrast, we definitely see worker displacement, stagnant earnings, a failing job ladder, rising inequality at the top, “over-education” (workers taking jobs for which they’re historically overqualified), and declining rates of employment-to-population and household and small business formation. What we do not see are the productivity gains, either on a micro or macro level, that are supposedly driving worker displacement. (See Figure 1.)

Figure 1

 

fernald-graphic

Former Treasury Secretary Larry Summers made this point forcefully at the Hamilton Project event. He said “people see there’s already a lot of disemployment but not a lot of productivity growth.” And he continued by asserting that “the core problem is that there aren’t enough jobs,” and that it’s hard to believe the future promise of labor-supplanting technology is driving current displacement. The reason, he said, is that we’d expect to see the installment of new labor-saving systems that would cause a temporary increase in labor demand during the transition.

Summers noted that back when he was an undergraduate at MIT in the 1960s, his professors said labor would not be displaced by technology. In those days, the non-employment rate for prime-age male workers was 6 percent. Now it’s 16 percent. Summers’ co-panelist David Autor added that since 2000, the education wage premium has reached a plateau and the rate of over-education has increased, both of which are hard to square with the argument that the reason for rising inequality is the advance of technology. Summers added that the idea that more education solves the problem of displaced labor is “fundamentally an evasion.” Summers’ arguments and Autor’s observation imply that if we’re wondering how things got so bad for workers, it’s not because we live in the Second Machine Age.

So if not technology, what explains labor displacement?

Broadly speaking, the explanation is this: market practices and public policies that favor managers over workers, and those who make their living by owning capital over those who make their living by earning wages. That choice lurks behind the decline in full employment as a priority in macroeconomic policymaking. It’s also behind a shift in the legal standards, mores, and incentives of corporate management in favor of the interests of owners over other stakeholders. That choice is also evident in the abandonment of long-term productive investment as a priority in public budgeting in favor of upper-income tax breaks and retirement programs for the elderly.

As Summers noted at the Hamilton Project’s event, there seems to be a lot of so-called rents—economics speak for excessive payment for something beyond its actual value—in corporate profits that can’t be understood as the fruits of productive investment. The big question is: who gets those rents? In 1988, Summers wrote an article fleshing out the idea that the division of rents between corporate stakeholders is what drives rising inequality. More than a quarter century later, he could not have been more prescient.

The good news is that if such a profound shift played out over only three or four decades, then it’s reversible. That wouldn’t be true if it were the result of the technological trends detailed in “The Second Machine Age.” So what should be the focus of public policy is to figure out ways for workers to accrue more of corporate earnings, for more unemployed and underemployed people to find full-time, productive jobs, and for the broader economy to serve the interests of the actual people who inhabit it—those who overwhelmingly derive their living from their labor.

We know what needs to be done and how to do it, because we’ve done it before. (See Figure 2.) But it’s a lot harder to actually do than doubling the number of logic gates on a computer chip every two years—the ostensible tech explanation for our current economic woes.

Figure 2

incomegrowth-quintile1

ICYMI: Lynch on the economic gains from reducing education inequality

Posted on by Nick Bunker

From Robert Lynch’s new report on economic growth and education inequality:

The study shows the consequences of raising the educational achievement of children from the bottom three quarters of families who are most socioeconomically disadvantaged to more closely match those of children born into the top quarter of families.

. . .

In the first and most modest scenario, we examine the consequences of simply raising the educational achievement of U.S. children so that it matches, instead of lags behind, the average of the 34 economically advanced nations who are members of the Organisation for Economic Co-operation and Development.

. . .

In the second, middle-range scenario, we explore the effects of raising the achievement of U.S. children to match that of the children of our neighbors to the immediate north in Canada

. . .

In the third and most ambitious scenario, the economic consequences of completely closing educational achievement gaps between U.S. children from lower and higher socioeconomic backgrounds are estimated.

. . .

Under scenario one, the inflation-adjusted size of the U.S. economy in 2050 would be 1.7 percent, or $678 billion, larger.

. . .

If American children matched the academic achievement of Canadian kids, then economic growth would be significantly larger. In 2050 the U.S. economy would be 6.7 percent, or $2.7 trillion, larger.

. . .

Finally, if achievement gaps between children from different socioeconomic backgrounds were completely closed, then the U.S. economy would be 10 percent, or $4 trillion, larger in 2050.

0115-gap-table03

Heather Boushey on “Capital in the Twenty-First Century”

Posted on by Nick Bunker

The Schwartz Center for Economic Policy Analysis hosted a panel discussion of “Capital in the Twenty-First Century” with economist Thomas Piketty on October 3, 2014. After Piketty’s remarks, the New School’s Anwar Shaikh and Equitable Growth’s Executive Director Heather Boushey gave remarks on the book. The text of Dr. Boushey’s speech is below and a video can be found here. 

Speech As Prepared for Delivery

I want to use my 10 minutes to focus on a couple of points: What are the implications if Thomas Piketty is right? Where should we start looking for policy answers?

Thomas points his readers to the novels of Jane Austen, Henry James and Henri Balzac. I want to quote him – he says, “for Jane Austen’s heroes, the question of work did not arise; all that mattered was the size of one’s fortune, whether acquired through inheritance or marriage.” Reading Henry James and Jane Austen certainly made me glad to have been born in 1970, not 1800.These novels are a testament to the limited choices that women had.

Today, to some extent, anyone can create a decent standard of living – or become a millionaire – through accomplishment in this life, rather than what we inherited from our parents. Of course, Thomas presents evidence that the “upper classes instinctively abandoned idleness and invented meritocracy lest universal suffrage deprive them of everything they owned,” but let’s set that aside for a moment.

There’s been a gender revolution, although it remains fairly recent and still incomplete. When I went off to college, my mother admitted to me she was jealous of the opportunities that I had. She told me how when she was thinking about her college option, they were much more limited than mine. She felt that her options were only to study to become a nurse, teacher, or secretary. That wasn’t the array of opportunities that I faced or today’s young women face.

These changes have been good for our economy. According to Stanford economist Peter Klenow and his colleagues, the opening up of professions to women and minorities accounted for a fifth of growth in U.S. GDP between 1960 and 2008. A fifth! That’s non-trivial. In my own research with John Schmitt and Eileen Appelbaum, we found that the increase in women’s labor supply in the United States has added 11 percent to GDP since 1979.

We – all of us, no matter our age – have lived through an era where the presumption is that our society marches always towards great equality or less discrimination, even if slowly. But, if Thomas is right, then this era could be at an end. To get a feel for this, one could point to the PBS it Downton Abbey where Lord Grantham’s family will face eviction from their family manor when the Earl dies. There was no other way for Grantham’s three daughters to maintain their standard of living other than marrying well. So, the show’s first season focuses on whether the eldest daughters would concede to marry her cousin Matthew.

If Thomas is right, then once again, the rules over inheritances will make all the difference for the potential for women’s equality. Do inheritances go to the eldest child or to the eldest male child? What happens upon the death of a spouse – does the wife or the child inherit? I fear that the answers to these questions are not likely to be good for women because while the gender revolution has come a long way, it has stalled in recent decades. Thomas’s data makes me wonder if we’ll wish we’d solidified that more quickly.

In 2014, only one-in-ten U.S. billionaires were women (11.4 percent) and the female share of self-made billionaires is only 3.1 percent. While women have made progress in the workplace, the gender pay gap remains 78 cents on the dollar and this gap begins as soon as women enter the labor force and grows over time.

The gap in pay and labor force participation between men and women, especially here in the United States, is in no small part because we have no found sufficient ways to help workers with care responsibilities. For example, in the vast majority of workplaces neither women nor men have access to paid family leave. That is, except in California, New Jersey, and Rhode Island, where paid family and medical leave has been implemented.

The lack of a federal paid leave policy leaves female caregivers disadvantaged in the labor market. We see this when we compare the labor force participation rates of women in the United states to other OECD countries where the United States has fallen to 17th out of 22 countries. Policy plays a clear role here.

Cross-national studies on the role of policies that reconcile work and family demands have found that the work hours of women in dual-earner families are similar to those of men when child care is publicly provided. Paid maternity and parental leave also increases the employment rate of mothers and more generous paid leave benefits increase the economic contributions of wives to family earnings.

If we’re on the cusp of an era where wealth becomes more important, the failure to implement these policies and achieve greater equality in the preceding era are all the more urgent to address. But, Thomas also questions whether we can raise “g.” And we know, expanding opportunities to excluded groups raises productivity. So there might be some potential there.

That leads me to two aims for policymakers that I draw from the book. First, recognizing that women are an underutilized source of growth and addressing this is extremely urgent for our economy and may be imperative if we don’t want to regress on the gender progress we have made.

In Japan, in order to boost growth in the face of declining population growth, they are pursuing “womenomics’ and implementing policies to boost female labor force participation and close the gender wage gap. When I talk to policy leaders from the United Kingdom or Canada, they will make the argument to me that addressing conflicts between work and family are critical for economic productivity. Too often, I find that I have to make that argument to U.S. policymakers.

While I fear that Thomas’s analysis predicts that women may have fewer economic opportunities moving forward, I also wonder what it means to ponder an economy where dead capital could again supersede human capital. Certainly, it would imply less innovation if economic opportunities were confined to those who started with the most capital. But, is this an overreaction?

In Capital in the Twenty-First Century, Thomas focuses on the rise of the “supermanager,” which he referenced earlier. Which brings me to a second area for policy. We must consider that some of what we’re calling labor income is actually capital income or unproductive rents. This has important policy implications. We hosted a conference last week where Alan Blinder and Emmanuel Saez debated this point, noting that we don’t have data that allows us to discern whether high incomes are rents or productive. At the end of the day, this is a key piece of information we need to inform policymakers in terms of whether and how to intervene.

I have thought a lot about your wealth tax idea, Thomas, and am very taken by remarks Michael Ettlinger made at that same conference we hosted last week where he pointed out that wealth is harder to track and harder to value than income. That’s not to say we shouldn’t not seek to pursue this or try to pull together the data, but I also want us to consider a variety of other strategies that could also be effective.

I want to end by saying that I’m really pleased we are having this conversation at the New School of Social Research. To echo what Anwar said, I think it’s encouraging and exciting to see economic research that beings by seeking to understand the real world and then uses that data to inform a theoretical framework. I think that Thomas is part of a new generation of economic asking different questions than their teachers.

Many of us who came into adulthood as the 1980s turned into the 1990s begin not from President Kennedy’s dictum that a rising tide lifts all boats, but rather from the premise articulated by presidential economics advisor Gene Sperling that “the rising tide will lift some boats, but other will run aground.”

We had to begin here.

The only economic reality we’ve ever experienced is one where productivity gains go to the top while leaving the vast majority to cope with stagnant wages, greater hours of work, and, most especially in the past decades, rising debt burdens. We’ve experienced first-hand the damage this has done to our generation and the ones that follow. The idea that the real world matters was a key idea I took from my education here at the New School and I’m glad we’ve been able to be here together to discuss this important book here today.

President Obama’s “middle-class economics”

Posted on by Bridget Ansel

Equitable growth was a central theme in President Obama’s State of the Union address last night. The president’s speech laid out a vision for “middle-class economics” that is clearly meant as a rebuke to “trickle-down economics,” the philosophy which has dominated Washington policymaking for the past four decades. But what exactly is middle-class economics?

First of all, it’s good political messaging because a plurality of Americans self-identify as middle class—it’s not just for those at the middle of the income ladder. The President’s “middle class economics” vision includes policies that help those at the bottom, middle, and, yes, the top of the income and wealth spectrum in our society, and in turn aims to kick-start the U.S. economy into a new era of equitable growth.

But middle-class economics also is good economics. Boosting wages is perhaps the right place to start, given the salience of wage stagnation as a key indicator of the failures of the past several decades of trickle-down’s ill-distributed growth. The president’s speech called for boosting the minimum wage, a policy move supported by a widening circle of politicians, including prominent Republicans who recognize that it’s not only publically popular but also important to improving the livelihoods of those on the bottom and middle rungs of the income ladder as that wage increase “trickles up” the income ladder.

The declining strength of the minimum wage over the past three decades is illustrated in this great infographic. And the best evidence on the economics of the minimum wage suggests little-to-no meaningful effects on job creation or job losses. Instead we see substantial reductions in labor employee turnover and improvements in business efficiency that help business owners and shareholders alike. Moreover, recent studies using a wave of state-level minimum wage increases show that states that increased their minimum wage saw stronger job growth than those that did not—another boon to both employees and employers.

It’s also worth noting that Econ101 says putting more money in the pockets of low-wage workers is good for the economy as it boosts consumer demand. It is these individuals that are most likely to spend that extra dollar in their pocket, and that spending is part of what drives economic growth. And, despite the popular counterpoint that many minimum wage workers are teenagers working for pocket change, over half of all minimum wage workers were 25 years old or older.

The president’s speech last night also included a pitch to reduce work-family conflict, with a policy agenda including paid sick leave, paid family leave, and affordable child care. All of these are much needed updates to workplace rules designed for the Mad Men-era, when a family could maintain a comfortable middle-class standard of living on one income. An updated set of family friendly policies isn’t just good for hard-working families, whether they’re dual-earner couples or struggling single parents. What’s good for families is also good for the economy.

One recent study shows that paid parental leave is not the “job killer,” and in contrasts actually boosts labor force participation and wages, as well as job quality. For instance, in a 2009-2010 survey of California employers, 87 percent reported that the state’s paid family leave policies resulted in no cost increases. Family friendly workplace programs also help working parents stay in the labor market. These policies mean breadwinners do not face the hard choice that 41 million American workers currently must make—miss a paycheck or even lose a job to care for a sick child or taking an ailing parent to the doctor’s office.

Finally, the President’s middle-class economics includes a new set of taxes on capital to lift them closer to those already levied on wages. The focus on capital taxation makes sense in light of the new evidence on the dramatic wealth gaps in the United States. My colleague, Nick Bunker, has written elsewhere on the president’s tax-reform proposals, but it’s worth briefly noting here the key take-away: Trickle-down economic messengers contend that increasing taxes on capital is a sure-fire way to kill growth, but a wide range of thoughtful economists tells us otherwise.

Tax Policy Center director and Syracuse University economist Len Burman, for instance, concludes that top capital gains rates have no relationship to economic growth. This means raising taxes on capital would enable our nation to make the investments we need to power more broad-based economic growth that helps everyone up and down the economic ladder now and well into the future. Think new infrastructure, universal pre-kindergarten, more affordable college, and more money for basic research and development to ensure the United States remains the world’s global technology and innovation leader.

In short, middle class economics tells us we can raise capital gains tax rates back to where they were under President Ronald Reagan—and by doing so finance government programs that can serve as a springboard for more equitable growth.

 

 

An appreciation of Robert Solow

Posted on by Nick Bunker

President Obama today is awarding the Presidential Medal of Freedom to a number of accomplished Americans, including Robert Solow, Institute Professor, emeritus and Professor of Economics, emeritus at the Massachusetts Institute of Technology, Nobel Laureate in Economics, and a member of Equitable Growth’s Steering Committee

Robert Solow’s name is familiar to anyone who’s taken an introductory macroeconomics course. Solow’s model of economic growth is the first, and for the vast majority of students, the only growth model they will learn. And it’s for this work that Solow won the Nobel Prize in 1987.

The Solow growth model has one key takeaway: the source of long-term economic growth is technological growth. Before Solow’s 1956 and 1957 papers outlining the model, some economists believed that a country could boost its rate of economic growth by increasing its savings rate or adding more workers to its labor force.

But Solow’s model shows something else. Increasing the savings rate could get an economy to a higher level of output after the increase, but the long-run rate of economic growth wouldn’t increase. Doubling the savings rate would increase a country’s GDP per capita, but it wouldn’t change the fact that the economy would grow at the same rate as before. But a “technological” advance boosts the long-run growth rate of the economy.

Think of it this way: an increase in the savings rate moves an economy along a line, but technological growth shifts the line out.

Now by technology Solow’s model doesn’t mean just advances in computers or robots, but rather anything that allows for a more efficient use of capital and labor. In that way, technology is essentially the same thing as total factor productivity. What determines the growth in TFP over time is still very much an open question in economics.

But Solow’s model is important for guiding how we thinking about economic growth in the real world. For example, once you understand the Solow model you realize a country like China growing much faster than the United States isn’t so surprising. China is experiencing catch-up growth as it invests more in its economy and adopts technology and other resources from richer countries. Eventually China will catch up to the technological frontier and grow at about the same rate as the United States. At least in the long-run.

As for countries already at the frontier, the model indicates that the path to sustainable long-term economic growth is to improve productivity. Rich countries can help boost the productivity of labor by improving access to and the quality of education, increasing the productivity of capital by creating institutions that allocate it more efficiently, fostering innovation, or a variety of other policy options.

Solow’s most famous work is certainly theoretical, but it has clear policy implications. Solow himself delved more directly into the world of economic policy when he served in government. He served as a senior economist for the Council of Economic Advisers during the Kennedy Administration in the early 1960s.

Though Solow officially retired from MIT in 1995, he continues to engage in the economic and policy debates of the day. He wrote one of the best received reviews of Thomas Piketty’s Capital in the 21st Century published in the New Republic. And he does not shy away from engaging in contentious debates.

The Presidential Medal of Freedom is awarded to individuals who make especially “meritorious contributions” to society. Robert Solow’s contributions certainly have great merit. Through his groundbreaking insights into economic growth, his government service, and his role in the public debate, Solow has helped create a more prosperous United States.