Minimum wages and the distribution of family incomes in the United States

Posted on by Kavya Vaghul

The ability of minimum-wage policies in the United States to aid lower-income families depends on how they affect wage gains, potential job losses, and other sources of family income, including public assistance. In contrast to a large body of research on the effects of minimum wages on employment,1 there are relatively fewer studies that empirically estimate the impact of minimum wage policies on family incomes.

In my new paper, I use individual-level data between 1984 and 2013 from the Current Population Survey by the U.S. Census Bureau to provide a thorough assessment of how U.S. minimum wage policies have affected the distribution of family incomes.2 Similar to existing work, I consider how minimum wages influence the poverty rate. Going beyond most existing research, however, I also calculate the effect of the policies for each income percentile, adjusting for family size. This highlights the types of families that are helped or hurt by wage increases. I also calculate the effect on a broader measure of income that includes tax credits and noncash transfers. I quantify the offset effect of higher wages on the use of transfer programs and the gains net of the offsets by income percentiles, painting a fuller picture of how minimum-wage policies affect the U.S. income distribution and the overall well-being of U.S. families.

New Working Paper
Minimum wages and the distribution of family incomes

Overall, I find robust evidence that higher minimum wages lead to increases in incomes among families at the bottom of the income distribution and that these wages reduce the poverty rate. A 10 percent increase in the minimum wage reduces the nonelderly poverty rate by about 5 percent. At the same time, I find evidence for some substitution of government transfers with earnings, as evidenced by the somewhat smaller income increases after accounting for tax credits such as the Earned Income Tax Credit and noncash transfers such as the Supplemental Nutrition Assistance Program. The overall increase in post-tax income is about 70 percent as large as the increase in pretax income.

Effect of minimum wages on poverty

I use individual level data from the UNICON extract of the March Current Population Survey between 1984 and 2013. I focus on the nonelderly population under 65 years of age. I define family income following the official poverty measurement, using (pretax) cash income, and adjust for family size and composition using Census Bureau guidelines.3

I find that a 10 percent increase in the minimum wage reduces poverty among the nonelderly population by 2.1 percent and 5.3 percent across the range of specifications in the long run (three or more years after the policy change). There are also reductions in shares earning below 125 percent and below 75 percent of the poverty threshold. For my preferred model with the richest set of controls, the falls in shares below 75 percent, 100 percent, and 125 percent of the poverty threshold are 5.6 percent, 5.3 percent, and 3.4 percent, respectively, from a 10 percent increase in the minimum wage. (See Table 1.)

Table 1

Since minimum wage policies are not randomly assigned across states, it is important to account for any bias that may arise from differences across states raising the minimum wage as compared to those which do not. For instance, there is a strong regional clustering of minimum wage policies.4 Economists disagree, however, on the best way to account for such biases. For this reason, I report results using eight different specifications with alternative controls for state-level controls that subsumes most of the approaches used in the current economics literature on minimum wages. Starting with the classic model that assumes all states are on parallel trends (known as the two-way fixed effects model), I progressively add regional controls (division-period effects), state-specific linear trends, and state-specific business cycle effects. This exercise allows the evolution of family income distribution to differ across states in many different ways.

Moreover, all of these controls have been shown to be important in the existing minimum-wage literature.5 Importantly, all of these specifications find that increases in the minimum wage reduce the nonelderly poverty rate.6 At the same time, as I show in the paper, the specification with all three sets of controls (the last column in Table 1) performs the best in a variety of falsification tests, meaning they do not spuriously suggest an effect much earlier than the policy change or suggest effects much higher up in the income distribution. This is why I consider it the preferred specification.

Effect of minimum wages on family-income distribution

In my paper, I use the shift in the cumulative distribution of family income to calculate income changes by percentiles. I find that the largest increases occur between the bottom 10th and 15th percentiles. A 10 percent increase in the minimum wage raises pretax cash incomes in this range anywhere between 1.5 percent and 4.9 percent depending on control sets. (See Table 2.)

Table 2

Some of the increase in pretax cash incomes among these families at or near the bottom of the income distribution is offset by reduced tax credits and noncash transfers. Losses in tax credits (such as the Earned Income Tax Credit and the Child Tax Credit) and noncash transfers (such as the Supplemental Nutrition Assistance Program) offset some of these gains. For the bottom quartile, the income gains are approximately $370 after accounting for these offsets due to reduced tax credits and noncash transfers—or around 70 percent as large as the pretax cash income gains. The offsets appear to be particularly pronounced between the 13th and 17th percentiles of the income distribution.

These findings are consistent with some individuals losing eligibility for benefits as a result of increased income. Typically, eligibility for supplemental nutrition assistance, for example, requires income to be less than 130 percent of the federal poverty threshold, which for this population binds just under the 15th percentile. On average, those in the bottom quartile of the income distribution can expect an approximately $525 increase in annual income from the minimum-wage policy; the gains are largest around the 15th percentile. (See Figure 1.)

Figure 1

Policy implications

To put the policy implications of these estimates in perspective, I calculate the impact from an increase in the federal minimum wage from the current $7.25 per hour to $12 per hour. One could use the same estimates in this paper to project the impact of alternative policies—such as raising the minimum wage to $10 per hour or $15 per hour. The caveat is that when considering inflation-adjusted minimum-wage levels much larger than those used in the study, the projections may be less reliable.

Taking into account the state minimum wages as of January 2017, an increase in the federal minimum wage to $12 (in 2017 dollars) would raise the effective minimum wage—meaning the maximum federal or state standard—by 41 percent. The long-run estimates from the paper and a 13.5 percent poverty rate among the nonelderly population in 2016 suggests a 2.45 percentage point reduction in the poverty rate from this minimum wage increase. Given the roughly 270 million nonelderly Americans in 2016, this translates into 6.6 million fewer individuals living in poverty.

We can also expect the same minimum-wage increase to raise family incomes by 14.5 percent at the 10th percentile of the family-income distribution in the long run. For the average family near the 10th percentile in 2016, this translates into an annual increase of $2,538, and after accounting for the offset due to reduced tax credits and noncash transfers, this amounts to an increase of $2,140.If we take the range of estimates from all specifications, the proposed minimum wage changes can be expected to reduce the poverty rate among the non-elderly population by 1.00 and 2.53 percentage points, hence reducing the number of non-elderly individuals living in poverty by somewhere between 2.7 and 6.8 million. For the 10th percentile of family incomes, this translates to an annual income increase ranging between 5.2 and 16.8 percent, or between $905 and $2,937. After accounting for offsets due to lost public assistance, the income increases would range between $657 and $2,790.
To put these changes in context, the Earned Income Tax Credit reduces the nonelderly poverty rate by around 1.7 percentage points, and cash transfers (means tested and nonmeans tested) reduce it by around 3.8 percentage points, while noncash transfers (other than Medicaid) reduce it by around 0.9 percentage points. In other words, a substantial increase in the minimum wage would likely have a positive impact on the nonelderly poverty rate comparable to means-tested public assistance programs.

These calculations did not factor in how minimum-wage increases may affect overall consumer prices, though such price increases are very small compared to the income gains for those in the bottom of the income distribution. The expected price increase from raising the federal minimum wage to $12 per hour would be less than 1 percent.7 Therefore, netting out any price increases does not substantially affect the real income gains for the bottom quarter of the income distribution. Price increases do mean, however,  that a sizeable portion of these income gains at the bottom are likely to be borne by middle- and upper-income consumers through small increases in prices.

Conclusion

A substantial increase in the federal minimum wage can play an important role in reducing poverty and raising family incomes in the United States at the bottom of the income ladder while reducing the use of public assistance. The loss in cash and noncash transfers and tax credits among those who would benefit the most from minimum-wage increases is likely to dampen some of the benefits, especially among those around the poverty line, yet the resulting public savings could be ploughed back into further shoring up the safety net—in turn increasing the complementarity between minimum wages and income support for raising the incomes of families at the bottom of the income ladder.

—Arindrajit Dube is an associate professor of economics at the University of Massachusetts, Amherst

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Minimum wages and the distribution of family incomes in the United States

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Must-Watch: Trade, Jobs, and Inequality

Posted on by Brad DeLong

Must-Watch: Trade, Jobs, and Inequality http://www.gc.cuny.edu/All-GC-Events/Calendar/Detail?id=38997: “CUNY :: The Graduate Center :: 365 Fifth Avenue :: C200: Proshansky Auditorium :: April 26, 2017: 6:30 PM http://www.gc.cuny.edu/publicprograms…

…New York Times columnist Eduardo Porter (Economic Scene) hosts a panel of experts on the complex interrelationship between trade, jobs, and inequality. Participants:

  • Paul Krugman, Nobel Prize-winning economist, New York Times columnist, and distinguished professor at the Graduate Center.

  • David Autor, leading labor economist; professor at MIT, where he directs the School Effectiveness and Inequality Initiative; and editor in chief of the Journal of Economic Perspectives.

  • Brad DeLong, economics professor at U.C. Berkeley; weblogger for the Washington Center for Equitable Growth; and former U.S. deputy assistant secretary of the treasury, in the Clinton administration.

  • Anne Harrison, professor at the Wharton School, University of Pennsylvania; former director of development policy at the World Bank; and author of Globalization and Poverty…

Macro-prudential financial regulations versus capital controls

Posted on by Nick Bunker

A recent speech by the Bank of International Settlements’ head of research, Hyun Song Shin, could not be more timely. Shin argues that a recent re-evaluation of capital controls on the flow of global investments by some analysts may have gone too far. Shin sees the use of capital controls as trying to cure the symptoms of excessive lending by banks with too much foreign capital accumulating on their balance sheets and not the underlying disease, which is excessive leverage and the instability of funding based on the fickle flows of international capital.

But as Matt Klein points out at FT Alphaville, the line between macro-prudential regulations—such as the so called Dodd-Frank financial regulatory laws put in place in the United States in the wake of the Great Recession—and capital controls such as those used by China and Malaysia to avoid the worst of the global financial crisis of the 1990s isn’t so clear. Of course, there is the possibility that two policies can be used in conjunction with the mix of policies varying depending on the economy.

To put this in a more understandable context, let’s think through how international capital flows can result in a crisis. Say, a country receives an influx of foreign capital that ends up in the country’s banking system, as happened in many East Asian economies in the 1990s when much borrowing was done in U.S. dollars. Foreign lenders are now depositors at the banks and own a large chunk of these domestic banks’ liabilities. The banks can now use these deposits to make loans to the rest of the local economy. If enough of these foreign-capital fueled loans go to one sector of the economy, then the result is a buildup in debt in that section of the economy.

This whole process moves along fine until one day a rising number of domestic borrowers suddenly can’t service their loans for some reason. The banks now have assets that are declining in value, but their liabilities (the deposits from the foreign lenders) are still there. The foreigners realize the banks’ assets are shaky, take out their deposits, and the money leaves the country. Series of events like this are familiar in emerging market economies where global capital is seeking out higher returns. These concerns are relevant today for emerging markets as many of these economies have borrowed significant amounts in U.S. dollars in recent years.

But are such concerns relevant to the United States? In fact, as the recipient of quite a bit of foreign capital, the United States runs a capital account surplus. On net, the United States receives capital from the rest of the world. What’s more, there’s some evidence that the global imbalances of the mid-2000s—better known as the global savings glut—contributed to the U.S. housing bubble. And while the savings glut has morphed over the years, capital is still flowing into the United States, though today, corporate bonds seem to be the preferred asset this time around.

Policymakers in the United States belatedly recognized the dangers of this kind of debt build up and the fragility of the financial sector and passed the Dodd-Frank financial reform act. Part of the new view on financial regulation was an appreciation of “macro-prudential” regulation. These regulations seek to limit risks in certain sectors of the U.S. economy, such as reducing leverage in the banking sector or highlighting the systemic importance of particular firms. But if the concern is that foreign capital flows are increasing financial instability, another solution is to impose capital controls that would slow down the inflow and outflow of foreign capital. China, for example, has yet to fully liberalize it’s capital account and delaying this opening may be benefitial for the global economy.

With apologies to the Robinson Crusoe parables that introductory economics teachers love, no economy is an island. That cliché is especially true in a world where restrictions on the international movement of capital have been either eliminated or drastically reduced, enabling capital to flow unconstrained by borders toward its most efficient use. There may be significant benefits from more liberalized global capital flows, yet the costs are much larger than most proponents probably expected. The freer flow of capital has led to several severe financial crises as it contributed to the buildup of debt. Policymakers interested in promoting financial and economic stability clearly have a delicate balance to walk.

What Can Be Done to Improve the Episteme of Economics?

Posted on by Brad DeLong

I think this is needed:

INET: Education Initiative: “We are thrilled that you are joining us at the Berkeley Spring 2017 Education Convening, Friday, April 28th 9am-5pm Blum Hall, B100 #5570, Berkeley, CA 94720-5570… https://www.ineteconomics.org/education/curricula-modules/education-initiative

…Sign up here: https://fs24.formsite.com/inet/form97/index.html or email aoe@ineteconomics.org…

I strongly share INET’s view that things have gone horribly wrong, and that it is important to listen, learn, and brainstorm about how to improve economics education.

Let me just not six straws in the wind:

  1. The macro-modeling discussion is wrong: The brilliant Olivier Blanchard https://piie.com/blogs/realtime-economic-issues-watch/need-least-five-classes-macro-models: “The current core… RBC (real business cycle) structure [model] with one main distortion, nominal rigidities, seems too much at odds with reality…. Both the Euler equation for consumers and the pricing equation for price-setters seem to imply, in combination with rational expectations, much too forward-lookingness…. The core model must have nominal rigidities, bounded rationality and limited horizons, incomplete markets and the role of debt…”

  2. The macro-finance discussion is wrong: The efficient market hypothesis (EMH) claimed that movements in stock indexes were driven either by (a) changing rational expectations of future cash flows or by (b) changing rational expectations of interest rates on investment-grade bonds, so that expected returns were either (a) unchanged or (b) moved roughly one-for-one with returns on investment grade bonds. That claim lies in total shreds. Movements in stock indexes have either no utility-theoretic rationale at all or must be ascribed to huge and rapid changes in the curvature of investors’ utility functions. Yet Robert Lucas claims that the EMH is perfect, perfect he tells us http://www.economist.com/node/14165405: “Fama tested the predictions of the EMH…. These tests could have come out either way, but they came out very favourably…. A flood of criticism which has served mainly to confirm the accuracy of the hypothesis…. Exceptions and ‘anomalies’ [are]… for the purposes of macroeconomic analysis and forecasting… too small to matter…”

  3. The challenge posed by the 2007-9 financial crisis is too-often ignored: Tom Sargent https://www.minneapolisfed.org/publications/the-region/interview-with-thomas-sargent: “I was at Princeton then…. There were interesting discussions of many aspects of the financial crisis. But the sense was surely not that modern macro needed to be reconstructed…. Seminar participants were in the business of using the tools of modern macro, especially rational expectations theorizing, to shed light on the financial crisis…”

  4. What smart economists have to say about policy is too-oftendismissed: Then-Treasury Secretary Tim Geithner, according to Zach Goldfarb https://www.washingtonpost.com/blogs/wonkblog/post/geithner-stimulus-is-sugar-for-the-economy/2011/05/19/AGz9JvLH_blog.html: “The economic team went round and round. Geithner would hold his views close, but occasionally he would get frustrated. Once, as [Christina] Romer pressed for more stimulus spending, Geithner snapped. Stimulus, he told Romer, was ‘sugar’, and its effect was fleeting. The administration, he urged, needed to focus on long-term economic growth, and the first step was reining in the debt…. In the end, Obama signed into law only a relatively modest $13 billion jobs program, much less than what was favored by Romer and many other economists in the administration…”

  5. The competitive model has too great a hold: “Brad, you’re the only person I’ve ever heard say that Card-Krueger changed their mind on how much market power there is in the labor market…”

  6. The problem is of very long standing indeed: John Maynard Keynes (1926) https://www.panarchy.org/keynes/laissezfaire.1926.html: “Some of the most important work of Alfred Marshall-to take one instance-was directed to the elucidation of the leading cases in which private interest and social interest are not harmonious. Nevertheless, the guarded and undogmatic attitude of the best economists has not prevailed against the general opinion that an individualistic laissez-faire is both what they ought to teach and what in fact they do teach…”

So:

INET: Education Initiative: “We are thrilled that you are joining us at the Berkeley Spring 2017 Education Convening, Friday, April 28th 9am-5pm Blum Hall, B100 #5570, Berkeley, CA 94720-5570… https://www.ineteconomics.org/education/curricula-modules/education-initiative

…Sign up here: https://fs24.formsite.com/inet/form97/index.html or email aoe@ineteconomics.org…

We are convening students and professors who are interested in broadening economics education…. Our goals are to learn more about prevailing needs, pool and share existing pluralist curriculums, and brainstorm the architecture and direction of concrete future endeavors in post-secondary economics education. The economics discipline is in disrepair: publicly discredited, theoretically narrow, and academically constrained. Economics education reflects these flaws…. INET is gathering people in the academic economics community in convenings across the U.S. to better understand the challenges and resources faced by those working to reinvigorate the economics discipline.

Invitations are extended to: pre- and non-tenure faculty, including adjuncts; undergraduate and graduate students; experienced faculty actively engaged in pluralist education…. The convenings will be group-led, facilitated, full-day workshops…. These convenings are an exploratory process for INET. We have not made any funding commitments in this field beyond this series of convenings…. We do not view these meetings primarily as places to present funding proposals, but… to share experiences and ideas.

Next steps for INET in education will be announced following these convenings in May 2017….

As the day is long and the goal is ambitious, we will devote part of our morning to building a community agreement together. In anticipation of this, we invite you all to consider what makes a conversation comfortable and supportive for you (bonus points if you can frame it affirmatively…. This is not a suitable gathering for funding proposals. Chatham House Rules….

  • 9–10am: Breakfast & Coming Together
  • 10–11am: Constraints: Barriers to Economic Education
  • 11am–12pm: Resources: Existing Tools for Economics Education
  • 12–1pm: Lunch
  • 1–2pm: Matching: Fitting Resources to Constraints
  • 2–3pm: Gaps: Identifying Remaining Needs
  • 3-3:30pm: Coffee Break
  • 3:30–5pm: Future: Identifying Avenues of Change
  • 5-6pm: Dinner

Must-Read: INET: Education Initiative—Berkeley, CA, April 28, 2017

Posted on by Brad DeLong

Must-Read: Friday 9-5 pm: Blum Center: U.C. Berkeley: INET says: learn, share, and brainstorm about concrete future endeavors in broad-church post-secondary economics education. I strongly share INET’s view that things are seriously wrong…

Sign up here: https://fs24.formsite.com/inet/form97/index.html or email aoe@ineteconomics.org…

INET: Education Initiative: “We are thrilled that you are joining us at the Berkeley Spring 2017 Education Convening, Friday, April 28th 9am-5pm Blum Hall, B100 #5570, Berkeley, CA 94720-5570… https://www.ineteconomics.org/education/curricula-modules/education-initiative

…We are convening students and professors who are interested in broadening economics education…. Our goals are to learn more about prevailing needs, pool and share existing pluralist curriculums, and brainstorm the architecture and direction of concrete future endeavors in post-secondary economics education. The economics discipline is in disrepair: publicly discredited, theoretically narrow, and academically constrained. Economics education reflects these flaws…. INET is gathering people in the academic economics community in convenings across the U.S. to better understand the challenges and resources faced by those working to reinvigorate the economics discipline.

Invitations are extended to: pre- and non-tenure faculty, including adjuncts; undergraduate and graduate students; experienced faculty actively engaged in pluralist education…. The convenings will be group-led, facilitated, full-day workshops…. These convenings are an exploratory process for INET. We have not made any funding commitments in this field beyond this series of convenings…. We do not view these meetings primarily as places to present funding proposals, but… to share experiences and ideas.

Next steps for INET in education will be announced following these convenings in May 2017….

As the day is long and the goal is ambitious, we will devote part of our morning to building a community agreement together. In anticipation of this, we invite you all to consider what makes a conversation comfortable and supportive for you (bonus points if you can frame it affirmatively…. This is not a suitable gathering for funding proposals. Chatham House Rules….

  • 9–10am: Breakfast & Coming Together
  • 10–11am: Constraints: Barriers to Economic Education
  • 11am–12pm: Resources: Existing Tools for Economics Education
  • 12–1pm: Lunch
  • 1–2pm: Matching: Fitting Resources to Constraints
  • 2–3pm: Gaps: Identifying Remaining Needs
  • 3-3:30pm: Coffee Break
  • 3:30–5pm: Future: Identifying Avenues of Change
  • 5-6pm: Dinner

A premature promise on tax rates could threaten tax reform

Posted on by Emilie Openchowski
Budget Director Mick Mulvaney speaks during a daily press briefing at the White House.

In an interview with the Associated Press late last week, President Donald Trump said that he would release his tax plan tomorrow. Senior administration officials have subsequently walked back the level of detail that will be provided while confirming that an announcement will occur. On Sunday, Mick Mulvaney, director of the Office of Management and Budget, said that the announcement would include “some specific governing principles, some guidance … [and] some indication of what the rates are going to be.”

Mulvaney’s suggestion that the announcement may include an indication of the administration’s proposed rates and little else is not surprising, as lower rates appear to be the only element of the plan that all of the relevant players agree on both in and outside of the administration. In the final iteration of his campaign plan, then-candidate Trump proposed a 15 percent corporate rate, an optional 15 percent rate for pass-through businesses, and a maximum rate of 33 percent for individuals. Speaker of the House Paul Ryan (R-WI) has proposed a 20 percent corporate rate, a maximum rate of 25 percent for pass-through businesses, and a maximum rate of 33 percent for individuals as part of the Better Way plan.

The Trump administration is in the unusual (but in some ways enviable) position of having already indicated that it is engaging in a substantial rewrite of the campaign’s tax proposals. This post-inauguration rewrite offers a unique opportunity to revisit the substance of the campaign proposals out of the glare of the campaign trail. Yet if tomorrow’s announcement confirms the Trump administration’s commitment to rates akin to those announced previously—which seems highly likely in light of yesterday’s press reports—then it could put the White House on the path to tax cuts rather than tax reform even before the plan has been fully developed, and even if the revenue target remains unknown.

The core issue in tax reform is defining the tax base. Since 1986—the previous time Congress enacted comprehensive tax reform—would-be tax reformers have focused on two issues. First, reformers across the political spectrum want to eliminate wasteful tax expenditures that provide special treatment to a favored group at the expense of the general public. (A tax expenditure is a provision of tax law that provides preferential treatment for a certain type of income or spending such as the exclusion from taxable income of employer-provided health insurance premiums and the deductions for home mortgage interest, state and local taxes, and charitable contributions.) And second, some reformers advocate for a shift from the hybrid income-consumption tax base of the current income tax in the direction of a pure consumption tax base.

Setting aside the relative merits of consumption and income taxation, there is broadly shared agreement on the proper design of a consumption tax. In particular, whether implemented as the Hall-Rabushka flat tax or the Bradford X-tax, or instead as a value-added tax, a retail sales tax, or a consumed-income tax, well-designed consumption tax proposals retain a tax on business cash flow at rates consistent with the taxation of wage income. (Business cash flow is the difference between receipts and spending. A cash flow base contrasts with an income base in that the income base does not allow a full deduction in the year an asset is purchased when that asset retains value over an extended period of time.)

Notably, however, the business tax rates suggested by the Trump presidential campaign and the House Republican Better Way plan are far below the generally applicable tax rates. While one could argue that residual rates on capital gains and dividends for C corporations partially offset this discrepancy, the option to defer realization would create opportunities for large-scale tax avoidance using strategies designed to exploit deferral and thus render them largely ineffective for this purpose. And, of course, pass-through businesses would not be subject to such taxes.

What is the result of changes in tax law such as those proposed by the Trump campaign and House Republicans? While the precise answer will ultimately depend on the yet-to-be-determined details of the package, the rates already tell the broad story. These reforms would shift the U.S. tax system in the direction of a consumption tax but at the same time create a generous new tax benefit for people who can characterize their income as business income. That is, the package would shift the tax system not only toward a system more reliant on consumption taxation, but also toward a two-tier tax system under which wage earners pay at a higher rate than those who derive their income from a business, all else being equal. The proposed reforms would do this by creating a new tax expenditure for people with business income that, similar to other wasteful tax expenditures, would distort economic decisions, create opportunities for avoidance, and cut taxes for a favored constituency at the expense of the broader public.

As an economic matter, the implications of this new tax expenditure for business income are unattractive. The rate cuts would deliver windfall gains to business owners based on investments that have been made in the past, which would now be taxed at a lower rate. And they would provide preferential taxation of business income attributable to market power, rents, and luck, and to disguised labor income (labor income shifted from the individual base to the business base through tax planning). The changes in tax law would create a preference for these sources of income at precisely the time research suggests they account for an increasing share of the corporate tax base. Finally, the preference would create a massive new compliance challenge for the Internal Revenue Service in policing business owners’ efforts to shift labor income into the business tax base.

The potential for large-scale tax avoidance as a result of the shifting of labor income into the business tax base has already led to challenges for congressional tax staffers attempting to flesh out the details of the plan. Well-designed consumption taxes avoid the need to distinguish between types of income by maintaining the cash-flow tax at a rate aligned with the individual system and instead allowing expensing of investments. This design cleanly distinguishes the normal return on capital from other types of income.

The reason to avoid this well-understood approach is an apparent desire to provide preferential tax treatment of income derived from market power, rents, and luck, and for disguised labor income, possibly in the hopes of boosting entrepreneurship. Yet there is little reason to think that an open-ended tax preference for income derived from market power, rents, and luck—or based on the ability of one’s tax advisers to re-label wages business income for tax purposes—relates in any coherent way to socially valuable entrepreneurship, let alone that this link would be strong enough to justify privileging income from these sources over all other sources. The purpose of tax reform is to eliminate poorly justified tax expenditures, not to create new ones.

Finally, while many politicians and analysts point to the difference between tax rates on business income in the United States and corporate tax rates abroad as evidence of the need for rate cuts for U.S. businesses, this comparison is inapt. First, there are numerous options for targeted reforms to address the challenges evident in the U.S. international tax system, including worldwide consolidation, formulary apportionment, the Obama administration’s minimum tax approach, and border adjustments such as those in the House Republican Better Way plan and in value-added taxes around the world. Would-be reformers could adopt any one of these approaches. A rate cut is a poor substitute for a targeted reform directly addressing the root cause of the problem.

Second, the portion of income attributable to sales in a country with a value-added tax and derived from market power, rents, and luck, or consisting of disguised labor income is included in the value-added tax base. Thus, comparing only the corporate rate across countries dramatically understates the rate of tax imposed on these types of income in countries with value-added taxes.

Should-Read: Dietrich Vollrath: Topics in Economic Growth

Posted on by Brad DeLong

Should-Read: Once upon a time I thought that Google Search and the links graph of the web would make my website self-organizing. Hasn’t happened. I do have to do something about that failure—someday. But here we have the smarter-than-me Dietrich Vollrath trying to get a jump on the problem:

Dietrich Vollrath: Topics in Economic Growth: “I just created some new pages… https://growthecon.com/blog/Topics-Pages/

…that collect resources and materials related to specific topics regarding growth… an exercise in intellectual housecleaning… a way to organize some materials for possible use in classes in the future. Each topic has links to my own posts on the subject, links to other web articles or resources, and some selected academic citations…. Right now, the topics include: Are we rich? Can you reform your way to higher growth? Does growth depend on competition? Does economic growth mean economic development? Productivity slowdown. Is manufacturing special? Robots and jobs. Deep determinants of development. Does economic growth harm the environment? It’s a decent start…

The importance of unemployment benefits for protecting against income drops

Posted on by Emilie Openchowski
People walk by the recruiters at a jobs fair in the Pittsburgh suburb of Green Tree, Pennsylvania.

During the worst part of the Great Recession, virtually every segment of the U.S. economy was adversely affected. Employment losses were severe and unevenly distributed, making many likely to be eligible for unemployment insurance. The program is supposed to support the unemployed as they search for a new job. But what happens when someone can’t find a job before his or her benefits expire? The consequences could be dire.

In an important new paper, economists Jesse Rothstein of the University of California, Berkeley and Robert Valletta of the Federal Reserve Bank of San Francisco investigate the role that unemployment insurance plays in supporting family incomes and how the unemployment insurance system interacts with other parts of our social safety net. The unemployment insurance system is designed to provide temporary income to workers during spells of unemployment. The typical duration of these benefits—individual states have broad latitude in setting the exact details in each state—is 26 weeks or less. But during and after the Great Recession, many states extended eligibility to up to 99 weeks.

Even with these extensions, however, many unemployed workers still exhausted these benefits before finding new jobs. Rothstein and Valletta find that after a job loss, households with unemployed workers saw their incomes fall by about half. Unemployment benefits replaced about a half of the lost income, supporting family incomes to a significant extent but failing to help many families experiencing unemployment avoid slipping into poverty as they tried to find new jobs. Initially, unemployment insurance and a rise in income from other household members helped to buffer the blow of a 50 percent drop in income due to job loss. Yet once these benefits expired, households suffered a second blow to income of 13 percent, with nearly no additional support from other social safety net programs. The remaining social safety net replaced only a small share of the lost unemployment benefits. (See Figure 1.)

Figure 1

The Supplemental Nutrition Assistance Program, for example, made up for only about 2 percent of pre-job loss income in households that tapped unemployment insurance and then about the same 2 percent after they lost unemployment insurance benefits.

It’s important to note that household consumption may not have fallen as dramatically as income over the period of job loss and unemployment exhaustion. But given the evidence that more than half of American families could not replace a month of their income with liquid savings and that one-third have no savings at all, it is difficult to see how households would be able to maintain their standards of living.

The bright side of these findings is that unemployment insurance does its job: partially insuring against large income declines after a job loss. But once an unemployed worker is no longer eligible for the program, the rest of the social insurance system does little to support those households. Other new research shows the significant decline in income and spending that happens after unemployment benefits are exhausted. If policymakers want to ensure that U.S. workers can have some modicum of economic security during the next economic downturn, they should take this research to heart.

Must- and Should-Reads: April 24, 2017

Posted on by Brad DeLong

Interesting Reads:

A Low-Pressure Economy Is Not Only Dark But Invisible in the Horserace Noah Smith is Running…

Posted on by Brad DeLong
Cursor and Cracking the Mystery of Labor s Falling Share of GDP Bloomberg View

I think the estimable Noah Smith gets this one wrong. He writes:

Noah Smith: Cracking the Mystery of Labor’s Falling Share of GDP: “Economists are very worried about the decline in labor’s share of U.S. national income… https://www.bloomberg.com/view/articles/2017-04-24/cracking-the-mystery-of-labor-s-falling-share-of-gdp

…For decades, macroeconomic models assumed that labor and capital took home roughly constant portions of output—labor got just a bit less than two-thirds of the pie, capital slightly more than one-third. Nowadays it’s more like 60-40. Economists are therefore scrambling to explain the change. There are, by my count, now four main potential explanations for the mysterious slide in labor’s share. These are: 1) China, 2) robots, 3) monopolies and 4) landlords…”

There is, in my view, a fifth—and a much more likely—possibility: the low-pressure economy.

The first misstep Noah takes is in saying that 100% of national income is divided between “labor” and “capital”. It is not. Entrepreneurship, risk-bearing, innovation, monopoly rents, and other factors are rolled into the non-labor share as well. It’s not the labor share and the capital share. It’s the labor share and everything else.

Suppose that you were not attached to sophisticated economic theory but just believed in the basic Adam Smith supply-and-demand: when something is in high demand, its price goes up; when something is in low demand, its price goes down. How then would you interpret the graph above at the top of this post?

You would say:

  1. Hmmm. In the late 1960s Lyndon Johnson created a high-pressure economy—he did not want to raise taxes to pay for fighting the Vietnam War, and did not want the Federal Reserve to raise interest rates. Then Richard Nixon continued the policy, naming Arthur Burns his own partner in his attempt in 1959 to persuade Eisenhower to create a high-pressure economy for the 1960 campaign, to run the Federal Reserve. And so the labor share went up.

  2. The 1973-1975 oil shock recession and then the 1979-1982 Iran Revolution plus Volcker Disinflation recessions gave a further large negative wallop to the pressure the economy was under. And so the labor share fell.

  3. It may have been “morning in America” from 1984 on in Reagan campaign commercials, but that was definitely not the case as far as the labor market was concerned.

  4. When the labor market became tight again in the internet boom of the late 1990s, lo and behold the labor share jumped back up again.

  5. But the recovery from the recession that followed the dot-com boom and 9/11 was a disappointing one. And the labor share fell.

  6. And then came the financial crisis and the disappointing recovery since. And the labor share fell some more.

Noah Smith’s quadriad of “China, robots, monopolies, and landlords” is needed only if you have a strong belief that there is one unique macroeconomic equilibrium point about which the business cycle fluctuates and to which the economy returns rapidly after a business-cycle shock creates a high- or a low-pressure economy. It is certainly convenient for economic model builders to believe in such a tendency for a rapid return to a unique macroeconomic equilibrium.

But where in the real world is there any evidence that there is in fact such a thing?

IMHO, the low-pressure economy is the leading horse in the race to understand why the labor share today is lower than it was in the late 1960s or the late 1990s. Yet Noah Smith does not even see it as in the race…