Thinking about inequality before taxes and transfers

Posted on by Nick Bunker

Trying to disentangle the causes and the current state of income inequality in the United States can be a tricky enterprise. Take what economists refer to as the distribution of disposable income, or income after accounting for the effects of taxes and government transfer programs such as unemployment insurance and government pensions. By that measure, the United States has the highest level of income inequality among a group of 19 high-income countries, including Germany, the United Kingdom, and Norway.

But does the United States have such high disposable income inequality because its distribution of market income, or income earned through a job or from holding a financial asset, was much higher or because taxes and government transfer programs were doing less than other countries?

For a while, the evidence indicated that the second answer was correct. Data from LIS, an organization that collects international data on household income, show that the distribution of market income in the United States is in the same neighborhood as other high-income countries. The United States lags behind in efforts to alleviate income inequality through taxes and transfers.

But a new reevaluation of that data actually shows the United States should look more toward the market distribution of income. Janet Gornick and Branko Milanovic of the LIS Center looked at the data again, but made one important adjustment. They only looked at the distribution of income (both market and disposable) for households with workers under the age of 60. In the United States, older workers stay in the labor force longer and draw much more of their income from labor earnings than older workers in other high-income countries. A 62 year old in the United States has to work longer and earn more labor income than a pensioner living in a European country who can rely upon government programs. Older households in European countries end up looking much poorer in terms of market income and that in turn makes the overall market income inequality in those countries looks much higher.

As a result, when Gornick and Milanovic restrict their analysis to households with people under the age of 60, the United States becomes a starker leader in the inequality in terms of market incomes. What’s more, the two researchers find that the inequality reduction due to tax and transfer redistribution in the United States is in line with the rest of the high-income countries.

What does this mean going forward? As Paul Krugman points out, the policy implications are quite strong. Policymakers in the United States should focus more on policies concerned with the market distribution of income, or what Yale political scientist Jacob Hacker has called “predistribution.” Some of these potential polices were outlined in a column by Eduardo Porter in The New York Times earlier this week. He cites several ideas, including those floated in a new book by Oxford University economist Anthony B. Atkinson. They include higher minimum wages, stronger labor unions, and a focus on antitrust policy.

But Atkinson also suggests raising tax rates on those at the very top of the income ladder. The goal of these rate increases wouldn’t simply be higher levels of government revenue, but rather to reduce the incentives for corporate executives to bargain for higher compensation. Economists Thomas Piketty at the Paris School of Economics, Emmanuel Saez at the University of California-Berkeley, and Stephanie Stantcheva at Harvard University have made a similar argument.

While there is a distinction between market income and disposable income, we have to remember that tax-and-transfer programs also have an effect on market incomes. And not just at the top of the income ladder as Atkinson and Piketty, Saez, and Stantcheva point out. The more generous retirement programs in European economies are responsible for fewer oldsters remaining in the workforce and that, as discussed above, shapes the market income distribution.

The paper by Gornick and Milanovic and other evidence points us toward thinking more about the distribution of market income than redistribution, but we must recognize that policies aimed at the latter can affect the former as well.

Things to Read at Nighttime on May 6, 2015

Posted on by Brad DeLong

Must- and Should-Reads:

Over at Equitable Growth—The Equitablog

And Over Here:

Must-Read: David Glasner: John Taylor’s Cluelessness about Strategy, Tactics and Discretion

Posted on by Brad DeLong

Must-Read: The very sharp David Glasner compresses into a nutshell one of what seem to me to be a large number of incoherences from John Taylor, in this case from Taylor’s recent attack on Bernanke. More and more it seems to me that John Taylor’s arguments sound like economics to outsiders, but do not pass elementary tests of coherence to other economists:

David Glasner: John Taylor’s Cluelessness about Strategy, Tactics and Discretion: “Let’s be very specific. The Fed, for better or for worse…

…I think for worse — has made a strategic decision to set a 2% inflation target. Taylor does not say whether he supports the 2% target; his criticism is that the Fed is not setting the instrument – the Fed Funds rate – that it uses to hit the 2% target in accordance with the Taylor rule. He regards the failure to set the Fed Funds rate in accordance with the Taylor rule as a departure from a rules-based policy. But the Fed has been continually undershot its 2% inflation target for the past three years. So the question naturally arises: if the Fed had raised the Fed Funds rate to the level prescribed by the Taylor rule, would the Fed have succeeded in hitting its inflation target?

If Taylor thinks that a higher Fed Funds rate than has prevailed since 2012 would have led to higher inflation than we experienced, then there is something very wrong with the Taylor rule, because, under the Taylor rule, the Fed Funds rate is positively related to the difference between the actual inflation rate and the target rate. If a Fed Funds rate higher than the rate set for the past three years would have led, as the Taylor rule implies, to lower inflation than we experienced, following the Taylor rule would have meant disregarding the Fed’s own inflation target. How is that consistent with a rules-based policy?…

Must-Read: Barry Ritholtz: The QE Era

Posted on by Brad DeLong

Must-Read: Here we have a fairly powerful visual argument that:

  1. American financial markets did not expect QE to do much.
  2. Nevertheless, QE had substantial effects: whenever the Federal Reserve went on a long-bond buying spree, those who had sold the bonds took a nontrivial share of their cash and piled into stocks.
  3. That is the way it is supposed to work for QE to be effective.

Barry Ritholtz: The QE Era:

Inbox

But did the piling into stocks and the resulting rise in stock prices induce anyone to go short equities and purchase currently-produced goods and services on any significant scale? The theory of Tobin’s Q says that it must have. But is the theory of Tobin’s Q true?

Must-Read: Eduardo Porter: What the Debate on Inequality Is Missing

Posted on by Brad DeLong

Must-Read: It is only fair to note that Eduardo Porter is raising the standard of New York Times news analysis singlehandedly.

The only problem I see is the reflexive “opinions of shape of earth differ” jerk of the “debate… about poverty and inequality” in “Washington” “bogged down… pointless, often surreal”. Claims that we are spending a huge amount of money on our poor and that the government needs to shrink are surreal. But they are not pointless. Claims that we would all benefit in the long run from spending more money on the poor and on a government that was bigger if those could be done the right way are neither pointless nor surreal.

But the rest is gold.

His latest of an increasingly long streak of excellent takes:

Eduardo Porter: What the Debate on Inequality Is Missing: “The actual size of government? Measured by the taxes we pay…

…it was about 25 percent of our gross national product in 1970. It is still about 25 percent of our G.D.P. today. And the share of our wealth spent on the poor, apart from money devoted to the rising cost of health care, has not changed very much, either…. In… ‘Inequality, What Can Be Done?’… Anthony B. Atkinson of Oxford puts forth a set of proposals… a higher minimum wage… a guarantee of government employment up to 35 hours a week… strengthening unions and creating a ‘social and economic council’ where representatives of labor and civil society could have a say in policy, offering a counterweight to corporate power… marginal income tax rates could be pushed higher… a universal capital endowment for every adult….

Many of these ideas may strike classic American economists as outdated lefty proposals that already failed in the 1970s. But they look increasingly relevant in what many are calling the Second Gilded Age. ‘One of the key messages, given the kind of redistribution we need, is that we can’t achieve it simply through taxes and transfers,’ Professor Atkinson told me. ‘We are stuck in a narrow set of ideas. The most important thing is to broaden the agenda.’

Richard Thaler Misbehaves–or, Rather, Behaves

Posted on by Brad DeLong

A good review by Jonathan Knee of the exteremely-sharp Richard Thaler’s truly excellent new book, Misbehaving. The intellectual evolution of the Chicago School is very interesting indeed. Back in 1950 Milton Friedman would argue that economists should reason as if people were rational optimizers as long as such reasoning produce predictions about economic variables–prices and quantities–that fit the the data. He left to one side the consideration even if the prices and quantities were right the assessments of societal well-being would be wrong.

By the time I entered the profession 30 years later, however, the Chicago School–but not Milton Friedman–had evolved so that it no longer cared whether its models actually fit the data or not. The canonical Chicago empirical paper seized the high ground of the null hypothesis for the efficient market thesis and then carefully restricted the range and type of evidence allowed into the room to achieve the goal of failing to reject the null at 0.05 confidence. The canonical Chicago theoretical paper became an explanation of why a population of rational optimizing agents good route around and neutralize the impact of any specified market failure.

Note that Friedman and to a lesser degree Stigler had little patience with these lines of reasoning. Friedman increasingly based his policy recommendations on the moral value of free choice to live one’s life as one thought best–thinking that for people to be told or even nudged what to do–and on the inability of voters to have even a chance of curbing government failures arising out of bureaucracy, machine corruption, plutocratic corruption, and simply the poorly-informed do-gooder “there oughta be a law!” impulse. Stigler tended to focus on the incoherence and complexity of government policy in, for example, antitrust: arising out of a combination of scholastic autonomous legal doctrine development and of legislatures that at different times had sought to curb monopoly, empower small-scale entrepreneurs, protect large-scale intellectual and other property interests, and promote economies of scale. At the intellectual level making the point that the result was incoherent and substantially self-neutralizing policy was easy–but it was not Stigler but rather later generations eager to jump to the unwarranted conclusion that we would be better off with the entire edifice razed to the ground.

As I say often, doing real economics is very very hard. You have to start with how people actually behave, with what the institutions are that curb or amplify their behavioral and calculation successes or failures at choosing rational actions, and with what emergent regularities we see in the aggregates. And I have been often struck by Chicago-School baron Robert Lucas’s declaration that we cannot hope to do real economics–that all we can do is grind out papers on how the economy would behave if institutions were transparent and all humans were rational optimizers, for both actual institutions and actual human psychology remain beyond our grasp:

)Economics tries to… make predictions about the way… 280 million people are going to respond if you change something…. Kahnemann and Tversky… can’t even tell us anything interesting about how a couple that’s been married for ten years splits or makes decisions about what city to live in–let alone 250 million…. We’re not going to build up useful economics… starting from individuals…. Behavioral economics should be on the reading list…. But… as an alternative to what macroeconomics or public finance people are doing… it’s not going to come from behavioral economics… at least in my lifetime…

Yet it is not impossible to do real economics, and thus to be a good economist.

But it does mean that, as John Maynard Keynes wrote in his 1924 obituary for his teacher Alfred Marshall, while:

the study of economics does not seem to require any specialised gifts of an unusually high order…. Is it not… a very easy subject compared with the higher branches of philosophy and pure science? Yet good, or even competent, economists are the rarest of birds.

And Keynes continues:

An easy subject, at which very few excel! The paradox finds its explanation, perhaps, in that the master-economist must possess a rare combination of gifts… mathematician, historian, statesman, philosopher… understand symbols and speak in words… contemplate the particular in terms of the general… touch abstract and concrete in the same flight of thought… study the present in the light of the past for the purposes of the future. No part of man’s nature or his institutions must lie entirely outside his regard…. Much, but not all, of this ideal many-sidedness Marshall possessed…

John Maynard Keynes would see Richard Thaler as a very good economist indeed.

Jonathan Knee: In ‘Misbehaving,’ an Economics Professor Isn’t Afraid to Attack His Own – NYTimes.com: “The book is part memoir, part attack on… the Chicago School…

…And Professor Thaler is generally happy to name names when detailing the intellectual deficiencies and petty rivalries of his vocation…. The economics profession that Mr. Thaler entered in the early 1970s was deeply invested in proving that it was more than a mere social science…. Early in his career, Professor Thaler created a list of observed behaviors that were obviously inconsistent with the predictions of established orthodoxy. These found names like ‘the endowment effect,’ which leads individuals to systematically value things they already own much more than the identical item in someone else’s hands. ‘Misbehaving’ charts Mr. Thaler’s journey to document these anomalies in the face of economists’ increasingly desperate, and sometimes comical, efforts to deny their existence or relevance….

Professor Thaler’s narrative ultimately demonstrates that by trying to set itself as somehow above other social sciences, the ‘rationalist’ school of economics actually ended up contributing far less than it could have. The group’s intellectual denial led to not just sloppy social science, but sloppy philosophy…. The ‘misbehaving’ of Professor Thaler’s title is supposed to refer to how human actions are inconsistent with rationalist economic theory. It could just as easily refer to his own professional misbehavior in rejecting the prevalent worldview of academic economists at the time. Although not without serious risk to any aspiring academic, hopefully, his book and his career will inspire more miscreants across a wide range of intellectual specialties.

The importance of where you live for U.S. economic mobility

Posted on by Nick Bunker

Robust intergenerational economic mobility is supposed to be one of the defining characteristics of the United States. Yet economic research conducted over the past several years—and then revisited in a study released this week—finds that the degree of mobility across generations seems to depend on where you live and who your neighbors are.  Figuring out what drives that variation has become an important academic endeavor.

The most recent contours of this investigation were set in early 2014, when a group of economists released a study looking at the variation in the level of United States intergenerational mobility in the United States by where families lived. The results were striking. Some sections of the country had mobility levels that rivaled those of high-mobility countries such as Denmark. But other parts of the United States recorded levels so low that there was no comparison among other high-income countries.

The findings of that report, like lots of good research, sparked more questions. Were these patterns a result of certain kinds of people moving to regions where high mobility was already happening? Or was there something about these areas themselves that promoted high levels of mobility? Two of those researchers returned to this question with a new paper. The authors, economists Raj Chetty and Nathaniel Hendren of Harvard University, sort out the effects of location on intergenerational economic mobility. Using about five million observations of family tax records and looking at families that moved when children were young, Chetty and Hendren study the effects of a new location on mobility.

In short, they find that there is something about specific locations that promote economic mobility across generations. More precisely, the authors find that within the United States, 50 to 70 percent of the variation in mobility is due the “causal effects of place.” In other words, if we want to boost intergenerational mobility in the United States we can’t just focus on the attributes of specific individuals. We have to look at how to improve communities and neighborhoods.

But then another question comes up: What are the characteristics of those mobility-promoting places? Chetty and Hendren don’t find a definitive explanation, but they do  suggest some answers by returning to evidence they uncovered in 2014.  In that study, Chetty and Hendren found several variables that were strongly correlated with intergenerational mobility:

  • Measures of race
  • Segregation
  • Income inequality
  • The quality of Kindergarten through 12th grade schools
  • Social capital, or the strength of civic engagement in a community
  • Family structure

In their latest work, Chetty and Hendren test to see if these six correlations are due to the causal effects of location itselfor the characteristics of those that live there—what the authors call the “sorting component.”

Chetty and Hendren find that areas with more African-Americans and single-parent families have lower levels of intergenerational mobility. While about half of this relationship is due to individual characteristics, the other half is due to the negative effects of the place where these people live.  . So areas with high levels of single parents have lower mobility, for example, but only part of that relationship is due to the effect of moving into an area with high levels of single parents.

For two other variables, their initial correlations were much more influenced by the causal effects of place. The correlation of social capital with mobility appears to be entirely caused by the place itself. In other words, if you’re looking to move to an area that has a causal effect on mobility, social capital is a good indicator of where you and your family want to live.

The same goes for the quality of a K-through-12 education. At the level of commuting zone (the larger jurisdiction Chetty and Hendren use, comprised of 741 areas of the country),  correlation between mobility and education is entirely about a correlation with the causal effect of place. But then focusing on the smaller and more numerous counties within commuting zones, they find significant correlations with the sorting component.

When it comes to poverty, inequality and segregation, the results are particularly interesting. In a companion paper with Larry Katz, also of Harvard, Chetty and Hendren find that the Move to Opportunity program, which encouraged several thousand low-income families to move out of high-poverty neighborhoods into low-poverty areas, was quite successful at boosting intergenerational economic mobility. But in this paper, the three authors find that poverty rates are not strongly correlated with the causal effects of places. What are much more strongly correlated with the causal effect are measures of income segregation and income inequality.

While all these correlations are interesting and suggestive, they are still correlations. Yes, they are correlations with a causal effect but they don’t tell us if, for example, social capital is a key factor underpinning the causal impact of living in one place over another. Policymakers no doubt will find this research intriguing as they seek to promote the social and economic variables that produce more mobility-inducing areas, but further research drilling down on causation is still required.

Things to Read at Nighttime on May 5, 2015

Posted on by Brad DeLong

Must- and Should-Reads:

Might Like to Be Aware of: