Kling’s 3-axis model and income inequality

I’d like to extend a warm welcome to a new commenter at Our Dinner Table, Adam, who pointed me to this article: Rising Riches: 1 in 5 in US reach affluence.

Arnold Kling’s 3-axis model can help us predict what various folks might believe about income inequality and why they will continue to talk past each other.

Liberals operate on the oppressed-oppressor axis. The rich are the oppressors and the poor are the oppressed. They believe something must be done (government action) to ‘fix’ this situation. This view seems to be expressed in the article.

Conservatives operate on the barbarism-civilization axis. Rich people earn their money based on traditional values of strong work ethic and responsible choices. The poor may be more responsible for their position that liberals believe. So, using government to ‘fix’ income inequality erodes the values of work ethic and responsible choices.

This view is also expressed in the article, but by a successful pharmacist who “grew up on food stamps, but now splurges on…Hugo Boss shoes,” which I took as a subtle attempt to discredit his view.

Libertarians (as if anyone really cares what libertarian think) operate on the freedom-coercion axis. As long as the rich didn’t violate anybody’s freedoms to become rich, then all the power to them. Using force to try to ‘fix’ income inequality violates freedom, so is bad.

I fall into a mix conservative/libertarian camp here. Though, I am sure there are some poor people who are ‘disadvantaged’ and not merely victims of their own bad choices and unwillingness to take advantage of the tremendous opportunity this country has to offer (like a free $100,000 education).

I have a question for people who believe the ‘disadvantaged’ explanation.

Have you considered that encouraging responsible behaviors may be a better way to help the disadvantaged than redistribution?

Don Boudreaux, of Cafe Hayek, has some good thoughts on the article in his post, A Barrier to Reducing Income Inequality??? 

 

Blackboard Economics e.g.

In this post on his blog, Arnold Kling links to a post from Daniel Little that says:

the idea that a properly functioning market economy will tend to reduce poverty and narrow the extremes of income inequality has been historically refuted — at least in the case of American capitalism.

Little provides supports this claim with two charts.

I think this is a good example of what Ronald Coase refers to as Blackboard Economics. That is, on paper, Little may be making a good point, but reality doesn’t support. Look out the window of real life and things are different.

Liberals, conservatives and libertarians

This week’s EconTalk podcast is very timely. It features guest Arnold Kling discussing his three languages of politics. It’s timely because it ties in with the discussion we’ve been having here about noise grenades and rudeness people display to those with opposing political views.

Kling observes that unproductive political discourse may be caused by people in different political camps thinking along different good/evil axes, which causes them to essentially speak different languages.

For liberals the good end of the axis is helping the oppressed, while the oppressors are on the evil end. If you’re not helping the oppressed, then you are an oppressor and evil.

For conservatives, civilization is good, barbarism is evil. If you are eroding the traditional structures and values of society, you’re not good.

For libertarians, freedom is good, coercion is evil. If you must force someone to behave how you’d like, eventually the force will be abused.

A simplified view of the issue of illegal immigration illustrates how to use these three axes.

  • Liberals see illegal immigrants as the oppressed, and people who don’t want illegal immigrants as the oppressors.
  • Libertarians see no reason to force people out of the U.S. or keep them out by force. The more the merrier.

So, liberals and libertarians support the same side in this issue, but for different reasons.

  • Conservatives think illegal immigration violates the rule of law, which risks civilization.

It’s difficult for anybody with one of the three worldviews to even so much as come to understand the others’ positions.

I also doubt that many liberals understand the libertarian view, even though they essentially agree with the end result.

Of course, there are more nuances to this issue. For example, I know conservatives who distinguish between illegal immigrants coming here for the goodies of the welfare state and those seeking opportunity. I know liberals who are concerned that loose border controls may let in criminals. But, I think the three axes does a good job of representing the prevailing views on the issue.

Kling also admits that this isn’t lock tight and doesn’t answer why people think this way — it’s just an observation that may help us come to understand those we disagree with. He also has a Kindle Short on the topic available for $1.99. I am currently reading it and enjoying it.

I recommend listening to the podcast. It’s a great discussion. Kling and Roberts share some interesting personal stories and also comment on Paul Krugman.

Also, as an oversight I had not added Kling’s blog, askblog, to my links in the right margin. His blog subtitle is taking the most charitable view of those who disagree. If more people would adopt that stance, we’d be better off!

Similar to Kling, I’ve been on all at least two of axes in my life and on some issues, will find myself on more than one. More on that to come.

Update: I finished reading Kling’s Kindle Short and I do recommend it. It’s well worth the $1.99.

Thoughts on taxes III: Social Engineering

In my original Thoughts on taxes post, I listed this as the second reason I prefer a simple tax system:

  • We don’t get the social engineering benefits that we think we do from the cleverly designed tax code that we have. We may only get bad outcomes.

I would prefer that we only think of taxes as a way to fund government, but many folks can’t resist the temptation to make the tax code serve double duty by also trying to use it for social engineering. That is, to encourage more behavior that we think of as good (like owning homes, earning income and going to college) and less behavior we think of as bad (like earning high income and making short-term investments:)).

Well, it’s not that we think earning a high income is bad. It’s that many people believe income inequality is bad and they think tax rates can balance that out, but as we’ll see shortly, progressive tax rates may contribute to income inequality.

I believe this desire to use the tax code for social engineering has two problems. First, and most important, we don’t actually realize the social engineering benefits. Those just get pushed to other margins through by distorting natural incentives. More on that in bit.

Second, it stands to reason that the natural rewards for good behavior (like buying homes, going to college and long-term investing) should be enough to encourage that behavior without any special tax treatment.

To think about how trying to reward good behavior in the tax code pushes the supposed benefits to other margins, consider the home mortgage interest deduction. We’ve been brainwashed to believe this is good because it encourages home ownership.

We’ve also been brainwashed to believe that home ownership is a good thing.

But, why exactly is home ownership something that we should encourage? Arnold Kling wonders this as well. What’s wrong with renting?

Home ownership isn’t for everyone. Home ownership doesn’t necessarily make one wealthier, wiser or more responsible, despite that conventional wisdom that fed the housing bubble.

Have you heard how much ownership the mortgage interest deduction has encouraged? I haven’t. If there is research on this topic, I haven’t seen it and a couple (admittedly quick) Google searches didn’t immediately turn up anything. If you can point me to any research on the topic, please do so in the comments.

But, even if there is research, I’m skeptical that it would thoroughly consider all the possible distortions to natural incentives the mortgage interest deduction could be causing and how those distortions have moved the benefits of home ownership to other margins.

Even I can’t know all the distortions caused by this part of the tax code, but I am willing to bet that the my following list of possibilities is something most folks haven’t ever considered. I know this because I bring it up to folks all the time and the response so far has always been “Wow, I never thought of that.”

I think, perhaps, the biggest distortion that may offset most of the social benefit of the deduction is higher home prices. Believe it or not, the value of the mortgage interest deduction benefit is accounted for in higher home prices.

Some folks I’ve discussed this with have a hard time believing it. They tell me that they didn’t explicitly consider that when making an offer on their home.

How market prices work is hard to understand. While my friends may not have explicitly considered it, the folks they were bidding against may have and they had to beat those bids to get the house. So, they did not have to explicitly consider this benefit for it to be built into the price.

If you still don’t believe me, you should also consider why the real estate brokers and home lenders actively lobby to keep the mortgage interest deduction. Do you think they are just looking after our best interests? No. Higher home prices means high transaction prices for real estate agents (7% commission x a higher number is a higher number).s.

The mortgage interest deduction also encourages folks to take out larger loans, keep that debt out longer and have less equity in their home than they might have otherwise.

These can weaken someone’s financial position and gives less incentive to be responsible home owners. As we found out in the housing bust, owners with no equity are no more responsible than renters who do not have to pay rent.

If I had not considered how taxes distort natural incentives before, this list of four possible distortions of the mortgage interest deduction would at least make me think more about the topic and possibly consider distortions driven by other socially engineered pieces of the tax code.

Could the most progressive income tax code of all developed countries actually be contributing to income inequality? In other words, does the higher marginal rates on higher income lead high income folks to seek higher rates of gross income to offset those higher tax rates?

Like home prices, this isn’t intuitive, but is the same thing. Labor is price, just like a home price is a price. If home prices adjust to include tax benefits, labor prices can adjust to cover tax costs.

Don’t think so? Imagine one of your favorite Hollywood stars. Even better if he happens to be vocal advocate for increasing taxes on the wealthy (e.g. Matt Damon).

Now, also consider the clout of your highly paid actor. Does he sell tickets? If so, he has some good earnings leverage over the studios that sign him to their projects.

Next, think about what happens in his next movie negotiation if he gets his wish and tax rates on high incomes are increased. Let’s say before he was banking $10 million per movie, or $6 million after tax.

If tax rates increase from 40% to 60%, for example, do you think he’ll settle for taking home $4 million on his next project? Probably not. Why should he? Do you think he would recognize the $2 million hit as a consequence of his advocacy? No.

His agent will ask for $15 million so his client can take home the same $6 million as he did before. And the actor will never connect the dots on how the tax rate actually made his gross income even more “inequal” ($15 million vs. $10 million) to the folks who didn’t see a 50% increase in tax rates.

But, we don’t need to guess how tax rates can distort a rich actor’s incentives. What if a neighbor, who you don’t know well, is planning an extended vacation next summer and offers to pay you to mow his lawn while he’s gone. He tells you it takes an hour to mow.

What price would get you to agree to his offer? $20? $40? $50? $100?

Which price raised your interest level?  I’d have tepid interest for $50 and be much more interested for $100. But, everyone is different because we all have different opportunity costs.

You agree to the offer at your desired price, but then find out that one of the Homeowner Association covenants, that you never read, states that the HOA gets 50% of any such neighbor-to-neighbor dealings. Now we’ve cut the fee your attention-getting-fee in half.

Are you still interested in mowing his lawn? No. Your opportunity costs are higher than that amount, else you would have picked that number the first time.

What would make it all better? If your neighbor doubled the fee to offset the HOA’s 50% tax.

See, our own behavior and incentive distortions are not much different from the rich Hollywood actor and it’s plausible that distortions caused by unequal tax rates winds up being priced into labor, which contributes to the ‘income inequality’ that so many folks get bellyaches over.

Writing this post has made me think about a new game to play on this blog: Guess the incentive distortions. Periodically, I’ll pick a policy and see if I can name a few possible distortions that might make the policy less desirable than it sounds.

Incentive distortions caused by tax rates are rarely discussed. When they are, they are often too quickly discounted. 

“I hope that works out for you”

Subtitle: Ideas are cheap; results matter

I’ve worked in many places that have an unhealthy incentive problem where ideas are rewarded and results are not.

People with fresh, new ideas were the movers and shakers. They could do even better if they could argue in hostile forums why their ideas would work  (folks who gain success at this are also called bullies).

The problem was that nobody asked these folks to prove their ideas with actual results.   Ideas won and lost by how passionately their champions fought for them and how good they sounded, not whether they worked or not. Often, ideas won out because the champions essentially repeated over and over, “I just know it will work! We have to try it.”

If your idea was selected by management, you were golden. If the idea later failed, there were plenty of excuses used. It was executed poorly. The messaging wasn’t right. It just wasn’t the right time. Rarely did the idea champions or the management who green lighted the idea ever just come out and say, maybe this just isn’t something customers value.

This environment generated lots of ideas and lots of infighting to get ideas selected, but not a lot of results.

I was never in charge, but I had the ear of some of the folks that were, once or twice removed, and I started a subtle campaign to curb this toxic, non-results driven, environment.

I suggested that the folks who had the ideas be responsible for proving them out with real world results and, since they usually felt with such passion that their ideas would work, I suggested they carry out their ideas within their own budgets. Why not? You are so sure it’ll work, put your money where your mouth is. If this will work so well, this should help you achieve your targets.

I coined a phrase, “You should give it a try. I hope that works out for you.”

The folks with the ideas use to win when someone in management would say, “Okay, we’ll try your idea.”  Now they started hearing, “You should give it a try. Let us know how it goes. I hope that works out for you.”

Suddenly, the folks with the great ideas were more open to criticism of their ideas and shooting holes in them before they got started proving them out, because they were more concerned whether the idea would actually work and less concerned if a few decision-makers in management would pick it.

I was reminded of this when I read a recent blog post on Arnold Kling’s askblog, The Left’s Post-Election Self Examination, where he comments on a leftist’s suddenly (post-election) more critical examination of Obamacare.

When Obamacare passed, it was easy for Democrats to claim victory that they had “fixed” health care. The actual results of their great idea wouldn’t be known until after the next election cycle, since that’s when it would start kicking in. They were like the folks at my work who got their idea selected by management.

One positive to this year’s election outcome is that many of the people in the Senate and the person in the White House responsible for passing Obamacare will still be here when the Obamacare realities begin to materialize and they may be held to account for the results of their great idea.

I wasn’t surprised to hear talk of Nancy Pelosi considering stepping-down as House minority leader shortly have the election. She’s probably thinking it would be good to get out of the spotlight before the Obamacare stuff starts to hit the fan.

Not surprising either that the leftist that Kling commented on is becoming more critical of Obamacare. This is what I saw happen to the idea-folks when they were faced with answering to the results of their ideas.

So, perhaps one unintended positive outcome of this election is that the American people are told the folks responsible for Obamacare, “Let’s give this a try. I hope that works out for you.”

keynesian economists misjudge the economy

Natural disasters like hurricane Sandy tend to spur the following food fight among economists.

One or more economists — seeking attention and a chance to look clever — say something stupid like well, at least, the rebuilding will be good for the economy.

In response, other economists quote Frederic Bastiat’s Broken Window Fallacyask why we don’t smash everyone’s house to help the economy and lecture us that economic metrics, like GDP, do not take into account the value lost in destruction.

However, I think that both sides of this food fight talk past each other. Silas Barta’s has similar thoughts.

While I agree with the second set of economists, I think they ignore what I think is one key point of the first set of economists argument — ‘slack resources’.

The first set of economists know destruction is bad, but believe that because the economy wasn’t operating at ‘full capacity’, it had slack resources that can now be put to good use in the rebuilding effort. The second set of economists never address this point.

Here’s how I would address the slack resources argument: ‘Slack resources’ is a subjective, incorrect and misleading way to characterize what’s happening in a bad economy. So is the idea of ‘full capacity’.

It looks right-enough that almost nobody questions it, even the second set of economists. Except, maybe, one that I know of (Arnold Kling).

And I can understand why so few people question the ‘slack resources’ hypothesis. When you see a friend who is unemployed and struggling to find work you tend to think of him as a slack resource.

It’s like seeing your kid doing nothing on a Saturday afternoon and you get this strong urge to put him to work. He or she appears to be a slack resource.

It’s natural for us to think — We should be able to put these folks to work! They’re ‘slacking’ off.

But, I believe the ‘slack resources’ characterization is incorrect and misleading. Scratch past the surface you will find more to the story.

Have coffee with that unemployed — slack resource — friend and you find out he has turned down three job offers, because they were for 20% less than what he made at his previous job.

You ask, why not accept the pay cut so you can get back to work? Maybe you’ll get in there, knock their socks off and be back to your old wage in no time.

Well, it turns out he had enough savings and unemployment benefits to allow him to hold out for a job that will pay him his previous wage. Why should I accept less until I absolutely have to (i.e. when I run out of unemployment benefits)?

We find out our friend isn’t a slack resource. Rather, his skills are being re-priced and he doesn’t like it.

I don’t blame him. Nobody likes to have their wages “re-priced” down, but it happens all the time and it happens due to decisions that you and I make.

When one of our favorite Hollywood superstars makes a stinker of a movie that we choose not see, he may have to accept lower pay on the next movie to get studios to hire him. He could say, if only my fans would have supported me and seen that movie. His fans might respond, if only you would have made a movie worth seeing.

The first set of economists in the food fight see a bad economy as having slack resources. But what they truly reveal to me is that they don’t understand what’s really happening — things are being repriced based on the decisions that we make.

This is lack of real understanding of a bad economy is readily apparent when you consider how many barriers to repricing the first set of economists have had a hand in putting in place.

Minimum wage is one such barrier. It’s also the reason why there are so many officially unemployed unskilled workers at the moment. The market clearing price for unskilled labor is below the minimum wage, which is a price floor. Econ 101 teaches us that when the market clearing price is lower than the price floor, we will have a situation where supply (workers) exceeds demand (jobs). That’s exactly what we have.

This is fodder for another post, but it never seems to bother these economists that their favored wage price floor is causing so much unemployment. They’d rather feel sanctimonious about supporting something that seems well-intended than allow the official price of unskilled labor to move below what they have deemed an acceptable level.

Unemployment benefits is another such barrier to repricing. Many people believe that the low amount one receives from unemployment insurance is not enough to prevent them from accepting  work and they may be right if we lived in a simpler world.

But, in this world we have folks who have some savings, working spouses and the ability to take on black and gray market jobs to earn some coin while also receiving unemployment. We also learn in Econ 101 that incentives matter. If I accept an official lower paying job, I lose my unemployment check. Why do that when I can accept an unofficial lower paying job and continue to receive unemployment — or ‘double dip’?

These barriers slow the repricing process and lengthens the ‘bad economy’. They are the reasons why our recessions seem to take longer and longer to recover from.

If our friend didn’t have a free unemployment check that he would lose by accepting an official job, he might accept an official job sooner.

So, the next time you hear an economist talk about slack resources, give some consideration to whether the resource is really slack or whether someone just hasn’t been willing to accept a lower price for that resource and why.

Coming soon…repricing downward is awful, but is it really that awful?

Good reading

Sheldon Richman explains that the “market does not ration.” (HT: Cafe Hayek)

I liked how Arnold Kling worded this:

My own view is that these are two areas [health care and education] where outcomes depend largely on factors other than the services provided. Meanwhile, we have succumbed to the claims of suppliers that their services ought to be heavily subsidized. The subsidies lead to over-provision of education and health care services, well past the point where the marginal return from additional spending becomes negligible. In health care, this is known as the flat of the curve hypothesis. Perhaps the hypothesis also applies in education.

Eating apples is a good thing. But it’s not good to continue eating more and more apples every day.

George Schulz in this weekend’s Wall Street Journal, gives some good advice to would-be Presidents. When I read this, it made me think about the short-term thinking of Keynesian economics:

The political people would come in and say ‘You’ve got to be careful, Mr. President. There’s gonna be a recession [if the Federal Reserve tightens the money supply]. You’re gonna lose seats in the midterm election.’

“And he basically said, ‘If not us who? If not now when?’ And he held a political umbrella over [Fed Chairman] Paul Volcker, and Paul did what needed to be done. And by late ’82 early ’83, inflation was under control, the tax changes that he made were kicking in, and the economy took off. But it took a politician with an ability to take a short-term hit in order to get the long-run results that we needed.”

Government’s role is not to smooth GDP.  It’s job is to predictably protect our freedom:

“Let’s talk about football. . . . You want to know the rules and have an impartial referee, but you also want to make sure somebody isn’t going to come along and change the rules in the middle of the game. . . . Now it’s as though we have all these people who have money on the sidelines and we say ‘Come on and play the game,’ and they say ‘Well what are the rules?’ and we say ‘We’ll tell you later.’ And what about the referee? Well, we’re still struggling for who that’s gonna be. . . . That’s not an environment designed to get people to play.

We all learned this on the playground as we were growing up, didn’t we? We stopped playing tag and kickball with the kids who changed the rules in their own favor after every play. It wasn’t worth our time. Stop changing the rules.

Schulz also makes a good point about being cautious to use debt for true emergencies (and not GDP smoothing or buying votes, rewarding cronies and special interests):

Now remember something. Alexander Hamilton, our first secretary of the Treasury, and a very good one, redeemed all of the Revolutionary War debt at par value, and he said the ‘full faith and credit’ of the United States must be inviolate, among other reasons because it will be necessary in a crisis to be able to borrow. And we saw ourselves through the Civil War because we were able to borrow. We saw ourselves able to defeat the Nazis and the Japanese because we were able to borrow. We’ve got ourselves now to the point where if we suddenly had to finance another very big event of some kind, it would be hard to do it. We are exhausting our borrowing capacity.”

Finally, he reminds us what results with price controls:

“I fear that the approach to controlling costs in the health-care business is moving more and more to a wage-and-price-control approach. And one thing you know from experience is when you control the price of something, you end up getting less of it. So if you control the price of health-care providers, you will have fewer of them and that’s gonna wind up as a crisis. The most vivid expression of that . . . was Jimmy Carter’s gas lines.”