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June 30, 2007

Levy and Temin: Inequality and Institutions in 20th Century America

Since I'm highlighting Vox EU today, here's one more from their site. This is Frank Levy and Peter Temin discussing the institutional factors behind recent changes in inequality such as the implementation of the "Washington Consensus" during the 1980s "adopted in the name of improving economic efficiency":

Inequality and institutions in 20th century America, by Frank Levy and Peter Temin, Vox EU: A central feature of post-World War II America was mass upward mobility: individuals seeing sharply rising incomes through much of their careers, and each generation living better than the last. It therefore is problematic that recent productivity gains have not significantly raised incomes for most American workers. In the quarter century between 1980 and 2005, business productivity increased by 71%. Over the same quarter century, median weekly earnings of full-time workers rose from $613 to $705, a gain of only 14% (figures in 2005 dollars), as our recent research shows.1 Detailed analysis of these years shows that college-educated women are the only large labour-force group for whom median compensation grew in line with labour productivity.

Since productivity growth expands total income, slow income growth for the average worker implies faster income growth elsewhere in the distribution. In the US case, growth occurred at the very top.  Piketty and Saez estimated that the share of gross personal income claimed by the top 1% of tax-filing units – about 1.4m returns – rose from 8.2% in 1980 to 17.4% in 2005. Among tax returns that report positive wage and salary income, the share of wages and salaries claimed by the top 1% rose from 6.4% in 1980 to 11.6% in 2005.2

To place these developments in historical perspective, we construct the following ratio

Formula61507

The numerator of this ratio is the sum of median annual earnings of full-time workers and the value of estimated fringe benefits. The denominator is Non-Farm Business Productivity – the standard labour productivity measure - expressed as an annual dollar amount. We can think of this ratio as a bargaining power index, BPI for short, since it is the share of total output per worker that the average full-time worker captures in compensation.

Figure 1 displays this Bargaining Power Index from 1950-2005. For purposes of comparison, Figure 1 also displays the Piketty-Saez estimate of the 99.5th income percentile on federal tax returns – the median income of the top 1% of reported incomes – adjusted for fringe benefits and normalised by Non-Farm Business Productivity.

Bargain61507

In the “Golden Age” of 1947-73, labour productivity and median family income each roughly doubled. The median compensation of full-time workers (the numerator of the BPI) and labour productivity (the denominator) grew at the same rate from 1950 to the late 1970s. Simultaneously, income equality increased as very high incomes (illustrated by the 99.5th percentile) grew more slowly than labour productivity.

In the 1970s stagflation, median compensation of full-time workers began to lag behind productivity growth, a trend that accelerated after 1980. In Figure 1, the lag is illustrated by the BPI declining from 0.6 in 1980 to 0.53 in 1990 and to 0.43 in 2005. This declining bargaining power of the average full-time worker is a useful way to describe why significant productivity growth since 1980 has translated into weak growth in earnings and compensation.

Many economists attribute the average worker’s declining bargaining power to skill-biased technical change – technology, augmented by globalisation, which heavily favours better-educated workers. In this explanation, the broad distribution of productivity-gains during the Golden Age is often assumed to be a free-market outcome that can be restored by creating a more educated workforce.

We argue instead that the Golden Age relied on market outcomes strongly moderated by institutional factors. Following the literature on economic growth that emphasises the role of institutions in economic outcomes, we argue that institutions and norms affect the distribution of economic rewards as well as their aggregate size. Our argument leads to an explanation of earnings levels and inequality in which skill-biased technical change, globalisation and related factors function within an institutional framework. In our interpretation, the recent impacts of technology and trade have been amplified by the collapse of these institutions, a collapse which arose because economic forces led to a shift in the political environment over the 1970s and 1980s. If our interpretation is correct, no rebalancing of the labour force can restore a more equal distribution of productivity gains without government intervention and changes in private sector behavior.

We do not challenge the existence of technology’s and trade’s effects on labour demand.3 Rather, we argue that technology and trade’s impacts are embedded in a larger institutional story. We argue that the current trend toward greater inequality in America is primarily the result of a change in economic policy that took place in the late 1970s and early 1980s. The stability in income equality where wages rose with national productivity for a generation after the Second World War was the result of policies that began in the Great Depression with the New Deal and were amplified by both public and private actions after the war. This stability was not the result of a natural economy; it was the result of policies designed to promote it. We have termed this set of policies the Treaty of Detroit, after the most famous labour–management agreement of the postwar years.

This agreement was replaced in the 1980s (and surrounding years) by another set of institutional arrangements which we call the Washinton Concensus.4 These new policies also originated in a time of economic distress, albeit nowhere near the distress of the 1930s. In a process similar to the experience of the Great Depression, policy-makers – unable to comprehend the macroeconomic causes of distress – instituted microeconomic changes in an attempt to ameliorate the macroeconomic problems. In both cases, the measures taken were only partially successful, and recovery came from diverse influences. The microeconomic changes, however, had durable impacts on the distribution of economic production.

These microeconomic changes were not inevitable. Different labour-market institutions within Western Europe are compatible with similar rates of unemployment, and different labour-market institutions in Western Europe and America appear to be compatible with similar rates of economic growth. Rapidly rising incomes among the very rich appear in the U.S., England and Canada (largely in response to U.S. competition.) but do not appear in most continental European countries or Japan.

Globalisation clearly does not determine institutions. Some economists and commentators have asserted that globalisation has made more than one set of institutions not viable, yet the variety of institutions that are found in Western Europe shows only very limited signs of disappearing. Finally, economic shocks do not determine institutions. The Vietnam War and the oil shocks deranged the international economy, yet countries responded to these shocks in idiosyncratic ways. The contrast between the US and Japan in the 1970s is only one example of the great diversity.

Deregulation, floating exchange rates, international capital mobility, low minimum wages and taxes, and the destruction of labour unions, were not unique responses to the oil crisis or the productivity collapse. The effects of these policies have been amplified by skill-biased technical change and, in the extreme, winner-take-all markets. But the technology did not fully determine who received the rents produced any more than technology fully determined who got the rents from the great postwar expansion; African-Americans were largely excluded from the GI Bill and other public policies by a series of political and bureaucratic actions.

The elements of the Washinton Concensus were adopted in the name of improving economic efficiency. But there is growing recognition that the current free-market income distribution – the combination of large inequalities and stagnant wages for many workers – creates its own “soft” inefficiencies as people become disenchanted with existing economic arrangements.  People suffering from stagnant incomes —both here and in some similar countries—have begun to protest. Our analysis suggests that the trends in the distribution derive in part from the shift from one complex set of policies to another—from the Treaty of Detroit to the Washinton Concensus. There is no single determinant, whether education, minimum wage, capital or labour mobility, that determines the path of income distribution. Any specific measure therefore can alleviate the distress of some people, but it cannot change the overall distributional trends shown in our graphs.

The last six years of U.S. federal tax history have involved an inhospitable politics in which winners have used their political power to expand their winnings. But political sentiment does shift. Economic distress like that of the 1930s can induce such a shift. Even the smaller economic distress of the 1970s was enough to redirect American economic policy. Only time will tell if more economic distress is needed to change policy yet again.


Footnotes

1 Levy, Frank, and Peter Temin, “Inequality and Institutions in 20th Century America,” NBER Working Paper 13106, May 2007. [Return]

2 See Thomas Piketty and Emmanuel Saez. 2003. “Income Inequality in the United States,” Quarterly Journal of Economics, and the updating of their figures to 2005 on Emmanuel Saez’ website. Their calculations are based on pre-tax market income (wages, partnership income, interest, dividends, rents, etc.), excluding transfer payments. A tax-filing unit represents a tax return (which may be single or joint). Piketty and Saez estimate the total number of tax-filing units that would occur if all U.S. households filed federal income taxes and figures like the “top 1% of tax-filing units” refer to the top 1% of that estimated number rather than the top 1% of those who actually file. [Return]

3 Card, David, and John E. DiNardo 2002. “Skill-Biased Technical Change and Rising Wage Inequality: Some Problems and Puzzles.” Journal of Labor Economics, 20 no 4 (October), pp. 733-783. [Return]

4 This term normally is used for LDCs, but the spirit of this concept applies well to the changing institutions within the United States. We use the term here to refer to the microeconomic policies of deregulation and privatisation of the consensus, not the macroeconomic policies of fiscal discipline and stable exchange rates.[Return]

Paul Krugman: America Comes Up Short

Paul Krugman wonders why Americans are losing stature:

America Comes Up Short, by Paul Krugman, Commentary, NY Times: Traveling through Europe recently, I’ve been able to confirm through personal experience what statistical surveys tell us: the perceived stature of Americans is not what it was. Europeans used to look up to us; now, many of them look down on us instead.

No, I’m not talking metaphorically about our loss of moral authority in the wake of Guantánamo and Abu Ghraib. I’m literally talking about feet and inches. ...

Americans, who in the words of a recent paper by the economic historian John Komlos and Benjamin Lauderdale ..., were “tallest in the world between colonial times and the middle of the 20th century,” have now “become shorter (and fatter) than Western and Northern Europeans...”

This is not a trivial matter. As the paper says, “height is indicative of how well the human organism thrives in its socioeconomic environment.” There’s a whole discipline of “anthropometric history” that uses evidence on heights to assess changes in social conditions.

For example, nothing demonstrates the harsh class distinctions of Britain in the age of Dickens better than the 9-inch height gap between 15-year-old students at Sandhurst, the elite military academy, and their counterparts at the working-class Marine School. The dismal ... conditions of urban Americans during the Gilded Age were reflected in a 1- 1/2 inch decline in the average height of men born in 1890, compared with those born in 1830. Americans born after 1920 were the first industrial generation to regain preindustrial stature. ...

There is normally a strong association between per capita income and ... average height. By that standard, Americans should be taller than Europeans:... But ... something has caused Americans to grow richer without growing significantly taller.

It’s not the population’s changing ethnic mix...: the stagnation ... is clear even ...[for] native-born whites.

And although ... growing income and social inequality in America might be one culprit, the remarkable thing is that ... even high-status Americans are falling short...

We seem to be left with two main possible explanations... One is that America really has turned into “Fast Food Nation.”

“U.S. children,” write Mr. Komlos and Mr. Lauderdale, “consume more meals prepared outside the home, more fast food rich in fat, high in energy density and low in essential micronutrients, than do European children.” Our reliance on fast food, in turn, may reflect lack of family time because we work too much: U.S. G.D.P. per capita is high partly because employed Americans work many more hours than their European counterparts.

A broader explanation would be that contemporary America ... doesn’t take very good care of its children. Recently, Unicef issued a report comparing a number of measures of child well-being in 21 rich countries... The report put the Netherlands at the top; sure enough, the Dutch are now the world’s tallest people, almost 3 inches taller ... than non-Hispanic American whites. The U.S. ended up in 20th place, below Poland, Portugal and Hungary, but ahead of Britain.

Whatever the full explanation for America’s stature deficit, our relative shortness, like our low life expectancy, suggests that something is amiss with our way of life. A critical European might say that America is a land of harried parents and neglected children, of expensive health care that misses those who need it most, a society that for all its wealth somehow manages to be nasty, brutish — and short.

_________________________
Previous (6/11) column: Paul Krugman: Authentic? Never Mind
Next (6/29) column: Paul Krugman: The Murdoch Factor

Demographics and the Great Moderation

Many reasons for the Great Moderation - the substantial decline in economic volatility and inflation in the mid 1980s - have been given, including better technology (e.g. information processing allowing better inventory control and management), better policy (e.g. inflation targeting), a run of good luck where no big shocks hit the economy, and financial innovation and deregulation.

The paper discussed in this article from the Minneapolis Fed proposes another reason for the Great Moderation, demographic changes, and finds changes in the demographic composition of the labor force can account for around one fifth to one third of the decline in output variability:

Demographics and Economic Volatility, by Douglas Clement, Editor, The Region, Minneapolis Fed: In 2004, then Fed Governor Ben Bernanke addressed the “Great Moderation”—the remarkable decline in economic volatility observed in the United States and other advanced economies over the past two or three decades. He reviewed evidence for three explanations: structural change, good luck and improved policy, and then he focused on the last: the role that better monetary policy has played, particularly in the United States...

In a recent paper, ... Henry Siu of the University of British Columbia and Nir Jaimovich of Stanford University develop a new theory to help explain the Great Moderation in not only the United States but other industrialized economies. “Specifically,” write Jaimovich and Siu, “we find that changes in the age composition of the workforce account for a significant fraction of the variation in business cycle volatility.”

In “The Young, the Old and the Restless: Demographics and Business Cycle Volatility” (Federal Reserve Bank of Minneapolis Staff Report 387), the economists begin by documenting age variations in labor market volatility. The task is easiest in the United States and Japan, which compile data on average hours worked by different demographic groups. Both nations, they find, display profound differences across age groups.

In the United States, the young exhibit far greater fluctuation in hours worked per capita than the middle-aged; those at or close to retirement fall somewhere between. By one statistical measure, employment fluctuation for workers 15 to 19 years old is over five times that for those 40 to 49 years old. So while teenagers account for just 3 percent of total employment, they account for 11 percent of employment volatility. And the volatility of workers 65 years and older is about twice that of those 40 to 49 years old—not as volatile as teens but still quite high.

The relationship is similar in Japan. “As in the U.S.,” they write, “there is a distinct U-shaped pattern to ... volatility of hours worked as a function of age.”

For the other G7 members—Canada, France, Germany, Italy and the United Kingdom—the economists look at employment rates since age-specific data on hours worked aren't available. While the nations vary, each strongly displays the same relationship: Younger and older workers have far more labor market volatility than the middle-aged. Averaged across the seven countries, employment volatility “for 15-19 year olds is nearly six times greater than that of 40-49 year olds,” conclude Jaimovich and Siu. “Similarly, the average employment volatility of 60-64 year olds is about three times greater than that of 40-49 year olds.”

This pattern is remarkable, they note, given the significant dissimilarities among these nations. “That these economies differ greatly in terms of industry composition and the degree of labor market regulation makes this finding all the more striking [which suggests] that the age composition of the labor force is potentially a key determinant of the responsiveness of an economy to business cycle shocks.”

Demographic differences

Having established a similarity among G7 countries—in all seven, the young and old have higher employment fluctuations than the middle-aged—the economists take the next step: examining cross-country differences in the extent and timing of demographic change. These differences are crucial to their strategy for discerning the relationship between demographics and business cycles.

In the United States and Canada, post-World War II baby booms led to a large cohort of “20-something” workers in the 1970s and a subsequent boom in “prime-aged” workers beginning in 1990 or so. But France, Italy and Germany had far smaller baby booms, and the labor force has gradually aged. The United Kingdom fell between those extremes, while Japan experienced a strong decline in fertility after World War II, resulting in an increasing share of workers over 60 years, especially since 1980.

The economists exploit these differences in demographic trends to determine the impact of labor force age composition on economic volatility. After all, a simple correlation in a specific country between trends in economic volatility and shares of the labor force made up by young workers could be mere coincidence, they note. ... But finding the demography/volatility correlation in several countries—which face the same oil prices, but very different demographic patterns—“strongly suggests that the correlation is not spurious.”

Their graphs provide a striking picture. (See charts below.) In six of the seven G7 countries, the economists observe, “business cycle volatility and the volatile labor force share clearly co-vary.” The relationship is weaker in France, they admit, “but relative to the other countries, there is little change in volatility to explain.”

Measuring magnitude

To measure the degree to which age distribution impacts volatility, the economists use regression analysis, a statistical technique that gauges how much different factors influence a specific outcome. (Regression equations might be used, for instance, to estimate the impact of higher teacher salaries on student test scores, holding other factors constant.) In this case, the economists input data from the seven countries over a span of several decades and, in a “first cut” estimate, find that a 10 percent increase in the volatile share of the labor force (15-19 year olds plus 60-64 year olds) would increase economic volatility by 0.402.*

After experimenting with various age-group definitions and statistical refinements, and expanding the analysis to the entire age distribution rather than simply the “volatile” share, they estimate a slightly stronger impact: A 10 percent labor force shift into the most stable age group (40-49 years) will decrease volatility by 0.406.

So, if this estimate were applied to the United States and the Great Moderation that Bernanke discussed, how much of this moderation might demographic change explain? ..

During [the 1978 to 1999]... time span, Jaimovich and Siu point out, the volatile share of the labor force dropped from 38.5 percent to 27.1 percent, an 11.4 point reduction. According to their regression estimates, "such a shift in workforce composition ... predicts a volatility reduction [of] ... roughly 32 percent ... of total macroeconomic moderation between 1978 and 1999.

Using a different statistical method for measuring the impact of age shifts, the economists generate a more modest estimate, about 21 percent. Still, it's in the same ballpark. “That the results ... are similar in magnitude ... we take as evidence for an important role for demographics in explaining the Great Moderation.”

Business cycle models

The final step in this ambitious paper is to build a mathematical model that can analyze the relationship between differences in labor force age volatility and trends in general economic volatility. The economists take a standard “real business cycle” model and modify it accordingly. ...

The economists refine the model and run it, generating simulated figures for labor and output for the United States between 1968 and 2004. The simulations do a good job of matching real data over that time span...

In other words, their model, their regression analysis and their other estimation techniques all arrive at the same robust conclusion: “Variation in the age composition of aggregate hours accounts for a significant fraction of the moderation in U.S. business cycle volatility.”

Moderation61507

* The units for volatility discussed here and in the following paragraphs can be described as the standard deviation of fluctuations in real GDP from its trend. [Return]

Trade and Inequality

If you haven't heard about it, Vox EU is a new blog from the Centre for Economic Policy Research and it has an impressive list of contributors. In this entry, Paul Krugman adds to his discussion in "Divided Over Trade" and "Winners and Losers from Trade" on the increasing role of trade as a source of inequality:

Trade and inequality, revisited, by Paul Krugman, VoxEU: Trade and inequality, revisited Paul Krugman 15 June 2007 Print Email Comment Republish

It’s no longer safe to assert that trade’s impact on the income distribution in wealthy countries is fairly minor. There’s a good case that it is big, and getting bigger. I’m not endorsing protectionism, but free-traders need better answers to the anxieties of globalisation’s losers.

During the 1980s and 1990s, there was considerable concern about the possible role of globalisation in contributing to rising income inequality, especially in the United States. This concern was based on standard economic theory: since the 1941 Stolper-Samuelson paper, we’ve known that growing trade can have large effects on income distribution, and can easily leave broad groups, such as less-skilled workers, worse off.

After economists looked hard at the numbers, however, the consensus was that the effect of trade on inequality was probably modest. Recently, Ben Bernanke cited these results – but he recognised a problem: “Unfortunately, much of the available empirical research on the influence of trade on earnings inequality dates from the 1980s and 1990s and thus does not address later developments. Whether studies of the more recent period will reveal effects of trade on the distribution of earnings that differ from those observed earlier is to some degree an open question.”

But the question isn’t really that open. It’s clear that applying the same models to current data that, for example, led William Cline of the Peterson Institute to conclude in 1997 that trade was responsible for a 6% widening in the college-high school gap would lead to a much larger estimate today. Furthermore, some of the considerations that once seemed to set limits on the possible inequality-promoting effects of trade now seem much less constraining.

There are really two key points here: the rise of China, and the growing fragmentation of production.

First, thanks to the rise of China, OECD imports of manufactured goods from developing countries have continued to rise rapidly since the early 1990s. Cline’s estimate of income distribution effects was based on data from 1993, when US imports of manufactures from developing countries were approximately 2% of GDP; now that number is close to 5%, and rising rapidly.

At the same time, the rise of China has prevented, for the time being, a development that I and others expected to mitigate the effects of trade on income distribution: up-skilling by the developing country exporters. “As newly industrializing countries grow,” I wrote in 1995, “their comparative advantage may shift away from products of very low skill intensity.” And that’s exactly what happened – for the countries that were the major exporters of manufactured goods to the OECD then. As John Romalis has shown, the exports of the original group of Asian newly-industrialising economies have shifted dramatically away from labour-intensive toward skill-intensive products.

But along has come China, which is far more labour-abundant now than the NIEs were then. A simple indicator is relative wage rates: in 1990, according to the US Bureau of Labor Statistics, the original four Asian NIEs had hourly compensation costs that were 25% of the US level. Now the BLS estimates that China’s labour costs are only 3% of US levels.

In 1995 I also believed that the effects of trade on inequality would eventually hit a limit, because at a certain point advanced economies would run out of labour-intensive industries to lose – more formally, that we’d reach a point of complete specialisation, beyond which further growth in trade would have no further effects on wages. What has happened instead is that the limit keeps being pushed out, as trade creates “new” labour-intensive industries through the fragmentation of production.

For example, the manufacture of microprocessors for personal computers is clearly a highly sensitive, skill-intensive process. Intel’s microprocessor production, however, now takes place in two stages: the “fabs,” which print the circuits on disks of silicon, are all located in high-wage advanced countries, but the assembly and testing, in which those disks are cut into individual chips and tested to be sure that they work, is conducted in China, Malaysia, and the Philippines.

Outsourcing of services, in both directions, adds to the possibilities of unequalising trade. The skill-intensive pieces of production processes that mainly take place in the third world are often now located in the OECD – for example, Lenovo, the Chinese computer company, has its executive headquarters in North Carolina.

What all this comes down to is that it’s no longer safe to assert, as we could a dozen years ago, that the effects of trade on income distribution in wealthy countries are fairly minor. There’s now a good case that they are quite big, and getting bigger.

This doesn’t mean that I’m endorsing protectionism. It does mean that free-traders need better answers to the anxieties of those who are likely to end up on the losing side from globalisation.

Dani Rodrik adds:

A new mainstream consensus on trade and wages?: Krugman was the co-author of a well-known 1994 paper (called "Trade, Jobs, and Wages") which laid out the case for trade's relative insignificance. Interestingly, his co-author on that paper, Robert Lawrence, does not see much of a footprint of trade behind the recent rise in inequality. In fact, he argues the case is even less compelling now...

How to reconcile the two perspectives? I think Lawrence is right to the extent that the skill premium has stopped rising since 2000, and therefore the type of approach that Cline and others used ... would not actually explain current inequality... But there are other (non-Stolper-Samuelson) models, based on bargaining for example, that could.

In any case, ...[w]hat is remarkable is that a growing number of prominent economists--Bernanke, Summers, Krugman--are now willing to give globalization a starring rather than supporting role in the recent rise on inequality.

"Paying Taxes Can Make Citizens Happy"

Colleagues find that paying taxes can make people happy:

Paying taxes, according to the brain, can bring satisfaction, EurekAlert: Want to light up the pleasure center in your brain? Just pay your taxes, and then give a little extra voluntarily to your local food bank. University of Oregon scientists have found that doing those deeds can give you the same sort of satisfaction you derive from feeding your own hunger pangs.

A three-member team – a cognitive psychologist and two economists – published its results in the June 15 issue of the journal Science. The scientists gave 19 women participants $100 and then scanned their brains with functional magnetic resonance imaging (fMRI) as they watched their money go to the food bank through mandatory taxation, and as they made choices about whether to give more money voluntarily or keep it for themselves.

The participants lay on their backs in the fMRI scanner for an hour-long session and viewed the financial transfers on a computer screen. The scanner used a super-cooled magnet, carefully tuned radio waves and powerful computers to calculate what parts of the brain were active as subjects saw their money go to the food bank and made yes or no decisions on additional giving.

Researchers found that two evolutionarily ancient regions deep in the brain – the caudate nucleus and the nucleus accumbens – fired when subjects saw the charity get the money. The activation was even larger when people gave the money voluntarily, instead of just paying it as taxes. These brain regions are the same ones that fire when basic needs such as food and pleasures (sweets or social contact) are satisfied.

“The surprising element for us was that in a situation in which your money is simply given to others – where you do not have a free choice – you still get reward-center activity,” said Ulrich Mayr, a professor of psychology. “I don’t think that most economists would have suspected that. It reinforces the idea that there is true altruism – where it’s all about how well the common good is doing. I’ve heard people claim that they don’t mind paying taxes, if it’s for a good cause – and here we showed that you can actually see this going on inside the brain, and even measure it.

The study gives economists a novel look inside the brain during taxation, said co-author William T. Harbaugh, a UO professor of economics and member of the National Bureau of Economic Research in Cambridge, Mass. “To economists, the surprising thing about this paper is that we actually see people getting rewards as they give up money,” he said. “Neural firing in this fundamental, primitive part of the brain is larger when your money goes to a non-profit charity to help other people.” “On top of that,” Harbaugh added, “people experience more brain activation when they give voluntarily – even though everything here is anonymous. That’s a very surprising result – and, to me, an optimistic one.”

However, this latter finding, which offers confirmation to the economic theory of “warm-glow” giving, doesn’t necessarily mean that taxes should be lowered and charity relied on more heavily, Harbaugh said. In a voluntary environment, he added, lots of people free-ride and donations fall.

The study, Mayr said, reflects the balancing act that every society must face. “What this shows to someone who designs tax policy is that taxes aren’t all bad,” he said. “Paying taxes can make citizens happy. People are, to varying degrees, pure altruists. On top of that they like that warm glow they get from charitable giving. Until now we couldn’t trace that in the brain.”

Neural activation from mandatory taxation, the researchers said, helps predict who will give. “We could call the people whose brains light up more when money goes to charity than to themselves altruists,” Mayr said. “The others are egoists. Based on what we saw in the experiments, we can use this classification to predict how much people are willing to give when the choice is theirs.”

There remain a lot of unanswered questions, Harbaugh said. “We show that people liked paying a tax that went to a food bank. But suppose the tax had been unfair. What then" Or suppose that people voted to make other people pay the tax, too" That would help other people even more, so would the voter get a bigger neural reward"”

Harbaugh, Mayr and co-author Dan Burghart, an economics graduate student, say they are not worried about the possibility that governments could use their method to monitor tax evasion, or charities could use it to figure out whom to ask for money. “To do this, we needed a $3 million scanner, some liquid helium and a few weeks of computer time,” Harbaugh said.

“If a participant moved her head,” Burghart added, “we had to start all over. It will be a while before this is built into cell phones.”

"The Return of Authoritarian Capitalism"

Does democratic capitalism dominate authoritarian capitalism?:

The return of Authoritarian Capitalists, by Azar Gat, Commentary, Tribune Media Services: Today's global liberal democratic order faces a significant challenge from the rise of nondemocratic great powers - the West's old Cold War rivals, China and Russia, now operating under "authoritarian capitalist" rather than Communist regimes.

The category is not new - authoritarian capitalist great powers played a leading role in the international system up until 1945. But they have been largely absent since then. The liberal democratic camp defeated its authoritarian, Fascist and Communist rivals alike in all of the three major great-power struggles of the 20th century - the two world wars and the Cold War.

It is tempting to trace this outcome to the special traits and intrinsic advantages of liberal democracy. But the reasons for the liberal democracies' victories were different for each type of adversary.

The Soviet Union failed because its economic systems limited it. But the nondemocratic capitalist great powers, Germany and Japan, were defeated in war fundamentally because they were medium-sized countries with limited resource bases.

Thus contingency, not inherent advantages of liberal democracy, played a decisive role in tipping the balance ... in favor of the democracies.

The most decisive element of contingency was the United States. Because of its continental size, no less than its democratic-capitalist system, the ... United States ... decisively tilted the global balance of power in favor of whichever side Washington was on.

So if any factor gave the liberal democracies their edge, it was above all the existence of the United States rather than any inherent advantage. In fact, had it not been for the United States, liberal democracy may well have lost the great struggles of the 20th century.

This is a sobering thought that is often overlooked....

This is especially true in light of the recent emergence of nondemocratic powers, above all booming, authoritarian, capitalist China. Russia, too, is ... assuming an increasingly authoritarian character as its economic clout grows.

Some believe these countries could ultimately become liberal democracies through a combination of internal development, increasing affluence and outside influence.

Alternatively, they may have enough weight to create a new non-democratic but economically advanced Second World. They could establish a powerful authoritarian-capitalist order ... that participates in the global economy on its own terms, as imperial Germany and imperial Japan did.

By shifting from Communist command economy to capitalism, China and Russia have switched to a far more efficient brand of authoritarianism. ...

Beijing and Moscow and their future followers might well become antagonists of the democratic countries - with all the potential for insecurity and conflict that this entails - while holding considerably more power than any of the democracies' past rivals ever did by virtue of being both large and capitalist.

The most important counterweight remains the United States. For all the criticism leveled against it, the United States and its alliance with Europe stands as the single most important hope for the future of liberal democracy. ...

Then let's lead by example. Becoming more authoritarian ourselves, as we have, is surely the wrong direction to go, and trying to force democracy through war has backfired and made it easier for authoritarian regimes to gain allies.

We are losing the global propaganda war and there's no reason other than the incompetence of the current administration that should happen. We have a good story to sell to the rest of the world, but it's been obscured by foreign policy missteps and lack of attention to rising economic insecurity and other domestic policy issues.

Smells Like Teen Spirit

Tyler Cowen argues that the relatively unstructured lives of U.S. teenagers along with the "commercial, competitive, philanthropic, nonegalitarian and open nature of American society" ensure that "America’s economic head start probably won’t go away anytime soon":

The Loose Reins on U.S. Teenagers Can Produce Trouble or Entrepreneurs, by Tyler Cowen, Economic Scene, NY Times: Michael S. Dell (of Dell Inc.) sold stamps to collectors when he was 12 and Bill Gates founded Microsoft when he was 19. Facebook, the social networking site, was the brainchild of Mark Zuckerberg, a Harvard University sophomore at the time. A study by the Global Entrepreneurship Monitor showed that the United States was unusual among developed countries in having a higher business start-up rate among its 18- to 24-year-olds than its 35- to 44-year-olds.

But why has America produced so many successful young entrepreneurs? ... [read more] ...

Progressive Taxation as a Political Shield for Globalization

David Wessel of the Wall Street Journal says there is increasing support for income redistribution policies to compensate the losers from globalization and prevent a backlash against trade liberalization:

The Case for Taxing Globalization's Big Winners, by David Wessel, Commentary, WSJ (free): A new argument is emerging among the pro-globalization crowd in the U.S...: Tax the rich more heavily to thwart an economically crippling political backlash against trade prompted by workers who see themselves -- with some justification -- as losers from globalization.

The sharpest articulation of this view comes not from one of the Democratic presidential campaigns, but from economist Matthew Slaughter, who recently left President Bush's Council of Economic Advisers to return to Dartmouth's Tuck School of Business.

"Policy has become more protectionist because the public is becoming more protectionist," Mr. Slaughter and ... Yale political scientist Kenneth Scheve, write in the new issue of Foreign Affairs magazine. "And the public is becoming more protectionist because incomes are stagnating or falling."

Globalization, the two academics argue with unswerving conviction, is good for the U.S. ... But the benefits ... have been distributed unevenly. ...

The conventional response from fans of globalization, including the Bush administration, is rhetorical support for more aid for workers hurt by imports ... and better education to equip the next generation of Americans with skills needed to command high wages in a global economy. Both are crucial. Progress on both is painfully inadequate.

But trade-adjustment assistance is traditionally targeted narrowly at workers hurt by imports. Today's angst about globalization is far more pervasive. ... And education takes generations to pay off.

What to do? ... "It is best not to address increasingly salient concerns about inequality by interfering with trade," Mr. Summers argued [recently]... His solution: use progressive taxation to offset some, but not all, of the increase in inequality. For starters, return tax rates for couples with incomes above $200,000 to the levels they were under President Clinton.

"Truly expanding the political support for open borders requires making a radical change in fiscal policy," Messrs. Slaughter and Scheve argue. Their particular proposal: eliminate the Social Security-Medicare payroll tax on the bottom half of workers -- roughly those earning less than $33,000 a year -- and make up the lost revenue by raising the payroll tax on others.

This, obviously, would be a sea change in fiscal policy. ... But all this talk is likely to influence any Democrat who takes the White House in 2008. He or she will almost surely move to raise taxes on the best-off Americans -- both to raise revenue to pay the bills and to resist the three-decade-old inequality trend.

There's a lot of argument about the extent and cause of widening inequality, and a lot about the damage higher tax rates can do to economic growth. That will go on. But the ... palpable resentment of the losers is producing growing resistance among politicians ... to further lowering barriers to trade and promoting globalization...

Expecting market forces to reverse the recent trend toward ever-bigger winnings for those at the top is unwise; the forces are too strong. Taxing winners isn't without risk; as Mr. Summers says, globalization makes it easier for them to "pick up their marbles and go somewhere else."

But using the tax code to slice the apple more evenly is far more palatable than trying to hold back globalization with policies that risk shrinking the economic apple.

Personally, I'm not much on redistribution simply to make outcomes more equal. But there are (at least) three reasons to depart from this. First, when there is change such that makes one group better off at the expense of another as has happened recently with globalization, and when redistribution can leave everyone better off, then redistribution is justified.

Second, I think everyone should have equal opportunity to be a CEO or a hedge fund manager, or whatever they want to be. However, the playing field is far from level and there is a lot more we could do on this side of the equation. Not everyone will be a CEO of course, or achieve their dream job whatever it might be, but everyone should have an equal chance to be one of the winners. In the meantime, until more has been done to level the playing field, progressive taxation is a means of making up for inequality in opportunity.

Third, for me at least, progressive taxation is justified by the equal marginal sacrifice principle (the last dollar paid should cause the same amount of disutility for everyone). Thus, even if opportunity is equal, and even if there were no winners and losers to worry about, justification for progressive taxation would remain. I think a more progressive tax structure than we currently have is needed to equalize the disutility of paying taxes.

We could list "preventing a political backlash" as a fourth reason for redistribution. But I'm not sure we need to invoke the political economy argument. If we use progressive taxation in accordance with the three principles above, then income will be more equally distributed and a backlash against globalization is less likely to occur.


Are the fears of a downward spiral of protectionism real? From China Daily, some evidence that congress has China's attention:


Chinatrade51407

and also:

China seizes rancid US nuts amid health scares, China Daily: China has discovered a batch of pistachio nuts imported from the United States were rancid and infested with white ants, the General Administration of Quality Supervision, Inspection and Quarantine said on Tuesday.

The pistachio nuts were discovered by the entry-exit inspection and quarantine bureau of Guangdong Province on June 2, according to the administration. ...

The administration said it had asked local inspection bureaus to thoroughly check the quality of pistachio nuts imported from US.

The administration also publicized some other unqualified US-imported food on the same day, which are three types of capsules and raisins from three US companies...

It ordered its local agencies to tighten monitoring on food imported from the US and advised domestic importers to specify food safety requirements in contracts to lower trade risks.

and, in response to "4 in Senate Seek Penalty for China":

China warns US Congress on trade bill, China Daily/Reuters: China fired a warning shot at U.S. lawmakers on Tuesday, saying that proposed legislation to pressure Beijing to step up exchange rate reform risked politicizing trade and would not sway its priorities.

With U.S. Congress members increasingly riled by their nation's trade deficit, a group of senators is expected to unveil legislation this week seeking to pressure Beijing to revalue its yuan currency more quickly...

China's Foreign Ministry, reluctant in the past to wade into trade disputes, told the U.S. lawmakers to back off. ...

"But whose standard is this? It's the United States'. But ultimately China's renminbi exchange rate must suit Chinese realities, and it must benefit China's and the world's economic development."

"The US Congress could pass this legislation which will lead to the problem of higher tariffs on Chinese goods... If this happens then the Chinese departments concerned will make a response."

China's warning over the U.S. legislative moves comes as the two countries' trade-sparring risks turning into a shoving match that could spill over into next year's presidential contest. ...

Beijing says Washington's lax economic policies are to blame for the trade gap. "Economic and trade issues should not be politicized, and related problems, especially ones arising from the U.S. domestically, should not be dragged into China-U.S. economics and trade," Qin said. ...

"Why a Conservative America Is a Myth"

A report from Media Matters says Americans are far more progressive than conventional wisdom and reporting would have us believe:

The Progressive Majority: Why a Conservative America Is a Myth, Media Matters for America: Summary Conventional wisdom says that the American public is fundamentally conservative - hostile to government, in favor of unregulated markets, at peace with inequality, wanting a foreign policy based on the projection of military power, and traditional in its social values.

But as this report demonstrates, that picture is fundamentally false. Media perceptions and past Republican electoral successes notwithstanding, Americans are progressive across a wide range of controversial issues, and they're growing more progressive all the time.

This report gathers together years of public opinion data from unimpeachably nonpartisan sources to show that on issue after issue, the majority of Americans hold progressive positions. And this is true not only of specific policy proposals, but of the fundamental perspectives and approaches that Americans bring to bear on issues.

Nor is the progressive majority merely a product of the current political moment. On a broad array of issues, particularly social issues, American opinion has grown more and more progressive over the past few decades. In contrast, it is difficult to find an issue on which the public has grown steadily more conservative over the last 10, 20, or 30 years.

The issues covered in this report include the following ... The role of government ... The economy ... Social issues ... Security ... The environment ... Energy ...[and] Health care...

In short, a look across the scope of American public opinion reveals a public that holds progressive positions and supports progressive solutions on economic issues, on social issues, on security issues - indeed, on nearly all the key issues confronting the country. For years, the conventional wisdom has maintained just the opposite, but the facts are impossible to ignore.

Here are a few graphs, tables, and charts that caught my attention as I scanned the report, "The Progressive Majority: Why a Conservative America is a Myth":

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George Borjas: Are Opponents Of The Immigration Bill Anti-Hispanic?

George Borjas asks what might have motivated opposition to the immigration bill:

Are Opponents Of The Immigration Bill Anti-Hispanic?, by George Borjas: ...The accusation that skeptics of the immigration bill are xenophobic, racist, anti-Hispanic--whatever!--is not new. It is a tried-and-true method of stifling debate. Unfortunately, playing this particular race card often works in the kind of world we live in.

The fact is: different people have different motives for taking positions on contentious social policy issues. Surely some of those skeptics are guilty as accused. But many are not. Moreover, their accusers have their own set of motives and axes to grind. Immigration skeptics do not have a monopoly on bigotry. It all reminds me of the debate over welfare policy eons ago. Because a disproportionately large number of female-headed households on welfare were black, critics of the welfare system were often accused of masking their true racist intentions. In hindsight, it's pretty clear that the welfare critics were right: the welfare system "as we knew it" provided distorted incentives--incentives that encouraged more welfare, less work, more poverty. ...

Most of us who oppose the immigration reform bill are making a similar argument: It too leads to distorted incentives. The amnesty will likely encourage more illegal immigration; the guest worker program will increase profits for employers, but at the cost of a two-tier labor market with an easily exploitable workforce and lower wages for native workers; and the guest workers themselves have a huge economic incentive to become permanent settlers, even if doing so means becoming illegal immigrants.

So there are very good reasons to oppose Bush's immigration proposal. I suspect that it is the common sense intuition behind these arguments that leads the bill's supporters to lash out at those who disagree with them. And since it is difficult for them to argue on the basis of the merits, they choose to stifle debate the only way they can: by playing the race card.

Let me try something. Here are two scenarios:

  1. A farmer hires a guest worker from Mexico to drive a tractor and plow a field.
  2. Using technology, a camera is mounted on the front of the tractor and connected to the internet in a way that allows a worker in Mexico to sit in front of a computer screen and plow the field by steering the tractor remotely.

To make it simple, assume it costs the farmer the same amount either way, and the quality of the work is identical.

In both cases, the effect on the wages of domestic workers is similar - wages would tend to be depressed by the expanded supply of labor available to do the job, though the magnitudes could differ if, say, 2 made more labor available than 1.

There are differences. One is, obviously, where the workers and their families live, go to school, get health care, etc. Another is where they spend (at least part of) their paychecks and who collects the payroll and sales taxes the wages and spending generate.

-- I can imagine people whose primary concern is the effect of immigration or offshoring on domestic labor markets and wages opposing both 1 and 2.

-- It seems people who are "are xenophobic, racist, anti-Hispanic--whatever!" but supportive of globalization in general would oppose 1 but support 2. However, if they use the effect on wages as cover, then they too would oppose both.

-- People who are "cosmopolitan" types, would support both 1 and 2. Winners from immigration and offshoring are also more likely to support both.

-- It's harder to think of why someone might support 1, but oppose 2, except perhaps if they'd rather have as much of the income as possible paid and spent domestically, or if they believe that work conditions in the home country would be deplorable and hence it is better to have the workers come here as guests.

Savings Glut or Money Glut?

Martin Wolf returns to the question of whether global imbalances and other features of the international economy are due to a “savings glut” or a “money glut”:

Villains and victims of global capital flows, by Martin Wolf, Commentary, Financial Times: Fast growth, huge current account “imbalances”, low real interest rates and risk spreads, subdued inflation and easy access to finance characterise the world economy. ...

The two interesting alternative explanations are the “savings glut” and the “money glut”. ... The “savings glut” hypothesis is associated with Ben Bernanke... A substantial excess of savings over investment  ... predominantly in China and Japan and the oil exporters ... has led to low global real interest rates and huge capital flows towards the world’s most creditworthy and willing borrowers, above all, US households. The short-term effect is an appreciation of real exchange rates and soaring current account deficits in destination countries. To sustain output in line with potential, domestic demand in those countries must also be substantially higher than gross domestic product. A country must choose fiscal and monetary policies that bring this result about.

Not only has the US absorbed 70 per cent of the rest of the world’s surplus capital, but consumption has accounted for 91 per cent of the increase in gross domestic product in this decade. Thus excess saving in one part of the world has driven excess consumption in another. ...

In the savings-glut world, governments are responsible for much of the capital outflow. This is either because domestic residents are not allowed to hold foreign assets (as in China) or because most of the export revenue accrues to governments (as in the oil exporters). Either way, governments end up with vast foreign currency assets as the counterpart of domestic excess savings.

In this world, the US is passive victim, excess savers are the villains and the Federal Reserve is the hero. In the money-glut world, however, the world’s savers are passive victims, profligate Americans are villains and the Federal Reserve is an anti-hero. In this world the US central bank is a serial bubble-blower...

The argument is that US monetary excess causes low nominal and, given subdued inflationary expectations, real interest rates. This causes rapid credit growth to consumers and a collapse in household savings. The excess spending floods across the frontiers, generating a huge trade deficit and a corresponding outflow of dollars.

The outflow weakens the dollar. Floating currencies are forced up to uncompetitive levels. But pegged currencies are kept down by open-ended foreign currency intervention. This leads to a massive accumulation of foreign currency reserves... It also creates difficulties with sterilising the impact on money supply and inflation.

In this view of the world economy, savings are not a driving force, as in the savings-glut hypothesis, but a passive result of excess money creation by the system’s hegemonic power. ... Governments of countries that possess the huge trade surpluses ... follow the fiscal and monetary policies that sustain the excess savings needed to curb excessive demand and inflation.

It is no surprise that the Federal Reserve is a believer in the savings-glut hypothesis. But many Asians blame their present predicament on “dollar hegemony”, which is the core of the “money-glut” hypothesis. The big questions, however, are which is true and whether it matters.

My answer ... is that the savings-glut hypothesis is truer, [and]... it does matter. If we live in the savings-glut world, the US current account deficit is protecting the world from deep recession. If we live in the money-glut world, that very same deficit is threatening the world with a dollar collapse and, ultimately, even a return of worldwide inflation.

The savings-glut view is far more comforting. Excess savers will learn to spend, in the end – sooner rather than later, if US spending were to weaken dramatically. But if we live in the money-glut world, the great gains in monetary stability of the past quarter century are at risk. Either way, the present world cannot continue indefinitely...

I will just add that it's possible to have both a high level of savings and a high level of liquidity growth at the same time.

Inequality, Politics, and Policy

Greg Ip of the WSJ on the impact of growing inequality on politics and policy:

Remarks by Greg Ip, WSJ: ...[I]ncome inequality has become an important and growing force in U.S. politics. I use that as a catch-all term; it could also be called middle-class angst or wage stagnation.

There are quite a few ways to measure real wages and inequality, but they all broadly tell the same story. The U.S. has been getting steadily more unequal since the early 1970s. ...

Economists agree there are several causes, though they disagree on their relative importance. They include the rising premium on skills and education, institutional changes such as the decreased strength of unions, and policy decisions. ...

There would probably be less angst about this if the average American was doing well. But until recently he hasn't. ...

How has this manifested itself politically? Scholars may dispute the contribution of trade or immigration to inequality, but in the public's mind the link is firmly established. Every time we write an article about stagnant wages or inequality we are flooded with comments from readers blaming outsourcing and immigration. ...

In congressional races last fall, especially in Midwest states hit hard by the manufacturing downturn, Democratic challengers made good use of the public's link between inequality and trade. A race-by-race analysis found that six pro-trade senators were voted out of the Senate and five trade skeptics joined; and in the House, 22 pro-trade congressmen left and 16 trade skeptics joined.

These skeptical Democrats have made their presence felt. Congress forced Bush to accept inclusion of labor and environmental standards in trade agreements. It also may have made the administration itself more disposed to protectionist actions to avoid appearing soft on unfair trading practices and ceding its leadership to Congress. ...

This sentiment also is spilling into areas of foreign investment: the administration has been forced to implement closer scrutiny of foreign takeovers. Hillary Clinton in March proposed that there be some sort of trigger when foreign ownership of our debt would trigger a White House action to reduce it.

It is also affecting the immigration debate. Many Americans, especially Republicans, think high levels of illegal immigration undermine the integrity of our borders and our laws. Others, though, principally fret that immigrants represent new competition for jobs that will hold down wages. And thus the failure, at least for now, of Bush's immigration plan is yet another victim of the growing concern over inequality and middle class angst.

Finally, inequality is finding its way into many areas of tax and regulatory policy: the subprime meltdown, portrayed by some as evidence of Wall Street profiting at the expense of unsophisticated borrowers; the move to subject executive pay to shareholder votes; and interest in the Senate in taxing carried interest at ordinary income rates. ...

[T]he issue seems likely to be a force in domestic policy for the medium term. It will make it harder to alter Social Security, and it has increased interest in universal health care. Democratic candidates have been quicker to incorporate it into their campaign rhetoric, led by John Edwards who ran on the Two Americas theme in 2004. ...

The Hamilton Project: Reforms to The U.S. Tax System In Today’s Global Economy

Larry Summers, Robert Rubin, and others are proposing reforms to the U.S. tax system in an event today sponsored by the Brookings Institution, see Reforming Taxation in the Global Age [video] Here's part of the press release that came via email:

The Hamilton Project ... hosted a forum today entitled “Reforming Taxation in the Global Age”... During the forum, the Hamilton Project released a new strategy paper and three new discussion papers examining the need to modernize and reform the U.S. tax code to reduce inequality, expand opportunity and respond to the realities of a global economy. ...

Summers opened the forum by highlighting a new strategy paper he co-authored, along with Jason Furman and Hamilton Project Policy Director Jason Bordoff, on “Achieving Progressive Tax Reform in an Increasingly Global Economy.” The paper highlights the enormity of the increase in inequality: in total $664 billion has been shifted from the bottom 80 percent of households to the top one percent of households. At the same time, the tax system has become less progressive—since 1960 the average tax rate for the top 0.1 percent of households has been cut nearly in half while rising slightly for middle-income families

Summers noted that the erosion of progressivity in the tax code is the result of a combination of deliberate policy choices (like the 2001 and 2003 tax cuts) and the failure to reform the tax code to keep up with rapid changes associated with globalization and the increasingly sophisticated financial system. In particular, Summers highlighted the growing ease with which corporations have leveraged these factors to avoid paying taxes, thus contributing to the income gains for the wealthiest Americans.

“The increase in inequality has shifted $664 billion from middle-class families to the most fortunate – the equivalent of taking away $7,000 from each household in the bottom 80 percent. Rather than trying to offset part of this income shift, the tax code has become less progressive thus exacerbating these challenges,” noted Summers. “This inequality, in turn, undermines political support for a competitive market economy, which contributes to economic growth. By making our tax system more progressive, we can help everyone share in the tremendous benefits generated by the economy while creating the political and economic conditions for sustained growth.”

With recent tax cuts set to expire in 2010, policymakers are beginning to weigh various approaches to tax reform... In a new strategy paper that anticipates these reforms, the Hamilton Project outlines six broad principles that should guide progressive tax reform in today’s global economy... [In addition,]... An important part of the progressive tax system is a robust tax on large bequests and gifts. ... Another area in need of broad reform is corporate taxation of multinational firms. As U.S. firms have become increasingly global, the treatment of foreign income has become a major source of tax avoidance. ...

Members of the expert panel summarized the discussion by noting that the goal of any tax reform measures should include progress toward reducing the nation’s large fiscal gap, making the tax system more progressive, and helping to offset some of the increase in inequality in recent decades. A common thread throughout much of the discussion focused on finding tax reform measures that address inequality while also creating positive incentives for robust and socially responsible economic policies.

“Any attempt to restore fiscal balance will have to address both revenues and spending,” noted former Treasury Secretary, Robert E. Rubin. “One challenge is to strike the right balance so that restoring fiscal balance is joined with public investment in areas critical to economic growth, broad participation in that growth and economic security for American workers and families.”

“The tax code can be an effective tool in promoting social policy if applied wisely,” noted Jason Furman, director of the Hamilton Project. “It can also have a negative impact if not used appropriately, such as in the case of taxes on health insurance which can raise health spending without providing help for many of the uninsured to get coverage. The bottom line: by making the tax system more progressive and making the tax code more fair and efficient, we can have a positive impact on a range of social priorities, from improving health insurance to expanding access to college.”

Here's the introduction to the paper by Jason Furman, Lawrence H. Summers, and Jason Bordoff:

Achieving Progressive Tax Reform in an Increasingly Global Economy, by Jason Furman, Lawrence H. Summers and Jason Bordoff, Hamilton Project: Introduction The progressive tax system, and the nation's fiscal system more broadly, have historically played an important role in expanding opportunities for all Americans while reducing inequality. But the same dynamic forces of technological change, financial innovation, and globalization that have contributed to rising income inequality also present new challenges for progressive taxation. Financial engineering, for example, has made it easier for the financially sophisticated—typically the wealthy—to take advantage of new financial instruments that shelter their gains from tax. And as capital is able to move ever more quickly and easily across borders, corporate income becomes increasingly elusive of taxation. These forces, together with deliberate policy changes, have led to an erosion of progressivity—the principle that higher incomes should face higher rates of taxation—and a dramatic reduction in the average tax rate facing very high-income households. More than half of that decline is the result of declining effective corporate tax rates, as high-income households own disproportionate amounts of capital.

The tax code is not only a means of raising revenue to pay for government services. It also impacts an astonishing array of economic and social activities, from homeownership to education and child care to support for low-income workers. Taxes contribute, as part of the problem or as part of the solution, to many of the challenges our nation faces. The present tax treatment of health insurance, for example, pushes health spending upward while offering many of the uninsured little help in getting coverage. The tax treatment of retirement savings provides a windfall for high-income Americans who would likely have saved anyway, while offering scant encouragement to saving by low- and moderate-income Americans, many of whom face the prospect of an insecure retirement. America's factories and cars continue to emit vast amounts of the carbon dioxide that drives climate change, a problem that would be remedied, in part, if the tax code imposed a cost for burning carbon-emitting fossil fuels.

There is broad agreement about many of the shortcomings of our current tax system, but little consensus about the solution. To make progress, lawmakers will, at a minimum, have to come together in good faith and agree on a broad approach. In an effort to define a common approach, this strategy paper offers six broad principles that reflect the new challenges facing our tax system in the twenty-first century. We believe these principles should command wide assent as policymakers consider tax reforms, whether incremental or far-reaching:

  1. Fiscal responsibility requires addressing both taxes and spending.
  2. Rising inequality strengthens the case for progressivity.
  3. The tax system should collect the taxes that are owed.
  4. Tax reform should strengthen taxation at the business level.
  5. Taxes for individuals should be simplified.
  6. Social policy can and should often be advanced through the tax code—and it must be well designed.

The remainder of the paper will discuss each of these principles in detail.

Health Savings Accounts Are Unpopular

Bad news for consumer-directed health plans such as Health Savings Accounts:

Health Savings Plans Start to Falter, by Vanessa Fuhrmans, WSJ: President Bush and many big employers have hailed "consumer-directed" health plans and savings accounts as an effective weapon in the battle against runaway medical costs. But several years after the plans got off to a fast start, the approach appears to be stumbling -- largely because of consumers' unease in using them. ...

[C]onsumer-directed plans, which involve a high-deductible insurance policy that can be combined with a savings account to help pay for out-of-pocket health costs. The plans ... have lower premiums but shift more of the responsibility for health-care spending onto consumers... Employers often put money in the accounts to subsidize the higher deductibles. ...

But low enrollment and low satisfaction among workers who are offered them raise the question of whether consumer-directed plans will stall before they ever hit the mainstream...

Where employees ... have a choice, only 19% choose the newfangled plans, [a] Kaiser study estimates. In the Federal Employees Health Benefits Program, which has offered the plans for several years, only about 50,000 of its eight million members were enrolled in them in 2006...

In addition, those who are in consumer-directed health plans often report lower satisfaction and confusion about how the plans are supposed to work. ...

Towers Perrin, an employee-benefits ... consulting firm says consumer-directed plans have much potential, [but] its executives were surprised consumer responses were so negative.

"If I were a product manager in any other industry and saw scores this low in customer satisfaction and understanding, I'd be thinking of pulling that product from the shelves...," says David Guilmette, managing director of Towers Perrin's health-care consulting practice. ...

A growing number of industry experts believe that for consumer-directed plans to succeed, they have to offer coverage that is at least as rich as traditional plans. That means providing upfront coverage of most preventive services and treatments and a generous contribution to employees' accounts.

"If you're just trying to cost shift, and you only get 10% of your employees in, they are the youngest and healthiest, and you haven't accomplished anything in terms of health-care costs," says Bill Sharon, a senior vice president at Aon Consulting...

The Job Finding Rate is Sluggish

Bad news for dynamism:

U.S. Job Market May Be Less Dynamic, by Greg Ip, WSJ: The U.S. job market’s famous dynamism may be ebbing a bit.

Policy makers and economists praise the dynamic nature of the U.S. job market... But the latest evidence is that the job market may be a bit less dynamic than it once was. In the current expansion, job growth has come principally from a decline in job cuts, not from a rise in hiring activity, a new Bureau or Labor Statistics report finds.

The report by the BLS says that in the latest economic recovery, “net employment gains appear to be predominantly from fewer layoffs, plant closings and other labor force reducing events, and to a lesser extent from greater business openings and expansions that the economy typically experiences during an economic recovery.” This is true of both large and small firms. ...

This, from New Economist, is related: Are Robert Shimer and Robert Hall wrong about unemployment?. It looks at job finding and job separation rates over the business cycle.

Suburban Sprawl

Maybe it's living in the west my whole life, most of the time in relatively unpopulated areas compared to major cities, but I'm finding it hard to get too worked up over this:

Suburban Cowboys, by Ben Adler, The American Prospect: You know your conservative pet cause has arrived when it gets an event at the Heritage Foundation. Every kooky right-wing crusade, from denying global warming to teaching creationism in public schools, will eventually have its moment in the sun at the conservative think tank.

So it is no surprise that the honor was recently granted to a growing group of reactionaries who think that America's sprawling, post-war development pattern is actually a good thing -- and that the nascent anti-sprawl "smart growth" movement needs to be stopped. These pro-sprawl views have begun to find their voice on the op-ed pages and, on May 22nd, with a discussion at Heritage modestly titled "War on the Dream: How Anti-Sprawl Policy Threatens the Quality of Life."

The event took its name from the title of a new book by Wendell Cox, a public policy consultant (critics call him a "hired gun for the roadway industry") and visiting fellow at Heritage. Cox was introduced by another Heritage fellow, Ron Utt, who is perhaps best known as the man who led the Reagan administration's privatization efforts. ...

The new right-wing bogeyman that Utt and Cox devote considerable energy to destroying is the smart growth movement. Smart growth advocates seek to present an alternative to the suburban-sprawl model of development. They also suggest that local governments undo restrictions that require separation of residential and commercial property, and requirements that every business be surrounded by a massive parking lot. Simultaneously, they seek to redress the severe imbalance of public funding that currently favors highways over mass transit. The desired result is a walkable, transit-accessible, mixed-use community that is more integrated and has less environmental impact than its suburban counterparts.

But commentators like Utt and Cox counter that sprawl enables home-buying by constructing cheap new houses in cornfields, and cuts down on congestion by dispersing traffic into ever-expanding networks of new highways. Of course, there are elements of truth in both propositions, but Utt and Cox never address whether their preferred pattern is environmentally sustainable or culturally desirable.

The shallow logic of the pro-sprawl propagandists is apparent in ... Cox and Utt's discussion... Utt noted ... that housing prices are lower in Houston and Atlanta than in Washington, D.C. or Chicago, implying that the greater affordability of the Southern cities can be explained by their sprawling development patterns.

This is an interesting inversion of the typical conservative faith in the efficiency of the market. Says Dan Emerine, project manager for the Smart Growth Network..., "One of the problems that isn't being addressed in such a claim is simply the desirability of living in those locations. To the extent that there is a premium for living in such locations as D.C. or Chicago, it's because those locations are scarce. If you have a scarce good, simple economics tells you that you will get a higher price than otherwise might exist." He went on to explain that smart-growth advocates want to level the playing field to ensure that all communities can develop in ways that allow "many more opportunities for people to live in communities that are transit-oriented and pedestrian friendly." ...

James Howard Kunstler." ...  is the author of several books on sprawl..., and an ardent opponent of sprawl on aesthetic, spiritual, and ecological grounds. ... Kunstler told the Prospect that Cox is part of "an interesting cohort of observers whose basic argument is that suburbia is OK because people seem to like it." ...

"The interesting thing is that their argument doesn't go beyond that," Kunstler says. "It absolutely fails to take into account whether circumstances will permit us to keep living this way. The fact that people like something doesn't mean it's sustainable." Like many smart-growth advocates, Kunstler argues that the era of cheap oil cannot last forever, and that the environmental impact of paving over ever more land and driving greater distances is devastating. Even if the suburban lifestyle offers a higher quality of life, as Cox maintains, it simply cannot be accommodated indefinitely. ...

Ultimately the pro-sprawl reaction, a sort of Reagonomics of urban planning, betrays many of the peculiar traits of modern conservatism: the impulse to demonize any opposition, no matter how minimal or common-sense, and a proclivity to selectively pull bits of information out of context ...

As the Smart Growth Network's Emerine argues, "I think the criticism stems from a real misunderstanding of what advocates of smart growth and better community planning are trying to accomplish. I think the evidence shows that we are really about leveling the playing field for the market and types of development that there is a real market demand for." The question is, why don't pro-sprawl conservatives like Utt and Cox want to allow the free market to work?

One part did catch my attention (beyond the confusing parts about free-markets), the part that says that living in D.C. or Chicago is preferable to living elsewhere, so that's why houses are so much more expensive.

Overlooking the condescension in the statements (I can't speak for Houston and Atlanta, or for other people, but I just don't think Chicago or D.C. are more desirable places to live than where I live), is it demand as claimed? Are housing prices higher because D.C., Chicago, and other places because they are such desirable places to live? Here's another view from Edward Glaeser:

Glaeser's recent work on real estate addresses the issues of supply rather than of demand. He is far more interested in the forces shaping land development and residential building in the United States than in the forces shaping buyers' motivations and actions. He views supply as crucial to appreciating what has happened to the U.S. real-estate market over the past 30 years. ... Between 1980 and 2000, four of the five cities in the U.S. with the fastest-growing housing prices were in Boston's metropolitan area... Glaeser and several colleagues considered two explanations. First, the possibility that builders in the metro area were running out of land and that home prices reflected that scarcity. The second hypothesis was that building permits were scarce, not land. Had the 187 townships in the metro area created a web of regulations that hindered building to such a degree that demand far outstripped supply, driving prices up?

Almost as a rule, Glaeser is skeptical of the lack-of-land argument. He has previously noted ... that 95 percent of the United States remains undeveloped and that if every American were given a house on a quarter acre, so that every family of four had a full acre, that distribution would not use up half the land in Texas. Most of Boston's metro area, he concluded, wasn't particularly dense, and even in places where it was, like the centers of Boston and Cambridge, there was ample opportunity to construct higher buildings with more housing units.

So, after sorting through a mountain of data, Glaeser decided that the housing crisis was man-made. The region's zoning regulations — which were enacted ... in the first half of the 20th century to separate residential land from commercial and industrial land and which generally promoted the orderly growth of suburbs — had become so various and complex in the second half of the 20th century that they were limiting growth. Land-use rules of the 1920's were meant to assure homeowners that their neighbors wouldn't raise hogs in their backyards, throw up a shack on a sliver of land nearby or build a factory next door, but the zoning rules of the 1970's and 1980's were different in nature and effect. ...

The objections in the article to urban sprawl are "aesthetic, spiritual, and ecological." I don't have much to say about aesthetics and spirituality, though its hard to see why suburban areas can't posses these traits, and I'd rather not have someone else's utopian vision imposed upon me. So I'll take the main objection to be ecological, and that in turn boils down to cars, driving, and carbon if I am reading this right. If so, let's solve the problem in a way that gives people as much choice as we can in how they respond and reorganize in response to the policy change. Part of that can be a cautious reexamination of zoning restrictions and better public transportation systems, but much more than that will be needed and, as has been widely discussed, carbon taxes or cap and trade policies address the environmental issues in a way that preserves choice and avoids the need for direct government mandates and interventions.

FRBSF: House Prices and Subprime Mortgage Delinquencies

Mark Doms, Frederick Furlong, and John Krainer of the San Francisco Fed examine the relationship between housing prices and subprime mortgage delinquencies. They find that "differences in the performance of subprime mortgages among [geographical regions] may reflect in part the effects of house-price appreciation on the incentives and the opportunities of some mortgage borrowers to keep loans current":

House Prices and Subprime Mortgage Delinquencies, by Mark Doms, Frederick Furlong, and John Krainer, Economic Letter, FRBSF: The recent sharp increase in subprime mortgage delinquencies has captured the public spotlight and led analysts to search for the factors that are likely to have contributed to the problem. These factors commonly include the lack of income documentation, high loan-to-income ratios, the lowering of credit standards, and the resets on adjustable-rate loans, to name but a few. Although these factors are important to consider, it also is important to remember that the delinquencies have occurred during a time of seismic shifts in the patterns of house-price appreciation, shifts that were unprecedented in terms of their size and suddenness and that varied widely across metropolitan areas.

In this Letter, we explore how the pace of and change in house-price appreciation can affect the incentives and opportunities for borrowers in a market to avoid delinquencies and foreclosures. For instance, with likely gains in home equity in markets where house prices have risen significantly, a homeowner should have greater incentives and opportunities to keep a mortgage loan current. Indeed, we show that markets that recently experienced greater house-price appreciation tended to have lower delinquency rates and smaller increases in delinquency rates. We also find that metropolitan areas where house prices decelerated the most in 2006 have experienced the largest increases in subprime delinquency rates. One of several possible explanations for this relationship is that, in the face of sharp declines in the pace of house-price appreciation, some borrowers may have lowered their expectations about future appreciation rates, and, hence, the attractiveness of the investment component of homeownership also declined.

The subprime market One hurdle facing researchers in the subprime market area is that there is no readily agreed upon definition of "subprime." Indeed, the subprime residential mortgage market barely existed in 1995, although since then it has grown rapidly, by some estimates accounting for approximately 20% of all first lien mortgages made in 2006. Generally speaking, subprime is a lender-given designation for borrowers with low credit scores (FICO score less than 620, for example), with little credit history, or with other types of observable credit impairment.

Although "subprime" is not rigorously and consistently defined in the mortgage industry, one firm, First American LoanPerformance (FALP), has produced a number of statistics on regional delinquency rates based on subprime mortgages in its database. The delinquency rate is defined as the percent of subprime loans that are delinquent 60 days or more. The data, which are from 2005 and 2006, contain observations on 309 metropolitan statistical areas (MSAs), and form the basis of our analysis (see also The Wall Street Journal 2007). It is worth noting that the FALP data do not represent the entire universe of mortgages; also, estimates of delinquency rates on subprime mortgages vary among sources, reflecting differences in the definition of subprime and sample coverage. However, where possible, we have compared the FALP data to those from other sources and have found high correlations among them.

The FALP data show considerable regional variation in the delinquency rates and in the changes in the delinquency rates. The median delinquency rate in 2006 among the 309 MSAs was 12.2%, with a range from about 3% to 25%. MSAs near the Gulf Coast that were severely affected by Hurricane Katrina were among those with the highest delinquency rates. Overall, however, the MSAs with the highest delinquency rates tend to be located in the Midwest; of the 18 MSAs with the highest subprime delinquency rates in 2006, 14 were in Michigan or Ohio.

In terms of changes in subprime delinquency rates, nearly all MSAs posted increases from 2005 to 2006. The median change was about 3 percentage points, and the largest increase was 11 percentage points. Of the 309 MSAs in the sample, only 25 had decreases in their delinquency rates, with the sharpest declines among MSAs near the Gulf Coast. Of the 18 MSAs that posted the largest increases in delinquency rates, 12 were in California and 3 were in Massachusetts. These MSAs typically had relatively low delinquency rates at the end of 2005.

Delinquency rates in 2006 and recent house-price appreciation There are a number of possible reasons for the observed differences in subprime delinquency rates among MSAs in 2006, including variation in economic conditions, differences in the riskiness of the subprime borrower pools across MSAs, and changes in the house prices. Parsing out the relative importance of these reasons involves a degree of complication that is beyond the scope of this Letter.

With that said, we examine the relationship between house-price appreciation and delinquency rates for subprime mortgages among MSAs. Specifically, we compare the share of subprime mortgages in delinquency at the end of 2006 and the percent change in house prices, as measured by the Office of Federal Housing Enterprise Oversight (OFHEO) indexes, from 2004 through 2006. For this period, the pace of house-price appreciation varied considerably. For the sample of 309 MSAs, appreciation rates ranged from -2% in Kokomo, Indiana, to almost 54% in the Phoenix, Arizona, area.

Figure 1 provides a graphical perspective on the link between delinquency rates and house-price appreciation. The figure covers the largest 150 MSAs in the sample. Excluded from the figure are several MSAs near the Gulf Coast that were severely affected by Hurricane Katrina. The figure shows a very strong negative correlation between recent rates of house-price appreciation and the level of the subprime delinquency rate in 2006 (the correlation coefficient is 0.79); that is, higher rates of house-price appreciation are associated with lower rates of delinquencies.

This negative correlation could arise for a variety of reasons. One possibility is that the economies in MSAs with rapidly appreciating house prices were strong, and, hence, relatively fewer households became delinquent in their payments. However, we find that controlling for economic conditions (as measured by employment growth and the unemployment rate) does little to alter the relationship displayed in Figure 1.

Another possibility is that distressed borrowers in strong housing markets have opportunities to pursue alternatives to delinquency. For instance, a homeowner in a market with rapid house-price appreciation is likely to have built up more home equity than a homeowner in a market with smaller gains in house prices. With higher home equity, homeowners have a greater incentive to keep their mortgage loans current. Further, homeowners with a greater equity stake would be in a better position either to sell their homes and pay back the remaining principal or to refinance existing mortgages to ones that would offer lower, more affordable payments, at least for a while.

Changes in delinquency rates We also find that changes in delinquency rates on subprime residential mortgages were strongly related to changes in the pace of house-price appreciation. In the analysis we looked at the changes in the subprime delinquency rates from 2005 to 2006 and the changes in house-price appreciation rates in 2006 compared to 2005. An MSA experiencing a deceleration in house prices would have a negative change in its appreciation rate. For the overall sample, changes in appreciation rates ranged from about -32% (deceleration) in the Cape Coral-Fort Myers, Florida, areas to over 11% (acceleration) in Lawton, Oklahoma.

Figure 2 plots the pairings of changes in mortgage delinquency rates and changes in house-price appreciation for the largest 150 MSAs in the sample. A negative value on the vertical axis implies that house prices in 2006 grew less quickly than house prices in 2005—that is, a deceleration in house prices. As the figure shows, MSAs that experienced large decelerations in prices tended to experience large increases in rates of subprime mortgage delinquencies (the correlation is 0.61).

In addition to the simple correlation illustrated in the figure, we used a variety of techniques to examine the empirical relationship. For example, we took into account differences in the pace of house-price appreciation among the MSAs in 2006, to control for the possibility that areas experiencing large decelerations in house prices were simply ones with low rates of appreciation in 2006. While we found evidence that low rates of appreciation were associated with large changes in delinquency rates, we still found a strong and highly statistically significant relationship between increases in the delinquency rates and house-price deceleration. We also found that the relationship holds up when we control for changes in economic conditions in housing markets.

The finding that changes in delinquencies are related to house-price deceleration raises the possibility that the increases in delinquencies reflect not just borrower distress but also a decline in the demand for housing. This might be true if some borrowers originally were willing to spend more on their mortgages than they otherwise would because they expected large gains in equity from future house-price appreciation. When those gains did not materialize, some borrowers may have reassessed their expectations about future appreciation rates and thus their decisions about spending on housing.

Such an effect from changes in expectations about future house-price appreciation would be expected to affect the demand for housing more generally, not just subprime borrowers. Indeed, the data on home sales and surveys on the demand for home mortgages indicate a general decline in demand for buying homes. In addition, while delinquency rates on prime mortgage loans remain quite low, the MSA-based data show a positive correlation between changes in delinquency rates on subprime and prime mortgages.

It also is possible that the patterns of house-price appreciation are linked to delinquency rates through their influence on mortgage lenders' assessments of risk. For example, MSAs that had large decelerations in house prices also had very high rates of house-price appreciation prior to 2006. The earlier rapid rates of appreciation may have paved the way for new, riskier borrowers to enter the market, as lenders were more willing to finance house purchases in markets with rising prices. However, in this case, the eventual rise in delinquencies would have been due to the previous high rates of house-price appreciation rather than the subsequent deceleration

Conclusion The sharp rise in delinquency rates on subprime residential mortgages has raised concerns about credit underwriting practices and economic distress among borrowers and has drawn the attention of policymakers at the Fed and elsewhere. No doubt, this is a complex issue, influenced by a number of different dynamics. Our analysis focuses on one of the potential dynamics, and we find that differences in the performance of subprime mortgages among MSAs may reflect in part the effects of house-price appreciation on the incentives and the opportunities of some mortgage borrowers to keep loans current. Two of the potential channels through which house-price appreciation may affect the subprime delinquency rate that we suggest are the incentive to protect home equity associated with recent appreciation in house prices and the effect of changes in expectations about future house-price appreciation on the demand for housing.