Topic: Tax and Budget Policy

William Galston’s Not-So-Great Decoupling of Pay, Productivity, and Common Sense

Wall Street Journal columnist William A. Galston says “the Great Decoupling of wages and benefits from productivity [is] the biggest economic story of the past 40 years.”  Wow!  The Biggest Economic Story of the past 40 years!  Imagine that!  I have been researching such data longer than 40 years yet this particular story is so old (and so wrong) I had almost forgotten about it.   

The alleged decoupling of growth of pay from productivity, as Robert Gordon explained in 2009, “compares apples with oranges, and then oranges with bananas.” Median wages for the whole economy were deflated by the consumer price index, which exaggerated inflation and understated real income growth. Rapidly growing health and retirement benefits were often excluded. These muddled measures of real pay, which also failed to adjust for changing household size or hours, were compared to productivity of the nonfarm business sector, not the whole economy. And real output was calculated using GDP deflators that showed much less inflation than the CPI. With those errors, one estimate for the income-productivity gap from 1979-2007 was 1.46 percentage points, but Gordon’s adjustments shrunk that to a negligible 0.16. He also noted that mean and median incomes grew at remarkably similar rates, suggesting inequality did not explain much.

A 2013 study from the London School of Economics likewise found no significant gap between growth of compensation and productivity in the United States or UK (unlike the EU and Japan) if both measures are properly calculated with the same price index. The LSE study concluded that, “the debate around net decoupling in the UK and US is rather a distraction (it is actually more important in Continental Europe and Japan). Obtaining faster productivity growth is a highly desirable policy goal in the current climate of near recession as it will ultimately lead to faster wage growth and consumption.”

Galston tells other stories, such as “mobility has stalled” – which is indefensible nonsense. His allusion to the “past 40 years,” appears based on a Pew Research paper’s pointless claim that the “middle class” constituted a smaller share of adults in 2011 than in the idyllic year of 1971. As Pew Research hesitantly revealed, that is mainly because millions of people moved up – “the upper-income tier [earning more than double median income] rose to 20% of adults in 2011, up from 14% in 1971.”

All this statistical fog is thin camouflage for Galston’s invitation to grant authoritarian politicians and bureaucrats the discretion to somehow “link the tax rates individual firms have to the compensation practices they adopt.” That may well be the worst economic policy idea of the past 40 years, trailing barely behind Nixon’s dictatorial price controls.

ABBA and the Story of the Most-Inane-Ever Tax Controversy

The tax code is a complicated nightmare, particularly for businesses.

Some people may think this is because of multiple tax rates, which definitely is an issue for all the non-corporate businesses that file “Schedule C” forms using the personal income tax.

A discriminatory rate structure adds to complexity, to be sure, but the main reason for a convoluted business tax system (for large and small companies) is that politicians don’t allow firms to use the simple and logical (and theoretically sound) approach of cash-flow taxation.

Here’s how a sensible business tax would work.

Total Revenue - Total Cost = Profit

And it would be wonderful if our tax system was this simple, and that’s basically how the business portion of the flat tax operates, but that’s not how the current tax code works.

We have about 76,000 pages of tax rules in large part because politicians and bureaucrats have decided that the “cash flow” approach doesn’t give them enough money.

So they’ve created all sorts of rules that in many cases prevent businesses from properly subtracting (or deducting) their costs when calculating their profits.

One of the worst examples is depreciation, which deals with the tax treatment of business investment expenses. You might think lawmakers would like investment since that boosts productivity, wage, and competitiveness, but you would be wrong. The tax code rarely allows companies to fully deduct investment expenses (factories, machines, etc) in the year they occur. Instead, they have to deduct (or depreciate) those costs over many years. In some cases, even decades.

But rather than write about the boring topic of depreciation to make my point about legitimate tax deductions, I’m going to venture into the world of popular culture.

Though since I’m a middle-aged curmudgeon, my example of popular culture is a band that was big about 30 years ago.

Hyping Billions in Taxpayer Spending

In today’s issue of Nature, scientists from the National Ignition Facility (NIF) in California are trumpeting their advance in achieving fusion ignition. However, the National Ignition Facility is just like so many other projects from the Department of Energy. It’s behind schedule and over budget.

Approved by Congress in 1993, the lab did not officially open until 2009 after numerous delays. According to a report in 2000 by the Government Accountability Office, “NIF’s cost increases and schedule delays were caused by poor Lawrence Livermore management and inadequate DOE oversight.”

The completed lab has cost taxpayers $5 billion, up from the initial estimates of $2.1 billion. It costs an additional $330 million to operate annually.

In 2009, scientists proclaimed that the NIF would achieve fusion within three years. Unsurprisingly for a government-funded project, NIF announced in 2012 that it failed to meet its goal. The New York Times said “the output of the experiments consistently fell short of what was predicted, suggesting that the scientists’ understanding of fusion was incomplete.”

NIF announced that it would spend the next three years trying to evaluate why it hadn’t achieved it. But in a moment of honesty in its report to Congress, NIF conceded “it is too early to assess whether or not ignition can be achieved at the National Ignition Facility.”

So while some news reports herald the advance at NIF as bringing it closer to achieving a sun-like power source, the project is still years away from its goal and billions over budget. 

Goldilocks, Canada, and the Size of Government

I feel a bit like Goldilocks.

Think about when you were a kid and your parents told you the story of Goldilocks and the Three Bears.

You may remember that she entered the house and tasted bowls of porridge that were too hot and also too cold before she found the porridge that was just right.

And then she found a bed that was too hard, and then another that was too soft, before finding one that was just right.

Well, the reason I feel like Goldilocks is because I’ve shared some “Rahn Curve” research suggesting that growth is maximized when total government spending consumes no more than 20 percent of gross domestic product. I think this sounds reasonable, but Canadians apparently have a different perspective.

Back in 2010, a Canadian libertarian put together a video that explicitly argues that I want a government that is too big.

Now we have another video from Canada. It was put together by the Fraser Institute, and it suggests that the public sector should consume 30 percent of GDP, which means that I want a government that is too small.

My knee-jerk reaction is to be critical of the Fraser video. After all, there are examples - both current and historical - of nations that prosper with much lower burdens of government spending.

Lobbying the Taxpayers — with Taxpayers’ Money

Some people say innovation is dead in America, but NASA is always looking for innovative ways to extract more money from the taxpayers. The Wall Street Journal reports on some of their innovations in using our tax dollars to persuade us to give them even more of those tax dollars:

In William Forstchen’s new science fiction novel, “Pillar to the Sky,” there are no evil cyborgs, alien invasions or time travel calamities. The threat to humanity is far more pedestrian: tightfisted bureaucrats who have slashed NASA’s budget.

The novel is the first in a new series of “NASA-Inspired Works of Fiction,” which grew out of a collaboration between the National Aeronautics and Space Administration and science fiction publisher Tor. The partnership pairs up novelists with NASA scientists and engineers, who help writers develop scientifically plausible story lines and spot-check manuscripts for technical errors.

The plot of Mr. Forstchen’s novel hinges on a multibillion-dollar effort to build a 23,000-mile-high space elevator—a quest threatened by budget cuts and stingy congressmen….

It isn’t the first time NASA has ventured into pop culture. NASA has commissioned art work celebrating its accomplishments from luminaries like Norman Rockwell and Andy Warhol. …

Some see NASA’s involvement in movies, music and books as an attempt to subtly shape public opinion about its programs.

“Getting a message across embedded in a narrative rather than as an overt ad or press release is a subtle way of trying to influence people’s minds,” says Charles Seife, author of “Decoding the Universe,” who has written about NASA’s efforts to rebrand itself. “It makes me worry about propaganda.”

Lobbying with taxpayers’ money isn’t new. But as Thomas Jefferson wrote in the Virginia Statute of Religious Liberty: “To compel a man to furnish contributions of money for the propagation of opinions which he disbelieves is sinful and tyrannical.” To compel him to furnish contributions of money to petition his elected officials to demand more contributions from him just adds insult to injury.

Federal Government: Much Smaller in Canada

Canada released a new federal budget yesterday. The ruling Conservatives are centrists and far too supportive of the welfare state. Nonetheless, the government is expected to balance the budget next year while steadily reducing spending and debt as a share of GDP.

The contrast with the huge and unreformed federal budget in Washington is stark.

In Canada, federal spending fell to just 15.1 percent of GDP in 2013 and the government projects that the ratio will decline steadily to 14.0 percent by 2019 (p. 268). Federal debt as a share of GDP fell to just 33 percent this year.

In the United States, federal spending was 20.8 percent of GDP in 2013, and the CBO projects that the ratio will gradually rise to 21.4 percent by 2019. Federal debt held by the public as a share of GDP is 74 percent this year—more than twice the Canadian level.

On federal fiscal policy, Canada has had pragmatic centrist leadership for the last two decades, with voters keeping the loony left out of power. In the United States, we’ve had power divided between centrist Republicans and loony left Democrats in recent years.

Actually, the federal leadership of both U.S. parties is loony. The debt crisis in Europe illustrated that endlessly running large deficits when government debt is already high is dangerous. It is playing with fire. Yet congressional majorities have recently signed off on a big-spending appropriations deal, a big-spending farm bill, and a debt limit bill that does nothing to combat runaway red ink.

Pundits often claim that the Republicans are controlled by radical Tea Party elements. I wish that were true, but in terms of policy results there is no evidence of it. Republican and Democratic leaders are apparently satisfied with federal spending, deficits, and debt far larger than acceptable to the centrists in Canada.

The chart shows the remarkable gap in federal spending between the two countries in recent years.

Likely Sources of Obama’s Misconceptions about Income Mobility

President Obama has been expressing inordinate alarm about differences between income groups, and about mobility between such groups over time.   “The combined trends of increased inequality and decreasing mobility,” he says, “pose a fundamental threat to the American Dream, our way of life, and what we stand for.”  

A fundamental limitation of annual income distribution figures is that income in any given year may not be at all typical of a family’s normal or lifetime income.  Job loss or illness can push one year’s income well below normal, for example, and asset sales can produce one-time windfalls. People are commonly much poorer when young than they are by middle age, after accumulating experience and savings. For such reasons, the President’s strong opinions about “decreasing mobility” could be important, if true.

We need to separate two concepts of mobility. One is intergenerational mobility – whether “a child born into poverty … may never be able to escape that poverty,” as the President put it. Another involves intertemporal mobility – whether starting with a low wage at your first job supposedly impedes moving up the ladder of opportunity.

The President’s opinion that intergenerational mobility has declined was rigorously debunked by Raj Chetty, Emmanuel Saez and others.  As for inequality and mobility being related, they also found that, “the top 1 percent share is uncorrelated with upward mobility [p. 40].” Moreover, “The fraction of children living in single-parent households is the strongest correlate of upward income mobility among all the variables we explored [p.45].”  Since other countries have fewer single-parent households, this is just one reason for being wary of facile international comparisons.

Intertemporal mobility is not about links between parents and children, but about the ease with which individuals move from a lower to a higher income group, and vice-versa.  Are we stuck with the same paycheck we had just after leaving school, or can we move up with effort, experience, learning and saving?  Did having a big gain in the stock market in 2007 ensure that would happen again in 2008-2009?

The Federal Reserve Board’s Survey of Consumer Finances (SCF) tracks income mobility of the same families over time.  It turns out that mobility is surprisingly hectic even over short periods.