Joe the Economist (Greg Mankiw)
Economist Greg Mankiw has a post that fascinates me. As a professor who makes over $250,000 a year, he notices that under Obama’s tax plan he may make less money, and pass on less to his children. Since he’s pretty happy with the amount of money he has, as he should be, he says he has very little reason to do any more work.
Here’s what fascinates me about his post:
1. It assumes that his only incentive to do any work outside of his regular teaching and research is to make money. This seems so counter to what the idea of academia is for, and is passed over so easily.
Tenured academics like Greg M. have an incredible luxury: the time, freedom to work on what he wants, and a guaranteed paycheck (in his case, a large one). To say in that position you’ll only do “more work” if paid seems an offense to the idea of academia itself. Academics aren’t supposed to be on sale or work only on commission.
Greg M. himself is disproof of his own ideas. He spends alot of time blogging, and writing advice for junior professors and so on, all for free. If Obama wins, it looks like he’ll be doing more of that in the future. Obama, if his blog post is right, will alter the balance of commercial and non-commercial work he does. The irony is that that result might be better for society than Greg M. doing a bunch of consulting or paid-speaking.
2. The implication, taken by other writers like “Beldar” though not by Greg himself, is that Greg working less is proof that Obama’s tax cut will hurt the country. But hold on - Greg represents 5% of the country. The rest — the 95% percent who get a tax cut, will presumably have reasons to want to work harder, because their taxes are going down.
It’s a simple calculation. The tradeoff is those who make more than $250,000 doing less commercial and more non-commerical work, versus 95% percent of the population who have reasons to do more.
Its at least ambiguous. And since the money is worth more, on the margin, to people who make less than $250,000, they have more reason to want to work for it. $1000 means more to someone who makes $60,000 than to Greg M.
The upshot: Obama’s tax plan will encourage a rich man like Greg M. to devote more time to the public and his children instead of paid speaking gigs, and gives a lot more other people more incentives to earn more money. Sounds pretty good to me.
October 27th, 2008 at 4:28 pm
What happens when that top 5 - 10% works less? Don’t forget that the top 5 - 10% and their total rev / income will probably be comparable to the middle 30% or so.
To think that the bottom 25% will really work harder because of a tax cut is somewhat too idealistic. Sure 5% of that bottom 25 - 35% may work harder because of tax cuts, but really? They’re there for a reason and most the time that may be due to lack of initiative, so what makes them want to work harder? That bottom area will be happier working the same amount and just leeching money from the government.
As a basic economics student so far and just a meddling sophomore, my complete knowledge may not be sufficient for an intelligent response. I am after all defending a Cantab / hahhvad professor somewhat.
Anyways, the idea that a tax cut will cause people to work harder is well just too idealistic in my opinion. I think we’ve all learned in the past couple months what reality feels like. Ehh I guess I’m just pessimistic / cynical. Anyways, thanks for your insight and response.
October 27th, 2008 at 5:53 pm
Absolutely right on. I said similar (though I think you said it somewhat better):
http://trueconservative.typepad.com/trueconservative/2008/10/mankiws-right-moneys-not-the-incentive.html
October 28th, 2008 at 3:25 am
2 fallacies:
There are job makers and job takers. Sure, job takers will enjoy the benefits but only till the job runs out. The engine of growth is those very people willing to work hard enough to create new jobs.
Getting something for nothing does not encourage harder work. Quite the reverse it encourages less work.
October 28th, 2008 at 3:31 am
Our taxes go up when the Bush tax cuts expire, therefore we’re merely getting a rebate to hopefully offset the increase.
If no taxes are actually cut, how is it a tax cut? This is the thing that’s annoying me. There is no actual cut in the amount of taxes paid.
October 28th, 2008 at 3:31 am
If only 60-70% of adults pay taxes, then how can 95% receive a tax “cut?” When I was a child, my folks called this “welfare.” I guess that’s no longer politically correct. So if I can get a government check by just respiring, that’s a powerful incentive to do nothing.
October 28th, 2008 at 3:32 am
A tax cut or a tax increase causes a rebalance to occur. If an hourly worker makes more money they may work less and use the additional time to spend. The main thing about tax policy is who gets to pick the economic winners. The masses or the government. Do we get IPhones or rationed health care?
October 28th, 2008 at 3:32 am
It is indeed strange for an academic to make this argument, but I assume that it is more or less a piece of performance art. He wrote this to make a point. Stopping academics from working is like stopping an avalanche from falling any further down the mountain.
Now, on the topic in question, I do not doubt that that lowering taxes will increase productivity. This appeal to self-interest isn’t really idealistic. Why, when a company needs workers to work overtime, do they generally pay increased wages? If taking on additional work raises $300 for me, that’s nice, but I’m not nearly as likely to take the opportunity as if it would raise $450. The same would be true if I were looking at adding a part time job. It might not be worth the trouble at a certain rate of compensation, but worthwhile at another.
The problem with the 5% / 95% comparison is that Obama is not really giving the 95% a tax cut, but a tax credit. Also, he is not going to carry on the Bush tax cut which applied to all income levels. This raises three questions in my mind:
1. Will workers’ paychecks go up or down?
2. Will the size of the tax credit be related to how much you make, increasing with it?
3. Will the relationship between the two be obvious to workers?
Ordinary taxes, which are withheld from your regular paycheck, have a plain relationship to your work. I’m more skeptical of a tax credit. Most people are not easily motivated by long term benefits unless they are truly substantial, and I doubt that this would affect most persons’ choices.
October 28th, 2008 at 3:35 am
the 95% percent who get a tax cut
Of which some not insignificant number aren’t getting a tax cut at all. Rather, they are getting a handout. An no one works harder for a handout that they will get regardless of their effort. Do you suppose that’s why a large (not insignificant) number of workers on the production side of the equation are uncomfortable with a “spread the wealth” model?
October 28th, 2008 at 3:41 am
The logic of point 2 is indisputable; but the facts are in dispute. Just because Obama proposes to reduce taxes on 95% does not mean that he will reduce the Marginal tax rate. This chart http://taxprof.typepad.com/taxprof_blog/2008/10/marginal-tax-ra.html shows that marginal tax rates under Obama’s plan are considerably higher for people in the 30-50K AGI range. I think the reason is that Obama’s plan is more generous in the earned income tax credit for low income people, but the (more generous) EITC is phased out as incomes increase. So a person’s market income goes up by (say $1000), but he loses $500 of his EITC, so his net (after tax) income only goes up by $500. (My numbers may not be exactly right, but you get the idea.)
October 28th, 2008 at 3:47 am
Here I always thought that higher taxes meant the you had to work harder to maintain your lifestyle given that more of the money you earned was going to someone else. Meanwhile that someone else had to work less because they were being subsidized, usually some fat cat politician and his cronies. I like how both you and your opponent turn that on it’s head by making taxes about something it shouldn’t be about.
There are plenty of people in the bottom 95% who want more but were never willing to work harder or smarter to earn more. They are the ones who never bothered reading their textbooks prior to class, didn’t do their homework, and the like when they were in school. Now they slack off on the job too. Giving them more stuff they didn’t earn won’t change that.
Making someone else pay for the services that tax eaters get from government, or outright paying them subsidies isn’t going to get them to work harder. If what you are claiming were the case then welfare queens would be the hardest working group in america.
I think the whole premise is flawed and think you are both wrong. Is government, like the slaveholder, suppose to be in the business of making people to work harder? I would think that what the government is suppose to be in the business of is maximizing justice, and I just don’t see the justice of income redistribution.
It should be up to the individual if they want to work hard and reap the benefits of that, or take it easy and reap those benefits. There is much to be said for being a beach bum. I don’t however think a guy hanging out on the beach surfing and taking odd jobs so he has lots of free time for surfing should be getting subsidized by the guy working harder.
October 28th, 2008 at 3:50 am
It is interesting how this post doesn’t mention the effect any of this has on efficiently raising the money needed to fund the government (i.e., what you would think tax policy would be about ). The first part of the post seems likely to be true. People like Greg might forgo opportunities to make an extra dollar to be with their families. Good for Greg’s family, but less tax revenue for the government. Or to put it another way, if you tax something, you will get less of it. The second part of the post might be true if O were actually suggesting lowering tax rates, but it is my understanding he is not. He is proposing cutting a check to those who don’t make enough, but if they then go ahead and start making more, then he will punish such a person by phasing out the so-called tax cut. Clearly, this also makes earning additional income unattractive. If you subsidize something (in this case keeping your income below a politically fixed level) you will get more of it. Hard to see how either part of this equation gathers the money needed to run the government efficiently or encourages a robust, growing economy that throws off additional tax revenue.
October 28th, 2008 at 3:55 am
You need to read up on simple economics as applied in a “welfare state”.
It’s not just professors holding speeches that get the tax hike, it’s everyone that works hard and make a lot of money.
For instance, it means that a plumber/contractor that wants to start his own business decides that the tax he has to pay when making more money just wont make the extra hard work worth it. That means no business is started, and the people it could have emplyed is still unemployed. This means unemployment goes up, and less people have less money to pay contractors for work, so more contractors are out of business, and unemployment goes up even more. And the same for all other businesses.
The people that makes over 250.000 are the ones creating jobs, and if you punish their extra effort to create even more jobs, you get less employment.
And the people that gets the “tax cut” and presumably will work harder, what will they work with, if the people that employ them wont offer them any more jobs to work harder at?
You expect them to go into business for themselfes? But then they would get the tax hike, so why should they bother?
Think about it, would you work 2 hours overtime every day if the government takes the extra money you make? To most people it’s just not worth it, they will scale down and settle for good enough instead.
There is a reason the US has the strong economy it does, and an unemployment of around 5% that’s unheard of in Europe(except when counting creatively). I dont get it how people in the US can look at the US, then Europe, and then decide it’s a bright idea to follow Europes example and shut down the economy.
October 28th, 2008 at 3:58 am
If you believe that 95% of Americans are getting a tax cut with either candidate, I have some prime real estate to offer you. At very low rates.
October 28th, 2008 at 4:02 am
Sorry, naive as can be. Tell me this all again when you come live here in France, the kingdom of work disincentive. Our economy plugs along at a comfortable less than 2%, our OFFICIAL unemployment is currently about 8.3%. People DO stop working when the financial incentive goes down.
What’s that about leisure? Our generous 6 weeks vacation? Oh, well, that: no one has the money to go anywhere. But more importantly than that: Americans STILL have more leisure time. You don’t believe me? Well, think of all the time you save with your dishwasher, your clothes dryer, your convenient store opening hours. Not here. If that’s not enough, I can show you the studies where European living standards rank at the bottom when compared with US States.
My brother-in-law stops working treating burn patients during the winter because the DISincentive due to confiscatory tax rates is high. That can only be good for society, right? Oh, and the French don’t spend that extra time “volunteering”: that’s what government is supposed to do for you.
Also, what’s this about 95% of Americans getting a tax cut? Rather hard when only a fraction of those actually PAY taxes.
Finally, who the hell are you or any government to decide when anyone has made ENOUGH money? Perhaps I think that Asians should be happy with $30K, or that Women should be content with $15K if they’re married. Or that everyone across the Board should be happy with $40K per family. The rich are richer because, surprise surprise, they DO work harder. Rich Man’s Burden-NYTimes article.
October 28th, 2008 at 4:04 am
It seems that you claim that you know better his insensitives to work than he himself does. This sounds a little bit strange, as if you are so smarter than him that you better know what he needs.
The rest: as I understand, most people in US do not pay income taxes at all. And will continue enjoy this next year irrespective of POTUS choice. The only IMHO difference is whether the legendary “Joe the Plumber”, the new heroe of night horror stories, will buy his business and hire someone or not (this particular Joe will not, it seems, but I speak of general phenomena). I think that the overall balance will be negative: businesses will escape somewhere (Europe is decreasing taxes, it seems), die or just will not born.
October 28th, 2008 at 4:11 am
Why would I work harder for Obama’s “tax cut”? It isn’t coming out of *my* paycheck. Whether I work 90-hour weeks, or kick back and do the minimum, I’m still going to get that $1000 “refund” back from Daddy Gov’ment. Refundable “tax cuts” for people who wouldn’t normally pay taxes isn’t an incentive, it’s a *disincentive*.
And you should bloody well know that this argument is about marginal returns. A poor man works hard because he doesn’t want his children to starve and his house to be foreclosed upon. A rich man works hard to improve his wealth and standing. Rich men just naturally have more exposure to incentive, because they don’t need as much, proportionally, to maintain their necessities, compared to their earning potential. If you make it less rewarding to put their resources to work, they’ll skate by on the absolute minimum & dedicate every hour *not* required to fund their outstanding liabilities and necessities to something intrinsically rewarding but not economically rewarding - like blogging, or fishing, or playing golf.
In short, clear that shit out of your head, the election’s making you stupid. I swear, somebody should write a companion volume to Frank’s book, call it What’s the Matter With Connecticut?
October 28th, 2008 at 4:14 am
1) You necessarily presume that Obama actually will cut taxes on 95% of us, that his promise is no more ephemeral than that of Bill Clinton’s “middle class tax cut.”
2) If $1,000 means less to “rich” people who make over $250,000, doesn’t that mean the supply of rich peoples’ labor is more elastic than is that of poorer people? If poor people are working more for necessities, then isn’t their supply of labor relatively more likely to actually go up with higher taxes, as they will need more money to compensate?
3) Leaving aside the specific matter of Professor Mankiw, don’t you think that the decision by top managers and professionals to work more or retire later will have some actual benefit for the economy, independent of the spending they or their heirs will do with their added income? After all, the people who hire them think they will bring added benefit to their organizations. On the other side, when a skilled doctor or manager retires earlier than he might have, in the face of an effective taxation rate of 93%, we have to spend a lot of real capital training his replacement.
October 28th, 2008 at 4:15 am
During my lifetime, three presidents cut top tax rates in the face of a recession (JFK, Reagan, W), and in all three cases the economy came back to life. On the other hand, in the 1970’s , we had high taxes and expanded entitlements. I dont’ know if you’re old enough to remember the ’70’s, but by many measures it was worse than what we have today (at least so far). And of course, Herbert Hoover responded to the 1929 crash by raising taxes.
Empirical experience aside, it’s worth bearing in mind that the bottom 50% of taxpayers pay something like 4% of total income taxes–and many of them pay no income tax at all. Given their already low tax rate, it’s hard to see how a tax cut could be substantial enough to provide them with any incentive to work harder. In fact, since Obama plans to give “tax cuts” (eg supplementary checks) to the 42% who pay no income tax at all, there will be a disincentive to work more, since working more might mean less money, or even no money, from the government.
October 28th, 2008 at 4:19 am
Assuming the 95% are rational they may not work any harder-
It would appear that their marginal rates may be going higher when you factor in the phaseouts of the taxcredits- see below for an example
http://taxprof.typepad.com/taxprof_blog/2008/10/marginal-tax-ra.html
The other part of the argument is that the 95% folks who want to work harder will be able to. That presumes the labor market will hire them at or above their current income levels, a debatable point at least
October 28th, 2008 at 4:22 am
You write: “The rest — the 95% percent who get a tax cut, will presumably have reasons to want to work harder, because their taxes are going down.”
Here is the flaw in your argument: of that 95%, maybe 50% do not pay any taxes. In fact, a series of credits—child care, savings, additional child, child, low income, and other such—ensures that they receive back not only the taxes that they paid, but also a goodly portion of what other people pay.
I’ve worked for a huge tax preparation company in the past. Low income people, part of the 95% you’re talking about, come in with annual salaries of $10K-$17K +/-. Furthermore, they come in with a list of social security numbers for kids, some of which are theirs, some of which they’re keeping for other people. Now, let’s say that the $17K person comes in with four kids, his exemptions drop his taxable income to about $3K-$5K. Let’s say he’s paid $2K in taxes (I don’t have access to my tax tables right now, so I’m hypothesizing); with an adjusted taxable income of $3-$5K, he’s greatly overpaid—this is providing that he’s not already lowered his taxes via his W-4 and the number of exemptions included there.
Anyway, the guy’s taxes on income is now $0, but he’s paid $2K. He gets back that $2K. Add to that refund his child credit for each kid, the childcare credit, the additional child tax credit, and all the other goodies that this guy knows he can claim for—trust me, they know the ropes, down to how much money they should make before they stop working in order to max out on the refund—and the guy’s refund is likely to skyrocket to $6K.
So, this guy who you say is part of Obama’s great 95% lie not only pays no taxes, but he also gets money that isn’t his. A “tax cut” to this guy will not give him any incentive to work. The “tax cut” he currently receives in the form of credits ensures that he will game the system, and he does. Many of the low income people who came into the tax preparation office at which I worked knew all of the credits they needed to get the big refund—money for which they had not worked. They also knew the top annual wage they needed to earn to guarantee mega-bucks coming to them. Many of them stopped working/got fired at that point, and went on unemployment and welfare until the new year. Then they repeated the cycle.
What will happen as a result of Obama’s tax plan is that the low income guy will continue to game the system at the expense of the hard working man. The guys at the upper end of the economic ladder will lower their productivity and hide their money, and justifiably so. After all, it is theirs; they earned it. The guy in the middle—ah, well, he’ll be squeezed. He’ll see his labors benefitting not him but the slackers below him. Plus, he will have to assume the burden of Obama’s tax increase since the 5% at the top will hide their money or take less money in wages and more in other non-taxable and untraceable means. Consequently, the guy in the middle will have a reduced incentive to work, productivity will decline, and so will America.
When a man doesn’t pay taxes, he can not and should not get a tax cut; for, that is to give him money that someone else has worked hard for.
The smart thing to do is to equalize the tax burden all across the board. If 10% is good enough for the Lord God, then it had better be good enough for government.
October 28th, 2008 at 4:27 am
Have we reached the point where we can ignore economics? If you receive less money for the work you do, you will do less work. That is simple economics. As far as the anecdotal evidence you produced in the case of Mankiw, I will bet that is productivity in his hobby type activities no where near matches his productivity on the job. I will bet that the free advice he dispenses is a result of the experience he earned while gainfully employed. Also, since when is the idea of adequate compensation an offense against academia? The only academia offended for being compensated may be the Socialist/Communist type, but my experience (and I know dozens if not hundreds of professors) has been that even they enjoy being compensated for their misguided efforts.
May I now address the tax cut for the other 95 percent, of which I am surely one? First of all, I doubt that we will ever see such an animal. I do not believe that the Democrats are capable of coming through with that. This does not mean that I think they are lying, or that Obama is lying when he offers such a deal (although I think Obama’s reality is completely different than the American one). It’s actually worse. I think that the level of politics is so corrupt that the current crop of Democrats and most Republicans can not resist the temptation of feeding at the trough.
Second, if 95 percent of Americans can receive a tax cut, that means that we are still paying way too much money into the government, and is a forceful argument for more government reduction. This has been the conservative argument for decades. This suggests that we should elect the real deal and not fall for Obama’s line. The problem is that we do not have any small government candidates.
Third, whatever happened to the fact that almost fifty percent of the country does not pay taxes? Why should they receive anything at all? I personally think we have committed an error as a nation by not insisting that all adult members of the society pay something in taxes. It creates the sense that all members of society are responsible for their government, and eliminates the sense that the government owes everyone something.
My conclusion is that the tax plan that Obama offers is idiotic. If we are fortunate the American people will realize what a bad future Obama offers us.
October 28th, 2008 at 4:34 am
I think there are a few other points you may wish to consider.
It is impossible for 95% of the people to get a “tax cut” if some of them - a not insignificant portion of them - pay zero taxes. The advertised tax cut is actually a transfer payment at the lowest end, which presumably would be reduced if income goes up because of working harder. And if that is the case, the incentive for working harder is reduced, not increased. In the US we have a case study of that - generations of families on welfare, prior to the 1996 reform that made it harder to make that dependency a generational way of life. That is the reality that cannot be wished away. Where is your evidence that the bottom 95% will want to work more?
Those in the top 5% of earners (distinguished from investors) are in that category on the whole because they are producing something that is highly valued by others, who are willing to pay to get it. Those in the bottom 10% of earners are producing something less valued or unique. (I said “on the whole” - I am sure there are exceptions, but they don’t change the underlying idea.) When that top 5% works less, I posit that society as a whole loses more than it would gain if the bottom 10% worked more, disregarding the benefits of cohort mobility. Notice I did not say that the individuals were less valued, but it is surely true that the results of their labor are less valuable.
You touched on the idea of marginal rates, and in fact admit that Obama’s tax plan will create a financial disincentive for the most productive to work. It will do that for me. On the margin, my tax rate is already 45%, including self employment tax. Add another 20% to that because of the change in social security tax wage base plus the increase in marginal rates, and our two earner household will become a one earner household. While money is not the only reason I work, supporting your view of multiple incentives, it is a large motivation. Evidence supports the idea that lower marginal tax rates increase productivity, and my anecdote/ reasoning supports the idea that higher marginal tax rates reduce productivity. So the aggregate income number in that top 5% is going to reduce; then what happens? Or as a 60’s song said, “Tax the rich, feed the poor, till there are no rich no more.” It didn’t answer the question of then what happens when the poor have forgotten how to feed themselves, and there are no more rich to tax. Neither have you.
Finally, you state that
“Obama’s tax plan will encourage a rich man like Greg M. to devote more time to the public and his children instead of paid speaking gigs, and gives a lot more other people more incentives to earn more money.”
First, let it be said that I would pay money to hear Professor Mankiw’s ideas (paid speaking gig), whereas I would not pay money to hear a freshman English major lecture. The freshman English major may have more incentive to earn money, but is not producing comparable value. So I, and society as a whole, are deprived because Professor Mankiw shares his ideas less.
You are also assuming, if not demanding, that Professor Mankiw “devote more time to the public.” I don’t know Prof. M., and I am not casting aspersions when I ask why he would do that instead of devoting more time to, say, his coin collection or orchid greenhouse, or any other hobby?
.
October 28th, 2008 at 4:45 am
Just a note on the incentive to work more under Obama’s plan. Ideally, yes, a tax cut would give an incentive to work more, but for me, and a lot of people like me, he’s giving a credit, not a cut. And it’s a flat credit. $1,000, no matter how much I make (until he starts taxing me more). So he’s not actually changing my incentive to work more, he’s just giving me a $1000 handout because I’m such a nice guy, I guess.
Try his calculator on his website. Most of his proposals are fairly flat credits. None of them are actual tax rate reductions, which would have a benefit tied to how much you earn. And because the credits phase out at lower than $200k, you’ll actually have several points in your earning curve where you take a pretty big hit for making a bit more money.
If you think this doesn’t matter, consider my case. I’ve got 3 kids on SCHIP for health insurance. I’m a grad student in Computer Science. I make very little as a grad student, decent money as a programmer. My clients are all small businesses. My wife is a part-time teacher. We lose our kids’ health care if we go over $48k yearly income, so here at the end of the year, I’m turning down jobs to make sure we don’t go over that. I’d have to make several thousand dollars extra and go through a lot of hassle to get different insurance, then try to get back on SCHIP if I don’t have as much work next year.
These are the perverse incentives you build into the system when you penalize making money. I’m glad the government provides the program, and I’m not against limiting it to low-income people. I’m just illustrating what happens when you build these incentive structures. There are consequences.
October 28th, 2008 at 4:57 am
It’s amazing to me that anyone misunderstands this. Mankiw doesn’t say that he only works money. NO economic theory ever says that. What he says is that to the extent that he does SOME things for money (let us say, give a talk at a place he’s not crazy to visit, or provide consulting services for a company or the government) that he’s less likely to do so with higher taxes. Hence, he’s less likely to work AT THE MARGIN. As a result, he’s likely to only do things (which include both interesting research and playing with his kids) that he would have done without the monetary incentives.
If this is unclear, perhaps it’s time to read Mankiw’s textbook or take a good econ course.
October 28th, 2008 at 5:06 am
As others have pointed out, Obama is not proposing a cut in marginal tax rates. While lower marginal tax rates would indeed invent extra work, handouts do not. And, as Mankiw points out, the higher marginal tax rates under Obama will discourage work.
I intend to be a real example- last year I paid $400k in Federal taxes and $20k in Medicare. I’ll be taking a package from my 70hr a week job and look forward
to collecting unemployment next year while I putter and maybe take a class or two. While I will be on Cobra initially for health insurance, I will be waiting eagerly to buy into one of Obama’s subsidized plans. I hope Mr. Wu keeps working hard (so hard he doesn’t have time to actually read his candidate’s tax proposals), because I’ve got pretty high expectations for the lifestyle I’m entitled to (and I eagerly await Obama judges who will make this my “right”).
October 28th, 2008 at 5:12 am
If you believe that in general, there is a correlation between productivity and salary in a free market economy, then this tax plan reduces the incentive, at the margin, for our most productive 5% to keep producing. This is clearly the case as Mankiw presents his own circumstances. The question then becomes: is our society poorer as a result of these reduced incentives?
Of course, since 50% of taxes are paid by the top 5% of taxpayers, this begs a larger question: is raising (or lowering) the top marginal tax rate the right thing to do at all? It seems that what our government should shoot for is a marginal tax rate that a) maximizes revenue to the government and b) maximizes incentives to keep people working to maximize the benefit to society.
Instead, we have it backwards and upside down. We set spending priorities to maximize a given politician’s chance to get re-elected, and then fight over the combination of tax rates that will pay the ensuing bill (less about 5%, which we leave to our kids).
What a shame.
October 28th, 2008 at 5:32 am
Tim, where have you found any evidence that Obama’s “middle class tax cut” is a cut in marginal rates rather than just a “rebate” style tax-credit of the type favored by Democrats? I haven’t seen any such evidence.
Rebate-style credits don’t provide any incentives to work harder, marginal rate cuts do, and marginal rate increases do provide an aggregate disincentive.
So, unless you can find evidence that Obama’s plan is in fact a cut in marginal rates for the middle class, your counter-argument to Mankiw falls apart, and game and set go to Mankiw.
Obama’s plan is just trying to buy votes from one class by taxing and redistributing from another.
October 28th, 2008 at 5:43 am
The idea that Obama will actually cut taxes for 95% of workers (or is it all people) is delusional. With trillions of new spending to pay for (plus all the recent debt to service) the taxes on the middle class will be going up not down.
October 28th, 2008 at 5:52 am
1st) You accept the premise that only 5% will get a tax cut. In the history of American it is very common to promise this sort of thing and then raise the taxes for more then the 5% and tell a lot of the 95% that we actually can’t afford it. That will very likely happen again.
2nd) As someone in the $250 plus range there are other issues that will show up broader then Greg’s individual setup. I take a risk on new business, expanding current business and hiring good employees for those projects. Even now I have one project in the works and another just about to launch. However, I don’t need a lot of money so that’s not a big driver - at this point I am more concerned about losing what I have. So, I’m close to pulling in the projects. This will mean letting go some good people and having less opportunity to expand. However, I want to make sure my family is secure first. So, if Obama raises taxes my income may not change much but a number of jobs will go away.
October 28th, 2008 at 5:54 am
I think you are wrong about people in the bottom 25% working more. Under Obama’s plan they will be eligible for substantial tax credits which they will lose if they take a higher paying job. I saw a post showing the very high marginal rate for moving out of the bottom 25%. Even if one assumes that all the people in this group are industrious and are eager to work harder to improve their lot, for many of them it will be an irrational choice to give up the tax credits in exchange for a slightly better job, since they will actually end up with less money. At these lower income levels, even a small decrease can make a big difference in terms of paying the rent and electric bill.
The only people who will realistically be able to move out of this group are those who can make a quantum jump from a low paying job, like working part time waiting tables, to a high paying job, like new college grad hired as computer programmer. Others will make the very rational choice to stay in a stable, low paying job that enables them to keep their tax credits. It won’t be especially good for them or for society, but it will best option available to them under the Obama tax plan.
October 28th, 2008 at 5:58 am
That professor thing sure is a nice job. It would be really nice if they actually taught more.
Anyway
I believe Joe is right basically. And E Says explains it pretty good.
October 28th, 2008 at 6:09 am
it is not only what extra work we will not do it is what we will not be spending on to make up for what we will lose to the government: services: painting cleaning lawn services etc. travel restaurants … As we direct deposit less money into the pockets of the workers they will not be making up the difference with lowered taxes. Small business will suffer and workforce contraction will follow.
October 28th, 2008 at 6:33 am
Your final paragraph presumes the public good can only be done for free, which is a complete fallacy.
Furthermore, as mentioned above, when you start taking away the free welfare checks to those who do not currently pay taxes, the marginal tax rate increases dramatically for those in the “lower” (or zero) tax bracket. How do you think the vast African-American welfare underclass was created?
It wasn’t simply racism. There’s no incentive to work.
October 28th, 2008 at 6:46 am
for an academic “more work” means stuff like textbooks, or outside consulting projects, not more meetings or classes taught on the same base salary. why assume Joe the Economist would do more blog posts, or unpaid “work”? he’s perfectly capable of choosing more leisure instead. moreover, in this particular case Joe’s textbook is number one in the field, a global standard– is diverting Joe’s incentives away from doing updates to such a beneficial educational product really a good trade off? really? still sounds good to Wu?
October 28th, 2008 at 6:48 am
Tim,
I suggest that you look up the in an economics textbook, the effect of marginal incentives on work and economic growth. Obama’s “tax cuts” (ie. welfare for the non-taxpayers) don’t change the marginal incentives, and that was precisely Mankiw’s point. Obama’s tax plan lessens the incentive to work, harder work (more success) is disincentivized which ultimately leads society as a whole to be better off. Obama is not concerned about growth, he is concerned about “fairness,” which is why his plan relies on transfer payments (tax credits) to manipulate outcomes to his preference.
October 28th, 2008 at 6:49 am
It’s a falacious argument. Yes, the academic might work more on stuff he wants to do. But is this REALLY better for community?
Let me point out that the market chooses what is worth most for the community. At least left unfettered. Money is not a magical thing, it’s a way of tracking the value of things.
Take a freelance writer. He can choose to write novels — for money — which then get distributed to booksellers, etc, bringing money in every level of the way. Even at a midlist level, that writer is “lubricating” the economy.
Increase taxes — and let’s not confuse ourselves, it will be increased much lower than 250k. Clinton increased them to 40k and up, and he didn’t have nearly as long a wish list as Obama’s — and the writer will still write — it’s like a disease — but now he might write free stuff on line. A blog. Fan fiction. Whatever. No production, no distribution. Is he now even providing better entertainment? Let’s leave wishful thinking aside — WHY should he? No one is paying him.
(Now, of course, there is a myth that writers write best when they write what they want, not what sells. It is very much a myth. Study any writer bio.)
Worse than that, the tax increase just cost “potential.” How so? Well… most writers toil below the radar, but sometimes you get a phenomenon like J. K. Rowling. These are very much a matter of lottery. I mean, yes, there needs to be a certain merit, but there is also timing and luck. Well, if people aren’t even trying to run, then the phenomenon which enriches people all along the line, from writers to booksellers never happens.
The idea that each person doing what they want to do is more proffitable is the Star Trek Falacy. “Every person just works if they want to.” Evolutionarily human beings are designed not to put in more work than they need to. (The guy who went out hunting while there was a mammoth to eat in the cave was not only stupid, he was more likely to die. Which btw is the REAL solution to “persistent poverty.” The people who work more than they need to are rare, and even then, without market guidance, they’re likely to work at something of little real “value” to others.) It’s been proven over and over again that divorcing incentive from achievement doesn’t result in “better” anything. It results in long lines, to get the one turnip on the state store shelf, PLUS a thriving and untaxed black market.
October 28th, 2008 at 6:56 am
Your arguement is disingenuous at best.
First, under the Obama tax plan, the only alterations to tax rates will be on the top two. They will be raised from 33% to 36% and from 35% to 39.6%. All of the lower brackets will remain the same as they currently are, no lowered.
The tax breaks that Obama is promising are not actually tax breaks, but tax credits instead. Given that out of the 95% he is promising these cuts to, only 40% actually pay income taxes now, under the current tax code, do you really think that this will somehow increase worker production? Get real. First, that 40% figure, with the promised tax credits, will probably increase to 50% of our populace no longer contributing to our federal tax revenues. If one can work up to earning a certain dollar amount and owe absolutely no taxes, what would be the point in working more when it will, at a certain dollar amount, trip over that line in which that person would then actually owe some taxes? To me, it seems to actually be a disincentive for lower wage earners to work.
Higher wage earners will also have a disincentive to work harder. If you are in the new 39.1% bracket, and Obama follows through with his plan to increase payroll taxes on those individuals earning more than $250K as well, those earners will be pushed into a total marginal tax rate approaching 50%. Would you work harder if you knew that half of every dollar you made by doing so would be passed on to Uncle Sam?
Given the current state of the economy, raising taxes on the most productive and the job creators, is a mistake, in my opinion.
October 28th, 2008 at 7:03 am
Professor Mankiw will not accept a consulting gig that he might have otherwise taken. That means he won’t be hiring graduate students for research assistance on the gig. That means they will have less to spend at the pub or supermarket or, at the margin, might have to leave school because they can’t support themselves. etc etc etc
October 28th, 2008 at 7:03 am
Good post, Tim. Two points: (1) raising marginal tax rates encourages increased tax avoidance behavior. One simple method may be Prof. Mankiw’s idea - work less. Another solution to keep high-margin workers working - one drawn from a long an illustrious history on both sides of the Atlantic - is to reduce salaries at the top margin and replace them with non-taxable (or tax-avoidable) benefits, such as better insurance (life and health) policies, access to company cars and housing, and greater access to company-related luxuries such as sports tickets, working lunches/dinners, free taxis after dark, and generous “workshops” or “seminars” in Vegas, Hawai’i, or Bali. One consequence of this old system is to reduce a worker’s top marginal rate while replacing some of the lost benefits of higher wages. A downside of this - well-known in the 1970s - is to reduce workers’ economic freedom (the replacement benefits are mandatory, leaving little room for workers to do what they want with the money), reducing retirement/savings (workers cannot place such benefits in a retirement account, but cf. life insurance policies, and they cannot keep the benefits if they shift jobs), and, overall, making workers more dependent on corporate benefits and, therefore, on corporate management (and less able to move around in the marketplace). Unfortunately, big government often prefers big business (which lobby more effectively on the one hand, and are more easily identifable and regulatable than small businesses on the other). This heralds the return of the dreaded “grey corporate man” who had (thankfully) left center stage in the 1980s and 90s. That leads to the second point: (2) raising marginal rates on the top 5% of earners will have little overall effect on the fisc; either the rates will have to be raised to punitive levels (back to the Carter-era 70% plus?) and/or the rate hikes will have to affect a broader supply of taxpayers. This is logical because (a) there is a greater supply of middle and upper-middle income taxpayers, and (b) smaller taxpayers are in an inferior position to engage in effective tax-avoidance practices than their richer brethren, which means that their wealth is more easily captured (and measured) by the government.
This all leads to a macro-issue: generically-speaking, private money is spent more efficiently and with greater wealth-creation potential than public money. As greater liquidity is taken out of private hands and placed in government hands, the overall economy’s long-term growth potential will be adversely affected. Over time, that means that fewer jobs will be created, and advances in pay will slow.
Of course, greater government revenue-raising and expenditures creates a more dependent society - one part of society that prays that the government will not take too much of their wealth, and the other part that relies on government patronage (and, incidentally, has an incentive to re-elect politicians who promise to maintain and advance the patronage). In one sense, this should not be surprising - serfdom is probably the natural state of humanity, with its accompanying rigidities in the power structure. On the other hand, it is depressing to think that we have not moved beyond the sad state of affairs that governs most of humanity today - witness the effects of such economic policies in sub-saharan Africa, where parasitical governments buy support by promising too much, steal what they need to maintain the support, and seize control of natural resources as a valuable source of (tax) income independent of the sad local economy.
October 28th, 2008 at 7:19 am
To follow up on what James says, there is no way whatever that the piled on tax increases are going to be restricted to couples making $250k. I guarantee that the rate floor will crawl down to $200k first, than go lower as they need more money for the spending programs.
And the entire premise of the post here is nonsense. Greg Mankiw is not saying that he will not write or work- he is saying that he has no incentive to convert that writing or working into income, and thus to pay it out to the feds. If he has to give it to Uncle Sam, he will decide that he might as well give up the dealines, required marketing effort, and external controls exercised by others over his work, and simply do what he feels like when he is in the mood. That concept is not difficult to understand unless you are a tax and spend redistributionist who actually believe static models reflect tax policy outcomes.
Virtually every blogger on earth knows that- you write because you want to express thoughts. If the price of selling your efforts is not worth it, you do things instead that you may enjoy, but are relatively unproductive for the economy at large.
October 28th, 2008 at 7:39 am
his equation is wrong - thuse we can discard rest of his OPINION.
and he is a proffessor ?
at harvard?
perhaps what they say about Obama going there is true.
October 28th, 2008 at 7:40 am
1 where is your reaal estate
2 if you dont have any that is fraus GDMF
October 28th, 2008 at 7:45 am
Growing a business involves risk-taking (debt incurred to fund expansion). Imagine a scale with risk on one side and reward on the other. If higher taxes eat up some of the reward, the risk factor has to be reduced. Less business expansion means less J-O_B_S.
A tenured professor job is a poor example of what is really at stake.
October 28th, 2008 at 8:07 am
The rest — the 95% percent who get a tax cut, will presumably have reasons to want to work harder, because their taxes are going down.
But the rates aren’t going down (under o’s plan), so there is zero “incentive” to work harder. The way I understand it, you get a flat check whether you work hard or not.
Meanwhile, the rates are already go from 15 to 25 percent when you get about 32k, which is decidedly middle class. If I were changing a tax rate to specifically target the middle class, that is the one I would change.
The point about the above 250k not “working harder” is that they will have less incentive to seek higher paying jobs, because so much is gobbled up by taxes. Then, the government doesn’t get the taxes they would otherwise have paid with a raise. So they dont’ even get all the income they thought they would get from a raise in taxes.
October 28th, 2008 at 8:07 am
“The rest — the 95% percent who get a tax cut, will presumably have reasons to want to work harder, because their taxes are going down.”
You’ve never spent a summer on a landscaping crew, I assume.
October 28th, 2008 at 8:18 am
1 where is your real estate
2 if you dont have any that is fraud
October 28th, 2008 at 8:40 am
>>The rest — the 95% percent who get a tax cut, will presumably have reasons to want to work harder, because their taxes are going down.
40% of them are not paying any taxes now. So why would they want to work harder when the government will be giving them money and not requiring them to work for it. I don’t see any incentive there.
October 28th, 2008 at 8:47 am
There are many troubling aspects of Obama’s tax plan. Among them:
- He is planning to raise the corporate tax rate, at a time when most other countries are lowering theirs. Canada’s corporate tax rate is already lower than the U.S.’s, and by 2012 it will be 15%, vs 50% in the U.S. What effect do you think that will have when corporations think about opening a new facility or people consider creating new corporations? Where are they going to go?
- Obama intends to increase the capital gains and dividend tax. Again, this is already significantly higher than Canada’s, and he wants to move it even higher. Where do you think U.S. investment capital is going to go?
- Obama’s tax credit plan has the effect of putting steep marginal rate increases on low incomes. Accepted rational choice theory says you should keep your taxes flat at the low end to stimulate income mobility. Obama is essentially going to punish you severely for doing better.
- Under Obama’s plan, the top marginal tax rate will be over 50% - again, significantly higher than it is in Canada. What do you think that’s going to do to the decision-making of doctors, engineers, scientists, and other high-paying professions when individuals are faced with taking a job in Canada or staying in the United States?
And Canada is just the closest, easiest country to transfer capital and talent to. The rest of the world is moving along similar lines. The U.S. already has the second-highest corporate tax rates in the world. Obama wants to make them higher.
Obama’s tax plan is a disaster for U.S. competitiveness. It’s a global economy, folks. You no longer have the luxury of setting taxes at whatever level you feel like. Other countries have a say in the matter. A U.S. corporation that loses half its profit to tax is going to have a hell of a time competing against a Canadian corporation that only loses 15%. Basic economics, known to everyone but the intellectuals in the Obama universe.
October 28th, 2008 at 8:53 am
While all this is a nice discussion, it really does ignore the fact that individuals making 250K often are working much more than 40 hours a week. Right now the income tax rate it on the top earners is 35% that is 700 hours of labor in a 2000 hour work year. So what you are looking at under Obama’s tax increases of 10% on the top earners for a 40 hour week is 900 hours a year to pay income tax.
Everyone I know that makes more than 250K is working 60+ hours a week to do it (mostly families with both adults working in tech)., but for those that I know this becomes 1350 hours a year/ per individual in the house. This becomes 2700 hours of labor the government collects from these families.
Do we really think it fair to take that much time from someone or from a family?
October 28th, 2008 at 8:56 am
I’m a small businessman with about 12 employees. My company provides full health and dental benefits, a good retirement plan, generous bonuses (when we make money) and rather than lay people off, I’ll take a cut in pay (which I have recently). Employees can be flexible with respect to their schedules and can bring in their dogs or children when circumstances dictate. I make about 5 times what the lowest paid employee makes.
Now here’s my point. I could double the size of the company if I borrowed $1,000,000 and used the money to hire new employees and market to new customers. That would be 12 additional good and well paying jobs. But if you think I’m going to risk the loss of one hundred percent of $1,000,000 in exchange for the mere possibility that I would be able to keep 50% of the excess income over expenses that this investment might generate, you are smokin’ the rug. It’s simply not worth it. I don’t think I’m an outlier. I think there are tens of thousands of small business owners in exactly the same position as I am and every time taxes are raised on “corporations” or “rich people” another guy makes the same decision that I have. Nope, not worth it. Not even close. Who needs the hassle.
It has come to the point, believe it or not, that yesterday I started doing the calculations to figure out whether or not I would be better off making less money. Yes, people like me are creating spreadsheets trying to figure out if we would be better off making less money. Tommorrow I’ll figure out how much additional financial aid my son can get for college if I drop my income by 50%. Can you imagine that this is what this country has come to; that small business owners have to calculate how much better off they would be with fewer employees?
Who knows, maybe you’re doing me a favor with your desire to tax me into equality with you. Sure, I’ll eat out less (sorry waiters), I’ll take cheaper vacations (sorry taxi drivers and maids), and I’ll do my own lawn mowing (sorry mower guy) but I’ll have more time to spend with my family as I watch the number of people who complain about the lack of any jobs (not just the decent jobs that I failed to create) grow larger and larger.
October 28th, 2008 at 9:13 am
“[Greg] assumes that his only incentive to do any work outside of his regular teaching and research is to make money…Greg M. himself is disproof of his own ideas. He spends alot of time blogging, and writing advice for junior professors and so on, all for free.”
You’re suggesting that Greg will respond to a potential tax increase by working for free.
Yeah. That’s a hobby, not a job. Hobbies are leisure, recreation; you pick them up, put them down, get bored and do something else, walk away from it. You’re not obligated to do it well, or completely, or at all. If I’m doing something for free then I suffer no ill effects from just quitting right in the middle of it.
I mean, hell, if working for free just to benefit society is so great, then why does he need $250,000 a year? Why doesn’t he just go on welfare and do EVERYTHING for free? Indeed, why haven’t YOU done this?
October 28th, 2008 at 9:41 am
Barack Obama and his campaign may feel comfortable throwing around the “95% of people will get a tax cut” meme, but shouldn’t you know better? Letting the Bush tax cuts lapse - increasing tax rates for everyone - and then offering a confusing package of credits, that many people won’t be able to claim without professional tax preparation assistance, can in no way be called a “tax cut”.
Raising taxes - income tax on high earners, capital gains, removing the limit on the amount of wages subject to social security taxes, corporate taxes, etc. - in the face of a recession is not wise. “Brains25cents” was right - this will not have the desired effect in efficiently raising money for the government. Raising taxes on production like this will only slow the ability of the economy to recover.
October 28th, 2008 at 10:26 am
If you are familiar with Mankiw’s blog then you should know that your claim that Obama’s tax policies “gives a lot more other people more incentives to earn more money” is false. Obama’s tax policies “are designed in ways that raise marginal tax rates (the extra tax paid on an extra dollar of income) and therefore reduce incentives to earn income. The marginal rate rises because the size of the tax cut falls as income rises.” See “The Obama Tax Plan” (Aug. 13, 2008) http://gregmankiw.blogspot.com/2008/08/obama-tax-plan.html (quoting Alan Viard, and linking his article co-authored with Alex Brill).
Moreover, Mankiw’s analysis criticized in your original post, including his calculation of the total marginal rate of 93% on the top end imposed by Obama’s tax hikes through all levels of taxation (including income, payroll, estate, etc.) deserves more than a glib response. I would not underestimate the disincentive caused by that level of taxation. Nor would I assume that those being disincentivized resemble a college professor more than a small business owner or employer.
October 28th, 2008 at 10:40 am
Not only will it discourage the most productive from working more (and reducing the numbers of jobs they create - whoops Mankiw won’t be hiring that extra analyst or admin anytime soon), it will mean the people one rung down will also work less because there is less value to them to jump a rung.
And whoops again, so much for the new stuff they would buy and the people they would hire, meaning fewer jobs for those a rung down.
It also means fewer people paying taxes to support all those people who now don’t have jobs, creating more disincentives.
So now explain to me, how is this a good thing?
October 28th, 2008 at 10:45 am
Being in the lower income strata, I suppose I’m one who could look for a tax cut from Obama. That’d be fine with me. It wouldn’t be an incentive for me to work more, however. I already fill enough of my time with work. My guess is plenty of folks in the lower strata also put in full time+ work.
Where the incentive might be lacking is in putting together mega buck deals that have great risk but great potential. We lowly peons don’t play in that ball park. Some of us also wonder if more thought invested in those schemes might be better for all of us.