Tag Archives: inequality

Krugman Versus Mankiw on Capital Income Taxation

This morning’s New York Times featured an op-ed from Paul Krugman titled “Wealth Over Work.” In the piece, Krugman warns that we are on a dangerous path towards an oligarchical society, where inequality is rampant and wealth accumulates in the hands of a small group of powerful elite. The government enacts policies that promote the accumulation of this wealth and living off of capital income over deriving income from working in the labor force.

While the inequality argument is certainly a relevant and important topic, Krugman’s finger pointing seems over the top to me. Krugman, in his typical fashion vilifies the GOP:

Despite the frantic efforts of some Republicans to pretend otherwise, most people realize that today’s G.O.P. favors the interests of the rich over those of ordinary families. I suspect, however, that fewer people realize the extent to which the party favors returns on wealth over wages and salaries. And the dominance of income from capital, which can be inherited, over wages — the dominance of wealth over work — is what patrimonial capitalism is all about.

Some of his points are valid but there are two problems I have with Krugman’s argument:

  1. Krugman claims that one of the contributing factors to his claimed shift towards an oligarchical society is the favorable tax treatment capital income receives. Based on my experience studying taxes in Jim Hines’s government revenues class, this statement struck me as off. Taxes on investments such as capital gains and dividends are some of the most inefficient taxes a government can impose. I was happy to see that Greg Mankiw publicly called Krugman out on this on his personal blog. Mankiw points out that it is not class warfare that drives the rationale for lower capital taxes, but rather the fact that it is optimal economically. At its heart economics is about trade offs and governments are faced with a serious tradeoff when designing a tax system: the tradeoff between efficiency and progressivity. Capital taxes are extremely inefficient because capital owners can choose to not sell their assets very easily if they face the tax, distorting economic activity and producing dead weight loss, which is a net loss to society. Therefore having lower capital taxes if efficient. The tradeoff here is that the bulk of capital income goes to the wealthy and so a lower tax is also regressive. Our tax system corrects for this in other areas.
  2. My other problem with Krugman’s article is the borderline conspiracy theorist perspective he advances as to why this shift is occurring, “Why is this happening? Well, bear in mind that both Koch brothers are numbered among the 10 wealthiest Americans, and so are four Walmart heirs. Great wealth buys great political influence — and not just through campaign contributions. Many conservatives live inside an intellectual bubble of think tanks and captive media that is ultimately financed by a handful of megadonors. Not surprisingly, those inside the bubble tend to assume, instinctively, that what is good for oligarchs is good for America.” To me this argument sounds a little too extreme. Yes money can buy power and influence, but politicians ultimately must answer to all of their constituents in our democratic society and ultimately those well off can be heard. The adoption of Obamacare (which the Koch brothers strongly oppose) is one example of a the less powerful majority winning a battle.

Overall, Krugman provides a thought provoking piece but his points seem drastic and overblown, especially from an economic perspective.

Apocalypse, Now?

There’s been a bit of a buzz lately about a working paper by Safa Motesharrei, Jorge Rivas and Eugenia Kalnay about doom, utter destruction, and the apocalypse.

Motesharrei et al. describe a theoretical model – Human and Nature Dynamics, or HANDY, for short – that simulates the rise and fall of societies. It’s not a complicated model, really. All it has is four main equations, two of them describing the population of two classes of people, ‘commoners’ and ‘elites’, one describing ‘nature’, and one to describe the accumulation of ‘wealth’. And, or so people say, it predicts that we shall all perish soon!

I don’t want to go into too much detail here, but these are the equations (in the same order as above):

image

Looks simple enough, doesn’t it? The αCαECC and CE all depend on ωxC and xas well. Basically, α‘s denote death rates, β‘s denote birth rates, x‘s stand for the population of commoners and elites, C‘s are their respective consumption, and ω is accumulated wealth (somewhat of a strange notion of wealth, but more on that below). y is the stock of natural resources, γy(λ – y) is a regeneration term (where γ is a regeneration factor and λ is the maximum possible amount of natural resources – nature’s ‘capacity’), and xCy is a depletion term (where δ is the rate of depletion per worker). You should note here that δxCy is also society’s production.

There’s also some inequality in the model, because elites consume more than commoners:

Where s is a minimum (‘subsistence’) wage, ωth is the minimum level of wealth society needs to feed all its members, and κ≥1 measures inequality in salaries (i.e. elites get κ times more money). If any one of those consumption terms ends up being smaller than one, that group experiences a higher death rate. That’s bad.

The punchline of all this is that, given certain parameter values, this model simulates society’s collapse, either because all commoners starve to death and thus production stops (had I mentioned that only commoners produce in this model? Elites have positions in management, but they don’t really do anything substantial), and everybody dies, or because all of nature is used up, and everybody dies. Usually over time horizons of up to 1000 years.

Now, I’m all for mathematical modelling, and this is kind of a neat model, and it’s very good at producing neat little curves. And quite a few people seem to think that this is kind of a mathematical proof that inequality (a bigger κ will tend to kill you) and unsustainable use of natural resources (a bigger δ will also tend to kill you) will bring about our collective doom.

I think there are some good points to be made about how much inequality is justifiable, but also how much inequality we need to have an efficient economic system; I recommend reading John Rawls. There are also good points to be made about the value of preserving nature, the benefits of a medium-term shift towards more renewable energy sources, climate change, and a lot more things of that persuasion. But I don’t think this model does an awesome job at getting those points across.

For one thing, it’s very much underspecified. Aren’t there any other factors besides inequality and use of natural resources that could influence what happens to a society? What about the political system? What about social mobility (of which, in this model, there is none: you’re born a commoner, you’ll die a commoner)? And what exactly is a ‘society’, exactly? The authors talk about some examples of collapse, like the Roman Empire. So is a society today a nation state? Or ‘the West’? Or the whole world? If I can ruin somebody else’s stock of natural resources without hurting my own, does that still hurt me?

Also, some variables are rather strangely defined. For one thing, why do only commoners produce ‘wealth’? And why do the elites not contribute anything valuable to society? All they do is consume things that commoners have to produce, and at a higher rate at that. Is management really completely worthless? What about the arts, or science? And what is this ‘wealth’, anyway? It’s this strange, durable consumption good that people need to live, but can store pretty much indefinitely (in some scenarios, the commoners all die out, but elites still have a couple of decades left living off of society’s wealth stock. Is it all canned food?! Also, wouldn’t even the high and mighty elites eventually take to farming, if only to save their hide?). Plus, birth rates are constant. Over a thousand years. Seems like quite the assumption. Plus, the authors never really defend their choice of parameter values. It’s not like they estimate what the ‘correct’ values of those would be for today’s world. Or if they do, they don’t say so.

Motesharrei et al. actually acknowledge a lot of this stuff, and say that they’re working on including more of it in future versions of the model. And I’m very much looking forward to seeing that. But in the meantime, it seems to me that a lot of people just see a bunch of equations, and thus assume that this model must be making a very strong point about inequality and sustainability. Really though, it’s just a theoretical model, no more or less so than if it were completely verbal. There’s absolutely nothing empirical about it. I think a lot of the hype so far is math bias, rather than genuine appreciation of the model (which needs more work).

So I’m looking forward to the next revision of this paper, and to seeing the improvements it brings. But until then, please hold off on the ‘math has proven that we shall all die soon’-craze.

Increase the minimum wage to preserve social mobility

Greg Mankiw’s post this past Thursday regarding the minimum wage begs for discussion.  Perhaps it is because the post is nothing more then two links.  The issue of raising the minimum wage however is not that simple. Those that support an increase point to all the people that it could help, and argue that it wouldn’t cause damage to the recovery and may even help it.  Those that oppose the increase marginalize the effect and worry about distortions of the labor market.  While there is research to support the case that no negative effects would come from the increase, I feel there is a stronger case to be made.  While many are troubled by income inequality, I feel that a certain amount of inequality is both good and necessary.  What is far more important is social mobility.  The Federal Government should increase the minimum wage in order to maintain the social mobility that is critical to the United States economy.

Increasing the minimum wage can increase social mobility directly.  There is a lot of research to support the claim that an increased minimum wage results in things like increased productivity, higher employee morale, and increases employee retention.  Happy employees that are more productive and work at a job longer don’t stay entry level for very long.  By increasing the minimum wage, you can increase the workers chance of gaining the skills they need to command a bigger wage.  More money also makes it easier for them to make the decisions needed to get out of poverty, as research shows that those living in poverty actually suffer cognitive impairment because of it.  A little bit more of a margin for error could be all someone needs to be able to consistently make the decisions necessary to improve their life.

The current federal minimum wage is at $7.25/hr.  $7.25/hr. is low, representing roughly $15,000 a year, which is barely more then the federal poverty level for an individual of $11,670, before taxes.  Increasing the minimum wage to the requested $10.10/hr. may prove to have too much opposition, as the Congressional Budget Office predicts that could cost up to a million jobs through 2016.  In order to expedite the process by removing such arguments against an increase, an increase to $9/hr. could be implemented.  As the CBO paper shows, this would result in far fewer predicted losses.  It would also raise the annual income to $18,720/year, which provides a little breathing room above the poverty level.  It should be noted that states would still be able to increase their minimum wage if they felt conditions warranted an increase.  For instance, San Francisco has a rate of $10.74 (and an unemployment rate of 4.8%, well below the national average).  This reflects both the higher cost of living in the city, as well as the lack of negative effects of increasing the minimum wage, despite serious income inequality.

The opponents of the increase are right about something though. Increasing the minimum wage will not fix is poverty.  But this shouldn’t be the revelation that the opposition makes it out to be.  If minimum wage laws fixed poverty, then why are we still dealing with it?  Poverty is a complex social issue that depends on more then just income.  Increased social mobility can aid in the fight against poverty, by making it easier to better oneself and rise out of poverty.

The minimum wage in 1960 was $1.60/hr.  Adjusted for inflation, today that is $10.56/hr.  Increasing the minimum wage, and the benefits that come with it like worker retention and increased productivity increase social mobility by creating paths out of poverty.  Even though you can’t make someone take such a path, it must be available to everyone.  To encourage this, the minimum wage should be increased to at least $9/hr. in order to preserve the social mobility that has been a hallmark of the United States since it was founded.

Income Inequality vs. Growth

Yesterday’s International Monetary Fund reported hat the redistribution of wealth from top to bottom does not burden the economic growth less than what many economic literature indicated before. Before going any further into this discussion, let us explore the conventional story that is told and see what changes there might need be.

Equality vs. Efficiency is one of the issues that are handled heavily in policy making of many countries. Although people’s attitude about inequality may differ, but raised in the world of capitalism, I think most would agree that the function of inequality is rather important.  Adequate level of inequality is important in giving incentives for people to work harder; however, if all my hard work’s reward was redistributed to the people who did not work as hard, my motivation for work would be discouraged, lowering efficiency of human capital. And this is the very story that many capitalistic countries use as critiques against communist / socialist states.

Nonetheless, IMF says non-extreme methods of redistribution programs like taxes and social programs actually support growth rather than discourages it. Deputy director at the fund in research department, Jonathan Ostry stated the follwing:

“On average, redistribution seems to have helped support faster and more durable growth…There are merits to inequality, particularly as a motivational driver for growth, but inaction in the face of high inequality seems unwarranted in many cases. And excessive inequality seems more likely to weigh on growth by undermining access to health and education, and investment is deterred by as disparity between rich and poor brews political instability.”

Simply look back to the 2012 Occupy Wall Street Movement, the anger that surfaced from inequality. David Graeber, one of the leading member of the protest, is an economic anthropologist. He claimed in his book “Debt: The First 5,000 Years” that historically societies that maintained high levels of social safety net and debt restructuring program not only had more stable government in itself, but also stronger dominance among its neighbors. It is true Graeber’s approach is extreme and radical in many ways (although I think most college students would support his cancelation of college debt program), but his words rings truth with IMF’s support for more social safety net.

Even today, look at non-communist socialist countries in Europe. The Northern Europe is well known for their social programs, but they are also very renowned for quite high per capita GDP. Some may argue that it is because that they have high GDP, these countries are able to have these programs through taxation. I think there could be another vantage point to approach this situation. Perhaps it is assurance that working class has that people are able to excel in what they do and maximize their human capital efforts.

Anyhow, I think that reports like these are very important in taking back us into perspective. Of course, as a student studying economics, growth is a vital part if not the first thing on agenda in a country’s governance. However, we must also remember that the ultimate goal of these economic growth is to benefit all citizens of the country.

Inequality in a “Winner Takes All” World

Today in class, a question was asked about whether our best blog posts should be the ones we revise or should we aim to improve our mediocre ones. Professor Kimball responded that we should strive to make our best posts even better and put something out there that is worth reading. His discussion of how we live in a “winner takes all” society, which rewards the best producers of content and products, while inferior producers struggle and ultimately fail was echoed in a New York Times article “Winners Take All, but Can’t We Still Dream?” by Robert H. Frank, published just this weekend. In the article, Frank solidifies his case for a “Winner Take All” society where the best products and services dominate through access to cheap distribution channels. As Frank touches on in his article, I believe a winner-takes-all concept is an important underlying component to the rise in inequality.

First off, it is important to understand the basics of the winner-takes-all-theory. As distribution – both for physical and information goods – becomes cheaper, the best products take over as consumers have new choices and are not limited by geography or technology. As Frank describes, “In domain after domain… technology has enabled innovative business models to serve broader markets. Local accountants have been displaced by tax software, brick-and-mortar shops by Amazon.com and other online retailers. And now, there is even worry that live, in-theater HD broadcasts of Metropolitan Opera performances could displace local opera companies across the land.” When consumers have more choices than ever and lead increasingly busy lives, there is little time for anything but “the best”, whatever society believes that to be and the winners of this contest will take all.

The most important outcome of the winner-take-all concept from a theoretical standpoint is that it could be driving income inequality. As the proliferation of digital goods and service has strengthened the winner-take-all effect over the last several decades, the income of the wealthiest Americans has grown at a faster rate than middle and lower class incomes. According to the very definition of the winner-takes-all theory, the top income earners or the “winners” are taking all the income. They are the individuals with the best ideas, the best companies, the biggest customer bases, and it is incredibly difficult for these incumbents to be beat once they have succeeded in reaching this size. They are able to devote the money and resources they have accumulated to remaining successful and developing new innovations that will stifle upstart competitors.

There is no easy solution to the winner-takes-all theory’s outcome of inequality. If we believe that the theory is indeed a key driver of inequality, then it would seem there is little that can be done to unseat such a powerful force. Winner-takes-all is a symptom of a healthy capitalist system in the digital age. While I disagree with some of his analysis (as I mentioned in a previous blog post), perhaps it is time to give a second-thought to William Galston’s idea, which he outlined in a recent Wall Street Journal piece, that it is time for a new social contract, where the “losers” in society are provided for by the “winners”. That is a topic for another post, but in a winner-takes-all society, we must be open to different solutions to the inequality that is a result of the competitive process.

REVISED: “The Great Decoupling” in Itself is Not the Problem

In two recent Wall Street Journal opinion pieces – “The U.S. Needs a New Social Contract” and “Closing the Productivity and Pay Gap” – William Galston presented an in-depth analysis on the widening gap between productivity and wages. He calls the divergence between these two metrics the “Great Decoupling” and believes it is a defining phenomenon of our era. A significant share of income has shifted from labor to capital. According to Glaston, “In 1947, labor received 67% of nonfarm business output. At the end of 1973, that figure still stood at 66%. In 2012 (the latest year for which data have been released), labor received only 58% of total output, the lowest by far in the entire postwar period.” The chart below taken from FRED, shows the divergence visually – total factor productivity growth has outpaced wage growth considerably since the mid 1980s.

Screen shot 2014-02-22 at 6.28.20 PM

Galston’s concern on this topic is tied closely to the inequality issue that has been a recent hot topic. While he presents compelling ways to fix this problem, Galston fails to recognize the root causes and shows a general misunderstanding of economic principles.

The divergence in productivity and wages stems primarily from efficiency gains. As technology has improved, automation and computers have taken over many tasks once performed by hand and productivity has increased without the need for new workers. Galston fails to mention this point at all and it is very important. Technological progress drives long run growth in macroeconomic models and makes everyone better off. In the short-run technological advancements will shift income to owners of capital, but in the long run this should even out as new industries and jobs are created that did not exist previously. It is also important to think about this issue in absolute terms, rather than purely relative. While it is true that labor is receiving a smaller share of total income than it did through much of the post-war period, in absolute terms most workers are better off today.

A second issue that Galston fails to recognize is that in a competitive labor market the equilibrium wages should be equal to the marginal product of labor. If the marginal product of labor is higher than wages, firms could increase profits by hiring additional workers. Eventually the marginal product reaches a point where it is equal to the wage and it is not longer profitable for firms to hire additional employees. The point that Galston fails to realize is that, from a micro level, in order to increase wages we need to increase marginal product of labor.

The best way to increase marginal product of labor and therefore wages are to increase education so workers are able to utilize the advances in technology to increase their own productivity. Education reform should be a more pressing issue than it is in order to sustain economic growth. Many unskilled workers likely have a marginal product of labor that is below the current equilibrium wage level and so it does not make sense for firms to hire them. Focusing on providing education to the most unskilled workers could improve the plight of the poorest American’s, while unlocking productivity from a currently under-utilized labor source. Galston proposes some education reform in his piece and he is right about that – he just needs to realize that the “Great Decoupling” itself is not the problem, but rather a symptom of deeper economic forces in the economy.

“Fight” between Mankiw and Krugman

Greg Mankiw posted a blog defending the 1 percent richest people four days ago, and Paul Krugman obviously had a disagreement with that, he then wrote a post against Mankiw’s avocation.

Actually this is not the first time those two greatest economists disagree with each other on the equality problem. On June 8, 2013 Mankiw published his article Defending the One Percent, claimed that inequality problem is not that serious and the fixing the inequality is so hard and may result in the unfairness for those rich people. He argued that the reason why some people are richer is simply because they are better (in every possible way). And he also said the absolute equality is actually inequality, and actually rich people had contributed for the economy more than others in US. Basically, Mankiw’s idea is to control intervention toward equality in order to maximize efficiency.

In opposite, Krugman proposed that “We live in a society that allocates rights to intellectual property in a way that yields huge rewards to a select few, that taxes top incomes at a historically low rate”. Also on the other hand, Mankiw neglect the inequality of opportunity, which is vital to decide whether the resource will be allocated in a fair way, for this, Krugman said that children from rich families are more likely to remain their top position. Finally, he found it absurd for Mankiw to think that solving inequality would lead to absolute equality.

Now this “war” has been updated.

Mankiw’s new blog Yes, the Wealthy Can Be Deserving once again insisted on the rightness for rich people to own huge amount of money. Mankiw gave an example about Robert Downey’s income through the film The Avengers and argued that those incomes are totally legitimate and the player himself deserved the money, thus there should be no doubt toward the inequality. In addition, he believed that financial systems are “allocating the economy’s investment resources” fair enough to make the country work effectively.

One days later, Krugman agian wrote a blog to comment on Mankiw’s article. First he noted that film stars are not representative in terms of the “upper tiers of the income distribution”, executives from finance, corporate and real estate are actually what we are referring to as top 1 percent. And he strongly disagree with Mankiw’s statement about fair distribution, he pointed that our financial crisis was caused by the rich-dominated financial systems. So there is no such effectiveness addressed by Mankiw.

For me, I agree almost with Krugman, however, I also think it is great for Mankiw to think from the way of economic efficiency and dear to fight against main stream idea as long as he thought it is unreasonable.

I’d like to see this to continue and learn more from it.

The Great Decoupling in Itself is Not the Problem

In two recent Wall Street Journal opinion pieces – “The U.S. Needs a New Social Contract” and “Closing the Productivity and Pay Gap” – William Galston presented an in-depth analysis on the widening gap between productivity and wages. He calls the divergence between these two metrics the “Great Decoupling” and believes it is a defining phenomenon of our era. A significant share of income has shifted from labor to capital. According to Glaston, “In 1947, labor received 67% of nonfarm business output. At the end of 1973, that figure still stood at 66%. In 2012 (the latest year for which data have been released), labor received only 58% of total output, the lowest by far in the entire postwar period.” Galston’s concern on this issue is tied closely to the inequality issue that has been a recent hot topic. While he presents compelling ways to fix this problem, Galston fails to recognize the root causes and shows a gross misunderstanding of economic principles.

The divergence in productivity and wages stems primarily from efficiency gains. As technology has improved, automation and computers have taken over many tasks once performed by hand and productivity has increased dramatically without the need for new workers. Galston fails to mention this point at all and it is very important. Technological progress drives long run growth in macroeconomic models and makes everyone better off. In the short-run technological advancements will shift income to owners of capital, but in the long run this should even out as new industries and jobs are created that did not exist previously. It is also important to think about this issue in absolute terms, rather than purely relative. While it is true that labor is receiving a smaller share of total income than it did through much of the post-war period, in absolute terms workers are better off than through most of that period.

A second issue that Galston fails to recognize is that in a competitive labor market the equilibrium wages should be equal to the marginal product of labor. If the marginal product of labor is higher than wages, firms could increase profits by hiring additional workers. Eventually the marginal product reaches a point where it is equal to the wage and it is not longer profitable for firms to hire additional employees. The point that Galston fails to realize is that, from a micro level, in order to increase wages we need to increase marginal product of labor.

The best way to increase marginal product of labor and therefore wages are to increase education so workers are able to utilize the advances in technology to increase their own productivity. Education reform should be a more pressing issue than it is in order to sustain economic growth. Many unskilled workers likely have a marginal product of labor that is below the current equilibrium wage level and so it does not make sense for firms to hire them. A focus on providing education to the unskilled workers could improve the plight of the poorest American’s, while unlocking productivity from a currently under-utilized labor source. Galston proposes some education reform in his piece and he is right about that – he just needs to realize that the “Great Decoupling” itself is not the problem, but rather a symptom of deeper trends in the economy.

“Picking on” Greg Mankiw

Gregory Mankiw had a new post titled Yes, the Wealthy Can Be Deserving on NYT two days ago, I have to say that the title is quit catching because usually we think that rich people earn too much is resulted from inequality, which we should fight against with.

Mankiw argued that film stars like Robert Downey earned tons of money by playing a role in the famous films, and we are not appalled by their tremendous income because we think they “deserve” that. Just as the example given in his post, Robert Downey earned $50 million while the movie The Avengers made a revenue of $1.5 billion, so it seems to be fair enough.

However, Mankiw made two mistakes in his argument here: first, some people don’t care about Downey’s income doesn’t mean the income distribution is reasonable, maybe the people who responded to him are irrelevant in this situation. Say if you are also a film actor in that film and you played better than Mr. Stark but got way lower income, than you may care about the inequality. Second, the movie’s box office receipts were not the reason for paying so much to one single actor. The payments to players were decided even before the public show of the movie, you can’t predict the revenue of the film while you still have to pay a lot to film stars like Robert Downey. We knew a lots examples of movies played by famous film stars but received bad market responses, also movies played by nobody but brought huge profits.

The true reason why employing famous film stars cost you much is because you can’t find them everywhere. Mankiw said that “When people can see with their own eyes that a talented person made a great fortune fair and square, they tend not to resent it.” It is true in some case but not for here, even if you are as talented as Robert Downey, you may not be able to make money like he did because there is only one Robert Downey, the payment for him is not a reward for hard works, but more like a reflection of scarcity.

Mankiw is also wrong about CEOs’ pay. At first, he indicate that critics are wrong about the idea that CEOs’ are paid more than they really worth. He pointed that “the most natural explanation of high C.E.O. pay is that the value of a good C.E.O. is extraordinarily high”, and here is what he said:

A typical chief executive is overseeing billions of dollars of shareholder wealth as well as thousands of employees. The value of making the right decisions is tremendous. Just consider the role of Steve Jobs in the rise of Apple and its path-breaking products.

But actually Steve Jobs is not by his side. We all know that Jobs’ popular story of “1-dollar salary”. If his logic is correct, than Jobs is not as worthy as a hot dog. If the price paid by the board to those CEO is totally precise, than Jobs is the worthless CEO in this planet, even though he made billions of dollars to his shareholders.

Actually these “critics” are right, no matter how bad the CEO performed, he/she can always earn excessive income, and there are few cases where CEO didn’t get what they asked, that’s doesn’t mean the income for them is fair enough. Sometimes you paid high enough to your CEO even they perform very bad, in 2013, Steve Ballmer only get 79% of his target bonus but it is still too “generous” according to his performances. Actually, according to the diminishing marginal returns, higher income cannot act as an effective incentive for those CEOs to perform better.

In the end of his argument, Mankiw contributed the inequality problems to the imperfect tax system. But the true problem here is not about tax rate. Think if you are the CEO, will you ask for a stable income after tax or pretax? No doubt you will ask for the same amount of pay after tax, so even if we increase the tax rate for the rich CEOs, they will find a way to escape the “harm”. If the tax rate raises, that means CEOs will ask for higher pre-tax income, what that means? It means other employees will get less! It is typically the problem of income distribution, but Mankiw said “The solution here, however, is not to focus on the income distribution…”

I think our tax system is good enough, what’s more significant now is to put more money on solving unemployment and inequality, which means we must increase the efficiency of redistribution. And of course, it’s better to solve the income distribution inequality at first.

The American Dream is alive and well

Income inequality has been a divisive issue the past few years.  It has been a goal of the Obama administration to lessen this inequality due to its perceived effect on labor market outcomes, where the rich at a distinct advantage over the poor.  A post on Greg Mankiw’s blog about a piece of research seems to shed some light on this issue.  The research indicates that since the 1970’s, social mobility in the United States has remained at worst the same and could actually be easier.

Mankiw’s back of the envelope calculations show that the income one earns as an adult may be minimally effected by your parent’s income. He calculates that roughly 2% of the variation in income can be accounted for by parental wealth. The research is more comprehensive and seeks to address not the variation in wages, but whether parental wealth has an affect.  By tracking 3.7 million parents and children born between 1980 and 1993 for income and things like college attendance, Chetty et al determined that social mobility has increased.  While there is a perception of increased inequality, the paper points to this is due to the top 1% moving away from the center, skewing the distribution as it goes.  The authors note that how far away the top 1% is from the rest has nothing to do with social mobility, and compares the effect with the a ladder:

The rungs of the ladder have grown further apart (inequality has increased), but children’s chances of climbing from lower to higher rungs have not changed (rank-based mobility has remained stable).” 

This is strong evidence that the extra money spent by rich parents is not having an outcome altering effect.  While there is increased income inequality, the distance isn’t becoming harder to cover, only the disparity in outcomes between those that chose to put in the work and those that do not.

While there may be a correlation between having rich parents and going on to earn a similar (or larger) amount of money, money itself is probably not the cause.  Traits like talent, motivation, and genes are hard to include in a regression.  The question that society must answer is that if wealth isn’t affecting the outcomes of the next generation, is the redistribution of wealth really necessary?  A strong case could be made for redistribution if the current distribution was binding in some way, making it more difficult to improve ones standing standing.  However if it just making up for bad decisions, then the rationale is not nearly as strong.  What is clear is that the American dream is alive and well if you know how to go about getting it.  The tragedy is that so many don’t.