#BecauseMath Economics Taxation Unemployment

Will low corporate taxes bring the jobs back?

Many promises have been made that any number of conservative policies will bring jobs back to America. In this post, we’ll examine the claim that lower corporate taxes will reduce offshoring of jobs by presenting a simple example.

Imagine a multinational company, Big Widget Inc. (BWI), can make widgets either in the United States or in Mexico. In Mexico, where environmental regulations are gentler and wages lower, BWI can make widgets for $90. In the United States, they can make widgets for $95. No matter where they manufacture them, they can sell widgets for $100 in the United States.

Now, in this fictional world, let’s imagine the corporate tax rate is the same 40% in both countries. How much tax will BWI pay and to whom? Answering this requires a short primer on transfer pricing. When a company does business in 2 countries, it has a separate affiliate organization in each country. When goods manufactured by BWI Mexico are imported by BWI America, BWI assigns a “price” for those goods as if BWI Mexico sold those goods to BWI America. The price is called the transfer price. Ideally, this price will match the price that two unaffiliated companies would agree on. The terminology here is “arms length.” The tax authority in each country tries to prevent companies from gaming the transfer price, but there’s some wiggle room here.

If the two countries have the same tax rate, then BWI doesn’t care what the transfer price is. But, the two countries do. If the transfer price is $90, then BWI Mexico recognizes zero profit in Mexico and the USA collects all the taxes. If the transfer price is $100, then BWI Mexico recognizes all of the profit and Mexico collects all the taxes. In either case, BWI pays 40% of it’s $10 profit, or $4.

But Republicans tell us that reducing that corporate tax rate will bring that manufacturing back to the USA. Let’s explore that.

Imagine America cut its corporate income tax to 10% while Mexico holds its tax rate at 40%. In this scenario, BWI wants to minimize the transfer price for widgets. If the transfer price is $90, BWI can recognize the whole $10 profit in the USA and pay just $1 (10%) on its US profit. That’s a nice windfall for BWI but a big loss in tax revenue for Mexico. Mexico will probably insist on a higher transfer price. Maybe $95. At that transfer price and those tax rates, would widget manufacturing return to America?

By importing widgets at a $95 transfer price, BWI can make a $5 profit in each country. Mexico charges a 40% tax on the $5 attributed to BMI Mexico and the US charges 10% on the profit attributed to BWI America, so BWI Mexico pays $2 in taxes (40% x $5), BWI America pays $0.50 and BWI keeps a $7.50 after tax profit. That’s certainly better than the $6 after tax profit before the rate cut. But will BWI be motivated to move manufacturing to the US? In America, they can manufacture widgets for $95 and sell them for $100 and make a $4 after tax profit. BWI will still import since $7.50 beats $4. In fact, even at a transfer price of $100, which forces all profit on imported widgets to be taxed at the high Mexican rate, BWI *still* makes higher after tax profit by importing. The transfer price has to be over $105 (forcing the BMI America to sell at a loss!) before manufacturing in the US generates higher profits (Try it!).

I, myself, don’t see much reason to believe lowering the tax rate will boost American manufacturing. But, there’s another effect of this strategy that’s even more distressing. The policy fight over the transfer price rearranges some political alliances. We can see this by examining the desires of each of several parties–the US government, the Mexican government, US manufacturers and US workers. Two parties have an interest in a low transfer price. The US government wants a low transfer price so that profit is recognized in the US and can be taxed there. Manufacturing firms also want a low transfer price since they can pay less tax overall by moving profits to the low-tax US.

There are two parties in favor of high transfer prices, too. The Mexican government wants a high transfer price to keep taxable profits in Mexico. The other party interested in a high transfer price is American workers. It was only a very high transfer price that made manufacturing in the US more attractive. So, US workers and their unions will push to keep the transfer price high in order to move manufacturing from Mexico to the US. The sudden drop in the US corporate tax rate aligns US corporations and the US government in opposition to the Mexican government and US workers. The reader is left to decide for themselves who they think will win this political fight–the combined forces of multinational firms and US legislators or the Mexican government and American workers. But you can probably guess what I would predict.

This gaming of the corporate tax rate has two sets of winners, both of them powerful. But none of them are you and me.

Economics Philosophy

The Other Ayn Rand

The Ayn Rand you know warns of government over-reach. “Government ‘help’ to business is just as disastrous as government persecution,” she scolds. “The only way a government can be of service to national prosperity is by keeping its hands off.” Most of her modern disciples are very fond of “Atlas Shrugged,” Rand’s chronicle of railroad baroness Dagny Taggart and her struggle to succeed against an incessant headwind of government interference, regulation and outright thievery. Eventually, Dagny escapes to the insulated mountain enclave of uber-capitalist John Galt, where the world’s movers and shakers live and compete in perfect laissez-faire utopia. The moral is explicit and impossible to misinterpret: Government is the problem.

But Ms. Rand had more to say. Next to Shrugged, Rand’s next best known novel is “The Fountainhead.”  It is the story of Howard Roark, a brilliant, but misunderstood architect and iconoclast. In an early scene, Roark is found criticizing The Parthenon as a shoddy derivative of earlier work. Roark’s vision is clear and his self-assurance, unmeasured. Like Dagny Taggart, his unflagging integrity and loyalty to own genius comes at great cost.

Howard Roark’s extra-governmental problem

The key difference is that Howard Roark’s problems are mostly independent of government. His foes are unscrupulous reporters, nepotistic professional organizations and myopic corporate yesmen. When Roark seems on the cusp of winning a contract for the design of a new bank, he is not thwarted by any agent of any government. The owners of the bank unexpectedly add the condition that Roark make “one or two small changes.” These changes turn out to be quite drastic and antithetic to Roark’s entire vision. They want Roark’s genius in a comfortable box, one that won’t upset the architectural community, one that’ll be familiar to customers and employees. Roark refuses and returns to a life of poverty. The theme to which Rand continually returns is the struggle of the individual against the collective. But the face of that collective takes many forms, not all of which can be blamed on economic central planning, government overreach or wealth redistribution. The lesson of Howard Roark is that you don’t need government to stamp out innovation and initiative or to frustrate the work of visionaries.

A contemporary of Rand was the Austrian economist Friedrich Hayek. Hayek was also a faithful believer in the power of the market. He popularized the phrase “spontaneous order” to describe the systems of production that arise naturally, without central planning. An economy, he said, is similar to a brain or an ant colony or a snowflake in that when simple sub-parts interact, they naturally move toward the “best” position without the influence of any over-arching design. These decentralized systems produce astounding results which far exceed our expectations when examining only the individual pieces. In economic terms, the wants and needs of people, expressed through the price signals in the economy lead to the best allocation of resources. When a new and superior product or method of production arises, it supplants the old not because any one person or committee declared it better, but because, collectively and independently, consumers express their preference through their purchases and suppliers respond. Hayek called it a “fatal conceit” to imagine that a top-down, planned system could match these spontaneous systems for productivity or efficiency.

It’s this last point that I think needs examination. But first, I want to make the point that Hayek and Rand and I all agree that there is a system. Even when the government doesn’t mandate it, we are organized into businesses and unions and churches and fantasy football leagues. These institutions, as much as price signals, determine resource allocation. All of these systems, not just the governmental ones, are subject to capture and manipulation by self-seeking members. Economists would quickly point to cartels or monopolies as government-free, self-organizations that hamper economic efficiency. When one firm, or a number of ostensibly competing firms capture enough of a market, they can act to squelch competition and innovation or raise prices for consumers, increasing their own profits without providing additional benefit. Anti-trust actions can be seen as government intervention on behalf of individuals against the anti-meritocratic power of these institutions. In the case of a cartel, Hayek’s “spontaneous order” arises. It’s just not efficient. Some top-down interference in the market creates a better, more meritocratic system.

The sharp edge of spontaneous order

Race and gender are powerful and important social organizing principles within almost all of our institutions. And they organize us in a decentralized, spontaneous way. There’s no central committee or despot that decrees that men shall operate forklifts or Asians shall join the math team. Instead, independent individuals conform or rebel, praise or stigmatize, establishing and enforcing our collective values. In her book, Framed by Gender, sociologist Cecilia Ridgeway describes spontaneously emerging systems to explain why gender inequality persists in the face of efforts to correct it. Ridgeway writes that many institutions–businesses, schools, governments, media, etc.–interact (I would say “interlock”) to create a very resilient “gender system.” When efforts are made to correct inequality in just one of these institutions, that institution no longer fits in this structure. Rather than the structure toppling, the remaining, conformant institutions exert pressure on the non-conformant institution to bring it back into alignment. This makes the system quite resilient to change even if it could be made more efficient.

Racism, sexism and other forms of discrimination are inefficient as well as unfair. There are market forces that punish business that hire and promote employees for any reason other than their ability. And yet, discrimination persists. One reason for this may be the self-reinforcing system of institutions that resist meaningful change, not because the members of the institutions are overtly racist or sexist, but because the institutions themselves preserve bad (and good) ideas and practices.

For example, a university may unilaterally decide to correct its gender biases, implementing policies to encourage women in subjects traditionally dominated by men. A single university on this crusade might be met with resistance by firms reluctant to hire women graduates in male-dominated fields. This can damage the placement statistics of that university, incentivizing the university to revert. Those reluctant businesses, as well as enforcing social mores, are also subject to social forces. For example, more equitable hiring practices at these firms may be met with resistance (explicit or implicit) from customers motivated by deeply held gender beliefs. The defense of firms in discrimination suits has often been that they are only reflecting the desires of their clients and providing them a familiar and reassuring experience. The gender beliefs of customers, in turn, are reinforced by the experiences of individuals within institutions. “Of course men are better physicists. All of my smartest physics professors were men!”

Our institutions are connected in a tangled, self-reinforcing web of mutual influence. The result is values which pervade our institutions, but which do not have a single source in any of them. They can be attributed equally to the organizational structure of institutions and to the beliefs of the individuals within them. Even when we don’t explicitly express them, such beliefs can affect who we hire and promote, who we pay attention to, and who we aspire to become. Universities, businesses, consumers, families, TV stations and churches form a stable and spontaneously-ordered system. Each of these parts has an incentive to conform lest it be censured by the rest of society. This gives them a resilience against change, including changes toward greater efficiency.

Adam Smith to the rescue?

There are certainly economic forces that combat these inequities. At the level of strictly one-on-one interactions, it’s not in the interest of any of these institutions to hire or promote or admit someone for any reason other than they’re the best person for the position. In an ideal world, the firm that lets its racial or gender preferences get in the way of hiring quality employees, would be at a disadvantage. The question is whether these market forces are strong enough to overcome the formidable collective forces that maintain the status quo. And, if they are, how long will they need to do it? Social forces were strong enough to maintain segregated housing, buses and drinking fountains in the American South for 100 years past the end of slavery in spite of market incentives to satisfy free Black clientele. Eventually, it was top-down government action that put an end to some of these discriminatory (and anti-meritocratic) practices. Without Lyndon Johnson stepping in, who knows how long the South might have remained segregated.

Today, we face similar questions. The United States is very attached to its private health care system. The most vocal opponents of nationalized health care tend to be those with great faith in the organizing power of the market. Whatever the advertised advantages of nationalized health care, they object to putting a bloated, inefficient government between people and their doctor and assume it will lead to expensive, low-quality care. But, of course, that work is already done. The private institutions that currently provide health care are some of the largest and least efficient in the world. Howard Roark would not be surprised by this. Why should we automatically expect them to be efficient simply because they’re not run by public employees? These institutions are similar to governments in that they are subject to lobbying and incorrect incentives. They’re certainly large enough to create and hide waste and fraud. What’s worse, for most of us, there are now three giant bureaucracies between ourselves and our doctor–employers, insurance companies and hospitals. These large bureaucracies interact and shape one another, conveying values and reinforcing the existing order against attempts at change. The question deserves to be asked whether this “spontaneous order” is really the most efficient, or whether it’s subject to the same (or more) problems as centrally-controlled economies and industries–waste, fraud, cronyism, organizational sclerosis, unresponsiveness to consumers, etc..

True believers in beneficent “spontaneous order” do not deny the existence of non-governmental bureaucracies. They either claim these bureaucracies will be short-lived and replaced by better organizations, or they believe, with dogmatic certainty, that any state attempt to improve them will result in a worse situation. At risk of over-generalizing, I would submit that many spontaneous order junkies are simply reassured by a scientific sounding idea that justifies their own position at the top of the hierarchy. If you’re top banana, it may be comfortable to assume the market is a perfect meritocracy. At very least, your motivation to examine the status quo is reduced. But there are compelling examples to suggest that there are places in the market for government interference to protect competition, smooth out the business cycle and provide a safety net for the market’s inevitable victims. This does not mean we should ignore the power of spontaneous order, but neither should Hayek be used as a magical incantation that makes private sector inefficiency, discrimination and waste disappear. Policy proposals, from banking regulation and affirmative action to health care delivery systems and taxation, must be argued on their own merits, rather than falling back to simplistic axioms or allegories.

#BecauseMath Economics Unemployment

A non-economist examines the minimum wage

There are no economists at ThisWeekInStupid. But, that’s not going to stop us from weighing in any more than it stops economic ignoramuses like Paul Ryan, Bernie Sanders or Peter Schiff. Recently, we penned a piece opposing a minimum wage hike, or at least suggesting that there were plenty of other ways to help minimum wage workers that were less apt to cause unemployment. Today, we’re going to go back on that a little. The main argument against a minimum wage involves, naturally, a supply and demand plot, like this one.


The downward sloping curve is the demand for workers. These are the employers who hire fewer workers when the wage is high. Many businesses can make money hiring workers for $4/hour. Fewer businesses can operate profitably paying $15/hour and very few can survive if they must pay $25/hour. The other curve, which slopes upward, is the supply curve. These are the workers. For $4/hour, lots of people will go back to school or live on their spouses income or live in their parents’ basement rather than work. For $15/hour many more will be willing to work. And for $25/hour, workers will come out of the woodwork. They’ll get childcare, come out of retirement, rearrange their class schedule, etc. (Note that this curve assumes all workers are equal, which is nonsense, but it may be illustrative anyway.) Where these two curves meet is the equilibrium wage. That’s where wages will naturally fall without any government interference. This next graph is decorated a little more.


In this graph, I’ve colored two regions underneath the curves. The green region represents the producers surplus–extra profit for workers. That is, there are some workers which would have been willing to work for $4/hour. They consider their hour to be worth $4. If the equilibrium wage is $6/hour, then they are $2 richer for every hour they work.

The orange area is the consumer surplus–extra profit for employers. Some employers could break even by paying workers $8/hour. If they only pay $6/hour, the employer is wealthier by $2 for every hour worked. These two areas are what make capitalism fun. Voluntary exchanges make both parties wealthier. Always. So is it ever a good idea for government to interfere with voluntary exchange? Let’s see.

The effects of a minimum wage

When a minimum wage is introduced above the equilibrium wage, a few things change. The first result is unemployment. In our curve, the equilibrium wage might be $6/hour. With a minimum wage set at $8/hour, two things happen. First, more people are seeking work. Second, fewer businesses are willing to hire. Both of these effects cause unemployment (but only the second of these effects represents a change in employment from the equilibrium situation). It’s represented by U in the plot below.


At the new wage, employers are demanding fewer workers than the total workers seeking a job. Liberals should stop denying this effect. It’s true that there are studies that found that in a subset of businesses hiring minimum wage workers, the effect on employment was weak or absent. But these studies and others also point to a stimulative effect of a minimum wage wherein wealth is transferred to poorer workers who tend to immediately spend their money. This tends to boost demand. So the question is, if there’s a boost in demand, why does employment stay the same? Why doesn’t it increase? A natural explanation is the argument above. The first order effect is the one we see on the supply and demand curve pushing employment down. The stimulative effect helps to mitigate that effect. Also, there are many careful studies which reach the conclusion that a minimum wage does decrease employment.

Returning to the supply/demand plot, let’s look at what’s happened to the green and orange regions. The wage is higher, so the green region would be the area under the supply curve up to the new minimum wage. Except that there is unemployment. Only a fraction of the workers desiring employment can find jobs. So we should reduce the green region by the unemployment. An approximation of that is the green shaded region above.

The orange region is more straightforward. Those employers who could not profit by hiring workers at the minimum wage, stopped hiring. So the orange region is the area under the demand curve above the minimum wage.

So, are the workers, collectively, better off? Certainly those workers who keep their jobs are better off. Our worker who was willing to work for $4/hour is now making $8/hour and gaining wealth at $4 for every hour worked (up from $2 before the minimum wage). But, some other workers, including some willing to work for $4/hour, have lost the chance to work. In many cases, this represents an overall gain for the workers as a whole. It’s easy to see how the new green region could be larger than the old especially if the demand is quite inelastic–that is, if demand for workers stays largely the same as wages increase. But when this is the case, it’s important to ask, where did this extra money come from?

Partly, it comes out of the profits formerly collected by the employers. In our new curve, the orange region is clearly smaller. Employers of minimum wage workers will almost always argue against a minimum wage. The first order effect is to shrink their profits.

Another source of increased wages for workers is increased prices for the end goods. Conservatives often say dumb things like, “Employers just pass the additional costs on to consumers.” This is lazy economics (just ask a non-economist!). There’s a separate supply/demand curve for whatever good or service the employer is selling. Presumably, this curve is what set the consumer price of the end good in the first place. Unless the minimum wage changes the market for end goods, the pricing strategy of the employer is unlikely to change much. Of course, the supply curve for the end goods may change as competitors with smaller profit margins who cannot afford the new higher wage, drop out of the market. This may cause prices to rise, but it will still be subject to the end consumer demand curve. Consumers will not blithely pay higher prices just because our employers’ costs rise. Research shows that something like one-third of the additional cost of a minimum wage hike is passed to consumers as higher consumer prices.

So, some of the extra worker profit comes out of employer profit and some comes from the end consumers. One important thing should be clear from the plots. The profit the workers gain from the minimum wage is always less than the profit the employers lose. That is, the first order effect of government interference is to reduce the overall wealth of the economy. This should have been obvious from the beginning. When a worker valuing his time at $4/hour works for an employer who values that same work at $10/hour, there is, in total $6/hour profit to be made and split between the employer and employee. Changing the wage shifts the allocation between the employer and employee, but does not affect that total. So the total possible surplus (consumer + producer) was fixed before the minimum wage was introduced. The minimum wage can only affect this total by prohibiting some of the exchanges, reducing the total profit.

So, isn’t a minimum wage just a terrible idea?


Not necessarily. Think of a minimum wage as a leaky pipeline that transfers wealth from wealthy employers to less wealthy workers. There are some good reasons to redistribute wealth downward. First, wealth exhibits a diminishing marginal utility. That is, each dollar improves the life of a poor person more than it does a rich person. To a poor person, $500 may mean repairing his only car or fixing his children’s teeth. Meanwhile, to a rich person, it may mean an additional Coach purse or a spectacular bottle of wine. Even though the total amount of stuff has not increased (and has, in fact, decreased) the utility of the stuff, or the happiness it produces, may increase.

The second reason to redistribute wealth applies only in a Keynesian recession. When an economy is in the doldrums due to deflation and weak demand, shifting wealth from rich to poor can boost the economy since poor people tend to spend their money more quickly and readily than rich people. This moves money through the economy faster and creates inflation. In an economy dogged by deflation due to a shrinking money supply and weak demand, this is a welcome effect. But, in an economy operating at full capacity or one experiencing supply-push inflation, this is a problem. More spending can cause inflation to run too high, distorting price signals. The great part about a fixed minimum wage is that inflation quickly makes the minimum wage irrelevant as wages are pushed above the mandated minimum. A minimum wage below the equilibrium wage is like having no minimum at all. So a mildly restrictive minimum wage is an automatic recession fighter providing stimulus when demand (and wages) fall without causing inflation when wages rise.


The final reason to redistribute wealth, especially through a minimum wage, comes from Henry George (whom modern economists ignore at their peril). George and his disciples point out that at least some of the profits employers collect are “economic rent” on the non-produced inputs to production. That is, the division between employer and employee may be partly because of something about the employer which does not make her more productive. Certain people may have better access to capital due to their birth or connections or physical characteristics or land ownership or habitus. Where these characteristics are unrelated to productivity, they amount to a contrived exclusivity, depressing the demand for workers and reducing wages. Marx would say that the separation of the workers from the means of production enables excessive profit-taking by employers. Of course, not all advantages of employers are rent taking. An employer who has labored to produce 10 shovels might reasonably hire 10 workers to use them, taking profit for providing the shovels. But, when that employer takes additional rent because she owns the land or because her father-in-law fronted her the money for the shovels or because she has an exclusive right to produce or use shovels, she’s collecting economic rent. Rent-taking reduces the efficiency of markets and destroys wealth in the same way a minimum wage does but to the disadvantage of workers. A minimum wage forbids any exchange of labor for money below a certain wage. Rent requirements forbid or discourage businesses started by otherwise productive people without the right characteristics or connections.

A brief clarification is probably a good idea here. In economic terms “rent” is not only the money you pay your landlord to continue to live in your apartment (although that’s one example). It’s also the benefit you get from being white or being the boss’s nephew or even for holding the patent on a product. Not all assets on which you collect rent are nefarious or unfair. But what makes it rent-taking is that you benefit for some other reason than that you’re more productive.

Let’s look at our supply and demand curves again. Rent requirements artificially reduce the number of potential employers. For simplicity, we represent this as a simple multiplicative reduction in the labor demand. Suppose that our rent requirement means that 15% of potential employers are pushed out of the market.


In the curve above, it’s clear that the downward shift in demand reduces the wage and increases the profits for the remaining employers. At the same time, the employment shrinks. The effect is, in fact, quite similar to the effect of a minimum wage with the increased profits for employers coming partly from decreased profits for workers.

In cases where there are rent requirements for new businesses, a minimum wage may boost wages which were artificially suppressed by rent-seekers. But, a minimum wage is a very blunt instrument. It harms both rent-seekers and naturally profitable businesses. In this curve, we can see that the combination of a minimum wage and rent requirements is better for workers than no minimum wage (or might be), but still much inferior to eliminating both the minimum wage and rent requirements.


Here, the minimum wage has pushed the price back out to the equilibrium price, but it cannot undo the effect of the rent requirements. An economy is much better served by finding ways to reduce rent-seeking, especially since both the minimum wage and the rent requirements drive up consumer prices. But, in markets dominated by rent requirements, a reasonable minimum wage may do more good than harm.



Class Economics Education Elections Health Care Taxation

More questions for 11-year-old Peggy Noonan

Peggy Noonan took pen in hand on the pages of the Wall Street Journal to tell us we should think like 11-year-olds in combating Ebola and impose a travel ban. Peggy doesn’t trust people with degrees in public health or medicine. People with degree in law and business should know how to combat infectious diseases.

That got me thinking about what other policy decisions we could leave up to children. If you have an 11-year-old, please give them this brief survey and mail it to Ms. Noonan.

1. What should we do with foreigners brought here as children?
a. criminalize and shun them (but tax them)
b. hug them

2. Which of these parties do you think will best represent Americans?















3. Do you think giving housing, food, and medical care to poor families:
a. Makes them get less done; or
b. Helps them get more done

4. What should we do with children whose parents don’t provide health insurance?
a. Give them health insurance
b. Not give them health insurance

5. To reduce gun violence does America need
a. More guns
b. Fewer guns

5. Our country has a lot of debt. What shall we do to pay it off?
a. Tax the wealthiest people
b. Take it from old people’s retirement

6. Which is worse?
a. Secretly selling weapons to a militant dictatorship (Iran); or
b. Asking for too much paperwork from charities with “Tea Party” in their name

7. Which do you think is the best use of our money?
a. Bombs
b. Schools

Today’s GOP manages to capture all of the ignorance of children without any of their compassion.

Economics Education Taxation Unemployment

5 Ways To Help the Poor That Beat Raising the Minimum Wage

There’s a lot of minimum wage denial out there. Some of it is well-informed. But if I could have one political wish, it would be that my Democratic friends would stop pretending like Economics 101 is a vast right-wing conspiracy. It should be taken for granted that the primary effect of raising the minimum wage is less employment for people at the bottom of the wage scale. Yes, I’ve seen the Krueger and Card study where the effects on employment cluster around zero, but I think this is evidence of my point. You see, a minimum wage puts money in the pockets of the people most likely to spend it tomorrow–the poor. So if that secondary effect helps the economy increasing employment, there must be some other factor pulling the effect back toward zero, right? The CBO’s assessment of a $10.10 minimum wage was that it would cost 500,000 jobs, but lift 900,000 people out of poverty.

There’s another reason to be suspicious of the federal minimum wage. It’s a cruelly blunt instrument. A $15 minimum wage might do nothing at all to employment in Seattle, but might cost many more jobs in rural Mississippi, where prevailing wages are substantially lower. Proponents of the minimum wage are always very excited to tax Walmart and McDonald’s–massively profitable multi-nationals. But most of the minimum wage increase is likely to be paid by businesses with 10 or fewer employees, many of which have razor-thin margins. The result there will be higher consumers prices and serious lay-offs and previously profitable businesses closing. Further, earners of the minimum wage are not all working parents. At least some minimum wage workers are middle-class teenagers, who, frankly, are getting their share of breaks as is. Almost half of minimum wage earners are between 16 and 24. I spent a lot of years working for minimum wage to earn date money, then going home to dinner and two loving, college-educated parents. That was a terrific experience, but is my upper-middle class teenage self really the most worthy recipient of wage assistance? Could we find ways to direct more of the benefits of wage assistance to the truly needy?

Now, imagine we could find other ways to help the poor make ends meet without simultaneously encouraging unemployment. Imagine these same programs could target the wealthiest people and corporations to pay for them and the poorest to receive the benefits. Terrific, right? Here are five:

Boost the Earned Income Tax Credit. While I don’t always agree with him, Milton Friedman is a man I greatly admire. Besides being a brilliant economist, he was, I think, the original compassionate conservative. His ideas on the benefits of a “negative income tax” are still extremely relevant. We owe the existence of a robust EITC partly to Friedman and he would be ashamed to see Republican efforts to dismantle this program and it’s sister, the Child Tax Credit. Both are methods of rewarding work while redistributing wealth with minimal distortion to markets. Unlike programs which can create a “poverty trap,” wherein at some income levels, you actually take home less money by working more, the EITC and CTC always reward earning income.

Invest in Poor Schools. This is a long term play to be sure, but it also has important positive short term effects. Schools that keep kids safe and feed them as well as educate them make life easier for the lower class parents who are trying to build a better life. This leads to more productive and stable workers who can then demand higher pay and better educated workers for the future.

Ditch mandatory minimum sentences for drug possession. ThisWeekInStupid is not an advocate for drug legalization, but neither do we see the logic in obligating judges to jail drug users who might do more good than harm for their families and communities at home.

Provide free, convenient English courses. This is just one example of ways to boost the skill-level of minimum wage workers. Workers who have good English literacy and basic computer and arithmetic skills are better able to know and insist on their rightful wages. And, as worker productivity grows, it lifts the whole of the economy.

Scale back right-to-work. Unions contribute to a whole host of positive changes in working conditions including raising wages. Right-to-work laws reduce the effectiveness of unions by allowing workers to free-ride, enjoying the benefits of union negotiations without paying in to the system. Freeriders result in less cooperation and worse results. However, ThisWeekInStupid thinks there are strong arguments that unions of government employees are less beneficial since government workers’ vote puts them on both sides of the negotiating table.

Raising the minimum wage is the laziest way to help the poor and not the most effective. In inflation adjusted dollars, even a $11.00 minimum wage would be the highest ever. Now, I’ll take a minimum wage over nothing, but I’d much rather pursue other angles first.



America Economics Obama Taxation

All those things you hope the GOP will do? They can’t do them

Ben Howe says today’s GOP is different from GOP circa 2006–that we should stop holding the budget-busting, war-mongering actions of Bush-era Republicans against today’s fiscally responsible, TEA party Republicans. This is not your father’s GOP. This idea is getting some traction. There is some wishful thinking out there that this time your vote for Republicans will mean smaller government despite the fact that the last Republican President to reduce either federal spending (adjusted for inflation and population) or the budget deficit was Eisenhower.

There’s a part of me that would like to believe in the sincerity of GOP rhetoric. I do worry about a government that allocates fully a quarter of everything produced in the country. But, I’m skeptical not just because the faces at the top of the GOP have not changed. I believe people can change. The problems is the incentives for GOP legislators have changed very little since 2006. When a politician (of any persuasion) pays lip service to a policy you like, it’s important to consider how the stake holders feel about it and how they’re liable to react politically. Here are three good conservative ideas which the GOP has no chance, or indeed intention, of accomplishing.

Raising the retirement age (or other Social Security fixes). You know and I know that it’s ridiculous to pretend people aren’t staying healthy longer or that Social Security isn’t approaching a precipice. Without any changes, the trust fund (i.e. the surplus accumulated by payments into Social Security, also the money loaned to the treasury to fund our government these 20 years) is predicted to be exhausted in 2033. At that point (or some time before), Social Security must either cut benefits by an average of 23% or begin collecting more money. To listen to them, you’d think the GOP were making this top priority. But today’s Republicans have no hope, or even inclination to make substantive changes to the Social Security. The reason for this is that Republican electoral success increasingly relies on strong majorities among retirees to compensate for their poor showing among younger age groups. The Democrats enjoy an advantage among registered voters in every age category except the over 65 crowd. Candidates on the Left who openly advocate raising the retirement age or trimming benefits regularly face attacks from the Right. Most of us remember Mitt Romney’s criticism of the President’s 700 billion dollar reduction in Medicare spending. The Washington Post highlighted more such attacks against Democratic candidates by Karl Rove’s American Crossroads. Until Republicans find a demographic to replace retirees, all Republican entitlement reform is dead on arrival. You heard it here first, when it comes to fixing Social Security, the GOP will sell you, hard-working taxpayer, out to their AARP base in a heartbeat.

Eliminating mortgage interest deductions. This is a great Republican idea. The mortgage interest deduction is a giveaway to home owners and shifts the tax burden to poorer renters. It drives up home prices, complicates tax filing and distorts the market unnecessarily. But the GOP can’t do it. They take too much money from the people most harmed by this policy. The third largest individual donor to Mitt Romney, post TEA party revolution candidate for President, was Texas real estate developer, Bob J. Perry. He gave $15 million to the Romney campaign. Real estate interests gave three times more money to the Romney campaign than to the Obama campaign. Aside from investment professionals, real estate was the industry most supportive of Romney’s candidacy. The National Association of Realtors is a powerful organization which spends $40 million on lobbying every year. They support candidates on both sides including GOP House Candidate Mia Love and Democratic Senate candidate Mary Landrieu. Until money no longer rules politics, the mortgage interest deduction is here to stay.

Reducing agricultural subsidies. No one but the recipients of farm subsidies thinks they’re a good idea. The Department of Agriculture directly pay about $19 billion each year to American farmers, large and small, in the form of subsidies to crop insurance premiums and direct crop price support. Recipients include Jon bon Jovi, Rockefeller heirs and 1500 residents of New York City. Subsidies to US farmers harm third world agrarian economies which could be lifting themselves out of poverty while providing cheaper groceries for American consumers. Countries around the world hold this up as an example of the US’s protectionist trade policy and our hypocrisy as we ask countries like China to open their markets to foreign goods. Cutting these subsidies gets some play on conservative talk radio and in conservative think tanks. But it’s a non-starter among Republicans who actually govern. President Obama’s 2014 budget includes some cuts to these which Republican lawmakers have resisted. The Republican Study Committee recently uninvited the influential conservative Heritage Foundation to its meetings over Heritage’s support for reducing farm payments. Again, Republicans have both a demographic and a fund-raising problem. They enjoy broad support from rural communities and states whose voters, even when they don’t receive subsidies themselves, identify with the image of the struggling Midwest farmer. It also brings in the dollars. Campaign contributions by agribusiness has increased five-fold since 1990 with 71% of contributions going to Republicans. An estimated $150 million is spent on lobbyists for agricultural industries every year. In 2007, facing reductions to farm subsidies spearheaded by Democrats, 3000 lobbyists flew to Washington and killed changes to the farm bill. The farm lobby has even helped write provisions that enable US farmers to trade with embargoed countries like Iran.

Don’t misunderstand me. Democrats also are crazy to oppose these sensible proposals and electing Democrats is only slightly more likely to make these reality. But they have other policy objectives that are both possible and sensible like immigration reform, expanded infrastructure spending and health care reform. In the GOP playbook, I see only stupid ideas (aggressive foreign policy, balanced budget amendments, etc.) or smart but impossible ideas like those above. A realist must confront the fact that America can expect more of 2003 from today’s GOP. What Republicans can do is start wars. It’s a thing they believe in and that their base can get behind. It plays well with their demographics and brings in campaign contributions from military contractors. As previously discussed, in Republicanland, the Law of Unintended Consequences doesn’t apply to foreign policy, so there’s very little downside.

Meet the new boss…


Economics Taxation

This Week In Stupid: Electing Republicans shrinks the government

In 2003, I was a Republican and yet the idea of the Republicans controlling both houses of Congress and the Presidency made my blood run cold. At that time, George W. Bush had inherited a budget surplus. Liberals are fond of pointing this out claiming it as proof of the efficacy of Bill Clinton’s Presidency, but it was mostly due to the dot-com bubble revving up the economy. When the bubble burst in 2001, two things happened. First, expenses for things like unemployment payments rose suddenly. Second, tax revenue dropped as business started generating less revenue. But George W. had been elected on the promise of a tax cut to give Americans back the surplus. Would the Bush administration and the Republican Congress change course when facing budget deficits? In the midst of this debate, the Heritage Foundation published this gem of a rationalization for the deficit spending planned by Republicans. Their argument opposes completely the position of today’s conservatives: Deficit spending by governments has a very small effect on inflation.

Republicans bought this easy idea and spend they did. Not only did the GOP significantly cut taxes, but they began spending at an impressive pace by any standards. Bush pushed through the expansion of Medicare called Medicare Part D at an annual cost of $50 billion. They started two wars and dramatically increased spending for national security, creating the brand new Department of Homeland Security. That was all deficit spending.

The Gipper

Reagan is another fine example of a big spending Republican. Although Reagan is heralded as a champion of small government, the fact is that, during his tenure, the size of the federal budget expanded by more than a third, the number of government employees increased by the same amount and the deficit doubled. In the early 90s, the effects of a TRILLION DOLLAR deficit kept voters up nights. Further, even as the federal government expanded, less of that spending was transfers to states. Federal money for state education and health care programs was reduced. States increased their contribution to those programs, boosting spending even more.

What’s worse, Reagan, consistent critic of the stifling effects of government bureaucracy, actually (and dramatically) boosted government payrolls. In the Republican universe, this is the worst kind of government spending.

Now, I don’t fault Reagan. He followed exactly the path I (or Paul Krugman) would have in pulling the country out of a recession–borrow and spend. I, myself, would have spent less on big bombs and more on education, but I have the benefit of hindsight. Who knew the USSR would be kaput before his Vice President left office?

As an aside, many on the Right will lay the blame for this increase under Reagan at the feet of Democratic Congress at the time. I think that’s fine as long as they don’t simultaneously give Reagan credit for the recovery.

So, don’t buy it. Recent history demonstrates that Republicans are only critical of spending by Democrats. They know, just like you do, that spending during a recession is the right idea. They just wish they got to do it.

Economics Obama

Liberal Schizophrenia

Obama’s first 6 years have been characterized by government gridlock, budget deficits and, depending on your perspective, steady but slow economic recovery. Democrats, as the Party that still believes public policy should be tied to objective reality, need to get our collective head straight concerning what this experience tells us about deficit spending and economics. Most people, by now, are aware that there are Austrian, Keynesian and Monetarist schools of economic thought. In summary which is sure to keep me out of any institution that studies economics, Austrians favor almost no government intervention to smooth the business cycle, Keynesians advise running deficits during a recession and surpluses during a boom and monetarists (like Milton Friedman) focus on monetary policy, striving to preserve the supply of money in the economy by printing money during a recession (when the money supply naturally shrinks) and taking it out of circulation during a boom. For a much clearer summary, watch Tyler Cowen’s videos on the topic.

Now, from the Republicans I hear two assertions which are consistent with each other, although tenuously tethered to reality.

  1. Obama’s Presidency has been marked by runaway spending and debt and
  2. Recovery has been tepid

For Republicans, who don’t pay much attention to economics (“ivory tower eggheads”), this all makes lots of sense. Government spending hurts the economy by crowding out private investment (except for military spending, because how better to boost recovery than by blowing stuff up?). So, Obama’s tax-and-spend liberalism is responsible for our current “malaise.”

Liberals, on the other hand, try to challenge both points, contending that

  1. Obama is not a big spender and
  2. Recovery is robust

But, taken together, these are entirely inconsistent with our Keynesian perspective. To Keynesians like Greg Mankiw, Paul Krugman and ThisWeekInStupid, cutting spending during a recession is exactly the wrong idea. If Obama and his mixed Congress had been cutting spending, we would expect it to slow the recovery. So, to claim both of the above is playing right into Republican hands.

It’s also not reality. A clear-eyed assessment reveals that spending has been unprecedented. US national debt as a fraction of GDP reached levels not seen since World War II  reaching 122% of GDP in 2012. We at ThisWeekInStupid are not deficit hawks, but this is a lot of money by any accounting. Often I see liberals pointing out that big spending had begun by the time Barack Obama took office. After all, the debt-busting 2009 budget was signed by George W. Bush, based on his recommendations in February 2008 and, since fiscal 2009 begins in October 2008, almost one-third of the budget was spent before Barack Obama was inaugurated. Some even use this fact to claim that Obama has been reigning in the runaway spending of the Bush administration. This is cynical and transparently false. The 2009 budget should only be used to demonstrate that bipartisan economists agree that a boost in government spending, even deficit spending, was the right prescription in 2008.

Barack Obama could have recommended less spending in the years following. To his credit, he did not. Democrats should embrace the fiscal policies of Barack Obama, including his deliberate deficit spending, and continue to emphasize that a slow, steady recovery is exactly the kind that tends to last. Obama is a Keynesian big spender, which is exactly why we can expect better times ahead.

Economics Foreign Policy Philosophy

Unintended consequences

You don’t have to be long around Republicans before they teach you the “law of unintended consequences”–the principle that, sometimes, things don’t go according to plan and sometimes they have the opposite effect of the one you intended. In a discussion of public policy, once your opponent resorts to the “law of unintended consequences” you know you’ve won the argument. You can interpret this to mean

1. Your idea seems like a good one.

2. She can’t think of any reason it won’t work, but…

3. It might not work.

Which, of course, is true about every good idea, ever. It even applies to the idea of doing less. The idea of reducing regulations is equally subject to the law of unintended consequences. For example, deregulation of media and telecommunications in 1996 has been, generally, a disaster with terrible unforeseen repercussions including ruining music, hampering the internet and giving money a louder voice in politics.

But still, the “law of unintended consequences” is preached to and by Republicans and Libertarians every day. To avoid “unintended consequences,” conservatives prefer to make their mainstay ideas which are manifest bullshit from the beginning. If I can’t rule out that a policy will give different results than the ones I intended, the best policy, they seem to argue, is to pursue nonsensical or even Machievellian goals, hoping to stumble into good results.

But in Republican minds, the law of unintended consequences doesn’t apply to things like privatizing social security or defunding the EPA, and it especially does not apply to foreign policy (arming the Syrian opposition? What could go wrong?). So, the next time you hear your Republican friend say “well, but you know the law of unintended consequences, don’t you?” don’t get frustrated. Simply apply your palm to your face and walk away victorious.

Economics Taxation

Tax the Dead!

Inheritance tax is, by far, my favorite tax. If you concede that there’s any reason for government spending, spending the money of people who don’t eat, work, spend money, recreate or procreate is the best scenario of all. Which is why I was surprised to read un-stupid Harvard economist Greg Mankiw defending massive inheritance in the New York Times.

The way Mankiw goes about it is also perplexing. He begins with the idea of “consumption smoothing.” I find this odd since consumption smoothing and a related concept, diminishing marginal utility, are powerful ideas for justifying heavy taxes on the rich and even brazen wealth redistribution. Mankiw explains it clearly

People get utility from consuming goods and services, but they also exhibit “diminishing marginal utility”: The more you are already consuming, the less benefit you get from the next increase in consumption. Your utility increases if you move from a one- to a two-bathroom home. It rises less if you move from a four- to a five-bathroom home.

An extension of this is that taking $1000 from a very wealthy person and giving it to a very poor person increases the overall happiness of the universe. To the rich man $1000 might mean an extra day in Vail with the family–a nice thing. To the poor man it might mean dental work, college tuition or not getting evicted–all quite essential things. So, taking that extra vacation day from the rich man to fix the poor man’s teeth is a net gain for the universe. So far Mankiw is off to a poor start in justifying massive, inter-generational wealth accumulation.

Zombie capital

A common response to this idea, and the one Mankiw employs, is that wealthy people, on average, use their money more wisely. That’s how they got so wealthy. Speaking about a collective average, rich people make better financial decisions. They watch their dollars carefully and hustle when those dollars need it. They have the skills to turn those dollars into more dollars, often by producing the things you and I need and want. Again, I’d like to be very clear that this is not the case 100% of the time. A serious discussion could be had about whether it’s even true most of the time. But I think a strong case can be made that “rich people” are a group selected for their ability to make the things and render the services people are willing to give the most money for. This is, however, not the discussion I want to have here. My point is much simpler.

Dead, wealthy people do not do any of those things.

They don’t make financial decisions. They don’t invest or hustle or manage or innovate. They haven’t any “sweat equity” left to give. So, the discussion here is about the children of wealthy people. The statement that people with wealthy parents are better users of money is a much more tenuous proposition. Mankiw himself does not shy away from this proposition and it’s here that he goes thoroughly off the reservation. His contention is that large accumulations of money are necessary for economic growth and that the poor do not accumulate capital because they count on “regression to the mean” improving the standard of living of their children. Because of diminishing marginal utility, they prefer to spend money on themselves immediately over saving it for their children who will most likely be richer.


Wrong on all counts. Firstly, many small accumulations of capital are every bit as effective as one large lump. A basket watched by 100 eyes is much safer. Many studies have shown that the collective wisdom of many individuals is often more accurate and reliable than that of experts (isn’t this your line, free marketeers?). One tremendous point of progress in our financial system is the democratization of finance. Ironically, even as middle-class incomes have stagnated and financial instruments have become more opaque, the ability of ordinary folk to participate in markets has grown. Today, anyone with $500 can invest in a wide variety of equities and derivatives cheaply and quickly. Most recently, we’ve seen pooled “small money” beginning to replace “angel” money and venture capital on peer lending sites and kickstarter. Employee-owned businesses are making a comeback as well. Small money is the future. What we need is more investor education on how to make your small money work for you. Ours would be a much healthier economy if more people were investing small amounts.

With all thy getting, get understanding

Next, when you count investments in human capital, the poor are great savers. Education is a capital investment. And the poor and middle class do it with abandon. I’ve watched families mortgage to the hilt to land in the right school district or to make outrageous tuition payments. It’s even clearer when you include all of the unpaid labor that goes into raising and education children. This exchange of money and time for human capital is every bit as valid as the investments of the super-rich. Even families raising children at a subsistence level are providing a necessary future resource to the economy. The poor tend to have more children and they make less money, so they spend a much larger fraction of their wealth on tomorrow’s workforce. The question I would rather have heard Mankiw address is whether our national investment portfolio includes too much or too little of these human capital investments.

The first sign of under-investment in workers and education would be a wide gap between employment rates for skilled and unskilled workers. In 2013, workers with just a high school diploma are unemployed at a rate of 7.5%. In that same year, just 2% of workers with a professional or doctorate degree were unemployed. Adding to this, the under-educated make up a much larger fraction of the unused potential workforce on disability or in prison who are not counted in the unemployment statistics. Given the importance of education in our information economy, there’s a strong case to be made that the ways the poor spend their money (on raising and educating children) are exactly what our economy needs more of and that their tax burden should be reduced to boost long-term growth.

I think what Mankiw is trying to say is that inheritance taxes discourage saving by taxing those most prone to save (at least in the sense of saving actual dollars). It is important to pay attention to how public policy affects individuals’ decisions to save or consume. However, there are many ways to encourage saving and not many of them are as disgusting as giving someone tens of millions of dollars because of the circumstances of her birth. If we’re interested in encouraging saving and investment over consumption, why not take a page from our gentle socialist friends across the pond? In UK, everyone is allowed the equivalent of $16,000 per year in tax-free capital gains. This means that most of the working middle class do not pay any tax on their investment income in their younger years since most of their income is wages. Talk about an incentive to save! Why not pay for at least some of this via a heavy tax on inheritances and “let each receive accord to her merits”?

The inheritance tax has almost no downside. It is, in every way superior to every other tax I can think of. Tax the dead. They don’t even vote!