Matt Nolan

Series on tax: Part 2 – distortions and burden

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Over at Rates Blog I have put up part 2 or a 6 part series on tax (it was going to be 5 but I’ve extended it.  In part 1 we asked “why do we tax“.  In part 2 we are digging deeper into the costs of taxation.

We focus on two specific issues, the way taxes distort behaviour, and the idea of where the burden of tax falls.  As we explained in the first article these issues are really really difficult to actually work out – and the purpose of the second argument is just to give a “flavour” to the argument.  In honesty, if you wanted to figure out the true burden and distortions you’ll have to get yourselve a series of these CGE modeling economists armed with other economists who focus on normative judgments.

Last time I promised to discuss tax systmes that seem idea, that we don’t use.  And why we don’t.  Well, that is now the next article.

Also, thanks to Agnitio who helped me clear up this article.  It is a fairly wonkish one, and he came in at the last minute and helped me clarify what the hang I was doing 😉

jamesz

Rodrik’s idealism

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In the aftermath of the Reinhart/Rogoff fiasco, Dani Rodrik has called for economists to stick to their knitting:

…economists [should not] second-guess how their ideas will be used or misused in public debate and shade their public statements accordingly. …few economists are sufficiently well attuned to have a clear idea of how the politics will play out. Moreover, when economists adjust their message to fit their audience, the result is the opposite of what is intended: they rapidly lose credibility.
…
economists should match honesty about what their research says with honesty about the inherently provisional nature of what passes as evidence in their profession.

Rodrik’s view is very noble but difficult to successfully implement. On the one hand we need only look at Paul Krugman’s slide in credibility among economists when he became a nakedly partisan blogger. However, avoiding any perception of political alignment is incredibly difficult and Krugman has become a household name with his writing for the NYT.

If you want to have some impact on policy then you need to confidently relate your research to the hot issues of the day. The majority of research slides by unnoticed because researchers are so concerned about remaining politically neutral that they’re afraid to voice a strong opinion on their work’s policy relevance. That’s understandable because having an opinion usually requires a few leaps of faith that aren’t fully supported by your evidence. For a start, research you started over a year ago rarely has the same currency when completed that it did when you started. If you want it to be noticed the press release and the substance may have to part ways slightly. Failing to make those leaps, sadly, is likely to condemn your research to irrelevance: it’s more important for the purposes of persuasion to be confident than to be right.

Facing that difficult choice it’s no wonder that many academics mix opinion with evidence in their public pronouncements. The technocrats of this blog may dream of a day that Rodrik’s mantra becomes the norm, but the incentives are against us.

Matt Nolan

Series on tax: Part 1 – why?

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Huzzah, I am writing about tax on Rates Blog.  In Part 1 I ask “why do we tax“.

I get onto other issues later – in fact, this will be a five article series.  Here all I do is combine the idea of “government spending” and “paying for government spending”, and give a little wink to ideas such as equity and tax incidence.  They will play a more central role in the next article, when I discuss tax systems that seem ideal … but that we don’t use for often good reasons.

Matt Nolan

Energy policy as a new policy issue!

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So we’ve had Labour and the Greens make the cost of energy the first big pillar of their upcoming election campaign.  The energy industry is important in a large number of ways, is something people care about, and is definitely policy relevant – so it is a good pick.  I’d note I don’t talk on “political levels” (my own failure to be sure), but it is a good area to discuss in terms of the policy society desires.

Now I’ll be honest that given this I was heavily disappointed with the analysis done by the Greens and Labour. There have been two good posts discussing the issues – Lance Wiggs and Seamus Hogan.  This isn’t going to be one of those posts.  Instead I’m going to complain about something.

I’ve seen lots of people on twitter bang on about “ideology“, “starting a debate”, etc etc … but the fundamental number they provided of an average household saving $230-$330pa is what MOST of the public cares about.  I respect the dudes and dudettes that have been saying “hey let’s just discuss energy policy”.  But I’ve just spent the last few days listening to a large number of my non-economist friends going on about how they like the idea that Labour is going to give them this money …

And that figure is a load of complete crud.

Ignore the BERL report here.  I have no real criticism of them – they were VERY transparent with their assumptions so I knew from the start that:

  1. They had assumed the energy boost was a given – they were told it by Labour and were just running a scenario,
  2. They had excluded government dividends,
  3. They had assumed persistently deficient demand.

Yes all these assumptions will in turn increase the size of the result – but none of them are actually too relevant to the claim that Labour and Greens are selling the most, that is will improve the money in your pocket.

Instead I get the feeling that Labour seems willing to ignore capital costs (I’d note the Greens do talk about the LRMC).  When looking at the electricity industry, we want to think about long-run marginal costs rather than short-run marginal costs – given that we are talking about an industry with massive fixed costs (huge costs of investment).  Kiwiblog suggests that this important point may have been put by the wayside, the use of the Wolak report gives further fuel to this fire, and finally via the Labour site:

Hydroelectric power makes up almost two-thirds of our electricity, and it costs next to nothing to generate because it uses free water and dams that were paid off years ago.

This is what the site says now – when it first came out it said “free water and dams”.  The change doesn’t matter though – as you still need to invest in new capacity as demand rises and you need to maintain the current capital stock!

Now, there are things that I would like to see work on (given I’m not an industrial economist, I don’t have the research and evidence in my head that other true industrial economists do).

  • Why has the relative price of residential power risen so quickly (relative to commercial and residential),
  • Why has investment in the industry seemed patchy at best?

Given that the electricity industry is probably the second most regulated and researched industry in New Zealand (I’m putting it behind telecommunications – although I may well have them the wrong way around!) the answers are probably out there, and ways to improve current regulation probably exist.  As a result of all this, the Labour-Greens decision to pick only a single report, misuse the figures, ignore the criticisms of those figures, and then publish a policy impact that is effectively a LIE is all the more disgusting – frikken ask some of the myriad of experts out there for some help making policy, hell some of them are Labour supporters and will likely to work at a cut price.

Sidenote:  National doesn’t get off for free here – socialism, communism, really?  In of itself a monopsony buyer is not something you can just rule out due to “ideology”.

Update:  This will teach me for commenting on blogs on a Saturday morning.  I didn’t mean to use the c word (not the really bad one), I’m trying to cut back on my swearing.  I do essentially think that the promised boost to income to people is a lie though – and I mean to use that as a loaded term – so I’ll live.

Matt Nolan

Minimum wage and tax on low income earners

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What would you say if I told you I was currently in control of a hypothetical little country in my head – other than accusing me of of having some form of psychosis.

In this little country there is a group of low income earners, who have a reservation wage (the hourly satisfaction from growing vegetables in their own garden) of $6hr.  There are also a bunch of high income earners that do what they do, and who the low income earners can’t replicate.  The kicker is that, the work these low income earners are able to do is only available from a cheeky monopsony employer!  This employer is able to extract $15 per hour of value from each of these workers, and since it has all the market power it only pays them $6 an hour.

Ok, now I’m a benevolent government in my mind – and I’ve decided this isn’t fair.  I’m trying to decide whether I should turn up an demand a $10 minimum wage, or whether I should put a 40% tax on just low income earners and then throw the money back at them.

Now you might think that what I just wrote was a typo.  Surely I meant “cut” taxes on low income employees – after all, higher taxes mean less income!

Some keen eyed may have noted that I said “throw the money back at them”.  They may say “what’s the point, you are taking money off them, having to pay for ‘churn’, and then giving them less back”!  Now for kicks, assume there is no churn in my tax system – it is in my head after all.

The majority of people at this point think that the tax scheme is just me being weird, and that it makes no difference.  However, the minimum wage would increase the wage, so lets do that.

But, what would you think if I told you that, given all these assumption, they actually have the same result!

What

Many people would say that the tax is 0.4x$6=$2.40 per hour and the transfer back is $2.40 per hour so it cancels out.  But this involves not considering the incidence of tax.  Our low income employees have NO bargaining power, they are paid the least possible by this monopsony employer.  However, they will not work for less that $6 an hour that is their reservation level.  They still need to be paid this NET of tax in order to supply their labour.

As a result, the firm needs to offer to pay a GROSS wage of $10 an hour – $4 is paid in tax, which is then given to the low income employee regardless of whether they work!  So by taxing the employee and then giving them the tax money back irrespective of work, there effective wage goes up to $10 per hour!

But this isn’t realistic!

Indeed, it isn’t in the slightest.  However, here we are using the assumptions that are common regarding why a higher “minimum wage” is good and showing that those same assumptions also suggest that we could tax low income earners more and transfer the money back to them – and they end up with higher after tax income!

Now the devil is in the details.

  1. If the tax money is only returned if the employee is working, then we don’t get this result.
  2. It is unlikely (in either case) that there would be “no employment effect” – the firm will still not hire, or employee hours, of someone they would have otherwise.  Note that if we refuse this assumption in the case of increasing taxes only on low income earners we are ALSO refusing it for the case of minimum wages!
  3. We don’t really have monopsony employers anymore … but again this is a common assumption for the minimum wage argument.
  4. Fundamentally, both the quantities of supply and demand will “respond” somewhat to changes in price (the wage), and as a result the incidence of the tax itself is not so one sided.  However, if the transfer is without churn (and churn is pretty small nowadays) we are just taking that tax chunk that is ripped out of surplus and giving it to employees … just like we stated!  We just have the additional people who lose out from not being employed and the associated dead-weight loss.
  5. If we transfer the income to the low income group who are still employed and those who are not employed (so assuming lower employment occurs), then the difference between the tax case and the minimum wage case is that those people who get left out of work are better off in the tax case, to the cost of those who manage to get work (who are still better off in the no policy case in this example).
  6. The real dynamics, and what we can really observe and respond to, are entirely different to this – this is a thought experiment that isolates tendencies stemming from these policies.
  7. If the industry is a large part of the economy, this business gets even more complicated ….

What I would note though is that, the less market power we assume our employees have, and the lower we expect the employment effects to be, the closer we get to this situation – the more of the incidence of taxation ON these people actually falls on their employer!

A lesson

There is something pretty thought provoking to come out of this example though.  We have discussed a case where taxing someone, and then giving them back the money made them better off in a redistributional sense – because prices changed.  Even though we “taxed the employee”, the incidence of tax fell on the employer, and so we transferred income from one to the other.

Many people will look at a situation and say “I want to help those people, let’s cut tax” – but we need to actually ask about the incidence of tax, and the response of government spending to the lower revenue, before we can articulate who wins and who loses.  There is FAR to much arbitrary moralising by people regarding tax rates, without any clear indication that they have thought about tax incidence when coming to their conclusion.  And if you don’t think about the incidence of tax, you are stating an opinion on tax based on no thought … I have to be blunt.

As a secondary result, hopefully by “reframing” the minimum wage argument using different words, people can look at the issue with more critical eyes – yes it should provide a transfer, but who the transfer is between isn’t always clear!  The reason some people prefer direct tax credits and direct income transfers isn’t because we are being pedantic – it is because the actual distributional consequences are clearer and more proven … it is because we want to ensure society’s wish to help people (if it has this desire) does just that, rather than using poorly designed policies that merely “show the intention” of helping.

Matt Nolan

A $19hr “living wage”, wtf

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Warning:  I’m not an economist in this post.  I’m telling you what I think, don’t expect me to be nice as I’m not intending to be.  If it insults you I’m sorry, take it as a representation of my depth of feeling around the issue rather than a sledging if you can.

Let me start this by underlying everything with a certain point – living wages are idiotic if our concern is to make sure that the worst off in society have a sufficient income.  By imposing a “price floor”, you are ensuring that there are a group of people who can’t get jobs and will get hurt – unions don’t care because they don’t represent the unemployed, but I find it morally abhorrent.  You want a minimum standard of living for societies worst off – have a minimum income, it’s as easy as that.

Now this article in the Herald says people need $19hr to live.  What, when we think about the ability to live we actually need to look at access to income not hourly wages right?  When they release their full “analysis” I’ll be sure to say why this is nonsensical (eg where are lifecycle earnings, investment in human capital, defining necessities, access to credit etc) – but for now whatever.

Let’s take someone working full time at $19hr.  What does this person earn pre-tax $39,420pa (this excludes benefits which they are targeting to increase it further). What is nominal GDP per capita.  $47,157pa.

So either we have a society where different types of labour, and different peoples requirements for income (eg a 18 year old and a 57 year old), aren’t terribly different and so people shouldn’t get paid very differently – and as a result the potential worker who “offers the least” may well still get hired – or this will lead to higher unemployment and cut backs in hours for these people.  Who won’t get hired in this sort of situation – people that are risky to hire or haven’t developed skills yet.  So the young, the vulnerable, those that have been out of work.

I mean I swear to god unions, and their determination to get what they want without thinking about the consequences for other people, makes me sick.  There are people who struggle, and as a society I think we should try to help them – part of this is ignoring faux research by unions, and making sure that we actually push government to sufficiently redistribute to the poorest among ask (with the acknowledged cost that this redistribution does lead to less income/production overall).

Yes I know, I’m a “capitalist” right wing economist blah blah blah – but when people choose to actually think in terms of costs and benefits we can actually have a sensible discussion about social justice, and how society is willing to trade-off between equity and efficiency.  Introducing a policy like this isn’t just inefficient, it is inequitable and unjust – and will hurt those who are already the most disenfranchised.

Sidenote:  You may say this is unfair as they aren’t saying “make this the minimum wage”.  But think of it this way, they are trying to make the case for $19, so they can turn around and make $17 seem like a reasonable demand – while still ignore the costs stemming from this.  It is a misinforming marketing tool – that hardly makes it better!

Sidenote 2:  No offence but an actor that can’t get a sufficient wage is receiving a signal to look for other work – if you can hardly pay your bills and decide to continue acting you are “consuming” that acting.  If you can’t afford to live because you are busy with that, it’s your own fault.  Be careful asking for a higher minimum wage, it is likely you just won’t be able to find any work at all.  Remember, when computers with economics word generators replace me I’ll have to do the same thing.

Sidenote 3:  I am surprised that a church allowed a union to talk them into making it an issue of wages instead of income adequacy – I don’t remember catching the part of the bible that said that only those who have the opportunity to work given their endowment and the arbitrary policies of government should be allowed a minimum living standard.  Was there a “parable of the deserving poor” where we are taught to decide who deserves society’s support and who doesn’t?