How to stop inversions: increase the corporate tax rate. Yeah, you heard me.

I’m not going to write about the Netherlands today, even though Craig said I should.  He said that because I’ve had an inexplicably large number of blog hits from the Netherlands lately, and he wanted to see what would happen if I actually wrote about the Netherlands, just as an experiment.  Maybe just using the word “Netherlands” a lot of times in this first paragraph will be enough to conduct at least a minor experiment on this question.  (Just to be clear, for casual visitors who arrived here by taking a wrong turn at Google, an “inexplicably large number” in the case of this blog is 40 or so on several recent days.  Other than my friends, I get only  a few visitors.  Which is ok; I’m just one more economics blogger in the vast universe of economics bloggers, and many of the best economists on earth have excellent blogs.  But here are the numbers: even though I haven’t posted anything since July 20^th, and have only written four entries this year, I’ve had 515 hits in the past month on this blog.  241 of them---nearly half---were from the Netherlands.  I don’t have any idea why.)

Here’s what I am going to write about: Charles Krauthammer, Dean Baker, Jared Bernstein, Matthew Yglesias, Josh Barro and a whole bunch of other responses to the recent excitement about “inversion”, corporations moving their headquarters to other countries to escape high tax rates here in the United States.  I mention Krauthammer first because (and this shakes my faith in myself to the core; if this keeps up I’m going to stop reading my blog altogether) I agreed with almost everything he said.  Almost.  I also agree with Baker and Bernstein, mostly, although they were writing to dispute each other.  After a couple words about inversion, or maybe tomorrow, I’m going to add a word or two about the relationship between taxing corporations, which is what this issue is about, and taxing capital, which is way more interesting than it sounds, and is sometimes mistaken for the same issue.  (Hint: they are not at all the same issue.)

The first thing I want to say about inversion is to speak as a liberal to my brothers and sisters on the liberal side of the political spectrum, and to the White House.  What I want to say to them is this: chill freakin’ out! If you keep hyperventilating you’re going to faint.  Obama’s fevered reference to “corporate deserters” is irrational, and unfair.  It’s silly to blame corporations for doing whatever is in their best interest to do, as long as it’s not illegal or immoral, and seeking out the best legal tax environment is neither.  It makes no more sense to blame corporations for seeking most advantageous location to settle in than it does to blame rivers for flowing downhill instead of up.  Water seeks the lowest point it can find, and corporations seek profits.   After-tax profits.  That’s what they’re created to do. 

Here are the raw numbers from the OECD on total corporate tax rates.  The table combines “Central and Subcentral” taxes, which means that state and local taxes are included.  There’s a scroll-bar at the bottom so you can move through the years from 1981 to 2013.  If you do that you’ll notice that the issue is not that our tax rates are historically high, but that other nations have reduced their corporate tax rates over time to draw businesses.  There’s been a race to the bottom in corporate tax rates, and we have chosen not to compete in the race, or not to compete as vigorously as other countries have.  In 1981 our corporate income tax rate was 49.7%; now it’s 39.1%.  By contrast, Sweden’s corporate tax rate in 1981 was 57.8%, and now it’s 22%; Ireland’s was 45% in 1981, and now it’s 12.5%.  We have the highest corporate tax rate in the OECD table now, not because our taxes have gone up---they haven’t---but because everyone else’s tax rates have come down so much farther than ours have.

Krauthammer says that the solution to the problem of corporate flight from high tax rates is tax reform here, rather than building a legal wall to keep corporations from leaving.  So far I agree completely with Krauthammer, which is, as I said, disturbing. Later in his column he does recognize that the 35% top federal corporate tax rate is not really the effective rate that corporations pay: because of loopholes some of the larger corporations, according to Krauthammer, have effective tax rates of 13%.  I’m not sure where he got that figure.  Some corporations, some years, pay no taxes at all.  And this matters: corporations’ decisions on whether to move to another location will be based (in part) on the effective overall tax rates they pay in each place, not on an imaginary top possible rate.

Of course Dr. Krauthammer blames Obama for the lack of corporate tax reform, forgetting that there are big differences of opinion on what constitutes “reform”, and also that if Obama proposed a bill honoring motherhood and entirely eliminating corporate taxes the Republican house would be bent double in a seizure of feigned indignation, and would threaten to throw Boehner out of the House leadership if he even brought it to the floor, which, of course, he would not do.  They would turn it into a scandal of some kind, God knows how.  Darryl Issa would hold hearings on whether to impeach Obama and Hillary Clinton and possibly Bill Clinton and John Kennedy too, for proposing such things; his committee would eventually produce a final report at enormous public expense basically exonerating everyone on whatever they had decided to be upset about, and Fox News would ignore the final report and maintain their outrage on the grounds that, well, on the grounds that outrage is more fun than pretty much anything and anyone who exonerates Obama or Clinton is a poopy stupid-head.  So I disagree with him on whom to blame, but that’s secondary.  The real question is what we should do now.  And “tax reform” is as good a name for what we should do as any.  But to Krauthammer and most people on the right (and many on the left), “tax reform” means reducing the tax rate, but eliminating loopholes so that the action is revenue neutral.  In other words, reduce the top rate, but keep the average effective rate the same, more or less, which, if effective tax rate is the motive, doesn't really sound to me like it would reduce the incentive for corporations to find some other lower-tax location for their headquarters.   And also, the first part of that (lower rates) is easy, the second part (eliminate loopholes) is damned near impossible, as Matthew Yglesias points out at the link above, which is why it’s so hard to get done.  And anyway, as I’ll explain in a minute, this is exactly the opposite of what I think corporate tax reform should be.

Now, I’ve said before that I don’t like the corporate income tax anyway---if there were a way to do it I’d favor a zero tax rate for corporations.  I’ve written about that here on this blog.  Corporations are not people, so they have to pass the taxes we levy on them along to real human beings one way or another, and it’s not at all clear that the owners of corporations pay all of it, or even most of it.  From Matthew Yglesias:

“An interesting theoretical question is who actually does pay the corporate income tax? Does it fall on workers? On owners of land? On owners of capital? I can assure you that after reading a few papers on this thanks to the National Bureau of Economic Research's search tools that the answer is credible researchers disagree and the answer is highly sensitive to modeling assumptions!”

When I first said that decades ago, and even fairly recently, people on the liberal side of the world were aghast at the thought.  But apparently there’s been a revolution brewing that I never saw.  Dean Baker’s post, at the link above, comes out in favor of eliminating the corporate tax and raising the tax on the wealthy to make up the lost revenue.  Josh Barro, at the link above, suggests the same thing. 

But Jarred Bernstein raises the issue that has always actually given me some pause, and states it so well that I have to change my mind about eliminating the top corporate tax rates.  As he says (at the link above), eliminating corporate taxes:

“risks turning the corporate structure itself into a big tax shelter: If income generated and retained by incorporated businesses should become tax-free, then guess what type of income everybody will suddenly start making?”

Yeah.  Dammit.

So eliminating, or even reducing, the corporate tax rate is not a good idea.  Time to uncork the theory of the second-best, then.  If we can’t reduce rates to zero because ordinary people would suddenly become corporations, I’d suggest that corporations should pay the personal tax rate on their income, so there’s no incentive at all for people to pretend to be corporations as a way to shelter their income from taxation.  But I still think that corporations should pay zero or near-zero effective income taxes.  In other words, we should raise tax rates and increase tax deductions (which is the other word we use for “loopholes”) not just to be revenue neutral, but to drive revenue from corporate taxes down near zero.   Of course, there would be a huge fight about which deductions are worthwhile and which are not, and how to design the system so that all industries have exactly the tax breaks they need to get them to zero effective profit tax.  And yes, that means that we would need to raise the lost revenues elsewhere.  But there are plenty of good options: how about a carbon tax to fight global warming, or other Pigovian taxes to internalize production costs and promote the general welfare (which according to the preamble to the Constitution is one of the primary goals of the government that constitution created)?  How about a financial transactions tax to reduce computer driven speed trading in the stock market, which seems to have no purpose other than to make money for the computer’s owners and lose money for everyone else?  I know, those would be big political fights, but the point here isn’t what’s easy to do, it’s what might be good to do if we could.  And if we could reduce the effective tax rate to zero by adding good loopholes, that would also eliminate any reason for corporations to move somewhere else---unless the other location had effective taxes less than zero.

See?  Definitions of tax reform differ from one person to the next.

I guess I’ll talk about taxing capital tomorrow. 

Frayed border. Or 'fraid knot.

Just a quick rant on the border children.  Please, if you have an opinion on this, leave a comment.  I’m not an expert on any part of it, so please educate me.   But I can see what it looks like: a flood of refugees, as we have seen in this world in other places and at other times, fleeing from wars or disasters.  Only in this case, at this time and at the border of our country, there is a very large component of young people, mostly teenagers but also younger children, in this refugee population.

Here is the data.  (Always nice to start with the facts, don’t you think?)  Go ahead, take a look, I’ll wait.

Notice that in every sector except Tucson the “apprehension” of “unaccompanied alien children” has had a huge increase, but in one sector, the Rio Grande sector, it has been staggering: from 14,565 in 2013 to 42,164 in 2014 (which isn’t even over yet!).  That’s an increase of 189% so far and it will be far larger by the time the year is over.  But even that understates the problem, because there has also been an over 500% increase in that sector in the apprehension of “family units”.  These are people that seem to be traveling as a family.  But it’s more than possible that a very large number of these family units were not families when they started their journeys toward refuge.  Some “families” were probably formed rapidly as the border approached, so that the adults involved could have a better chance of staying here for at least a while.

Congress, of course, is going on recess.  But I’m tired of complaining about Congress.  Let’s discuss this among ourselves, and let them pursue their bewildered irrelevance at their leisure.  They are involved in a deep argument over whether this influx resulted from a 2008 law passed under George Bush or from a more recent executive action by Barack Obama.  Both of those may contribute, but to attribute the flood of refugees to either of those is just wrong: the cause of the flood is not a porous border or leniency for children.  The cause is that the life they are fleeing is enormously worse than the life they expect when they get here, and that life, the life faced by those few who are allowed stay, is no picnic.  They will be paupers, and illegal immigrants with no rights here at all.  And the journey they undertook to get that dismal chance was long and terrible. 

But what they left is overwhelmingly worse.  It must be worse, or why would they come?

There are several pieces in the Washington Post this morning on this, but there is only one that is required reading.  Oscar Arias (Nobel Peace Prize winner and twice President of Costa Rica) wrote this article on the Opinion page in the front section.  If I quoted as much of his comments as I’d like to I’d undoubtedly run afoul of some copyright law, but let me give you this much:

“The conservatives who oppose President Obama’s request for emergency funds for the crisis criticize him for dealing only with the symptoms and not with the ‘root cause’ of the problem. They are half right — but the half that’s wrong is very, very wrong. For them, the root cause is a lax immigration law, weak protections or insufficiently severe punishments. But no punishment, no wall and no army can solve this problem…If these children … are willing to risk their lives atop the infamous train through Mexico known as La Bestia (“the beast”), face the rape and abuse that many children experience during the journey, sell their possessions and their bodies, and give their life savings to unscrupulous smugglers, what else could possibly deter them? What can the United States do to these children that would be worse than what they are already suffering? And why is such a great country even asking that question?”

Yes.  They face certain danger, hunger and abuse on the road here, a high probability of rape, or of being sold into servitude, or of death.  They are leaving the country they know, the language they know, the customs and people they know, their families, their friends.  What punishment can we impose, what deterrent can we bring to bear, that is worse than what they are enduring to get here?  We can send them “home”, to face dangers that they think are even worse than the journey here.  And if we don’t make an anguish for them here that is worse than the one they are fleeing, they will continue to come.  This is basic economics: these people are making, we assume, a rational choice, weighing one set of risks against another, and will continue to make that same choice as long as it appears to be rational to do it.  

But it’s the last question in that list that haunts me.  Why the hell are we talking, and waiting, as though this were simply a dessicated debating point?  Why is a great country, this great country, my great country, asking that question?  There are tens of thousands of children who need help, who are desperate and alone in the world, facing poverty and legal limbo if they are allowed to stay and vastly worse poverty and violence if they are sent back home with no support and no help from the world.   

Arias goes on to say:

“The root cause of this crisis is not U.S. immigration law or the policies of one U.S. president. The root cause is the violence and poverty that make these children’s lives at home intolerable. The root cause dates to the parents and grandparents of the young people fleeing their countries today — our region’s ‘lost generation,’ those who were children and teenagers in the 1980s. Back then, two superpowers — the United States and the Soviet Union — chose our region as a place to work out their disputes. They were eager to help Central America transform students into soldiers. They were eager to provide the weapons while we provided the dead.”

Does he sound bitter?  Maybe.  But he lived through that period; he was President of Costa Rica the first time from 1986 to 1990.  And his comments make sense to me.  But in truth it doesn’t matter much right now who we blame, or how far back the blame goes.  It doesn’t matter whether it is Obama’s fault, or Bush’s fault, or the cold wars, or the drug wars. 

What matters, for the moment, is the present tense, not the past tense or even the future tense; what matters is the human story, the many human stories, appearing on our side of the border every day.  They need shelter, and food, and medical care.  We know how to provide those; we’re probably the best in the world at that task.  Every time there’s a disaster anywhere on earth---tsunamis, earthquakes, volcanoes, hurricanes---our rescue teams and our Coast Guard and our National Guard, and our Marines, with all their ships and aircraft and trucks and ambulances, and thousands of eager young people who want to make a difference in the world, show up to help. 

I’d like to invite the President and the Speaker to please get their heads out of their darker and more political body parts.  But if they can’t manage that, maybe the rest of us can.  Let’s take care of those children.  We can assign blame, and choose what path we want to take to make the world harsher, and colder, and less human, when we’ve got the current flood of children cared for.

Or---once the immediate crisis is under control---maybe we can undertake the radical (from the root) solution everyone says they want.  But that won’t involve some fiddling fix to our immigration laws.  Since, as Arias argued above, nothing we can do here will make our border harsher or colder than the situation these people have left behind, why don’t we take the alternative path.  Instead of making things worse for them here, why don’t we work with the Central American countries they’re escaping to make things better for them there? 

Naah.  Maybe that’s a bit too radical.

Here's to burned burgers and other carbon based products

It’s July  4, 2014, Independence Day in the United States.  It’s appropriate to write something thoughtful about the history of the country, the meaning of the revolution, and all that---but it was a rebellion, and in that spirit I think I'll reject the cultural pressure to write about the whole 4^th of July thing, and write about something else entirely.  I won’t even offer up an old family recipe for brioche hamburger buns or watermelon-wine sorbet or anything.   The Washington Post op-ed page is full of that stuff, so I’ll just link to Samuelson, which, astonishingly, I found worthwhile today, and to Gerson too, who is almost always worthwhile even when I completely disagree with him.

So yesterday I was grazing through the econoblogs and followed a link to this discussion of the carbon cycle by Dr. Peter Dorman, which I thought was interesting and unusual in a site called “EconoSpeak”.   The theory here is that emissions from gas-powered cars and coal burning power plants should not be considered “pollution” in a strict sense.  Really, he says that.   Here’s a quote:

“People whose actions move carbon into the atmosphere are not necessarily ‘polluters’.  We’ll see this later when we look at electric cars.  The fact that carbon goes out my tailpipe but not yours doesn’t mean that I am a carbon polluter when I drive and you’re not.  As you can imagine, this misunderstanding plays havoc with the industry that calls itself carbon accounting.”

His idea is pretty straightforward, actually, and captured in the line "carbon will find a path".  What this means is that once carbon is extracted from a safe sequestration far under the earth, it will spread itself out into the world, including into the atmosphere, no matter how it is used.  The carbon cycle will extract it from whatever use you put it to, use it, spill it, twist it, turn it upside down and inside out, and in the end some fraction of it will be contained in plants, some in animals, some in the (shallow, accessible) ground, some in the surface ocean, and some in the air.  Cars and factories are not the culprit: they are the most common direct path of carbon dioxide into the atmosphere, but not the ultimate source.  There is only one act in the carbon cycle that can be described as causing carbon pollution: extracting carbon from deep in the earth and adding it to the carbon cycle up here in the surface world.  The extraction of oil, coal, natural gas, or any other carbon-rich substance from deep isolation liberates it, and one way or another some of it will eventually enter the atmosphere, period.  Like melting water on a hilltop moves in rivulets and then streams, or soaks through the earth, or in sliding ice-packs that we call glaciers, by one path or another it moves downhill, carbon will move by one path or another to all the repositories it uses, including the bodies of living things, surface earth, surface water and the atmosphere.  Once freed from captivity in the deep earth, it will inevitably get to its various destinations in balanced proportions.  That’s the idea.

But if not through factory  or car emissions, how does it get from the surface in solid or liquid form into the air as a gas?  Well...the two most widely discussed atmospheric gasses that contain carbon are carbon dioxide and methane.   Biological sources account for significant amounts of the methane in the atmosphere. For example, one of the famous sources of methane pollution in the atmosphere is flatulence, the emission of excess carbon and hydrogen from the earth's 1.4 billion cows, or from its 7 billion people, or 19 billion chickens, or untold trillions of termites and methane producing microbes in the oceans, swamps and land fills.   So if it's true that "carbon will find a path", and if we eliminate factories and cars by, for example, taxing them out of existence, we haven’t solved the long run problem.  Carbon will just find its way into the atmosphere in other ways, possibly through increased (or prolonged) excretion of methane from animals.  It may take longer, but if he's right, then eliminating carbon dioxide pollution from factories, power plants and cars only means that we'll fart our way to global warming.  It might take longer but we’ll get there in the end.

Dr. Dorman didn't say this, but a fanciful vision I had when I read his blog post is that the release of new carbon from deep in the earth enables population explosions by providing the raw materials required to build new living bodies: all those new living things are built from carbon and that carbon has to be available.  More carbon, more plants, livestock, people and microbes---and more carbon in the air from biological emission sources.  Once we dig it up, it finds a way into the atmosphere, even if that involves using itself to build a lot more of us, and using us and our farms and waste dumps as a pathway into the air.

But that means that a carbon emissions tax on factories is the wrong approach: that just taxes the symptom.  What we need is a tax on the real source of carbon pollution: the extraction of carbon from deep isolation in the earth.  This would make gas and coal more expensive, and alternative energy sources more attractive, and would discourage carbon extraction into the surface world carbon cycle.

I'm not sure I completely buy the inevitability of it (there may be ways to re-sequester the carbon, to extract it from the air and capture it in a more or less isolated form), and reorganizing the emission sources away from factories, power plants and cars will at least slow the process, so I'm not really willing to abandon my support for carbon emissions taxes and subsidies for alternative industries that don’t push carbon directly into the atmosphere.  But the story has a strong logic, doesn't it?   Moving away from carbon fuels will slow things down, and so it’s a good idea for the “short run”---say, 50 years, or 100 years, or 1000 years---but to solve the truly long run atmospheric carbon problem we have to capture as much carbon back into a sequestered form as we liberate.  That “carbon cycle” also has to balance, or we have no long run chance to avert global warming.  So tax the source, and let the price mechanism induce a flood of ways to do without it.  And subsidize technologies that sequester carbon (artificial diamonds?) to extract the carbon from the system.  

The point of this notion is that it doesn't matter how we use the carbon once it's loose in the surface world.  What matters is that we need it, and where we get it, and how we can remove it from the whole system, not just from the air.

Interesting.

Happy 4^th.

A puzzle on St. Patrick's day

First, a link to the greatest St. Patrick’s day video of them all:  go here to elevate your vision and salute the true meaning of the day, as I do every year.  Well, every year since 2011.  Go ahead, I’ll wait.  When you get back I have a puzzle I want to discuss.

Ok…the puzzle is this: why is everyone so dismal?  And by “everyone”, of course, I mean economists.  Oh, I know economics is called the dismal science, but that was just Carlyle’s response to Malthus, and more generally everyone’s response to the iron law of wages and all of that.  But for the last century or so the iron law of wages hasn’t seemed quite so relentless.  Economics has moved on.  Hasn’t it?  Most of us, at least in the more advanced economies, live at well over subsistence level these days.

So I was going to write something about the CBOs dismal outlook for the next few decades, which I think is premature at the very least.  They are forecasting continuing deficits as far as the eye can see---that’s ok, we almost always run deficits so that’s a pretty safe forecast---but they’re expecting large deficits, weak economic growth, and high (or what they would call “normal”) interest rates, all of which mean that the national debt as a fraction of GDP will grow.  A recent post by Robert Barbera pointed out that weak economic growth and high interest rates are an odd combination in a forecast; usually high interest rates occur (and the Fed allows them to occur) because of robust demand for investments, meaning that the economy is growing at a healthy rate.

I was going to write that the CBO’s recent long-run forecast were unduly dismal.  The CBO has a pretty poor record for long-term economic forecasts.  Of course, so does everyone else.  We do ok on short term or medium term, most of the time. We’re usually (not always) ok on forecasts out six months or so, even a year or two.  But nobody gets 30 year forecasts right.  So the CBO forecast of unrelieved debt as a share of GDP seemed to me to set a special standard for cocky dedication to dismal.

But then I read this from Paul Krugman the other day.  It’s not Krugman’s view, it’s Thomas Piketty’s view in this book, as reported by Krugman, that staggers me.  The CBO’s long run expectations are a tiny forecast for a few decades out, in one country, and there are things that can be done about it if you believe the forecast and can get past Congressional gridlock.  Minor stuff compared to the Piketty vision.  Now, I haven’t read the book, so I’m reporting second hand.  But reading through Krugman’s description, it sounds like a forecast of pitiless and inevitable doom for nearly all mankind, and for nearly all time.  This recent joyful period of broad prosperity that we have experienced since the mid-nineteenth century is, in this view if I understand it, a historical anomaly, a temporary accident, and the age of Malthus, the iron law of wages, will return by the end of this century.  Few people will have any economic security in that dreary future, even fewer will have wealth.  Oh, there will be national wealth---but it will be narrowly owned. There will still be economic growth.  But the wealthiest, the rentiers, will gobble it all up, leaving the rest of us to scrabble desperately for our daily food.

You can read through the Krugman piece if you are in the mood for some mildly wonkish modeling, but here’s the gist of it in one picture:

In this graph, the line with black diamonds represents the rate of return to owned assets, and the line with the open squares is the global rate of economic growth.  If the first line is higher than the second, then the asset-owning class will get richer faster than the economy does, which means that income distribution will become more and more unequal.  It’s a long run prescription for a small aristocracy and a mass of hungry, hopeless serfs.  On the other hand if economic growth is higher than the rate of return to ownership of assets, then the asset-owners will gradually get richer, but the whole economy will provide enough so that the rest of the population rises even faster: the wealthy must continually refresh their wealth by contributing new substance to the economy, or they gradually, over generations, fade back into the general population.

It’s interesting to look at the difference between the period before about 1913 and the period between 1913 and the present.  I’m curious about the source of the data, and the criteria by which time periods to present were selected.  I mean, there was a massive change somewhere between 1820 and 1950, but it’s not clear from this graph when that change happened; we only know that 1913-1950 as a whole period was very different from the whole period from year 0-1913.  Why?  Well, we can credit technological progress, I suppose.  We can credit democracy. We can credit the emergence of merchant banking, and national banking, and the gradual abandonment of the gold (or other physical stuff) standard.  I’m not sure what Piketty’s explanation is; clearly this book needs to be on my reading list.  

But what interests me most is the final two periods depicted in the graph.  Why does Piketty forecast a return to 1.5% growth in the period from 2050 to 2100?  And if the trend line is extended, maybe he sees a return to the period before 1820 when growth was less than 1% per year, generally significantly less.  Why does he forecast that the return to asset ownership will once again soar to over 4%, and perhaps higher in later years?  And this awful trend is completely separate from other apocalyptic future events, such as global warming; this calamity would happen in addition to that.  

This matters.  Is there really a purely economic reason to believe that the future is so dismal?  Or is this forecast just one more bit of panicky pessimism, which will be forgotten when “animal spirits” rebound and new technologies arise to boost growth again?  Is this new avalanche of dismal economics real, or just evidence that we’re all tired, and discouraged?

I’m going to be interested to read Krugman’s next installment in his book review. I’m going to be interested in the book itself.  I have trouble accepting a future that bleak.   I have trouble accepting a general attitude in economics that assumes a future that bleak.  Come on guys.  It's St. Patrick's day.  Lighten up.

Talents, intelligence, work ethic, and sweet economic syrup.

It’s been so long since I wrote in this space, or any space, that I can’t remember how to string words together.  But I want to respond to something in the Washington Post last week, a letter to the editor that struck me, from a gentleman named Mark Swierczek, which was itself responding to a previous letter from Robert Sutton.  Both letters were expounding on the value and inevitability of income and wealth inequality in any free society.  And both seem to me to suffer from a special form of self-inflicted ideological blindness that appears, if looked at with gauzy, vacant eyes, like clean and simple logic.  

Here’s what they said, in their words.  From Robert Sutton:

“Income inequality is the natural, expected and welcome consequence of an economically free society. Absent the shackles of an overreaching government and social engineers, income will flow to those with greater talents, greater intelligence and the strong work ethic to use their God-given blessings. Governments that try to reverse that flow will be forever tilting at windmills, since nature never will stop working against them.”

And from Mark Swierczek:

“Income inequality is, in fact, the force that drives our economy. By rewarding achievement, income inequality provides the motivation for people to work hard and be successful, much as winner-take-all prizes in sporting events lead to the most-contested, best-played games.

In a free market, income inequality is also self-correcting since, as people work their way to the upper end of the income range, inequality is naturally reduced. Programs intended to reduce inequality via artificial means, on the other hand, tend to reduce economic incentive and therefore perpetuate the very inequality they are intended to address.”

These two letter writers believe that inequality is acceptable, even virtuous, because it is the combination of an unequal distribution of virtue combined with virtue-dependent economic mobility.   And there is a morsel of simple truth, of common experience, in that, which makes it appealing.  People who work harder, with better attitudes, and who have better educations, do seem to get ahead faster, on average, than those who are lazy, or ignorant, or sullen.  But why are they telling us this obvious thing?   I think they’re arguing against a proposition that no prominent economist, politician or columnist has ever made: no one wants to impose absolute income or wealth equality, and no columnist I have read has proposed that we eliminate differential rewards for hard work, intelligence or creativity.  We’ve always had income differences, and for large periods of our history that has been unremarked, because it was unremarkable.  The alarm, when it has been sounded at all, is about the rapid increase in income inequality in the last thirty-five years; it is that all of the benefits of growth, and of increased labor productivity, over those thirty-five years have flowed to the very top of the income scale, and not to the labor whose production has increased.  It’s about the rapid cultural change that has been highlighted in the work of Thomas Piketty from the Paris School of Economics and Emmanuel Saez at the University of California at Berkely, which showed in graphs that after a long period of relatively egalitarian economic growth we have now returned to the kind of income inequality that characterized the gilded age.  A graph like this, using data from Piketty and Saez, was posted in the very first post in Paul Krugman’s  NYT blog.

There’s a great deal to say about the potential negative economic impacts of income inequality that balance the positive impacts the letter writers describe. But I don’t want to dwell on that in this post, or on the Piketty-Saez data, because I think the letters above from Mr. Sutton and Mr. Swierczek make a more basic mistake.  They may not find the change in income inequality relevant, because their subtext is that inequality itself matters much less than the income mobility that creates it.  The subtext is if we diligently apply our “greater talents, greater intelligence and the strong work ethic”, we will be rewarded with a higher place on the income scale, so the station we hold in life is the station we have fairly earned.  All of which sounds simple and compelling---and all of which is flatly contradicted by the evidence of the real world.  The vision described by these two letter writers, which is a syrup of classical economic theories so distilled and simplified that few classical economists would swallow it straight, may describe some forces that are at work in the economy, but there are clearly other forces at work at the same time.   If this vision alone described the world then differences in income inequality from one period of history to another, or from one country to another, could be explained by changes in the degree to which economic virtue is rewarded at different times and places.  Hard work and talent would propel us farther, and create larger income inequalities, when economic mobility was high than when it was low, just as an object slides farther on ice than on asphalt.

But the by now well-known Great Gatsby curve shows that exactly the opposite is true.  Higher income mobility between generations is associated with less income inequality, not more.

Here’s one version of the curve, from this study by the Center for American Progress, written by economist Miles Corak:

This curve plots the level of inequality in developed countries against the intergenerational income mobility in those countries.  Countries farther out along the horizontal axis have more unequal household income; in this chart, the United States has---or had, in 1985, when the workers now reaching their peak earning years entered the workplace; this data describes the income inequality of their parents---the highest level of income inequality of all the countries shown.  And income inequality in the United States has exploded since 1985!

Countries higher on the vertical axis have a less income mobility between generations (or, put differently, a higher impact of parent’s income in 1985 on current income of their children reaching their peak earning years).   A quick glance shows that the correlation is just the reverse of that implied by Mr. Sutton and Mr. Swierczek .    If they were right, then countries in which your success depended only on your own worth and your own work rather than on the advantages your parents could provide, countries in which income could “flow to those with greater talents, greater intelligence and the strong work ethic to use their God-given blessings” would have high income inequality, since the economy would unequally reward hard work and effort.   The upward slope of the fitted line shows exactly the opposite.

The United States is among the most unequal and least mobile societies in this group; only Italy and Great Britain have less economic mobility between generations.  The American dream of rising from humble origins to great success, or at least greater success than your parents experienced, is less likely in the United States than it is in Canada, or Australia, or Sweden---and far less likely than in Finland, Norway or Denmark.

(To be fair, Mr. Swierczek does claim that in a free market with nothing to restrict income mobility the striving of those lower on the income scale to rise will cause income inequality to “self-correct”---but this must mean that in his view Norway, Sweden and Denmark with their substantial welfare states financed by high taxes have much freer markets than the United States does, since their income inequality has “self corrected” while ours has not.)

Of course the existence of a correlation between income inequality and income immobility does not imply that one causes the other, but it’s easy to come up with arguments for causality in either direction.  For example, income inequality may provide incentive to succeed, but incentive alone is not enough: incentive must be combined with opportunity, and opportunity is neither free nor distributed equally across the population.  Those who begin with high family incomes can buy more of it, for themselves and for their children, than those who do not.   So income inequality may create less income mobility.

It’s also possible that income immobility contributes, after multiple generations, to increasing income inequality, simply by building inequality between families as a residue over time.  So less income mobility may create income inequality.

It’s possible to look outside this graph for causation, too; there are clear correlations of each of these two variables with some third characteristic (race, for example, or education) that continues across generations. The “greater talents, greater intelligence and the strong work ethic” will have a smaller reward for those held back by discrimination on the basis of race, or gender, or religion, or any other characteristic, than for those who are not.  Educated parents read to their children more, and instill respect for education in those children, so the children of educated parents do better and go farther in school.  And other differences between wealthy and poor contribute to income inequality for at least one generation, such as family structure: poor families are more often single-parent households than rich families, and that fact may create more resources on average---a greater variety of adults to turn to---for the children who live in wealthy households. 

So the path to a more equal distribution of income may through a more equal distribution of opportunity, and a more equal reward for the hard application of work, talent and intelligence.  I think Mr. Sutton might agree with that. He might support efforts to reduce the impact of racism, or sexism, on economic mobility.  

But it’s also true that the path to a more equal distribution of opportunity and more equal reward for work and talent may run through a more equal distribution of income, and that no amount of effort to provide opportunity can compensate for the disadvantage of being born into a poor family in a culture with extreme income inequality.  And that is the causal link that Mr. Sutton and Mr. Swierczek don't see, or don't want to see. 

The point here is not that I have the answer; I emphatically don’t have any single answer.  I suspect that every one of the elements I described above as contributing to immobility or inequality does contribute, and that there are many, many more that I didn’t mention.   And nothing I've said here, no causal link I've suggested, explains the rapid increase in inequality, or the restoration of an income divergence rivaling the gilded age.

The point instead is that, as ideologically or personally satisfying as it may be to reduce the world to a one-dimensional explanation of inequality, particularly one that regards it as natural or just, the real economic world isn’t as simple as that.  If either more equal economic rewards or more dependable rewards to talent, intelligence, creativity and strong work ethic matters to you, then you need to move beyond personal gratification, or self-justification, or ideological zeal, beyond the simplistic economic visions in the letters above.  If these things matter, we need to create them and preserve them, because they don’t, unfortunately, create or preserve themselves.