Conflating Inequality and Unemployment

Posted by Bob Lord

I told my friend Thucky I'd address his arguments about tax rates and "welfare," their impact on the employment rate, and their connection to inequality in America. As you'll see, there are a lot of topics that feed in to this discussion, so sorry about the length.

Thucky's central point is that unemployment in America has been driven by high tax rates and welfare policies that are "too comfortable." Address this problem and he believes inequality will take care of itself. Thucky relies on studies by Edward Prescott and others to support his belief that higher tax rates and comfortable welfare policies increase unemployment. Although I think Thucky allows himself to be too easily seduced by the credentials of those who write the papers upon which he relies, his reading of the studies is basically sound. Hopefully, he thought a bit more critically when reading the Reinhart and Rogoff study and their conclusion. 

I actually don't differ with Thucky regarding the relationship of tax rates, welfare and employment. It's when Thucky uses that relationship to explain away inequality in America that I think his logic breaks down. 

Let's start with tax rates, welfare and unemployment, then try to connect them to inequality in America today.  

The connection that Thucky refers to between tax rates and welfare, on the one hand, and unemployment, on the other, is an outgrowth of the disutility of work. People value their time. They dedicate it to work in order to secure the financial and other rewards of work. At the bottom of the financial scale, the "other" rewards of work are fairly thin, so the financial rewards must be the motivator for those folks to work. 

There was a hilarious take-down by Matt Taibbi of a David Brooks column that illustrates this concept. Brooks had written a column pointing out how we'd reached a point where those with high incomes are working longer hours than those with more modest incomes. Taibbi reacted thus:

I would give just about anything to sit David Brooks down in front of some single mother somewhere who’s pulling two shitty minimum-wage jobs just to be able to afford a pair of $19 Mossimo sneakers at Target for her kid, and have him tell her, with a straight face, that her main problem is that she doesn’t work as hard as Jamie Dimon.

Only a person who has never actually held a real job could say something like this. There is, of course, a huge difference between working 80 hours a week in a profession that you love and which promises you vast financial rewards, and working 80 hours a week digging ditches for a septic-tank company, or listening to impatient assholes scream at you at some airport ticket counter all day long, or even teaching disinterested, uncontrollable kids in some crappy school district with metal detectors on every door.

Most of the work in this world completely sucks balls and the only reward most people get for their work is just barely enough money to survive, if that. The 95% of people out there who spend all day long shoveling the dogshit of life for subsistence wages are basically keeping things running just well enough so that David Brooks, me and the rest of that lucky 5% of mostly college-educated yuppies can live embarrassingly rewarding and interesting lives in which society throws gobs of money at us for pushing ideas around on paper (frequently, not even good ideas) and taking mutual-admiration-society business lunches in London and Paris and Las Vegas with our overpaid peers.

Brooks is right that most of the people in that 5% bracket log heavy hours, but where he’s wrong is in failing to recognize that most of us have enough shame to know that what we do for a living isn’t really working. I pull absolutely insane hours in my current profession, to the point of having almost no social life at all, but I know better than to call what I do for a living work. I was on a demolition crew when I was much younger, the kind of job where you have to wear a dust mask all day long, carry buckets full of concrete, and then spend all night picking fiberglass shards out of your forearms from ripping insulation out of the wall.

If I had to do even five hours of that work today I’d bawl my fucking eyes out for a month straight. I’m not complaining about my current good luck at all, but I would wet myself with shame if I ever heard it said that I work even half as hard as the average diner waitress.

Hard to dispute Taibbi's point. So, how does this relate to tax rates and "welfare?" Low end work needs to pay well enough to overcome the disutility of work. Workers don't work for pre-tax pay. They work for after-tax pay. If taxes go up, driving after-tax pay down, the financial reward of working is reduced. If, prior to the tax increase, the pay was barely enough incentive to work, workers may re-think their decisions and quit. 

Similarly, welfare impacts the disutility of work analysis. Think back to the 19th century, when we had virtually no social safety net at all. Back then, workers would endure excruciating work under oppressive conditions for very low pay, because the alternative was starvation and homelessness. If welfare becomes more comfortable, some workers at low-end jobs may opt out. Today's safety net is not exaclty plush, as Thucky seems to believe, but it may be enough to leave workers with some dignity in deciding whether to accept horrendous jobs at near slave wages. 

This is about as far as the logic behind Thucky's analysis goes. Certainly empirical data from the last 30 years or so contradicts Thucky's argument. After all, income tax rates have been reduced at all levels and welfare programs were made much less generous by Clinton and Gingrich, yet inequality grew gradually worse throughout that same period. 

Thucky's infatuation with technical studies highlights a problem Lynn Parramore discusses in her recent post, Meet America's Most Shameless Defender of the 1 percent, Harvard Economist Greg Mankiw, an analysis of Greg Mankiw's recent defense of the top 1%. Mankiw is a math geek turned economist. His style of analysis is overly technical, according to Parramore, and overlooks real world considerations. Parramore explains:

There’s also something very telling in Mankiw’s description of his youthful enthusiasm for mathematics. He was an excellent math student in high school, but realized in college that he would make a second-rate mathematician, so he turned to economics, graduating in 1980 from Princeton and going on to study at Harvard and MIT. This was just around the time that economics was falling into a deep infatuation with mathematical models and losing the sense of itself as a social science grounded in politics, history and culture. The result has been devastating. Economists left the human world behind and entered a mechanistic paradise where their dogmatic and ultimately destructive paradigm failed to acknowledge the forces that were gathering into an economic storm worse than anything the country had seen since the Great Depression.

Slowly and fitfully, the field is now trying to reorient itself. Some economists, like Rob Johnson and his colleagues at the Institute for New Economic Thinking, are calling to reestablish economics as a broad, interdisciplinary field, open to disagreement and grounded in the humanities. Figures like Mankiw, dedicated to the old model, will stand in the way of this process. The Mankiws of the economics profession have devoted themselves to math, but they have not been steeped in the traditional values and ethics that underpin our democracy, and they consistently fail to imagine that their elegant mathematical models might not accurately depict the real world of complex human interactions and institutions.

Mankiw is not a reality-based economist, and it’s no wonder, as he has been cocooned in elite institutions since his parents pulled him out of public school as a boy. He bounced from an elite private school to elite colleges, and then landed softly at Harvard where he has been teaching for three decades. Mankiw lives in Wellesley, Massachusetts, a town in suburban Boston that is one of the wealthiest in the country. He is a defender of the 1 percent because he knows no other community, and the 1 percent has embraced and richly rewarded the insecure math geek who sat in the back of his public school classroom trying to hide behind his spectacles. How could he question them now?

The studies by Edward Prescott and others whom Thucky holds in high regard are knee deep in mathamatical formulas. The economists who wrote those studies are very much Mankiw type economists. Like, Mankiw, they miss the human interaction driving the conclusions they reach. They fail to consider the behavior of employers, and it's that behavior that provides the connection between their conclusions and today's inequality, and explains why the argument Thucky makes regarding inequality is entirely off base.

Employers pay as little as they can get away with. There's nothing sinister about that. It's just human nature. That's why we need minimum wage laws and collective bargaining. That's why conditions for workers in the 19th century in America and in Bangladesh today were/are horrific. That's why WalMart pays its workers eight bucks or so an hour, even though that leaves many of them in poverty.

But the primary focus of the employer is pre-tax pay, becuase that's the amount of the check he has to write. To the worker, eight dollars an hour with no tax is the same as nine dollars per hour with one dollar of tax. Although the Bush tax cuts mostly benefitted the rich, the masses received a few bread crumbs. In the short run, that would cause the after-tax pay of low-end jobs to be greater than that needed to lure workers into the workplace. But over time, the employers would push pre-tax pay down such that after-tax pay settled back to the minimum necessary to secure the labor they need. So it should not be any surprise that real wages have decreased in the last decade. Those tax cuts for workers ultimately were passed back through to employers. 

The same analysis applies to changes in welfare policy. If we weaken the safety net, as we did in the '90s, we confer a benefit on employers. Put more bluntly, the weaker the safety net, the greater the license of employers to exploit workers.

What would happen, then, if we lowered tax rates for workers and shredded the safety net further? The only taxes workers pay at the low end at this point are employment taxes, so I'm not sure what Thucky has in mind by way of tax cuts. But presumably we could reduce employment taxes and make corresponing cuts to social security. Presumably, a few really lazy workers then would be newly incented to work. What Thucky fails to understand is that whatever marginally beneficial impact that would have would be overwhelmed in the long run as employers took advantage of the willingness of those already in the workplace to forego pay increases and stay on the job. Ultimately, this would be a windfall to employers.

Thus, in the long run, the outcome of Thucky's plan would be even greater inequality of income and greater inequality of wealth.

0 responses to “Conflating Inequality and Unemployment

  1. Even if that were true, so what? It would mean that the welfare system is poorly designed, not that welfare per se is a problem. Read Milton Friedman’s proposal for a negative income tax in that regard.

    But could Ohanian possibly be correct? Welfare in the US is a combination of many programs, which depend on such things as geographic location and family size. The “marginal rate” you are citing would not be a constant throughout the population of those receiving governmental assistance.

  2. You can think of welfare as taxation. Going from welfare to a 40th percentle job is the equivalent of a marginal tax of 63 percent (Lee Ohanian)

  3. But, its not tax rates that is causing our current problem, its tax rates plus comfortable welfare plus regulation – the triple whammy. We didn’t have the triple whammy in the 50s. We had the double whammy in the great depression.

  4. Not much of the economy operated in those higher tax rates and those who would have, moved their economic activity into corporations and accumulated long term capital gains. When Roosevelt chased them into corporations in the late 30’s with an undistributed profits tax, the economy collapsed a second time. It was when he relented and eliminated the undistributed profits tax and stopped the massive regulatory schemes that the economy began to recover in the very late 30s. Alas too late for the world – he had already created Hitler.

  5. Tell me, Thucky, why weren’t the 1950’s a horrible depression? After all, marginal tax rates were as high as 90%.

  6. Well, this is a gracious post. Thank you.

    Phoenix Justice agrees with Edward Prescott. Prescott found that the sales tax has the same impact as an income tax. They both reduce participation in the economy. This effect is now so pronounced that the economy has not produced a single hour of additional work in the last 5 years. As a result, this is the first 5 year period since the great depression that GDP per capita has fallen.

    Elevating the poor is in our cultural DNA, it is the whole reason we exist. No wealth – no elevation of the poor.

    Prescott’s work is all about people. Higher tax rates cause people to start their careers later, work less intensively, take more sick leave, retire earlier, be less intelligent,be more susceptible to Alzheimers, die earlier and overall, to produce much less of the tax revenue that might benefit the poor.

    Welfare has some of the same effects. When you get things for free, you don’t work as hard for them. Every year, over 20 million jobs open up. Anything that slows the alacrity of people sprinting to fill them, swells the pool of people not in jobs and the growth of the economy.

  7. One very glaring item missing about all of this tax talk is sales tax. The sales tax eats up after tax pay of the poor, working poor and middle class at a proportionate rate than the wealthy. Especially since the wealthy don’t spend every cent of their after tax pay as the poor, working poor and middle class do.