Thursdays are typically slow news days and I honestly can’t bring myself to write about Chris Dodd’s and Byron Dorgan’s decisions not to seek reelection. So instead I’ll pose a question. There’s simply no denying that government spending is rising as a proportion of GDP. The chart above (from Cato’s DownsizingGovernment site) shows the scope of this.
It might be argued that it’s just a temporary phenomenon, something that’s necessary now because of the recession but which will be reversed and return to norm once the crisis is over. Frankly, I’m skeptical of that. We’ve found it terribly difficult to reduce defense spending since World War II. Ike did warn us about that more than 50 years ago.
The actual operating cost of government is only a small part of the picture. Much of the spending is in what’s been called government’s “handmaiden industries” which I’d define as any industry in which government spending comprises 50% or more of total revenues. That includes healthcare, education, and aerospace, just to name three.
Government revenues come primarily from taxes and borrowing which is another way of saying future taxes and, attractive as the prospect may be, there is no such thing as perpetual motion. It violates the laws of thermodynamics. Workers in healthcare, education, aerospace, and the other “handmaiden industries” pay taxes but the taxes they pay are only a small fraction of government spending in those areas which means that other sectors of the economy must be taxed to keep government (by which I’ll mean government and its handmaiden industries) afloat.
Here’s my question. Assuming low or no growth in non-government sectors of the economy (which is a pretty good assumption for the foreseeable future), how large can government be as a proportion of GDP before the whole shebang comes down like a stack of cards?
I think we’re just about there. That doesn’t mean that I oppose all government spending, that I think there’s no role for government, that I want poor people to starve or die of disease. Far from it. I just think that we need to consider our subpriorities very carefully. I think we need to live within our means and, most especially, avoid institutionalizing ever-increasing government spending.
As evidence for my speculation I’d submit that non-construction business investment other than in the handmaiden industries has been pretty lousy over the last decade or so.
You, me, and Robert Higgs. The Higgsian view is that while spending might drop it wont drop to its “pre-crisis” levels. Thus, each crisis has a ratchet effect on the size and scope of government and that over time it will continue to expand.
Exactly which is why the notion of “pulling yourself up by your bootstraps” is patently absurd. In the end government cannot save us by simply expanding.
Good question and I have no idea, but I do think such a point exists. Kinda sorta like the Laffer curve.
Oh pish-posh we’ll just call these subpriorities rights and well find the money somewhere. That’s how it works in the minds of many Americans. Its my right so go take money from Michael Reynolds he has millions in intellectual property anyways. And as an extra cool benefit Michael seems to put little or no value on his leisure time–that is the more you tax him the harder he works!
In reality your are correct. If we keep simply raising taxes or borrowing (future taxes) it will reduce economic growth. This is a no brainer. Lets assume we have a person making $100,000. If you increase his taxes will he keep consuming at the pre-tax levels? No. Will he increase is work effort? Not if he values his leisure time. The only way you get an increase in work effort is if the person either does not value leisure or values it less than what his wage rate is. The former is simply not true and latter is weird (its when people are on their labor supply curve that is downward sloping with wage–i.e. lower wages means more work). In other words it is a speical case and it probably only applies to those who make lots of money–i.e. not your typical taxpayer.
So higher income taxes mean less consumption spending. Firms are the same way when it comes to corporate taxes as well and there there is not even a backward bending labor supply curve since firms don’t usually supply labor, but instead demand it. Increase taxes on firms and they’ll shed jobs, and engage in less capital investments. You can see this using extremely basic economics. I’m not talking macro-economics here by the way where you have all sorts of flavors where you can with some accuracy identify ideological leanings by looking at some of the theory (although not always–e.g. Mankiw is probably a libertrain minded Republican yet a Keynesian). I’m talking micro economics. Micro-economics is kind of like micro-evolution. Only the real nutters dispute micro-evolution (macro-evolution is really just micro-evolution–biology has it so much easier–but that is getting way of topic). It isn’t hard to find creationists who will say, “I believe in micro-evolution but not macro.” Micro-economics is largely the same way.
People will talk about global warming legislation, health care legislation, and so on and so forth. But all these things really are are potential increases in implicit tax rates. Instead of paying more taxes a firm will be required to purchase health insurance for its workers. Doable if you are a huge firm with thousands of employees and billions of dollars in revenues; you could self-insure. Global warming cap and trade if done so it actually does what its supposed to will mean higher costs on the factors of production. This will mean leas use of the factors of production. Its a no brainer. So firms are sitting by and taking a wait and see attitude. We’ve heard it anecdotally from Drew, we see it in the government compiled statistics and we have theory telling us the same story.
Yet everyone is perplexed at why the economy is no rebounding robustly.
Steve:
And as an extra cool benefit Michael seems to put little or no value on his leisure time…
I value my leisure time extremely. (I work a grueling 3-4 hour day.) And I enjoy doing expensive things during my leisure time, like travel or fine dining. Which, sadly, requires money.
So when my taxes go up, I compensate by increasing my productivity and make up the loss. I’m still not quite sure why this upsets you so. It seems pretty logical to me, just as if my gas bill or mortgage went up, I’d respond by working harder and being more productive. Taxes are just another expense, a bill I have to pay.
When I increase my production I generate jobs throughout my industry. (Although for technological reasons that may be about to change.) Booksellers, truckers, editors, paper mill workers, all make more money when I’m more productive. So as much as it disturbs your theory, my reality is that I am forced to be more productive by taxes, and my productivity spreads a wave of happiness everywhere. Except for you.
It doesn’t, well not as it applies to you. However, when you generalize to everyone else other than yourself then there is a problem.
The situation you describe is a special case–i.e. it is not true in general.
Backward Bending Labor Supply Curve
In short you are paid so much that you take quite a bit of leisure time. When the implicity hourly wage drops you supply more labor. Its possible but only at really high wage rates. The point at which an individuals labor supply curve starts to bend backwards varies from individual to individual.
However, this is an extremely rare occurence in aggregate. As such your assertion that it is generally true is false–i.e. it is not supported by empirical fact. Think of it this way:
If you got paid more (implicitly/hour) would you work more? We’ve already seen that if you get paid less (implicitly/hour) you’d work more. So if you answered “Yes” to the first question this is what you have:
Paid more -> work more.
Paid less -> work more.
What on earth wold get people to work less? Answer: Nothing. People will always work more if thier wage changes. This is illogical and not supported by empirical research.
Steve:
I’ve never asserted it was generally true, or true of anyone other than me. I don’t know. But it is logical to wonder whether there might be other people in a similar situation.
If I want/need X amount per year to make me happy, and the government reduces my X to a mere X-10%, I work a bit more to push it back up to X and achieve happiness. I can hardly be the only person who works harder and more productively in response to losing money to taxes.
Just because I know it will irritate you, let me further assert that taxes have helped spur innovation in my narrow world. I’m pushing hard for the move to e-books because it will cut overall costs for books and, I hope and believe, put more money in my pocket. To the extent many writers are getting on-board with this revolution (and our consent is important) it’s likely to be in part our greedy effort to compensate for taxes.
Frankly, I’m skeptical of that. We’ve found it terribly difficult to reduce defense spending since World War II. Ike did warn us about that more than 50 years ago.
A strange assertion, given the Cato chart you posted directly above. While military spending has increased somewhat since Eisenhower’s time, as a percentage of GDP it is down 50%.
how large can government be as a proportion of GDP before the whole shebang comes down like a stack of cards?
Well, it was ~20% in 1968. And it was ~20% in 2008. Right now it’s ~25% – perhaps the stimulus and healthcare bills will make that change permanent. I’m not crazy about either bill, but I don’t see a 5% increase resulting in the collapse of Western civilization as we know it.
It’s not that strange. What I’m suggesting is that the 5% has become a permanent institutionalized part of the national economy. And very little of the 20% in 1968 was healthcare. At least 8% of current GDP is now institutionalized, probably permanent government healthcare spending and, with healthcare reform in it’s present form, heading for 10 or 12% fast.
As to the “end of Western civilization”, equilibria are like that. Things look just fine until you reach that tipping point…
I would amend that to “with or without healthcare reform in its present form, heading for 10 or 12% fast.”
I guess I see a different story in the data you presented, which is that as Medicare drove government spending up in the 70’s, the decline in defense spending kept things at a rough equilibrium. Where it’s stayed, more or less, for the past 40 years. It’s possible that the changes of the past year will permanently and dramatically shift that equilibrium. But given the way politics works in this country, I doubt it.
You mean you did not write?
As a general point,
This, I think, ignores the value of leisure time. Think of it this way, suppose you make $10/hour. You work 10 hours. You make $100. The government takes 10%. Now you are down to $90. To make up the taxes you’d have to work approximately 1 hour and 7 minutes extra. Are you going to do it for just $10, or are you going to mutter something about taxes and not work extra?
Now suppose you get paid you get $100/hour. You work 1 hour. The government takes 10%. You think, “Hmm I’ll work an extra 15 minutes and earn and another $22.50 and now I’ll have $112.5.”
Now in the second case I can see you making such a decision. In the first…not so much. You are lucky, you are in the second case. Most people…they are in the first one.
It doesn’t irritate me at all. However, it does call into questions your claims of spreading happiness in that these people will be increasingly unlikely to retain jobs,
With e-books you don’t need bookstores, truckers, or even paper mills. You’ll likely need a few more programers so it could all be a wash…or not. Call me slightly bemused by this point.
BTW I’ve often argued that the largest “destroyer” of jobs has been technological innovation. Look at how many farmers we have today vs. 150 years ago. All those poor farm jobs destroyed.
Maxwell,
A strange assertion, given the Cato chart you posted directly above. While military spending has increased somewhat since Eisenhower’s time, as a percentage of GDP it is down 50%.
Did it return to its pre-WWII levels? I highly doubt it, although data for that time period might be a bit difficult to come by. Unless it drops to its pre-crisis/WWII levels then defense spending is an example that fits with Higg’s view.
I think that it may depend on what you operative definition of “fast” is. I believe that we’ll hit 10-12% of GDP in government health spending within the next 2-3 years with healthcare reform (in its present form) and in the next 5-10 years without it.
2-3 years is quick enough that any recovery could be seriously delayed.
Military spending in 1936 was 3.17% of GDP.
In 1999 it was 3.62% of GDP.
I’m arguably cherry-picking. 1936 was the peacetime high during the first half of the twentieth century and 1999 was the lowest in the second half. But it does suggest to me that something in the neighborhood of 3.5% of GDP is conceivable with some sort of Taftean foreign policy. Much less seems to be illusory.
However, I’ll disagree a bit on a five percent floor. The GWBush administration averaged about 4.5% of GDP during it’s eight years and only surpassed 5% of GDP in 2008 (5.15%). So I’d say 4.5% is probably closer to the natural floor, with spending over that most likely due to “temporary” events like Afghanistan and Iraq.
I’m using data from this site: http://www.usgovernmentspending.com/spending_brief.php
Dave, what the net interest line on the chart? Is it the amount being paid on debt obligations? If so, it actually seems small; I would think the tipping point would be when interest rates rise and debt payments seriously begin to crowd out the ability to pay for things.
Not sure. The graph is on the front page of the site linked.
You’re right, it does seem small. I would think that it’s actually nearly twice that much.
There are several other institutionalized costs I can think of: transfer payments and discretionary spending. I think that we’re unlikely to drive that much below 1% of GDP. This year it was something like four times that. And transfer payments are at something between 4% and 10% of GDP. Those will only grow.
Steve:
“I suspect” is not “I claim” or “I assert.” It’s a turn of phrase equivalent to “it may be” or “I wonder if.” My statement says exactly what I said it said: that I was speaking for my own situation, and wondered whether some minority of people in a similar situation might not have a similar reaction.
Are you going to do it for just $10, or are you going to mutter something about taxes and not work extra?
As I explained: I’m going to make my nut, regardless. If I need X amount per year I’m going to make X amount per year, regardless. I never think in terms of hourly pay, the concept is meaningless. I’m not an employee, I’m closer to being an entrepreneur.
I feel your thinking on this is somehow relevant more to Dilbert space than to the world in which I work. There is no sharp, clear dividing line between “work time” and “not work time,” and in any case since I am my own employer I have a different emotional relationship to work altogether. Some of the paradigm just doesn’t seem to fit my life.
With e-books you don’t need bookstores, truckers, or even paper mills. You’ll likely need a few more programers so it could all be a wash…or not. Call me slightly bemused by this point.
This is all somewhat up in the air right now. There are several different models going forward in the e-book universe.
My own guess is that we’ll end up with a couple of parallel models — the enhanced book, which will indeed require video and audio people, rights people, programmers, etc… And a separate but related track that will be closer to an electronic self-publishing of non-enhanced text, and that requires far fewer hands stirring the pot. In fact, all it absolutely requires is a writer and a PayPal button.
If you were going to be in Miami on the 15th you could hear me dazzle and horrify an audience of writers with a vision of their electronic future. Short version: bad for libraries, bookstores and publishers, good for creatives. At least for agile, quick-witted creatives.
Michael,
Writing “I think this is true…” and “I wonder if this is true…” are rather different IMO. One suggests a far higher probability/belief of the statement being true than the second.
Two things, first, can you see how an hourly employee might think the way I described? Second, the concepts I’m describing work not just for hourly pay but any and all pay…annual, monthly, hourly, even life time. Early retirement is one way of seeing how wage increases can lead to less labor being supplied on the individual level.
I never intended to suggest any such “sharp” delineation and even noted that when the labor curve starts to bend backwards is dependent on the individual. If a person wants to live a rather rustic retirement they might retire earlier than a fellow worker even though their lifetime income patterns are identical. And yes, having a passion for your work could also influence things as well (perhaps significantly). I don’t deny any of this, but they are more empirical fine points, IMO.
Well, I hope it makes good stories and such easier to obtain. Good luck with your trip…I hope security isn’t as much of a pain as I hear it has become.
BTW PD this graph suggests that forever after WWII as a percentage of GDP defense spending never returned to its pre-WWII levels.
Linky…hope that worked….
And in looking at the data from 1902 – 1939 defense averaged about 2.14% of GDP, after 1980 it was 5.25% on avergage with a bit of downward trend through 1980 – 2000/2001. I’d say that fits well with what Dave has been saying.
Steve:
Added cost of security: $200. Because I’m no longer confident I can get from OC to LAX and through security in time, I’m staying in a hotel the night before. Maybe I’ll send OBL the bill.
Dave-You seem to be assuming that the pie is staying the same size. If the economy is actually growing, if real wealth is being created, I would think you could have, at least to an some extent, increases in government spending while also increasing personal wealth.
I wonder if the poor performance of the last ten years isnt linked to supply side economics. An awful ot of our wealth has been concentrated into the hands of a very few people. If you assume, which I do, that much of that wealth creation was from rent seeking behavior, I think you have laid the foundation for a weak economy. Also, if more wealth is not getting into the hands of the middle class, where most people reside, it seems likely that there would be fewer entrepreneurs coming from that group. Add in lack of health care for any non-wealthy potential entrepreneur who has an illness or a sick family member, and you are looking at a challenged economy.
Steve
That was stated in the post. And I think it’s a very reasonable assumption for the foreseeable future.
However, in the final analysis I don’t know that it matters. Clearly, government consuming 100% of GDP won’t work. I also think that it’s arguable that government consuming 50% or more of GDP won’t work regardless of the size of GDP. I’m not sure I can explain why I think this but I do think that it’s so.
I think that it’s pretty obvious that government consuming 20% of GDP is sustainable. After all, we sustained it for quite a few years. So, basically, I think there’s some sweet spot between 20% and 50% over which the consequences will be pretty awful. This is more an intuition than it is a conclusion.
This will be lengthy, I hope people are interested enough to read through it.
As seasoned readers/commenters may know, Verdon and I are pretty much kindred spirits. By virtue of his training and profession he expresses many of my thoughts much more eloquently and more technically correct than I do. But let me make some statements as a “practitioner.”
My world is private equity investing. Which means I am in the world of small business owners. What does that mean? Company revenues of $30MM to perhaps $300MM. And my personal friends tend to be business owners in the $4MM to $20MM range. No Ginormous Generous Motors. But I know these small business people. I’ve been dealing with them for 20-ish years.
A theme in this thread is that such people might stand pat, or increase their work, in response to increased taxation to pay for perceived social needs. Since this is 2010, and this is the new metro-civil Drew, let me respond in as low key a fashion as I can: Bull fucking shit.
Look, Michael Reynolds, who says he writes 3-4 hours a day, might increase his workload to 5-6 hours in response to current policy prescription. But that’s an exception. He has alot of excess capacity. Or said another way, there is no additional capital risk nor is he on a critical border of marginal liesure/work constraints. I think we should all look at Michael and say “congratulations, you and your writing talents got you to the magic land, where you can just index your work load to the right a tad in response to these governmental policy initiatives.” But Michael, you are one in a million. And here is the crucial point: Michael doesn’t really create jobs by that extra hour or two. He will cover his own financial ass, but the general payrolls won’t increase. (And absolutely no perjorative intended here.)
Now: a real world example. A Chicagoland company is doing reasonably well. They have 4 regional locations, and have been considering a 5th. The owner pulls in a couple million a year. Upfront brick and mortar costs for the expansion are a few hundred thousand , start up losses perhaps a half to a million. The new venture may, or may not work. The owner, who is rich today, and will be rich whether he opens up this new facility or not, ponders the decision. He observes that the facility might employ 15-20 people. He thinks that if successful it generates, down the road, $250K/yr in opinc. But he doesn’t know if the $750K to $1MM downstroke is worth it if a) the cost to employ those 15 – 20 people will get much more expensive, and b) if it works the current set of polls wil say “thank you very much” and tax half of it away. I spoke to this individual, literally, this afternoon. His bank account is fine, his condo in downtown Chicago set, and the summer place in Michigan all good. he thinks “no.” He’s not expanding in this political environment.
Skip the idiotic speeches of an Obama or Pelosi, or whatever people. This is the way the small bus owner does his calculus. “I’m rich today, I’ll be rich tomorrow, I’m not going out on a limb for these guys.” So right now, he’s not taking the “whatever” MR approach, he’s sitting on his hands and hunkering down. He/she is closer to their intolerance level. I simply cannot overemphasize this. And there are a bazillion of these people.
If you really care about the Average Joe (as opposed to your political leanings) please heed these words. Whatever you think of me or my rants, what I am telling you is exactly what is going on out there in business, where people who cannot create their own jobs or wealth, who are reliant on others for employment, are suffering because of real and feared government intrusion. Its immoral.
………………….
Switching gears. Dave, if you showed the defense spending to GDP graph back to 1945 you would see a much more dramatic decline. My take is different than yours. In fact, defense spending is the only government expenditure that has displayed what one might expect – scale economy. There are only so many countries and oceans to defend. With ripples, it has declined dramatically relative to GDP over time, despite admitted waste. In contrast, non-defense spending – the Great Society really – is up up and away like my beautiful balloon. (Woudth that we actually “fixed” poverty.)
Does anyone doubt Obamacare will be the next rachet up? And, to the point in your post, how long can you milk the defense monkey to pay for non-defense? Carter did it; Clinton did it, claiming a “balanced budget.” Now what?
Steve –
I think you’re assuming far too much elasticity in tax / overall output – especially marginal rates in a progressive tax system. For salaried people, it’s unlikely it would change their output at all – they work hard anyway out of fear of being REPLACED.
You might make the point that if I make 50k a year, I’m unlikely to deliver pizzas on the side if I lose half of the$15/hr income from it. Ok, so the government lowers my marginal tax rate to make delivering pizzas on the side more attractive, now pizza delivery jobs pay 12 an hour and I only lose a quarter of it. All I’ve done is take 3 bucks an hour from the paycheck of a 30k earner who was delivering pizzas on the side.
I also have no trouble believing that Michael would work less if you gave him a tax break. He’s got more money in his pocket: X+10 without doing anything – why work harder for X+20 when his happy number is X?
Oh and my pizza example only applies to someone right on the cusp of that marginal rate. If he was well into the rate, he’d probably just keep the tax break instead of delivering pizzas. I know for sure that my wife, who works 32 hours a week to have more time at home would just say “thanks for the tax break!” and work exactly 32 hours after it, too.
The Obama Administration hasn’t shown a great deal of interest in cutting military expenditures. Quite to the contrary 100,000 troops in Afghanistan and another 70,000 in Iraq will cost almost twice as much as 20,000 in Afghanistan and 150,000 in Iraq did. Sure, they’re cutting a few weapons programs. Not enough to make up the difference, though.
Also, you can’t pay for 10% or greater GDP devoted to government spending on healthcare with what can be squeezed from military spending, especially if we engage in the sort of interventionism that Candidate Obama supported.
Steve and Drew:
I would never try to argue economic theory with either of you. But I find it interesting that you both dismiss my situation as anomalous. Steve, you go back to academic theory, and Drew you go to a more anecdotal approach.
But is it not possible that theory is missing a change in our economic reality? I don’t think I’m an entirely isolated case. There are a fair number of artist/entrepreneurs out there. (Or whatever category name you come up with.) I’m hardly the last of my breed. I know this since my wife is in the identical position.
And I assure you that I am behaving logically. To me a tax bill is no different than a medical bill or a gas bill. I owe a certain amount. So whether it’s a tax bill or mortgage or whatever, I need to pay it. If I don’t have enough money to pay it, I have to earn more. So I try to create more product and cover the expense.
Nothing about this strikes me as illogical. I have bills to pay — including taxes — I only have one way to do it, so I do it.
In practical effect Cox Cable and Blue Shield and Ralph’s Grocery and the IRS are all one to me. They’re each a bill, an expense.
I don’t think small businessman is the only paradigm. There are certainly hundreds of thousands if not millions of people in approximately my position: craftsmen, artists, writers, directors, comedians, web designers. We don’t generally think in terms of hourly wage, many of us are unable to draw sharp distinctions between “work” and “not work” and in our lives the IRS is just another bill collector.
It seems to me that if we as a group saw things your way we would relocate en masse to a low-tax state. (And I’ve done something like it in the past.) But rather than all of us being in Florida or Texas where our tax burden would be lower, we are disproportionately in California and New York. This despite the fact that we are an unusually mobile group. So, we choose to pay high taxes, and compensate by working more. Aren’t we acting as though we see taxes as just another cost of doing business? Isn’t the proof in the pudding?
Is it not possible that your theories are simply overlooking a fact and failing to account for a significant segment of the population?
Michael – You are not an anomaly, you’re an externality. It just so happens that externalities have far more to do with economic growth than what they supposedly know about economic theory. It’s unbelievable the profession isn’t as marginalized as climate science given how wildly different and often wrong economist’s predictions are. Why didn’t Clinton’s tax hike kill the economy? Why did we have our best and longest periods of growth, in gdp and real wages, when marginal rates were well over 50% and the minimum wage was regularly being hiked? Why didn’t Bush’s tax cut result in any real wage boost but just a bubble and bust? Why doesn’t gdp growth correlate with marginal tax rates?
Michael,
I’m going to just be tossing out some numbers to help put some of this in context, they aren’t based on any hard evidence. Lets assume you are correct, there are alot of artists/creative types like you. Lets say, 100,000. A large number. In an economy with 65,000,000 workers though it is not a large segment. Sure, they might increase labor supply, but on the other hand far, far more are not and might even reduce labor supply.
This is fine as far as it goes, but it is a bill that depends on how much you work. The more you work the higher the bill. Its like trying to dig your way out of a hole by making the hole deeper, at least in some sense. For you, it works because
1) your implicity hourly wage is high.
2)you do not have, in economic theory terms, a binding labor-leisure constraint–that is you have some leisure time that you can devote towards earning extra income that makes you better off.
Most people don’t have 1 nor 2. Most people that have jobs often work 40 or more hours a week. Most people don’t earn a wage where they are on the backward bending part of their labor supply curve (if they did they probably wouldn’t be working 40+ hours a week).
You increase taxes on my wife and I and she might say, “Screw it I’m not working more overtime.” That is a reduction in labor supply. Some people might decide that working another year is no longer worth it given that they,
A) have paid off their house.
B) paid off a working car that will likely be good for a number of years.
C) whose kids are grown and have jobs of their own.
D)have a decent retirement fund.
That is a reduction in the labor supply (and also possibly a significant loss in human capital). Please note this Sam, the idea of labor-leisure choices are not limited to just the number of hours worked.
Well…no. You could liquidate assets. You could ajust your life style to reduce other expenses. You could opt for a payment plan. Or any or all of the above.
The difference is if you unsubscribe from Cox Cable it is unlikely to impact thier prices. If you switch to Kaiser it wont have much impact on Blue Shield. And if you start going to Albertson’s Ralph’s probably wont even notice.
The IRS, they will notice. They will come after you. They will use threats of various types of violence. And as you change your behavior the impact the IRS has changes. Earn more the IRS wants more. Earn less they want less. If you earn more Cox, Ralphs and Blue Shield do not come to you and say, “Oh, now that you make more money we want you to pay more for your cable, groceries, and health insurance.” There is a difference. Just as there is a difference between a perfectly competitive firm (takes price as given) and a monopolist (has the power to set the price).
Hourly wage is one way of looking at the issue, so please don’t hung up on that. It could be monthly income, annual income, weekly income, bi-weekly, or even income by the “job”. How many jobs do you take on? And it isn’t just that people have crative type gigs, but that they have both points 1 & 2 I noted above. High wages, and are the backward bending part of their individual labor supply curve. While there might be quite a few people in that situation, in aggregate they are swamped by those who are not. The aggregate supply curve, when you get right down to it, is nothing more than the sum of each individual’s supply curve.
Not necessarily. There are a number of factors at play. For example moving costs money. Then there are non-monetary considerations such as family and friends or simply liking the weather. You might be willing to pay higher taxes (up to a point) to enjoy the better weather. So no, not everyone is going to do the calculus and say, “The bus for creative types for Arkansas leaves in 1 hour, everyone get on!” Some might, some might not. Some might make the move later, some never.
Its possible, but so far I don’t see the problem. Your statements say to me, “I’m on the backward bending portion of my labor supply curve.” Fits with the theory, fits with what you are saying. That you don’t up and move isn’t necessarily proof against the theory since all the other variables at work are being held constant. Do you have family here, do you really like the weather. Are you hear because being near LA makes it easier to push book deals than if you were in Abilene Texas? Do you hate Texas and can’t stand the humidity in Florida during the summer?
Economics is not merely about making predictions. Those GDP, employment, export, productivity numbers, etc. that you look at…all the work of economists. I used to work in a research departmant at the Bureau of Labor Statistics were we looked at price indices. We looked at ways of making them better. Very little predictive work involved…in fact, none.
You really think it was due to the high taxes? Please explain the mechanism connecting the top marginal tax rate with the minimum wage. Don’t worry about data and empirical support, we’ll get to that later. Right now I want the model so that we can worry about the data and empirical support.
You really think it was due to the high taxes? Please explain the mechanism connecting the top marginal tax rate with the minimum wage.
I’m not, I’m merely pointing out that some economists regularly say minimum wage hikes are bad, yet we had lots of great growth when it was being hiked, so what gives?
Yet it doesn’t stop you from making the prediction that if we only could get rid of government involvement we’d have perfection. Based on some 3 year period in the wild west of the 1800s I think? What I’m referring to is the wild differences in policies for growth in macro.
I’ve never made any such prediction and I’d be willing to wager $20 you can’t produce any quote supporting such a claim…and I never gamble…and technically I’m not now. I’ve never made any utopian arguments ever, anywhere.
No, I have referenced the Old West (last half of the 1800’s) as an era with relatively little government involvement and yet people prospered. There is also the example of Pennsylvania which for a number of years (1684-1688) had virtually no government.
One theory I’ve heard as to minimum wage hikes was that union contracts were often linked to the minimum wage. A hike in the minimum wage would result in a hike in union wages. Don’t know if it was true as I’ve never seen a union contract.
And I don’t think economic growth is driven by taxes with a positive relationship (higher taxes -> higher growth). In fact, I think one might make the argument that higher growth -> higher taxes. The economy is a multi-variable process so it is quite possible to get higher taxes even with higher growth if there is yet a third variable changing as well. Similarly with the minimum wage. If your thesis is that increases in the minimum wage and tax rates result in economic growth then lets do this:
1. Double taxes
2. Double the minimum wage
3. ????
4. Proft!!
Steve:
Thanks, that was very interesting and educational. (I almost feel I should pay you for the tutorial. Almost.)
The question I still have hinges on your guess as to the number of people in approximately my position. I don’t have a clue how many there are. But you don’t either, as you admit. And I wonder if there might not be more than you suspect.
If so, if we were talking about half a million people behaving in such a way that higher tax rates simply spurred them to higher productivity or even just more hours worked, is it not possible that in the aggregate this is a fairly large effect? Especially since in many cases we are more analogous to small business owners than to employees?
Right now if my tax rate were zero (oh, happy day) I’d still be writing Series #1. I’d be making enough, I’m lazy, so why not? But with taxes taken out Series #1 isn’t enough to keep me happy, so I take on Series #2. (This isn’t speculative, this is actual.)
Let’s say Series #2 ends up running to 8 books over 4 years, and each book sells 200k units. That’s 1.6 million units times 10 bucks each (averaging for hardcover and paper.) $16 million. 90% of that isn’t mine, it goes to everyone in the current supply chain: publisher, printer, wholesaler, retailer, eBay.
That sixteen mill is essentially caused to exist because I’m a greedy, irresponsible bastard who can’t handle his money and owes the IRS. Just as I am motivated to pay my cable bill I am motivated to pay my tax bill, and the involuntary nature of the latter is not relevant to my decision making.
Let’s move it out of my unusual situation as a “creative.” Let’s say I own a restaurant. The restaurant puts 200k clear in my pocket every year. Then my taxes go up and now I only clear 180k. Which I don’t like. I want more.
So, suddenly opening a second location seems like a much better idea. Because if I borrow the capital, and do the work, my second restaurant will also throw off 180k clear. And I like making 360k. And because I have some advantages of scale I’m not doubling my hours worked, I’m just increasing my load by, say, 70%.
In that case have I not been motivated by taxes to 1) increase my own income and 2) earn more per hour worked, and 3) create more jobs?
Steve –
Yes, double both! Which is as nonsensical as: if you like ice cream, why don’t you eat it for 3 meals a day? Just because you give me a silly extreme example I’m supposed to assume it’s bad from 0 up to that?
I have no idea why high marginal tax rates or incremental minimum wage hikes don’t hurt gdp growth – I was asking the all-knowing Steve. Anyway, it seems economists can’t figure out why either, which is the only point I’m making.
Michael,
You’re right I don’t know how many people are on the backward bending portion of their labor supply curve. I do know that most empirical studies of labor supply do not show a negative relationship to wage and labor supply. I’m inclined to think it isn’t a large enough effect to offset the negative impact of taxes on labor supply. This is why the overall consensus is that small increases in taxes are neutral (the point Sam raised, not everyone can immediately adjust their labor supply) and larger changes are negative (now the second income spouse staying home and avoiding various expenses like day care and so forth is worth more than the income). I have yet to see an economic theory that says, in the time of recession increase taxes.
Really? Why? What if the new restaurant doesn’t take off? Restaurants are a LOT of work and the overall return is lousy. Now your upside is less, and there is still the down side. Think of it this way, you have a gamble and the pay offs are:
$200k at 1/3 and -$100k at 2/3. Your expected payoff is $0. Now the government comes along and says, “We are increasing your taxes.” Now the numbers become, $180k at 1/3 and -$100k at 2/3 and your expected payoff is -$6,666.67. You’re going to invest? And most people are risk averse and some argue loss averse. Looking at these numbers I can’t see why one would want to expand and put forth all that extra effort when they have a sure thing of $180k and some leisure time.
Sure, but you have no potential for losses. Your second restaurant you assume will be just as successful as the first one. It almost surely wont at least initially. You’ll be in new area and have to build up new clientelle (if you are too close to your first restaurant you might end up splitting that restaurant’s clientelle with the new place meaning you still operate at a loss).
I don’t know how it works for books; presumably its a bit different. The publisher is taking on some of the risk I would guess if they say they like a new idea you have and send you and advance, but I really don’t know. Like I said, what you’ve described may very well be true in some instances, I’m just thinking it is a special case.
For example, my wife is paid hourly. Every extra hour she works past the 40 she is required means a loss of leisure time. Typically that is going to require higher pay than if she was working just 20 hours a week. Like you she works from home. If suddenly the wage rate she faces for working those 40 hours and beyond goes down….is she going to be more or less likely to work those hours past 40? I’m saying less. Not everyone would be like that to be sure. Some people might have jobs they well and truly love (you seem to have such a job, again you are lucky) and that would be a factor as well.
I was just reading an article the other day by Edward Prescott on labor supply in the U.S., Europe, Canada and Japan. His conclusion, the U.S. works more because of lower tax rates–i.e. all other factors held constant the U.S. wage is higher thus eliciting more labor and less leisure.
Sam,
Yes. Or why don’t you name an instance when raising taxes or the minimum wage helped the economy when it was in recession. Here’s one period you might try: the Great Depression. Taxes went up and Roosevelt implemented policies to artificially drive up wages and other prices. Neither worked. The taxes happened early on under Hoover and helped make a bad situation worse, and the wages and prices experiment later but also didn’t help. Coincidentally once the U.S. went off the gold standard the economy started growing again.
I’ve seen some claim that Clinton’s tax increases in his first term revived the economy. Only problem with that narrative is that the recession was well and truly over before Clinton was even elected, let alone inaugerated.
There are a number of other times where we had recessions, please let me know which one was ended due to tax increases.
My belief is that the economy of 1950 is not at all like the economy in 2005 and hence the conditions that applied then might not produce the same result as back then. Technological advancements, changes in union participation, changes in dominant industries in the economy, changes in other countries economies, and so forth make the two time periods rather different. For example, right after WWII much of Europes productive capacity was damaged, same for Japan’s and China was quite undeveloped. You can see the difference in the lag between when a recession ends and when the labor market rebounds. In the past the lag was months, now the lag is much longer. This time around it could be years. Doesn’t bode well for Obama. Sure he can claim inheritance now, but in 2012? I don’t think people will give a shit by then whether or not he inheritted the recession or not.
And as for growth back during that time I think it was factors other than taxes at work. We had the GI bill for one thing. How much of the growth was due to improvements in human capital? Some, alot, none? How about increases in the population. As the baby boomers moved into the labor market what effect did that have on the economy. Your traditional Solow style growth models hinge on population growth. I’m not a macro-economist (I spent of my time studying public finance, econometrics and mathematical models) so I’m just guessing. Try shooting an e-mail to Greg Mankiw and other macro-economists.
What I see in my part of the world, is that people work towards a specific income goal. If taxes go up, they work longer to met that goal. If they go down, they work less. Did the same thing when I was younger and working my way through school. I have no idea what percentage of people behave in this manner. Dont remember seeing an econ paper address it.
Steve
Steve (non-Vernon)
That was a very succinct way of saying what I’ve taken hundreds of words to communicate.
We work to pay bills. Taxes are a bill. So we work to pay them. The higher our bills, the more we work.
I would if that’s what I was trying to prove, but it’s not. I specifically said MARGINAL tax rates. More progressive taxation, not raising overall tax rates which no one, not even Keynesians, argue are good during a recession.
I can’t see the chart perfectly well, but it looks like there was a min wage hike during the 60-61 and 70-71 recessions. Also, there’s a suspicious lack of recession during the 60s – the all time best for the real value of the minimum wage.
Its 10:30 at night, I’ve just gotten back from Pittsburgh on a trip to meet a business owner, and I thought I’d run through the thread.
I was up at 4:30 to make the flight, the opportunity doen’t seem to make sense given the return. I’m tired, and I’m thinking, why did I do this? I don’t need this.
Unlike MR’s proposition that taxes are like the gas bill, so if they go up I’ll work harder, that’s not what I’m thinking. And I also know for a fact that’s not how my clientele think, including the business owner I spoke with today. He flat told me he want “out of business” because of what is going on in Washington. Not healthy.
“Anecdotal” evidence (after 20 years of being very, very successful at a profession you’d, ahem, like to think its “empirical” evidence) needs to be married with the theoretical. I read the counter arguments in the thread; I have to say I’m actually not very impressed. In contrast, I would like to associate myself with just about everything Steve V explained.
When you are a practioner and what one guy says is truth you observe just about everyday, and over 20 years…………..and what another guy says seems like nothing you’ve ever scene on a large scale, you have a tendency to take a decided side.
Drew:
Without knowing what business you’re in exactly I’d guess that you are obviously familiar only with a portion of the whole. In my case I am the whole and I’m thoroughly familiar with Michaelnomics.
I’d also suggest that people don’t always behave very rationally. That’s why economists are such lousy prophets: people are people, as annoying as that is. Rationally taxes are just another expense and it doesn’t make the slightest difference whether you’re paying $100 to the IRS or $100 to cable, it’s the same hundred dollars and you have to pay the bill.
Do people react very differently? Yes. As Vernon in effect admitted, there are other factors at work, emotional factors having to do with resentment, a feeling of compulsion, ideological axes that need grinding.
I’m behaving rationally, as though a C-note is a C-note, a bill a bill, an expense an expense. If I have to spend X amount per month then I have to earn something equal to or more than X. I have therefore no more reason to be upset by an extra $100 in the cost of taxes than I have to resent an extra $100 to Ralph’s, each requires me to earn a bit more. I may not like the work of earning more but there’s nothing Dark Magic about a tax bill as opposed to an insurance bill or a gas bill.
Drew I don’t doubt your anecdotal evidence, I doubt that the people you’re dealing with are rational.
Michael,
Are you telling us you have perfectly inelastic demand for various commodities and supply of labor. That if the price goes up you just keep on consuming what you have always consumed? That there is no price increase ever that will get you to substitute away from a good or even just reduce consumption because your relative income is reduced?
Here is my problem with the views expressed in this thread. They are completely and totally at odds with empirical facts. Price goes up, demand goes down. Downward sloping demand curves. But now we have Michael, Sam and Steve all saying: Nope, wrong! Demand curves are vertical in that there is no income effect and no subsutitution effect. Ever. For anyone. (Yes, that generalizing claim has been put out there again, “What I see in my part of the world, is that people work towards a specific income goal. If taxes go up, they work longer to met that goal. If they go down, they work less. Did the same thing when I was younger and working my way through school.”)
One of the most widely accepted economic hypotheses, that demand is downward sloping with respect to price and supply upward sloping, is actually false. If you wage goes down, you don’t work less you work more! Even if you have a low wage and are already near the limit in terms of leisure/labor supply (i.e. leisure time isn’t just watching television or vacation or going to the park, it is also sleeping, eating, and so on). Cut my wage in half, I’ll work 16 hour days!!! I’m sorry, bullshit (at least in aggregate). You are going to work twice as hard for the exact same pay? Maybe if it is a passion of yours, maybe if you are already paid a very high (implicit) wage. But aside from these special instances I’m thinking your average worker is going to make do with less. Hence the upward sloping labor supply curve, the downward sloping demand curves for other commodities.
For all the claims of rationality in this thread this is an irrational statment…or not one well thought at least. You can vary how much you spend. This is due to the income and substitution effects. The claim here is that $x is an exogenous amount handed to Michael from some outside source. However, it is based on decisions by Michael (and yes his family, but I’m sure there are times when he says to his kids, “No, that’s out of the question its just too much money.”). You can always tweak your lifestyle at the very least. As noted above turn up/down the thermostat, maybe substitute towards chicken vs. beef, or if you are buying a new car go for one that is more fuel efficient. Eat at home more.
One of the big things Dave has, more or less, been pointing out is that consumers have done this on a massive scale. He’s presented loads of data that people are simply spending less. Yet, the basic response in this thread has been, “No they haven’t.”
What planet are you people living on?
I was going to leave a long response to Michael but Verdon hit the main point. At the risk of being “anecdotal” (as opposed to “empirical”)………….have any of you naysayers ever bargained with a union?
If you think that people simply shrug their shoulders and work longer, harder etc because some third party wants them to you haven’t been in the business world. Ever heard of weekend pay, nightshift pay, overtime pay? The work/liesure tradeoff isn’t some theoretical construct. In the real world you have to pay a premium to get people to react.
And as a multiple business owner, if you’ve ever owned businesses in WI, PA, MY, WV, MO, IN, IL, AK, SD etc you don’t even want to know what its like to get people to work when its deer or turkey season or whatever. People will quit before foregoing that.
The notion that people are just fatted calves who will work longer hours at a moments request to pay taxes or forgoe their personal time is just absurd. Wasn’t it The Time Machine where the eloi just mindlessly walked into the cave to be eaten?
Not in my experience. Michael, would you just head the siren?