Why not everyone should pay into the system

There’s an idea going around that it’s a bad thing when poor people don’t pay taxes. This has manifested itself in the infamous Mitt Romney ‘47%’ gaffe and also in the debate here in the UK about contributory benefits, the personal allowance and whether people should be getting benefits out of a system they haven’t paid into. The central argument is that, if you don’t pay taxes, you’re going to want to increase the provision of public services – all public services – because you get a share of whatever scant benefits there might be from the increase, and you don’t have to pay for any of it.

There are a couple of standard objections to this view. One is that poor people do pay a lot of taxes, in the form of social insurance contributions, consumption taxes and so on. Another says that, even if people don’t pay taxes one year, they might pay taxes the next; certainly, many of the 47% has paid income tax recently, and might again soon. There’s also a related life-cycle issue – many people not paying taxes are retirees or students, who have paid or will pay taxes at some other time in their life.

Then there's the argument that social insurance is just that - insurance - and just like with, say, home insurance, if some people get back much more than they paid in, it's a feature rather than a bug.

I’m going to explore a few other objections, though.

Firstly, it confuses average and marginal costs and benefits. If I’m going to vote for more spending, the cost to me of that spending isn’t the taxes I already pay – it’s the extra tax I’d pay to finance that spending. I might not pay any tax now, but if the government increases spending, it might pay for that by lowering tax thresholds so that I will pay tax in the future, or raise one of the kinds of taxes that I do pay, like VAT. Whether or not I pay taxes now has little to do with whether or not I will pay the cost of a rise in spending.

Equally, the myth of the squeezed middle (more on this later) allows many people to argue for ‘free’ benefits – not because the middle class doesn’t pay taxes, but because at the margin any tax rise is going to fall on the rich. This is obvious in the USA, where the Democrats are pushing for higher taxes on the rich and only on the rich, and consequently the alternative of spending cuts looks comparatively unpalatable.*

Secondly, the simple fact of whether or not I’ve paid into the system doesn’t really matter that much. If I paid £1 in income tax last year, it’s not going to make me dramatically more averse to increased spending than if I didn’t pay anything. As a result, even if the tax rate paid by the poor was important, the 47% statistic would still be meaningless. What’s important is the average tax rate paid by the poor. And that becomes an argument against any and all redistribution, which no-one** advocates (even flat-tax advocates think that benefits should be progressive).

Thirdly, while people are self-interested voters at the margin, on average they are actually quite civic-minded. Bryan Caplan's excellent article, The Myth of the Rational Voter, was widely derided for calling voters idiots, but one of the interesting things it pointed out is that voters don't tend to vote for the things that will be best for them. People vote for farm subsidies not because they benefit them but because they (mistakenly) think that it will be good for society. Equally, even if poor people not paying tax had a marginal effect on how likely they were to vote for extra benefits, it wouldn't be the only or even the most important deciding factor. They might still vote against it if they thought that was what was best for society.

Summary: if anyone ever tries to argue that taxing the poor is vital for preserving democracy, tell them they're an idiot.

*This argument is starting to look a bit politically slanted. Of course, from a Rawlsian/utilitarian perspective, if you can get benefits to the poor and middle class solely by taxing the rich, maybe that’s a great thing.

**Apologies to any anarcho-capitalists I may have offended by this statement. I love you really.

The Pope Is Right – Bangladeshis Are Slaves

The new Pope has come out and called the conditions of Bangladeshi workers like the 400 tragically killed in a building collapse last week ‘slave labour,’ and he’s right.*

Let's be clear. He’s not right because ‘not paying a fair wage’ and ‘only looking to make a profit’ are things that ‘go against God.’ Here, I’m firmly on the side of Matt Yglesias’ posts on the subject (which were widely criticised). Essentially, there’s a tradeoff between work safety and employment/wages. As Bangladeshis get more productive, they’re going to work less, and they’re going to be willing to give up some of their rising wages in order to make their workplaces safer. This will happen, just like it happened in the UK in the 19^th and early 20^th century, and just like it happened in China over the past couple of decades. Until it does, we should be wary of imposing higher labour standards, because poor Bangladeshis probably prefer long hours and unsafe conditions to reduced wages. Once Bangladeshis get richer and more productive, working conditions will improve – and government legislation will likely follow the improvement in conditions rather than lead it.

Rather, the Pope is right because the Bangladeshis are slaves in another way. Or, more accurately, they’re serfs. Back in the days when the Pope had significant lands and armies, Europe was ruled by feudal lords. Peasants working on the land weren’t slaves – the lords didn’t own them – but there were tight legal restrictions on their freedom to move to the next farm over. That meant lords didn’t have to compete for labour – you couldn’t just work for someone else who offered better wages and conditions, which meant there was little incentive for your current lord to offer you better wages and conditions. It hurt the economy, too, as people were unable to work where they would be most productive.

Of course, serfdom is complete anathema today. It’s obvious to everyone that the feudal system was destructive and immoral. Nothing like that could ever happen now. Right?

Imagine that there are a large number of corporations who would love to hire Bangladeshi workers at fair wages and with good conditions. If the Bangladeshi employers wanted to keep their workers, they would have to pay higher wages and provide better working conditions.

This isn't just a hypothetical. These companies do exist. Sadly, however, they’re mostly based in North America and Europe. There are legal restrictions on where Bangladeshis are allowed to live and work which prevent them from working for said companies, stifling competition. That's what makes the Bangladeshi's willing to accept the bad wages and working conditions - they have no alternative. As long as serfdom is allowed to persist, the serfs won’t have much chance of earning a fair wage in a safe environment.

On the other hand, feudalism long ago ceased to exist. So maybe there’s some hope that things will improve.

*It’s worth noting that the building itself was illegal under existing Bangladeshi law. Like the Pope, I’m going to focus more on wider issues of labour exploitation in Bangladesh.

No.

Nick Clegg has a new immigration speech in which he rows back on amnesty for illegal immigrants and talks up £1000 bail for temporary immigrants.

This is not cool, Nick.

Secret courts were one thing – it was an issue of principle, and in practice it’s not likely to have much effect. Press regulation, while distasteful and cackhanded, is a bearable compromise with the Guardian latté left of the party. On neither issue does illiberal policy really hurt anyone all that much.

Immigration is not in that category.

One of the biggest reasons why, despite my idiosyncratic politics, I carry my Lib Dem membership card without too many caveats is that, until today, we were the one party with a serious and sensible and humane immigration policy. I didn’t have to consider the merits of the Tories because immigration was my one red line. We were the one party that rejected the monstrous insanity of ever-increasing migration protectionism squeezing out determined migrants who just want to work hard and pay taxes. Today Clegg has betrayed that, and for what?

It’s not even smart politics. Generic protest voters are already lost to Labour or UKIP, and this sort of softening on immigration isn’t going to bring them back. Upper-middle-class suburban voters don’t care so much about immigration as about the economy – we win there because of the toxicity of the Tories. Now we’re just as bad as the ‘nasty party.’ The Celtic fringe is hardly going to care about immigration considering those areas have the smallest foreign-born populations in the UK. And anyone who votes on local issues isn’t going to care much about immigration, because very few people think immigration is a problem for them.

The next constituency we had a chance to make inroads with was in inner-city, migrant-heavy constituencies, where anyone with a strong ground game who was willing to listen to locals’ concerns could succeed. Just look at the success of the Canadian Conservatives – or, heck, Respect! Requiring people to pay a grand for each of the relatives coming to their wedding is hardly going to help with that. Labour have to pander to the miniature Hitlers who don’t think anyone brown or poor who had the misfortune to be born in a different country has any right to live where they want, or work for people who want to employ them, or buy from people who want to sell to them – but we don’t.

We know – Clegg must know – how crucial immigrants are. Clegg acknowledges it in his speech! They benefit us. They certainly gain hugely themselves. And yet still he delivers this deeply, deeply disappointing speech.

This sort of stupid pandering is exactly how the Tories got away with the economic and humanitarian insanity that was migration capped at the ‘tens of thousands.’ This is where we get ‘British jobs for British workers’ from. This is why hundreds of millions of people are living in poverty around the world, and billions more aren’t earning the wages their skills justify.

Clegg took the risk of pissing off the left of the party by acknowledging that actually, Orange Book economic liberalism was part of the platform too. And now he’s pissing all over the one part of the economically liberal platform that those on the left liked.

I’ve defended the Lib Dems for a long time and I think they’ve accomplished a lot. But this is a lot to fucking swallow.

Kuehn on Immigration

The always interesting Daniel Kuehn has a thought-provoking post on immigration:

1. It's a really bad idea to give high skill immigrants a leg up in the immigration process. It's market planning that we would balk at if we did it for foreign investment or foreign trade but for some reason it's palatable for foreign flows in labor. We do not have high skill labor shortages and decades of research has shown that. The high skill immigration programs are often exploitative of workers. Science and engineering market failures are principally on the demand side, not the supply side. Plus it simply goes against our values. If we went all-in for an Australian or Canadian style points system program we might as well just remove the "huddled masses yearning to breathe free" plaque from the Statue of Liberty.

There’s something to this argument if you see immigration through the lens of comparative advantage, as this Bryan Caplan post does. We gain from trade when we trade things we are relatively better at making for things that other people are relatively better than making. But of course certain goods and in particular many services are much harder to trade across borders – that’s one reason why the gains of immigration are so high in the first place. So from this perspective, we don’t want to be letting in people who can produce the things we’re just as good at producing – academics and computer scientists. We want to let in the people who are low-skilled, because their opportunity cost of producing low-wage services is much lower than ours, so there can be huge gains from trade.

That’s fine as far as it goes. But there are a bunch of other good reasons why you’d want to promote high-skilled immigration. For one thing, one of the biggest benefits of freer immigration are agglomeration economies. When people cluster together, they all get a lot more productive. There are reasons to think that these effects are more important for high-skilled workers. If you’re a waiter, your productivity is not really affected that much by the number and quality of the other waiters around you. But if you’re a scientist or an entrepreneur, then you do gain a lot from getting to work with and share ideas with a larger population of other scientists and entrepreneurs. I don’t have any hard evidence to hand, but anecdotally the ‘place premium’ is higher for higher skilled workers, for this reason. Moving a physics PhD from Somalia to California raises their productivity more than it would an unskilled worker’s.

From the perspective of American welfare, which Kuehn thinks is what we should focus on, there are also benefits from high-skilled immigration. An influx of very low skilled immigrants would increase local inequality, with its attendant costs – lower civic trust, worse social cohesion and so on. Higher-skilled immigrants are more likely to assimilate more quickly into American society. Obviously the higher immigrants’ incomes, the larger the fiscal benefits, meaning a lower tax burden on current Americans. And given diminishing marginal utility of income, we should be more worried about wage suppression of low-skilled native workers than the high-skilled.

Of course, there are other reasons to accept the low-skilled in. They themselves are likely to experience a bigger improvement in their living standards than a high-skilled person would. And the costs of filtering out the high-skilled from the low-skilled are probably quite high, leading to an expensive and bureaucratic system that ends up deterring all potential immigrants from applying. So a mixed bag of immigrants is probably more desirable.

2. Illegal immigrants are exactly who we want here and occasional amnesty is not that bad of a policy. Most people insist they love immigrants but want them to be here legally and talk about how illegal immigration is unfair to people who wait in line to be legal immigrants. But being an illegal immigrant reveals important information about the immigrant: these people really want to be here. They want to be here so much they will take personal risks to avoid the wait. They also like American society more than they like Congress or the federal bureaucracy. That doesn't seem like that bad of a perspective to have. People will also sometimes talk about how amnesty is bad because it sends mixed signals and it will indicate that our commitment to immigration enforcement isn't credible. But amnesty legitimates the immigrants who have revealed this important information about themselves in the decision to come over illegally. Of course there are a lot of problems with illegal immigration, even for the immigrant themselves. They obviously don't get to live fulfilling lives while their status is in that kind of limbo. So I'm not necessarily advocating restricting immigration flows just to get a crop of dedicated illegals. What I'm saying is that people need to think about the self-selection implied by illegal immigration and realize that those are exactly the sort of people we want as fellow citizens. How many natives would go to such length to get into the United States?

Again, to some extent I agree with this – self-selection is an important part of why immigrants are so great for the country and the economy. But that’s true of any kind of immigration. The kind of people who are desirable enough employees for companies to subject themselves to the H1-B visa process are going to be the ‘best’ immigrants. The kind of people who would scrimp and save in order to pay an immigration tariff would be the ‘best’ immigrants. Even under completely open borders, the kind of people who would be willing to uproot themselves and their families in search of a better life would be the ‘best’ immigrants.

And illegal immigration is obviously horribly inefficient. Mexican ‘coyotes’ could be doing something much more productive. So could document forgers. The immigrants would be able to do their jobs a lot better if they could work on the books.

More than that, though, the strategy of illegal immigration followed by amnesty as a backdoor way of increasing immigration is counterproductive. It marginalises immigrants, makes voters less empathetic towards them – and if the majority of voters don’t think you’re ‘like me’ then the law is not going to treat you well. A sense that the law is being flouted doesn’t endear people to more immigration. If immigrants were permitted to come legally then they would assimilate much better into society, be more likely to speak English and probably people would feel better about letting them in.

Now, I know Daniel isn’t suggesting that this is a first-best policy, and I agree with him that we could do a lot worse than periodic amnesty for large numbers of illegal immigrants. But that’s hardly a ringing endorsement for the policy.

3. The population that should benefit from immigration policy is a moving target. You hear two different things on this issue. First, the Bryan Caplan types think that we should maximize global welfare. I think this is obviously wrong. When we get together to form a government we do it to satisfy our own needs and internalize our own externalities. The world should have no expectation of free riding on our collective action. That doesn't mean we don't care about the world when we make policy - it's only to say that the social welfare of the world should only enter policymaking to the extent that American citizens value the social welfare of the world. So policy should be made to maximize the welfare of Americans. This is fine for most policy, except immigration. When it comes to immigration the very question of which population has standing in these decisions is a moving target because the whole policy debate is about who is and is not an American! Now it's possible there's a stochastically dominant policy that will be preferred no matter what the population of "Americans" that we decide on is, but that's not guaranteed. The question of whose utility we are maximizing and what immigration policy should be is self-referential. What I draw from that is that we shouldn't stake too much on thinking about a specific population that we're trying to help. We should rely on other decision rules and principles. The Bryan Caplan types should stop talking about what's best for the world and the rest of the country besides the Bryan Caplan types should stop talking about what's best for Americans.

As a Bryan Caplan type, I have a good counterargument to this, which is that the world is not free-riding on our collective action. Freedom of movement is not something we graciously allow, it’s something we gratuitously restrict. When we restrict immigration, we are killing, not letting die. We are chaining Julio to the tree. And it’s pretty obvious that we shouldn’t be allowed to do whatever we want to foreign people if it makes the ‘master race’ better off.

I do think it’s a tough question to think about. If we admit that we’re trying to maximise the welfare of Americans, that naturally leads to the question – which Americans? Do the children of potential immigrants, who would be citizens, count? Schools in the USA are a lot better than in Mexico. How much more weight should we assign to low-income Americans’ wages as opposed to high-income?

So Kuehn decides that we shouldn’t assess the policy on utilitarian grounds at all. But then if we don’t think about policy based on whether it would increase welfare, what do we decide based on? If we see freedom of migration as a natural right, then it would be unjust to restrict immigration even if it did substantially decrease global welfare – but it’s clear that Kuehn doesn’t take this view. So what criteria is he using to evaluate immigration policy?

Ultimately, I think the answer to this has to be a Pareto-efficient immigration policy. Because the benefits of immigration are so large, we could easily design the policy in a way that increased everyone’s welfare. Then we wouldn’t have to care so much about which groups’ welfare we should be thinking about.

NGDP Targeting and the Inflation Messaging Problem

Quite apart from the substantial economic benefits of NGDP level targeting, it has a messaging advantage. Targeting nominal incomes is quite a lot easier to explain to the public than targeting inflation. For example, imagine the following hypothetical news story:

CPI inflation fell to 1.8% last month according to latest statistics, providing consumers with a welcome dose of relief in the horrible economy. 

 There is hope that the ending of the squeeze on real incomes will boost consumers’ spending power and help get the recovery back underway. 

[Central bank economist] said the news was cause for celebration. “We knew our flexible inflation target was a good idea and this has been proved now that inflation is coming back under control.” 

[Pensioner lobby spokesman] was cautiously optimistic. “This is an optimistic ray of light for pensioners, many of whom are poor and who you should all feel sorry for. Now if only the bank would unwind its distortionary QE policies then prices would be lower for working people and there would be rainbows and unicorns for everyone.”

Under NGDP targeting, we instead get this:

Nominal income growth declined to 2% last quarter according to latest statistics, suggesting dismal prospects for the recovery. 

The continued fall in nominal incomes is likely to dim the prospects for the recovery. This suggests that the Bank of England should be considering more monetary easing, considering that nominal income is getting further and further away from where it ‘should be’ under the Bank’s level target. 

[Central bank economist] said that the Bank would not act. “Yes, nominal income growth is abysmal. But we think there are costs and risks to further action. I won’t explain what these costs and risks are, but suffice to say that we won’t be helping anyone.” 

[Pensioner lobby spokesman] saw no cause for alarm. “Yes, growth is weak. But forget working people – the real problem is rich pensioners who hold government bonds! The Bank should reduce nominal growth even further to help these people out.”

What to Do When You Can't Tax Wealth

Ezra Klein points out that wealth inequality really sucks:

There’s a strong case to be made that what we worry about when we worry about economic inequality makes much more sense in terms of wealth than income.Take social mobility. A family might be doing fine on the income scale but still living hand-to-mouth, with little left over to pay for the child’s SAT prep or college tuition. A family with wealth, on the other hand, can always liquidate some assets to invest in their child’s future, and they can do so without worrying that they won’t be able to pay next month’s mortgage.Political power works similarly. A young hedge funder who just got her first big bonus might show up in the top 1 percent of the income distribution. But she’s still paying down college loans and saving up for a house and waiting to see whether these incredible checks keep coming. She doesn’t have the security to be trying to purchase politicians.But someone in the top percentile of the wealth distribution? They’ve probably been very comfortable for a long time, and they know they have the resources to continue being very comfortable for a long time, and so they can make speculative investments in politicians.

 Ezra hits on the crux of the problem, which is that wealth inequality is more pernicious than income inequality because it reduces equality of opportunity. We want a society which is broadly meritocratic, where the smartest, most hardworking people who can do things people want done get paid the most. And one obstacle to that is wealth inequality.

The problem is that we can’t tax wealth, because taxing wealth is really hard and has deleterious economic effects. Essentially, while wealth inequality is bad, wealth itself is obviously good and we don’t want to discourage it. So we have to find some other way of dealing with the problem. The Economist magazine released a report a couple of months ago calling for a number of changes to mitigate inequality.

We could address inequality in quite a few ways, but I think the problem is that whatever your policy prescription is, we’re already doing it.

We could invest more money in education so that people who are smart can rise to the top whatever their background. But education spending has risen a lot over the last decade (especially in the UK), and it’s not clear that it’s had that much effect on equality or on outcomes.

We could encourage – or force – poor people to save. This would reduce inequality without having to take wealth away from any of the rich. But to some extent we already do this. People pay national insurance contributions (payroll taxes in the US) and that entitles them to certain benefits. So they’re essentially saving for their retirement (and getting a generous subsidy to do so) without it showing up as wealth. I think a semi-private forced saving model, Singapore-style, might make people better off – but transition is hard and it would probably be a political nonstarter.

So the outlook is pretty depressing. It doesn’t seem like there’s a lot more we can do. And indeed the evidence is that inequality is really, really, really intractable. But there are a few things we could do.

Perhaps the most promising is deregulating the planning process – making it easier to build stuff and in particular tall stuff in big cities. This would push down house prices, making it easier for poor people to get on the housing ladder. It would provide steady construction jobs, resisting the bifurcation of the labour market (or be done cheaply by immigrants, which would be good too).

Perhaps most importantly, it would mean more people could afford to live in dense, high-productivity cities. In the (excellent) HBO series Girls, in order to make it as a writer, Lena Dunham’s character has to spend time working as an intern – and she can only afford to live in New York because her parents help her pay her rent. This is one of the biggest problems caused by wealth inequality. Even education-sceptics will acknowledge that the skills and networks you acquire through on-the-job training and internships are valuable. But few people without deep-pocketed parents can currently afford to pay London’s exorbitant rents while working for very low pay or even for free in order to work towards getting a high-paid job. Perhaps if the South Bank looked a bit more like Manhattan it wouldn’t be so hard.

(Human) Capital Punishment

Economists talk a lot about why we shouldn’t tax capital gains. The essential idea is sound – you’ve earned your money, it’s been taxed once, and the market value of that cash is the same whether you consume it now or invest it, get interest, and consume more later. If you tax the returns to investment, you make saving less attractive than it should be, and consuming now more attractive than it should be, which leads to there not being enough investment.

Now, a few economists are more sympathetic to the idea of capital taxes. If elasticities are low – rich people will still save lots anyway – it might be a relatively painless way of reducing inequality and getting revenue. And giving a preferential tax rate to capital gives people an incentive to pretend their wages are really capital (see carried interest loophole, the – or the absurd lengths English football players go to). But overall the consensus in the economics profession is that taxing capital is a really bad idea.

This is fine as far as it goes. But you get the worst of both worlds if one kind of capital is taxed more than another kind. You get less investment, and investment gets shifted towards the kind of capital that gets taxed at lower rates. And there is one kind of capital that gets taxed at exactly the same rate as wages – human capital.

Imagine you’re given £20000, and you’re given the option of investing that money in the stock market or spending it going back to school so that you can earn more from your labour in future. Any gains you get from your investment in stocks will be taxed like capital gains. But any gains you get from education will be taxed like wages, so you’ll probably pay more. And the progressive structure of the tax code makes this even worse because some of the ‘extra’ earnings might be taxed at an even higher rate than the rest of your income. So not only have the gains been taxed as wages but your overall average tax rate is higher than if you hadn’t invested in your education at all. The result of this is that people will invest too much in factories and machines, and not enough in education and training* - and the potential positive spillover effects of human capital only make the problem worse.

This is why we should listen to people like Scott Sumner when they caution us against the potential long-term effects of high marginal tax rates. Raising the top income tax rate might cause doctors today to work more, or it might cause them to work less, or it might cause them to dodge taxes. It might have a whole host of other effects. But one thing it does do is reduce the incentive for kids to put themselves through medical school in the future, because their investment in human capital is going to be taxed at a very high rate.

Of course, one way to fix the screwed-up nature of this system might be a shift towards greater consumption taxation, which might also solve someother problems. But how likely is that to happen?

*Of course, if you believe in the signaling model of education, then maybe this is a good thing.