The Agenda

Let’s Cut Through the Confusion Over Greg Mankiw’s Latest Column

Greg Mankiw has written another smart and engaging column, this time on marginal tax rates. But because Professor Mankiw isn’t primarily interested in scoring points, he used his column to describe his idiosyncratic motivations when he weighs the decision to write a short freelance piece. This wasn’t necessarily the most vivid or effective illustration of the power of marginal tax rates to influence work effort, as Mankiw is, by his own account, pretty satisfied with his current level of consumption:

 

I don’t want to move to a bigger house or buy that Ferrari, but I hope to put some money aside for my three children. They will never lead lives of leisure, but I hope they won’t have to struggle to find down payments to buy their own homes or to send their kids to college.

Suffice it to say, people who do want to move to a bigger house or buy a Ferrari will respond to MTRs differently.

Kevin Drum thinks that Mankiw is overstating the impact of marginal tax rates:

This is why the tax posse has such a habit of wildly overstating things. If they don’t, there’s no there there. It turns out that the effect of letting the Bush tax cuts on the rich expire is so minuscule that the only way to make it look sensational is to pick a scenario in which you (a) overstate effective tax rates, (b) compound those tax rates over 30 years, (c) slash the final number nearly in half by ignoring the estate tax exemption, and (d) use this year’s highly unusual zero rate as your baseline. It’s a virtuoso performance.

I have to say, I find this pretty odd. If anything, I’d say that Mankiw is understating the impact by focusing on his admirable and altruistic desire to benefit his children. As a member of the tax posse, let me highlight another number from Mankiw’s column:

First, assuming that the Bush tax cuts expire, I would pay 39.6 percent in federal income taxes on that extra income. Beyond that, the phaseout of deductions adds 1.2 percentage points to my effective marginal tax rate. I also pay Medicare tax, which the recent health care bill is raising to 3.8 percent, starting in 2013. And in Massachusetts, I pay 5.3 percent in state income taxes, part of which I get back as a federal deduction. Putting all those taxes together, that $1,000 of pretax income becomes only $523 of saving.

What Mankiw should have done, in my view, is give us a clear look at how pretax income translates to after-tax income in any given year. So we’d compare $523 to, say, $524.

The gap between $523 and $524 is trivial. But what about the gap between $523 and, say, $550, or $550 and $625? Or, for that matter, what happens when we go from $523 to $522 or $501 or, crucially, $499 and below? 

Because we’re socialized into certain working patterns, slight shifts in marginal tax rates don’t always have an immediate impact on work effort. But over time, MTRs can impact the broader culture of work in which we’re embedded, as a new empirical evidence suggests. We shift from an equilibrium with high after-tax incomes and more outsourcing of household labor to one in which we have low after-tax incomes and less outsourcing of household labor, and smaller overall economy than we’d have otherwise. 

As Robert F. Kennedy argued, Gross National Product isn’t everything:

Too much and too long, we seem to have surrendered community excellence and community values in the mere accumulation of material things. Our gross national product … if we should judge America by that – counts air pollution and cigarette advertising, and ambulances to clear our highways of carnage. It counts special locks for our doors and the jails for those who break them. It counts the destruction of our redwoods and the loss of our natural wonder in chaotic sprawl. It counts napalm and the cost of a nuclear warhead, and armored cars for police who fight riots in our streets. It counts Whitman’s rifle and Speck’s knife, and the television programs which glorify violence in order to sell toys to our children.

Yet the gross national product does not allow for the health of our children, the quality of their education, or the joy of their play. It does not include the beauty of our poetry or the strength of our marriages; the intelligence of our public debate or the integrity of our public officials. It measures neither our wit nor our courage; neither our wisdom nor our learning; neither our compassion nor our devotion to our country; it measures everything, in short, except that which makes life worthwhile. And it tells us everything about America except why we are proud that we are Americans.

I don’t share Robert F. Kennedy’s political views, obviously, but he makes a decent case that growth isn’t everything. But I think we can all agree that it is something

Moreover, I’d suggest that the really important question is about competing uses. The Tax Policy Center suggested [PDF] that the two top tax rates would have to go to 72.4 and 76.8 percent to reduce the deficit to 3 percent of GDP if we only relied on tax increases on households earning more than $250,000. Crudely, that suggests that Greg Mankiw’s $1,000 would become something like $200 in a world in which Congress adheres to President Obama’s campaign promise and balances the budget without raising taxes on households earning less than $250,000. What exactly would federal, state, and local governments do with that $800?

Or heck, let’s throw away the thought experiment and just talk about what federal, state, and local governments are doing with the $477 tax take from the Mankiws of the world that reflects status quo policy. 

Some of this money will undoubtedly go to provide various basic services. But are these services being delivered in the most cost-effective manner possible? And if not, what exactly is the motivation for taking more? A number of critics have derided the tax posse for the use of moralistic language:

But I think economists tend to underestimate the extent to which beliefs about taxation are shaped by values: ideas of fairness and justice. It’s interesting to me that many rich individuals don’t make an efficiency argument when railing against tax rates, but rather declare that they’re being robbed of the deserved fruits of their labours—they earned it, they should get to keep it.

I actually don’t think this is about robbery or fruits, etc. Rather, it is a basic question about where tax dollars are actually going. The intuition is more than just “they earned it, they should get to keep it.” I suspect it’s more like, “I understand that we should spend money to give old people medical care and help poor kids, and that we need roads and the military and all of that stuff. But are the people spending my money spending it carefully? Are they driving a hard enough bargain? Is the money we’re spending on poor folks actually getting to them, or is it going somewhere else?”  

The recent debate over the ARC tunnel suggests a shocking level of ignorance about how major infrastructure projects work, and I fear that this reflects a deeper ignorance about the challenges and, in at least some cases, the pathologies that have shaped the U.S. public sector. To be sure, a similar set of problems plague many private firms, but of course private firms are, with rare exceptions, relatively easy to wind down, and of course most are subject to the discipline of competition. 

So here is the grand bargain: let’s focus on wasteful, duplicative, ineffective, and unwarranted spending first, reduce tax expenditures second, and then and only then consider raising the overall tax burden. I sense that the first task will keep us busy for a long time.  

Reihan Salam is president of the Manhattan Institute and a contributing editor of National Review.

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