[edits 3:00 pm; edits 10/14 to add links to other blog discussions of Mankiw's op-ed]
When academics write about our own experiences in op-eds and blog posts, we risk making a common error--assuming that we can view ourselves objectively and that we can rationally dissect the pros and cons of our own situations as illustrative of humanity in general or at least of "typical" people in our circumstances. What we all tend to do is overlook obvious counterarguments to the position we espouse based on our own proclivities.
Talking about the potential lapse of the Bush tax cuts that were overly generous for the wealthy seems to be one of those areas where the trap lurks. Todd Henderson, a Chicago prof with an apparent income of upwards of $350,000 a year, whined about not being "rich" because he was barely able to afford luxuries that wealthy citizens enjoy (a landscaper to tend his lawn, a housekeeper to tend his house, etc.) and would have less discretionary funds to spend if he were to have to pay taxes at the pre-Bush rates. See, e.g., Brad DeLong, In Which Mr. Deling Responds to Someone Who Might Be Professor XXXX XXXXXXXXX, Sept. 18, 2010 (includes the original post by professor Henderson as well as a stinging commentary); Michael O'Hare, The Whining of the Rich, Sept. 18, 2010; The Whining Rich, ReadNews, Sept 21, 2010. As many noted afterwards, people tend to evaluate their circumstances in terms of those who have more: studies show that even multimillionaires think they need about double to be "secure". Henderson didn't stop to recognize that most Americans would be delighted to be in his circumstances, and for many of them it would be a dramatic change towards a better standard of living. If you are working two jobs to support a family of four and still have to make priority decisions between buying new jeans for your first-grader or buying better food for the toddler, then the idea of having several hundred of discretionary dollars a month after the luxuries Henderson reported as his necessary "expenses" (much of which was actually savings) would seem incredibly wonderful.
Mankiw, I think, has fallen into that trap, too. See Mankiw, I can afford higher taxes, but they'll make me work less, New York Times, Oct. 9, 2010. He notes that "Republicans say raising taxes on those who already face the highest marginal tax rates will hurt the economy" and proposes a case study--himself. He acknowledges up fron that he "can afford to pay more in taxes" and doesn't "have trouble making ends meet."
Nonetheless, as Republicans emphasize, taxes influence the decisions I make. I am regularly offered opportunities to earn extra money. It could be by talking to a business group, consulting on a legal case, giving a guest lecture, teaching summer school or writing an article. I turn down most but accept a few.
And I acknowledge that my motives in taking on extra work are partly mercenary. 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.
He claims that if he is offered $1000, his taxes, the corporate tax on his stock investments (treated as directly reducing his dividends and capital gains from the stock), a low rate of return, and estate taxes mean that his kids with get "at most, $1000" from his current $1000, making the opportunity not worthwhile. Therefore, he will decline more service opportunities if the tax rate increases and all Americans will "bear the burden", since their favorite singer, surgeon, orthodontist or others will provide fewer services.
He assumes a tax rate of 39.5% (highest federal rate) plus 1.2% because of the phase out of deductions at high income levels plus medicare tax of 3.8% plus Massachusetts income tax of 5.3% (minus an unspecified return because of the federal deduction), claiming that leaves him $523 out of the $1000. He says that without any taxes, his corporate stock would provide a return of 8%, while he claims that with corporate taxes he only gets a 5.2% return--asserting that the corporation "pays a 35% corporate tax on its earnings". He pays taxes on that income, so he claims his after-tax income on his investment is only 4%, resulting in $1700 after 30 years, which he claims is hit by the estate tax at a high marginal rate (he assumes somewhere below 55%), leaving his kids about $1000.
This analysis misses at least a few points (in addition to the fact that hardly anyone pays an effective tax rate equal to the statutory rate, once all the relevant provisions are taken into account, including deductible expenses to generate income, etc.).
- As to the basic premise of declining opportunities merely because the tax rate increases: Mankiw may have sufficient income and insufficient cravings for more to decline opportunities for more pay more readily than others, as he states, but there is an inconsistency between his stated goal of having more to pass on to his children and declining even more opportunities because of an increased tax on the opportunities accepted. Assuming his calculations are accurate and that he really wants to pass on more to his kids, then he can't really be sure that he would pass up the opportunity to work a little bit more to have more. He claims his kids will be $1000 richer for his working, and that means $1000 poorer if he doesn't take the opportunity. If his kids' wellbeing is his only goal, then if there is no new tax cut that effectively extends the Bush tax cuts he's enjoyed for most of the last decade it appears he would likely take that job and figure that $1000 is better than nothing. In fact, because of the increased tax bite, if his goal is really raising the amount available to his kids, he should take two opportunities now for every one opportunity that he took when the Bush tax cuts were operational to his benefit.
- As to corporate tax: Even many corporations that earn significant economic income pay absolutely zero in corporate taxes because of the many loopholes/tax expenditures in the Code and the ability to manipulate their taxes through agressive transfer pricing. Even corporations that end up paying taxes don't pay taxes at the statutory rate on their full economic income--the average effective corporate tax rate in the US is somewhere around or below 25% (varying depending on industries). And of course a corporation can change its policies on retention or distribution of profits taking into consideration the relationship between corporate taxation and shareholder taxation. And what about the incidence of corporate tax? Is it passed on in full to shareholders, as Mankiw presumes? That's not so clear as he suggests.
- As to estate tax: Mankiw disregards the fact that there will likely be a significant exemption under any new estate tax law that might replace the return of the 2001 estate tax as legislated under the Bush tax cuts. It will likely be an exemption of more than $1 million, perhaps as much as $3.5 million (double for a couple). So that $1700 won't be taxed at 55%. The effective tax rate on most estates that are actually taxed (ie, have some estate in excess of the exemption) is much lower than 55%, so the effective tax could be around 14% (depending on the size of Mankiw's estate and his willingness to engage in estate planning).
- As to the calculated no-tax-at-all 8% return from his corporate stock investment: there are many issues here, but the biggest problem is Mankiw's total disregard of the impact of non-taxation--or just insufficient taxation-- on the his corporation's business and his own ability to earn income from speaking, writing and whatever. Most countries with ineffective tax systems find themselves unable to function appropriately. Ineffective markets because of the lack of appropriate governmental limitations would be a certainty. Both the speaking engagements and the corporate profits might well vaporize in a no-tax or even an insufficient tax world. Since the wealthy like Mankiw benefit significantly from government and receive preferential tax treatment on their financial assets (of which they own the vast majority), they would be the most negatively impacted by the lack of appropriate government safeguards.
In short, Mankiw admits that he already makes one-on-one decisions about which opportunities he will pursue, and chooses to pursue few. He claims that taxes would lead him to choose to pursue even fewer, based on his calculations of the taxes on that incremental income, even though his reason for pursuing any opportunities at all is to set aside money for his children's future. Clearly, there are lots of tradeoffs to be made, and various factors come into these decisions (taxes, leisure, desire for status, etc.). As others have noted (see comments on TaxProf posting), someone with Mankiw's economic training and in his sought-after position should know how to bargain for the after-tax return he desires and be able to do so because of his considerable bargaining power. And as I've noted here, having a bigger tax bite should work as an incentive to work more, not less, if his goal is really to provide more for his kids.
But let's assume that it is possible that he would turn down more posts if there were an incremental increase in his tax rates due to the expiration of the Bush tax cuts. In that case, does that mean that the economy suffers, as Mankiw asserts? He suggests that when stars turn down additional earning opportunities, the not-rich bear the burden because the service provided is simply not available. But in fact that is when competition increases, which economists usually argue is good for economic growth. For every surgeon who turns down yet another operation, a path is opened for another surgeon to gain expertise and higher pay. (And the up-and-coming surgeon may even turn out not only to be available at a bargain, but a better surgeon more familiar with newer techniques.) For every speaker who turns down a speaking engagement, another with competent qualifications is waiting in the wings to become a star (or at least receive this incremental increase to compensation). The economy is in fact served by spreading the service opportunities across more people and allowing more people to develop a level of expertise that is worthy of higher compensation, instead of allowing a few "stars" to garner all the income. That is the way we achieved dramatic growth in the post-war years.
So go to it, Mankiw. Turn 'em all down, so that budding young economists--maybe even some women and people of color for a change--will have their chance in the limelight.
The below added 10/14: these blog posts also discuss Mankiw's op-ed:
John Schmitt, Three-Card Mankiw, No Apparent Motive Blog, Oct. 12, 2010. Schmitt approaches the Mankiw op-ed by accepting the marginal analysis as a reasonable approach for discussing the Obama proposal, but contrasts Mankiw's analysis (that looks at the total tax bill on his marginal $1000 of income to conclude work isn't worth it) with an analysis of the incremental increase in Mankiw's taxes due to the proposed Obama decision to allow the Bush tax cuts for the rich to lapse as scheduled by the 2001 GOP legislation. He also addresses aspects of the issues I raised above, including the misleading discussion of the corporate investment but from a different perspective and with additional insights that are worth reading in full. I particularly like this questioning of the difference between what economic actors say and what they do:
"Did Mankiw work less--let alone a lot less--in the 1990s, when marginal tax rates at the top were a bit higher, and then more--let alone a lot more--in the 2000s when they dipped down? Would anyone but an economist believe that?"
Andrew Gelman, Update on Mankiw's work incentives, Statistical Modeling at Columbia, Oct. 12, 2010 (with links to his own earlier posting and a post by Tyler Cowen linking to a further Mankiw blogpost on the impact of higher taxation on his work commitments). I didn't find this post all that interesting. But I do like the comment from Paul (of The Future According to Paul Blog) that included this tidbit, in the context of raising the issue of the impact of economic inequality and the negative societal costs of a lower top marginal tax rate even if it encourages more economic value at the top:
"I think economics is a bit like thermodynamics: while you can focus on what each individual atom/actor is doing, doing so often distracts from the more important larger picture, where the overall behavior isn't just a trivial sum of the individual behaviors."
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