Tuesday, January 17, 2017

A Possible Contradiction in Liberals' Concerns About Corruption?

by Neil H. Buchanan

Which is it?  Do rich people respond to incentives to get richer, or do they reach the point where enough is enough and other goals take precedence?  Does it matter?

I raised this issue briefly at the beginning of my most recent column, referring to Trump's cabinet of billionaires.  In defense of Senate Republicans' efforts to rush through confirmation votes without carrying out the legally required vetting for conflicts of interest, the Trump team's response is that these people could not possibly be subject to any temptation to abuse their positions.  They're rich already!

My purpose in that column was to point out a number of Republican hypocrisies, with my final point being that conservatives love to say that people should be held personally responsible for their actions and that "feelings" are irrelevant -- unless and until it is convenient for Republicans to say the opposite.  The point about rich people's satiation was merely the first step along the way to making that broader point.

Here, however, I want to explore on its own merits the question of whether financial incentives are still relevant to the super-rich.  As I noted, Paul Krugman had responded to Trump's argument by pointing out that it is completely inconsistent with Republicans' core belief that tax cuts for the rich are the key to economic nirvana.  They cannot have it both ways, Krugman (and I) said.

Even though the Republican position on Trump's cabinet nominees truly is in tension with their views on tax incentives, it is possible that the liberal positions are symmetrically hypocritical.  After all, one could respond to Krugman: "Well, you're also opportunistically contradicting yourself.  You oppose tax cuts for the rich but worry about corruption by Trump's appointees.  It's still a contradiction."

As plausible and evenhanded as that sounds, however, it in fact turns out that the liberal positions on those two issues are not in conflict.  In order to understand why, we have to dive a bit into some economics and psychology.

One of the most well established empirical findings in economics is that the estate tax does not have negative impacts on people's incentives to accumulate wealth.  Although Republicans love to complain about how the estate tax forces hard-working families to break up and sell the family farm or small business, there is still not a single example of that happening anywhere.

This finding is inconvenient for Republicans, because they view it as such a powerful political message.  Even if no family farms or businesses are being broken up, however, there is still the question of whether people change their behavior in response to the estate tax.

Conservatives certainly want to believe that they do, because it fits so neatly into their simple world view in which everyone responds to incentives in the same way.  If a person knows that the estate tax will reduce the amount of money that she will pass onto her heirs, then the conservative presumption is that she will not bother to build up her estate.

This basic conviction -- that if you tax something you will discourage people from doing it -- is baked into conservative economic beliefs.  One high-profile conservative economist once told me that he was fully aware of the empirical failure to find a disincentive effect of the estate tax, but he then said, "I just don't believe it.  There simply must be a negative effect."  If reality and theory are in conflict, so much for reality.

Of course, there are perfectly standard explanations for why rich people do not respond to the estate tax in the way that conservatives hypothesize.  One is that they are simply using the size of their estate to keep personal score of their success, so that they continue to build up their estates even though they know that some of it will not reach their heirs.

Another possible reason is that people might be trying to reach a particular goal, a dollar amount for an estate that the decedent-to-be views as large enough to fulfill her obligations to her family.  If that is true, then an increase in the estate tax would encourage a wealthy person to work harder, not to back off.  (Some readers might recognize this as the "income effect" dominating the "substitution effect.")

And because the aggregate finding is that the estate tax neither encourages nor discourages wealthy people in their pursuit of more riches, the most likely explanation is that some people respond in one direction while other people respond in the other direction, with the net result being a wash.

This also seems to happen with taxes in other areas.  For example, even though conservatives want to believe that the income tax is bad because it supposedly discourages people from earning income, there is a robust body of literature showing that the typical income earner does not respond to tax changes.  (The exception is that so-called secondary earners in households do seem to stay home when taxes go up.  However, fewer and fewer families have primary and secondary earners, with both spouses' incomes being necessary to maintain their lifestyle.)

Over time, more and more economists have come to accept the fact that the usual Republican line against taxes is simply not passing the reality test.  Neither high-end tax cuts (whether to the estate tax or to the income taxes that wealthy people pay) nor across-the-board tax cuts have the desired effect of encouraging a burst of entrepreneurship.  One result of that reality is that the Laffer Curve is very much dead.

The bottom line on all of this economic research is that the conservative case for tax cuts, especially regressive cuts (that is, those aimed at the rich), falls apart.  Tax cuts do not lead to increases in potential output (a supply-side effect), and they do not lead to increases in revenues.  (See especially Kansas's recent experiences.)

That is not to say that tax cuts of some types cannot be justified for other reasons.  For example, in the face of a recession, a package of tax cuts aimed at lower- and middle-income earners is likely to have a good demand-side impact, because such earners are likely to spend their tax cuts on necessities and pump up the economy.  (Direct spending by government is even more effective, but usually a combination of spending and progressive tax cuts will make a lot of sense.)

Where does this leave us with respect to the other side of the potential contradiction?  That is, if liberals follow the economic evidence and conclude that rich people as a group do not respond to tax cuts to amp up their supposedly virtuous activities (the proverbial "job creators" idea), must we also accept the idea that rich people are uncorruptible?

The problem with that conclusion is that liberals would never say (and have no reason to say) that there are no rich people who are insatiable.  When setting economic policy through the tax code, what matters is the aggregate effect, taking everyone into account.  When looking at a potential public servant, however, what matters is whether that individual rich person will abuse his power.

Many wealthy individuals who serve in government really do seem not to be in it for the money.  Outgoing Secretary of State (and former U.S. Senator) John Kerry is wealthy beyond imagination (both on his own and through his wife's stake in the Heinz fortune), yet there is no indication that he has tried to use government service to enrich himself.

Similarly, although I disagree with Mitt Romney on many issues and did not support him in the 2012 presidential election, his high net worth seems to be enough to satisfy him.  In the past, wealthy men from both political parties (Teddy and Franklin Delano Roosevelt, the Kennedys, Nelson Rockefeller) showed no signs of trying to raid the public piggy bank or to use their positions to enhance their wealth even indirectly.

So far, so good.  The problem is that the potential is always there.  Every public official has the power to take actions that would make them or their associates richer, so much so that before Trump came along it was standard operating procedure for everyone to support anti-corruption laws, including conflict-of-interest provisions, in vetting government appointees.  Indeed, the Republicans insisted on this when President Obama's nominees came up for confirmation.

In short, there is no contradiction between the liberal positions on taxes and corruption.  It is fully consistent to say that even though tax cuts for the rich do not encourage more wealth-producing activity, some wealthy people might nonetheless abuse their government posts to further enrich themselves at the expense of the American people.

It is a measure of how abnormal things have become that there are people now claiming that we should simply trust rich people to do the right thing.


Hashim said...

Neil: I think your two posts both overlook the converse means of reconciling your alleged claim of conservative hypocrisy. Namely, it's entirely consistent to believe that a person can be sufficiently wealthy that a slight increase in wealth isn't worth: *either* (1) engaging in the wrongful conduct of corrupting one's public office, *or* (2) engaging in additional work when the Govt is going to seize the lion's share of the profits. In other words, a sufficiently wealthy individual can consistently choose to forego a marginal increase in wealth because he places greater value on (1) honorable public service, and (2) non-work activities (family, leisure, etc.).

Simply put, you are caricaturing the conservative view of wealthy individuals by suggesting that conservatives think that wealthy individuals either care *only* about money or *not at all* about money, when in reality the question, as always, is one of trade-offs: does an individual care *enough* about money to subordinate some other goal? It's entirely rational for conservatives: (1) to be concerned that many individuals who already work long hours aren't going to spend even more hours away from their family and other personal pursuits if the Govt is going to seize the majority of the marginal profits; (2) but to not be concerned that such individuals are so dishonorable that they would corrupt their office merely to slightly increase their overall wealth when they're already plenty wealthy.

Just consider big-firm lawyers: if the Govt imposed a 90% tax on income earned on hours spent billing over 2500 hours, I'm quite confident that the number of lawyers who bill over 2500 hours would drop dramatically (even if some still would); but I'm also confident that most big-firm lawyers wouldn't cheat their clients even if they happened to have a financial conflict of interest (even though some might). In short, big-firm lawyers are sufficiently wealthy that most of them wouldn't cheat their clients even if they had the opportunity to do so, and they're also sufficiently wealthy that they wouldn't spend extra time working if the Govt seized the majority of their marginal profits over some material threshold.

Shag from Brookline said...

Hash seems to have a sideline of manufacturing haloes for big-firm lawyers. Honest hourly billings (and rates), possible conflicts of interest, but big-firm lawyers are sufficiently wealthy that most of them wouldn't cheat their clients even if they had the opportunity to do so? I wonder how public polling would respond?

But contrast Hash's example with Trump being offered - and rejecting for personal ethical reasons not required by law - a billions of dollars offer from a developer in a small Middle East country, presumably for licensing his name. Compared to the big-firm lawyers in Hash' example, how much time and effort and expense would be required on Trump's part to "earn" these billions? For the really, really wealthy, a 90% tax might might not deter a big score with no heavy lifting as 10% of billions is a tad greater than even wealthy big-firm lawyers might generate beyond 2500 hours.

t jones said...

A few points:
1. I believe that surveys have shown that there's almost no current level of income or assets which the possessor thinks is "enough."
2. In my experience, nobody stops working because of their marginal after tax earning rate. Because, with our progressive tax system, even though you reach a higher bracket, after tax you still have more money than you would have had if you didn't earn enough to reach that bracket. So, assuming most people want more, they don't stop working because they reach even an "unacceptably" high bracket (e.g., I'm pretty sure even though Bill Gates isn't "working" any more, but spending his time being charitable, his money is still working - invested - and not sitting around as cash in a big vault).
3. The effect of higher estate tax rates on the behavior of wealthy people is to encourage them to employ strategies to lower the effect of the estate tax on their estates, rather than strategies to limit the sizes of their estates.
4. Hashim, change your hypothetical to be more realistic - the 90% tax is imposed on income over a certain level, not on hours worked over a certain amount. Since it's not the hours worked which triggers the tax, the effect on hours worked would be at most indirect, and I suspect, non-existent.