Income inequality vs. consumption inequality

A post today by Kevin Drum reminded me of an issue that arose in the media a few months back that I've meant to address. Some economists (I gather mainly conservative ones) argue that focusing on income inequality is misguided. Thus, according to Michael Cox and Richard Alm some months back:

"Looking at a far more direct measure of American families’ economic status — household consumption — indicates that the gap between rich and poor is far less than most assume, and that the abstract, income-based way in which we measure the so-called poverty rate no longer applies to our society."

Given the view I've expressed elsewhere (even if with qualifications and reservations) that a consumption tax is superior to an income tax, not just on efficiency grounds but also as a distributional measure of relative wellbeing, why wouldn't I agree with this?

In a word, because it's wrong, and wrong in a way that is consistent with viewing the consumption tax (if suitably progressive) as the superior instrument.

The case for a consumption tax is NOT that this year's consumption provides a better measure of one's wellbeing than this year's income or wealth. Much the contrary. What makes the consumption tax potentially an appealing instrument for measuring relative wellbeing is that it is neutral between present and future consumption. Hence, it is a wealth tax in the sense that the present value of the tax one would pay if one consumed all of one's wealth immediately is not reduced by deferring some of the consumption to future years (or even indefinitely).

So if we have a 40% consumption tax that will be in place forever and I earn $1 million this year but consume only $100,000, then, while I pay only $40,000 of tax this year, the increase in the present value of my long-term tax liability is indeed $400,000.

So a consumption tax gets it right (if one accepts this line of argument) not because current consumption is the metric of interest, but because of how the tax unfolds in imposing liability over time.

If wealth-holding gets more uneven but current consumption doesn't, the society has indeed grown more unequal. People's opportunity sets or budget lines have diverged. A consumption tax would automatically adjust for this, but using annual consumption as one's measure of inequality gets it wrong.

Baseball idea

There should be a rule, solely for the post-season, that games are never treated either as rained out before they have become official, or as terminated short of 9 innings, on account of weather. Rather, they would in all cases be suspended and resumed where they left off at the next opportunity.

In the regular season, starting games over or ending them early seems acceptable, but in the post-season the stakes are too high and thus it would leave too bad a taste. We saw this in Game 5, where even the Phillies said they didn't want to win a shortened game (but imagine how irked they would have been had it been washed out after 4 innings with them ahead). Selig lucked into being able to suspend Game 5 because the Rays tied the score. But with the rule change I suggest the umpires would have been able to do this in any event, and the contortions of dragging out an important game under unplayable conditions would not be necessary.

[Deleted rant about Douglas Holtz-Eakin]

I've deleted a rant I had here about Doug Holtz-Eakin's doing more sleazy lying on the campaign trail, because only his former life as a reputable academic made it potentially comment-worthy. But face it, the guy really isn't worth talking about any more. Saruman, I expel you from the order of Wizards ... Although on second thought he reminds me more, at this point, of Emil Jannings in the latter stages of The Blue Angel.

UPDATE: As the old saying goes, we [meaning academics and people who care about the truth of what we say] didn't leave him, he left us. The question is why. I have to think he doesn't plan to return to anything like an academic setting, and has a fundamental career change in mind such that he doesn't care about his reputation in the old circles. Perhaps it's just my own limited imagination that finds this baffling - not the desire to do something different, but the rejection of intellectual honor and honesty (paying off reputationally) as personal values.

McCain explains his tax position

McCain keeps saying, so far as I can make any sense of it, that asking higher-income people to pay more tax than others is "socialist." Thus, he appears to be advocating a uniform head tax as the only alternative to "socialism," though needless to say he declines to make this explicit.

But what about the fact that, in the past, he has said that higher-income people should pay more and has criticized the Bush tax cuts as overly skewed to the rich? Luckily, he got to explain it all on Meet the Press, where Tom Brokaw pressed him on the contradiction between his present and past remarks.

Take it away, John, you silver-tongued devil:

“That's what -- listen, even the flat tax people somewhat pay more. Even -- you put into different, different categories of wealthier people paying, paying higher taxes into different brackets. I mean, and the, and these are different times, my friend. These are times of the biggest financial crisis we've faced in America.”

Wow. When is Palin going to start briefing him on the issues?

GWU Law School conference on generational equity

Yesterday I attended the first half of a conference at GWU Law School in Washington, D.C., organized by Neil Buchanan, concerning generational equity. 5 panels: philosophical perspectives, government finance (my panel, obviously), environmental, reproductive rights, "living constitution."

Ordinarily it's bad sportsmanship to go to a conference and not attend all of the panels, since this would both shrink the audiences and destroy the idea of bringing multiple perspectives together. But this time around I had no choice but to miss panels 3-5, as they are today in DC whereas I have to be back in New York to teach my next class.

On the philosophical perspectives panel, Bob Hockett and Ori Herstein presented papers dealing with aspects of the generational equity issue that don't especially excite my main interests - my fault, no doubt, not theirs - as I'm committed to a utilitarian perspective in which one weights present and future individuals equally whereas they are worried about problems such as the Derek Parfit non-identity issue (we don't know yet, and perhaps it isn't determined yet, which individuals they will be), or the issue of whether people can have rights before they exist. Great commentary, from a perspective that I very much share, by GW philosopher David DeGrazia, who has written books on animal rights that I now am curious to see.

On the fiscal panel, the main papers were by Neil Buchanan and me. Neil criticizes generational equity-based grounds for worrying about the fiscal gap, on the view that, even if future lifetime net tax rates go way up, future generations are still expected to have higher after-tax and transfer lifetime incomes than current ones.

I argued in my paper that relative wealth is only one of the inputs to a utilitarian analysis of generational equity, and that there are lots of other important inputs, with the unfortunate effect of making the implications of such analysis for our long-term budgetary problems empirically indeterminate. I argue that efficiency reasons (the risk of a fiscal meltdown, plus arguments for tax smoothing and outlay smoothing) strongly support addressing the fiscal gap immediately, subject only to countercyclical concerns which affect only the timing of implementation for tax increases and benefit/spending cuts, not the timing of their announcement. Plus I discuss the political economy issues and suggest that in the current U.S. they support taking a pretty grim view of the fiscal meltdown risks.

Nancy Altman offered comments on my paper. Although she is perhaps a bit more in the Krugman camp than I am (viewing it as primarily a healthcare crisis not a budget crisis, whereas I say it's equally both), I stated publicly during the discussion that she and I appear to be 90% in agreement. A minute later I whispered to her that this was too low - probably more like 95% agreement.

I'll post the paper on SSRN fairly soon and then of course link to it here. I've gotten a few excellent comments from readers that I need to incorporate, plus I need to adjust in a couple of places for (a) the most recent developments in the financial markets meltdown we're having, plus (b) the outcome on Nov 4, once that is known.

"Socialism"

I seem to be having Internet problems. I can't download, or even find any reference to, the McCain proposal to replace the income tax with a uniform head tax. Yet he must be planning to announce this, given his newfound aversion to "socialism."

THE big news story of the day

Working out in the health club this morning, I could see (from screens tuned to CNN and even Fox) that the big news story of the day, hands down, is Palin's $150,000 clothing budget from the RNC.

It is of course comical that a story like this should be so prominent, or should matter at all. Of course the RNC would want to outfit her (or any other candidate) appropriately to create the right visuals - the campaign consultants are paid to think through all this stuff.

What makes it a big story, of course, is the combination of (a) the trivially personal turn that presidential elections have taken for some time now (e.g., Edwards' haircut, evidently deemed the most important campaign story of 2007), (b) the Republicans' history of ruthlessly playing up these issues whenever it's a Democrat, inviting payback, and (c) the evident hypocrisy given Palin's over-the-top faux populism. So I'm enjoying it, but if this kind of story ceased to matter politically (symmetrically as between the parties) we all might be better off, albeit a hair less entertained.

As a matter of federal income tax law, by the way, the clothes are unambiguously taxable income to Palin if she keeps them. See Pevsner v. Commissioner, 628 F.2d 467 (5th Cir. 1980), in which an Yves St. Laurent sales manager was deemed taxable on her YSL-made business apparel, even though she wore it in the store for business reasons. (Pevsner arose as a business deduction issue when she paid for the clothes, rather than an income inclusion issue from someone else's doing so, but this makes no legal difference.) It was undisputed that Pevsner considered it important to show the flag by wearing the clothes to work, given her job, and that they were more expensive than what she would have purchased otherwise. But the court stated:

"The generally accepted rule governing the deductibility [= includability for Palin] of clothing expenses is that the cost of clothing is deductible as a business expense only if: (1) the clothing is of a type specifically required as a condition of employment, (2) it is not adaptable to general usage as ordinary clothing, and (3) it is not so worn." In other words, baseball players' or firefighters' uniforms and the like, but definitely not Palin's stylish threads (if she keeps them).

While the law seems crystal-clear, I admit that I don't know what constitutes ordinary practice for politicians, movie actors who keep the clothes they were given for a film shoot, etcetera.

UPDATE: From looking at other reactions to this story, I see inklings that (a)it potentially violated campaign finance laws, (b) some Republicans think it was a Palin-directed shopping spree rather than the work of the RNC image consultants, which if true would certainly increase the story's informational content about Palin's character, and (c) the McCain campaign claims, at least now that it has all come out, that they're planning to give all the loot to charity after November 4.

Jon Stewart's Daily Show

I actually got to attend a taping today, courtesy of a friend from out of the country who had an extra ticket (requested months in advance). I must say, McCain continues to give these guys great material, day after day, since almost any scurrilous or silly thing he says comes with ready videotape of a complete contradiction.

Best moment: when Jon blew the first segment (omitting the punchline) and had to retape it at the end, he added a joke just for the studio audience about the retaping that you can see (without knowing the context) in the show as broadcast.

Fiscal stimulus and the budget deficit / fiscal gap

Paul Krugman is among those mocking the idea that we need to worry about the long-term fiscal situation given the risk of severe recession and the need for fiscal not just monetary policy to address it.

Okay, I'm on board for fiscal stimulus this time around, although I don't like it in general because I think politicians tend to misuse it in other circumstances as an excuse for whatever they happen to want to do (e.g., the Bush 2003 tax cuts) and because it is used asymmetrically for the down cycles only. But I recognize that this may be one of those "Break glass in emergency only"-type moments.

Still, the response to the financial crisis is beginning to remind me of one of the perversities of how budget policy responded to 9/11. True, when 9/11 happened, we (a) needed to increase spending for Afghanistan and domestic security and (b) would have been ill-advised to implement immediate tax increases to pay for the extra spending. But there was no reason, apart from politics, not to enact deferred financing. Fundamentally, 9/11 indicated that we would have a larger long-term fiscal problem than was previously expected, yet it played out politically on the ground as if it meant that budgetary concerns could now be completely ignored. (Recall that, right before it happened, the "lockbox" question of whether Social Security surpluses were ostensibly being used to pay for current spending was at political center stage.)

The current financial crisis likewise indicates that, in the long run, our fiscal problems are larger, not smaller, than we previously believed. So it is vital to think about long-term fiscal problems even though big short-term deficits may make sense.

Krugman is blind to this because he insists that "[w]e don’t have an entitlement crisis — we have a health care crisis, one of whose manifestations is high projected costs for Medicare and Medicaid."

I just don't get this. Isn't it both? Consider a Venn diagram with one circle for the healthcare crisis and another for the fiscal gap. The two circles overlap a lot, reflecting the relationship that Krugman notes. But they also have non-overlapping aspects (privately funded healthcare problems for the one, Social Security & tax cuts & all the rest for the other). And the overlapping portion truly is both - not just one of them.

Why would one look at such a Venn diagram and say that only one of the two circles is actually there?

Budget policy next year if Obama wins

Jason Furman is apparently telling budget hawk Congressional Democrats that Obama would seek to establish "a government unified around the concept of fiscal discipline and centered around the pay-go rule. Insisting on paying for things will lead to better economic policy."

Does this contradict the need for short-term fiscal stimulus if things keep looking ugly? In a word, no. Stimulus is about the current outlays and revenues; fiscal discipline about the long-term relationship between them. Thus, you can have a big stimulus package that increases the current year deficit but is fully financed over the long term. Farsighted, non-cash-constrained economic actors wouldn't be fooled into greater economic activity this year, but they're not the targets of the stimulus package. And note that pre-announced financing (such as future tax increases) can actually increase the incentive to invest, etc. today.

The harder problem is political. I know that Furman is serious about and understands the need for long-term balance, but politically it can be hair-raising to try to get there, especially given the unlikelihood of Republican cooperation.

Clinton in 1993 made the correct political calculation that you can act fiscally responsibly today and not pay the price three years later if the economy improves meanwhile. (Although possibly he paid a steep price in the 1994 midterm elections?) Obama in 2009, if he's elected, could try the same thing in terms of announcing changes but not implementing them, but unfortunately implementation might be what matters in terms of when the voters react.

If McCain wins, the degree of fiscal discipline would be wildly unpredictable, probably from day to day. He's committed to immense tax cuts, but it would be surprising if he weren't a budget hawk for at least a week or two somewhere along the way. Most likely there'd be a bunch of stunts, such as reverse shut-down-the-government brinksmanship, e.g., vetoing bills that are 1 percent earmark in the hope of either shifting blame to the Democrats or counting on bipartisan veto override to get himself off the hook.

Doug Holtz-Eakin claims that McCain would square the budgetary circle through huge Medicare cuts. Probably this helps Doug to feel good about what he's doing these days, but while the claim is undoubtedly sincere I'd be beyond shocked if it actually happened.

Paul Krugman wins the Nobel Economics Prize

Interesting to have this happen now; I have no idea whether the Nobel committee cares about Krugman's public intellectual role. He's obviously a meritorious pick in any event for his economics work, which reflected a trajectory from (a) challenging the conventional wisdom, such as about international trade, to show that things were a bit more complicated and ambiguous, to (b) defending the conventional wisdom against rejections of it that were ignorant and overstated.

A word on his life as a public intellectual, although it's unrelated to the Prize as such. While I have confidence in my own judgments and feel that they usually end up being vindicated, he certainly was right and I was wrong about Bush, say, in 2000 - he got there several years before I did, at a point when I thought that, despite the wacky tax and budget proposals, Bush would be reasonably safe and not that different from his dad. At the time I thought he was too selectively harsh against one side. This reflected that I didn't realize the full enormity of things, or how different it was from politics as usual, for several years after that. So unless it was just a lucky strike, Krugman truly deserves the Cassandra Prize as well (since Cassandra was disbelieved but right)

Some conservative economists I know will be gnashing their teeth. Not, however, Greg Mankiw, who offers a couple of links describing the economics work and criticizing (though reasonably and interestingly) the op-ed columns.

Budget deficit update

According to Martin Sullivan in the 10/6/08 Tax Notes, the budget deficit for 2009 could end up as high as $914 billion, or 6.2% of GDP, both of which would be all-time national records. This would reflect scoring the financial rescue plan on what seems the correct basis, if it can be done sufficiently accurately, which is to treat only the excess of outlays over the estimated present value of future receipts as a write-off.

Some time back I posted seemingly dire GAO estimates of rising budget deficits and public debt. Under those estimates, the deficit would not reach this level, relative to GDP, until the mid-2020s. So much for that.

True, this is a temporary phenomenon, reflecting both special outlays related to the financial meltdown and the counter-cyclical effects of a recession that, while it may be long-lasting, is merely part of the overall business cycle. In other words, it's reasonable to assume that annual deficits will decline again in a few years and only start rising again when baby boom retirement and the entitlements explosion really takes off.

Still, this is a huge hit on the amount of cushion that we have if we delay dealing with the long-term fiscal gap. Especially when one keeps in mind that there seem to be frequent adverse shocks. E.g., 9/11 followed by the Afghanistan and Iraq wars was one, and now this is another. While reasonable long-term forecasts won't treat a given adverse shock the same as a permanent change in tax and spending levels, they also shouldn't assume that there aren't going to be any more adverse shocks.

Yes, there are occasionally favorable shocks as well (e.g., the totally unanticipated revenue surge of the late 1990s, from some mix of real economic growth and the Internet, etc. bubble). But I'm putting my chips on a predominance of adverse shocks in the years ahead.

To put it all in perspective, if we manage to contain the current financial crisis it will be by virtue of using some of the fiscal cushion that we still have to buy ourselves out of trouble. But given everything else that is happening and not happening in Washington and the economy, this merely brings the fiscal crisis closer. That one, when and if it comes, will make the financial crisis look like a Sunday school picnic, and by definition we won't be able to buy our way out of it.

Doug Holtz-Eakin, your thesis advisor is calling

His latest public statement was to the effect that Obama opposes the new McCain bailout plan because Obama just wants to help Wall Street, not Main Street.

Doug, did anyone tell you that the McCain plan is a direct pay to Wall Street, giving them face value rather than just market value for bad mortgages? Indeed, isn't it partly your plan? (I'd assume you helped draft it.)

Insert joke of choice here about Doug's earlier claim that McCain deserves credit for inventing the Blackberry.

This is a bit of a sensitive topic for me, because if McCain wins the election I will be praying that Doug gets to exert some influence on economic policy. After all, the alternatives in setting a McCain Administration's economic policy are presumably Steve Schmidt and Phil Gramm.

But O for the days when, say, Glenn Hubbard could represent an Administration with absymal budgetary policies and yet carefully avoid saying anything in public that was definitively false.

I recall, for example, Glenn's artistry (pointed out, almost but not quite with rueful admiration, in a blog entry by Brad DeLong many years back) when asked whether Bush's unending budget deficits would eventually raise interest rates. Option (a) would have been to admit that this was true. Glenn didn't want to do that. Option (b) would have been to lie and say it was false. Glenn didn't want to do that either. Option (c) was gracefully, almost imperceptibly (if you weren't watching carefully) to re-phrase the question as whether one or two years of budget deficits should be expected to raise interest rates. Then you could confidently and correctly say: No, as a matter of accepted economics that is incorrect. And that was what Glenn did.

I personally would not be comfortable spinning even to that degree, which is one reason why I do not thirst for public life, and thus would reject any offered post be it in a campaign or the government post-election. But if you do it that way you preserve a lot more of your academic reputation. Doug ought to take note, but I fear it's too late.

Staying calm in tough times

What do you tell yourself when, by market measures, your net worth declines by, say, a couple of hundred thousand dollars in the course of a week? (I haven't checked, but for someone my age with retirement saving it's a fair guess.)

I tell myself that all that's really changed is the median prediction for the future by a bunch of over-excitable folks who are playing Keynes' famous beauty contest game (trying to figure out who everyone else will think everyone else thinks is the winner).

In other words, though I accept the efficient capital markets hypothesis in the sense that I don't believe I can systematically make money by betting against market valuations, what's happened, I tell myself, is almost on a par with, say, the feeling a baseball fan should have if his team has a bad week in mid-August and the ESPN baseball analysts respond by downgrading the team by ten rungs or so in their weekly Power Rankings. There's arguably more heat than light to the change if you don't have to convert to cash any time soon.

Now, if only I could stay so serene about other things.

The time I met John McCain

Okay, I haven't told this story here yet. It was 1999. I had a book coming out soon on Social Security. Someone at NYU who handles press relations told me that Good Morning America was going to have John McCain stop by to discuss Social Security privatization (this being before that term was forbidden), and if I came I could ask him a question. For sure? I asked. Yes, she answered, the flacks at GMA assured me that you will get to ask a Social Security question on a widely watched national television show. OK, she knew the press angle better than I did.

For the record, while I considered Social Security privatization completely pointless, I wasn't by any means flat out hostile like most in my post-2001 political camp, and indeed had sketched out an idea that I called progressive privatization. What I liked about privatization, while recognizing that the stock market investment aspect was pointless and that it did nothing to ease the program's fiscal problems, was its being one way of clarifying the tax-benefit relationship for individual recipients that current Social Security assiduously obscures. You can read about it here or here.

Well, you know what Gore Vidal once said about being on television and one other thing - you can never have enough of either, he said - so, being next to unacquainted with the former, I headed up to midtown at some ungodly earthly hour, in order to get there by 6 am (or maybe it was even 5:30).

When I got there, I discovered that I had been totally scammed by the GMA flack, who had duped my NYU PR contact. They just wanted warm bodies to fill the room, most of them seemingly off a tourist bus. Everyone got to submit an index card and they would pick 3 to ask Senator McCain. Anything above the 6th grade level was definitely not wanted. (This had nothing to do with McCain but rather with the presumed TV audience for GMA.)

I should have just left, but like a cowed sheep in a herd of antelopes - I'm trying the Tom Friedman trick here of mixing and mangling the metaphors; it works (commercially) for him - I stayed around. Assiduous viewers (a couple of family members) got to see a couple of shots of me glowering from the back of the audience during McCain's gig, because I was so angry about having been conned to go there under false pretenses and way too early in the morning. The inconvenience, the disrespect, the lost sleep, the fact that I felt so used and foolish - but I digress.

At the end of the segment, they went to commercial and also were going to use a different part of the set for their next segment. So McCain, doing his duty as a politician, went through shaking hands with everyone in the crowd. No big thrill to me, though this was nothing particular against him; I simply don't have huge excitement about any of these guys, even though at the time I rated him much higher than I do now. But I didn't leave the set right away, because I wanted to find someone from the show to whom I could complain about having been lured there under false pretenses when all they wanted was a room full of warm bodies.

So I passed by McCain one more time. Thinking I wanted to shake his hand again, he snarled at me: "I already shook your hand!" (And "snarled" really is the right word here, though I don't mean to suggest he was out of control.)

This was a bit amusing given how little his or any other senator's hand means to me. Had I been a little quicker, I might have said something like "Relax, it's not like you're the Beatles or something."

I got two things out of it, a story to tell my Tax class later that morning (focused more on my mission of folly than McCain, but he supplied the capper), and a GMA long-sleeved T-shirt that I still wear in cold weather.

IRS Chief Counsel Donald Korb steps down

Courtesy of the Tax Prof blog, I gather that IRS Chief Counsel Don Korb has stepped down effective no later than next January 19, so that the next Administration can start right out with his successor.

This is not a surprise, since no one would be expected to want to stay in the Chief Counsel job forever. But I personally will be quite surprised if the new Chief Counsel is ready to be named by January 20. So I suspect that Korb will be asked, perhaps even implored, to stay on, although presumably from his announcement he does not wish to do so.

Suffice it to say that he is leaving large shoes to fill. Don Korb was amazingly energetic, entrepeneurial, and effective in filling the Chief Counsel post. He did a great deal to raise his office's profile and value, both to the government and to taxpayers. He innovated internally and externally, worked hard to strengthen his staff, and provided important outreach and guidance that was good for everyone. The next Administration will be very lucky to find anyone who can match his job performance.

VP debate - not the comment readers might expect

I really can't watch these things straight through - too tedious and stupid an experience for me.

But I would give a lot of money to put an end to the faux populism that resonates everywhere in American politics. All these durn "regular folks" who want your vote while pretending they have no money and aren't famous & powerful. Not just the supposed hockey mom - it's a phony and annoying tic that apparently is obligatory for everyone. And it's a strange tic to have in a country that is so much less committed to equality than nearly every western European country.

This is not a rant but an observation - there is a trade-off between efficiency and redistribution, which one can reasonably resolve at various points along the continuum, certainly including the American one. But it truly is odd for a country that's so much less egalitarian than the norm to be so rabidly committed to fake gestures of anti-elitism, invariably orchestrated by leaders of elites.

A nice heap of sugar

The Senate passed the bailout bill tonight after sweetening it with $150 billion ($110 billion net of offsets) in new tax breaks, including "extenders" that no doubt will soon be extended again. The bill, originally just 3 pages (although that gave the Treasury excessive authority without oversight), now apparently exceeds 450 pages. Good work, guys.

In a country with a massive and growing fiscal gap, the potential $700 billion cost already was a huge problem. Yes, I know in theory the Treasury might even end up turning a profit on this, but the incentive issues and institutional skill set make me skeptical. Other countries have apparently flipped assets for a profit in this setting, but these days, no matter what the task, ours always seems to be the government that can't.

We are converting the financial crisis into a worsening of the fiscal crisis, and while this particular drop in the bucket may be small, it demonstrates once again the fecklessness that really is worse than anything about the current fiscal projections.

Diane Rogers is right: "a teaspoon of sugar helps the medicine go down." But it's also true that sugar all the time eventually wrecks the teeth, the taste buds, and the digestive system.