Sunday, March 4, 2018

NYTimes Packs Five Ungrounded Economic Opinions in Two Sentences

Some misconceptions about tax incidence have been getting a lot of press, but Paul Krugman's column from last week is particularly efficient at perpetuating them:

"How much of a trickle-down effect depends on a bunch of technical factors: what share of corporate profits represents monopoly rents rather than returns to capital, how responsive inflows of foreign capital are to the U.S. rate of return.  Enthusiasts claim that the tax cut will eventually go 100% to workers; most serious modelers think the number is more like 20 or 25 percent."

Of course I am not a "serious modeler", but let's break this down:
  1. "Enthusiasts claim that the tax cut will eventually go 100% to workers"

  2. Actually, the White House Council of Economic Advisers, I, and anyone else using the standard supply and demand model claims that MORE THAN 100% of the tax cut will eventually go to workers. The analysis is in pdf here and executable Mathematica notebook here.

  3. "what share of the capital stock is even affected by the corporate tax rate"

  4. This extension of the supply and demand model only strengthens the conclusion, because now workers not only have to pay for the revenue received by the treasury and for the productivity lost due to less aggregate capital, but also the productivity lost due to the misallocation of capital between activities covered by the statutory corporate rate and activities not covered. The analysis is here. Perhaps the proponents of this argument are thinking that the tax does less damage when it covers less capital. Maybe, but for sure it brings in less revenue too, and Krugman is referring to damage as a percentage of revenue.

  5. "what share of corporate profits represents monopoly rents rather than returns to capital"

  6. Krugman and the others do not give any citation to "serious modeling" of monopoly rents (monopoly rents = free lunch is not a serious model by any definition). But it looks to me that adding monopoly rents to the model also strengthens the conclusion, because now workers not only have to pay for the revenue received by the treasury, the productivity lost due to less aggregate capital, the productivity lost due to the misallocation of capital, but also exacerbation of the productivity lost due to monopoly. The analysis is here and in the links therein.

  7. "how responsive inflows of foreign capital are to the U.S. rate of return"

  8. This is a red herring. All of the models that I have cited make the assumption most charitable to Krugman's conclusions: namely that foreign capital inflows are completely unresponsive (they are closed-economy models!). Nevertheless, they conclude that labor pays more than 100 percent of the corporate-income tax.

These counterintuitive results, and many more, are treated in the forthcoming Chicago Price Theory textbook by Sonia Jaffe, Robert Minton, Casey B. Mulligan, and Kevin M. Murphy.

Corporate-income Tax Incidence with Imperfect Competition

Summary: Labor Losses in an Economy with Imperfect Competition May Be Even Greater than Labor Losses in a Perfectly Competitive Economy, Which Themselves are Sizable

Two kinds of distortions are both important and easy to handle in the standard models of capital taxation: the distortion in terms of the total amount of capital and the distortion of the distribution of capital among activities that are differentially taxed.  In the long run, the deadweight loss of these distortions and other distortions comes entirely out of wages.

Raising the corporate-income tax rate adds to the total-capital and capital-composition distortions.[1]  Therefore wages are reduced more in the long run than revenue is enhanced (if at all).  In other words, labor pays more than 100 percent of the corporate-income tax.

But proponents of corporate-income taxation have asserted that, not withstanding the above, labor is scarcely harmed by the tax because of the prevalence of “monopoly.”  If such assertions are to be taken seriously, they need to be accompanied by some more detailed economic reasoning, which is provided below.

The abbreviated version is this: if policy goals (e.g., fighting monopolies) are pursued with oblique policy instruments (e.g., the corporate-income tax or, in New-Keynesian fashion, monetary policy), then unintended consequences abound.

Market Power is Uneven

Any reasonable view of market power has to acknowledge that market power is uneven: that industries, regions, etc., have different percentage gaps between price and marginal cost; between factor prices and marginal products.  If market power is important, then even a low-rate corporate-income tax likely adds significantly to already existing distortions because the tax-free economy is not well approximated as first best (in terms of the amount of capital or its composition).[2]

Rent Seeking: People Like Profits and Will Pursue Them

A third type of distortion has to do with rent seeking, which refers to activities that people and businesses do to obtain market power or government favors.  These include advertising, inventing new products, merging businesses, or lobbying public officials.

A number of factors determine the direction of the effect of corporate taxation on the deadweight losses associated with rent seeking (hereafter, DWRS).  One is whether the social return to rent seeking exceeds the private return.  Arguably inventing new products or merging businesses could benefit consumers beyond its benefit to the businesses taking these actions. One element in the rent seeking calculus is therefore to quantify the gap between social and private return.  The gap may well be negative, but it is usually too extreme to assert that all rent seeking is a waste.

The second element is the direction and magnitude of the effect of the corporate tax on rent seeking.  Are corporations more rent-seeking intensive than noncorporations?  Are corporations able to deduct their rent-seeking efforts from income for the purpose of determining their corporate-income tax liability?  Will the extra treasury revenue itself motivate socially costly rent seeking to influence how it is distributed?  This last point is particularly important because, in the neighborhood of a zero tax rate, the corporate tax creates far more tax revenue than it destroys rewards to monopoly (at large tax rates, see below).

These are all reasons why a higher corporate rate could encourage rent-seeking.[3]  To the extent that the corporate tax encourages rent seeking in some instances and discourages it in others, we need to know the net effect, weighted by the social benefit or damage associated with each instance.

With all of these factors determining the DWRS, we cannot rule out the possibility that corporate taxation adds to DWRS and therefore adds to the amount that the tax reduces wages as compared to the amount it would reduce wages in an economy with no rent seeking, which itself is in excess of the amount of revenue obtained from the tax.  If so, we can conclude even more confidently that labor pays more than 100 percent of the corporate-income tax because all three types of deadweight loss are adding to the tax’s burden on labor (a specific and rigorous demonstration is here as pdf and here as executable Mathematica notebook).

An interesting and ironic case is when rent seeking is labor-intensive, or otherwise deductible from the corporate income tax.  Here the corporate tax encourages rent seeking by reducing the price of rent-seeking inputs.  Ironically, if you use monopoly as a pejorative term, then you have to acknowledge that yet another cost of the corporate-income tax is wasteful rent seeking.  On the other hand, if you think that monopoly rents motivate socially valuable R&D, then one of the benefits of the corporate tax is that it encourages that R&D (but see my advice below on using less oblique policy measures).

A Proper Tax-Incidence Formula Does Not Merely Enter the "Monopoly Profit Share" as a Subtraction

The amount of DWRS is related to the amount of rents to be sought, which we might roughly describe as the “share of corporate profits that represent monopoly rents.”  The amount would be small if there are few rents to be had.

In contrast, the amount of the other two deadweight losses (capital amount and composition) depends on the level of the tax rate.  At high tax rates, the capital amount and composition dominate DWRS, and labor is paying more than 100 percent of the corporate-income tax at the margin.

Note that even if the corporate-income tax reduces DWRS more than enough to offset what it adds to the other two deadweight losses, that does not mean that labor benefits from the tax.  It means that labor pays less than 100 percent of it.  Moreover, for the reasons cited above, simply subtracting the monopoly-rent share in a tax-incidence analysis is a wild exaggeration, if not directionally incorrect, of how the true incidence differs from simpler models that have no DWRS.

Advice: Forgo Oblique and Uncertain Policy Instruments

Perhaps most important, the deadweight costs of capital amount and composition are direct consequences of the corporate tax.  In contrast, the benefit, if any, of corporate taxation coming through DWRS is indirect and uncertain, and presumably we could do better by attacking these problems more directly with antitrust enforcement, policing election fraud, supporting well-designed systems to encourage the supply of intellectual property, etc.

[1] The capital-composition distortion could in principle get better if (a) the non-corporate tax rate were sufficiently greater than the corporate rate and (b) little of the corporate activity could avoid the tax (e.g., through loopholes).
[2] We might get lucky that the corporate tax falls on the sectors that already have too much capital and sales, although the assertion that the corporate sector is full of monopolies suggests the opposite (the usual complaint about monopolies is that they charge too much and produce too little).  There is also the concern that the corporate tax falls on sectors that are labor-intensive (Harberger 1962) thereby depressing the aggregate demand for labor even beyond its effect on the capital stock.
[3] Arguably the people and businesses most productive at rent seeking have already obtained tax exemptions for themselves, so that raising the tax rate only encourages more exemption seeking.

Saturday, March 3, 2018

Robots: Leibniz' dream is coming true in economics

Gottfried Leibniz, one of the legends in the history of mathematics, envisioned that human reasoning would one day be automated, thereby resolving a great many disputes among experts. He wrote (translated from German at WikiQuote from his 1688 "The characteristics of the art in order to make science fair"):

[...] if controversies were to arise, there would be be no more need of disputation between two philosophers than between two calculators. For it would suffice for them to take their pencils in their hands and to sit down at the abacus, and say to each other (and if they so wish also to a friend called to help): Let us calculate.
image credit: Public domain.

More recently, Obama administration economists Furman and Summers claimed that only a fraction of the revenue loss from a corporate-income tax cut benefits labor. But the standard supply and demand model says the opposite.

Summers, as well as Nobel Laureate Paul Krugman, rejected this result, asserting that it depends on "what share of the capital stock is even affected by the corporate tax rate."

The supply and demand model readily accommodates the fact that the statutory corporate rate does not apply to much of the nation's capital. Now a machine has proven the supply-demand result, without assuming any functional form for the aggregate production function, and without restricting the share of capital that is subject to the tax (except that the share cannot be zero or negative).

You can view the proof in pdf here, or as an executable Mathematica notebook here.

For another economics dispute between Krugman and I that was resolved by machine, see here.

(They also incorrectly claim that "monopoly" overturns the result too. See here, and here. For some machine analysis of the issue, see the pdf here and the executable Mathematica notebook here.)

Wednesday, February 28, 2018

Honey, Who Shrank the Economic Pie?


Last week the White House released the latest Economic Report of the President that, following both statute and tradition, begins with a short letter to Congress from President Trump, followed by the detailed annual report of his Council of Economic Advisers.

The period from 2010 should have had relatively rapid growth as the economy recovered from the 2008-09 recession, but it did not. Both the president's letter and the CEA annual report blame the slow growth on federal policy failures during the previous administration.

A lot of research backs up their claim and suggests that higher growth rates are forthcoming if only some of those failures are reversed and not too many new ones are created.

First is the high statutory corporate tax rate that had prevailed for decades prior to 2017 (yes, the "effective rate" was not as high, but a low effective rate is just a symptom of some of the growth-retarding effects of corporate-income taxation.)

The Obama administration agreed that America would benefit if the federal statutory rate were reduced, saying that a reduction would be "as close to a free lunch as tax reformers will ever get."
But they were not enough interested in corporate tax reform to reach a deal with Congress, so the long-overdue rate cut has President Trump's signature on it and is expect to add to economic growth over the next several years.

Second was the so-called federal "stimulus" law of 2009 that was supposed to jumpstart the recovery. But, unlike the stimulus laws in some other countries, such as the United Kingdom, our stimulus did not expand the economic pie by enhancing incentives.

Instead, our stimulus was a redistribution exercise that eroded incentives to work and earn income by expanding food stamps, mortgage subsidies, health insurance assistance and unemployment assistance primarily for people who were unemployed or otherwise had low incomes (the end of the Bush administration did some of this too). The result was less work and less national income for as long as the stimulus lasted.

Third, very soon after the stimulus expired, a new permanent redistribution began to take effect in the form of the Affordable Care Act (ACA). Indeed, the health-insurance assistance provisions of the ACA were presaged in the 2009 stimulus.

As its authors attempt to target assistance to people who they thought needed it most, the ACA unleashes a host of unintended consequences that shrink the economic pie in the process of redistributing it.

Businesses are encouraged to forgo hiring in order to keep their employment below 50 full-time equivalents and to cut workers' hours in order to keep the workweek less than 30 hours. Productive and knowledgeable employees are encouraged to retire early in order to be eligible for taxpayer-funded assistance.

The ACA is also remarkably uneven in its treatment of different sectors, regions and workplace circumstances. Another result is therefore a misallocation of resources away from the most penalized activities to the most favored ones, thereby depressing productivity; i.e., the amount of value that workers create in the marketplace.

Most businesses and households did not react to these incentives because other considerations were dominant, but it only takes a small percent of them who do to make a noticeable dent in the growth rate. If and when the federal government can repeal the ACA or relax its growth-retarding provisions, that will add to the growth rate.

Fourth, other regulations came into effect during the Obama years. Perhaps the leading instance is the 2010 Dodd-Frank financial regulation law. The law is so remarkably complicated that research on its effects will be ongoing for years, and massive complexity is hardly the leading ingredient for economic growth.

But it is likely that new financial regulations have reduced the willingness of banks to lend to small and medium-sized businesses, which further restrains economic activity.

The national economic pie has been smaller due to Obama-era policies, leaving opportunities for subsequent federal policies to enhance economic performance.

Casey Mulligan is a professor of economics at the University of Chicago. His recent research has focused on non-pecuniary incentives to save and work and how the economy affects policy. His two recent books are, "The Redistribution Recession: How Labor Market Distortions Contracted the Economy," and "Side Effects: The Economic Consequences of the Health Reform."

Monday, February 12, 2018

Your job cannot be automated? Then you need to worry!


One of the greatest labor force changes of the 20th century was the movement of workers out of farming. In 1900, more than two out of five workers were in agriculture. Now it is less than two workers out of every 100.

It's not that people stopped eating. Rather, farm machinery and innovation increased the amount of food that could be produced per farm worker by more than a factor of 10. Food got cheaper and that got people to buy more food, but not 10 times as much. The end result has been fewer jobs in agriculture.

Automation is expected to come to other industries and occupations, and it is tempting to forecast less employment for them too. A variety of studies are using engineering information to determine which jobs will be automated next.

While automation may be a question of engineering, job loss is even more a question of economics. A key part of the agriculture story is that people were unwilling to purchase all of the food that farmers were capable of producing, even though food was getting cheaper. But not all industries share this with agriculture. 

Suppose that the automation in agriculture had only been for chicken farming and not for any other food production. Chicken would have gotten cheaper relative to beef, fish, vegetables, fruit, etc., and that would have caused people to buy more chicken and less of other types of food.

Many -- even most -- of the extra chickens produced would have been purchased by consumers, and there would have been less need to reduce employment in chicken farming. 

The most dramatic job losses would have occurred in the food industries like beef and fish that were not automated and that compete with chicken. In other words, jobs that are difficult to automate from an engineering perspective may be exactly the jobs pushed to extinction by automation because they cannot compete.

It all depends on the competitive landscape and how willing are consumers, encouraged by lower prices, to absorb the extra output made possible by automation.

Trucking is a modern example, because engineers are predicting that machines will soon do a lot of the driving formerly done by trucking employees. But the result may be more jobs for people in trucking and fewer jobs for people in railroads, airlines and shipping that compete with trucking (unless they also get more productive at the same time that trucking does).

Another example has occurred in my own profession: Two or three generations ago, a large fraction of economists were employed manually performing the arithmetic of statistical analysis. Then, computers came along to automate that arithmetic, without really automating the tasks done by theoretical economists.

The result was an increase in the fraction of economists doing statistical work, because universities, businesses and government wanted more statistical analysis when computers made it became cheaper and more accurate. The fraction of economists doing theoretical work fell, precisely because their tasks were not automated.

So the more interesting economic question for a worker is not whether his job can be automated but whether he or she will miss out on automation to occur in the workplace of his or her primary competitors.

Wednesday, December 27, 2017

Some Immediate Benefits of the Corporate Tax Cut


By cutting the statutory corporate tax rate and by permitting investment expenses to be immediately deducted from corporate income, the new tax law encourages corporations to enhance their workers' productivity by investing in structures, equipment and software.

The additional investment will accumulate over several years, which means that the full effect on productivity and wages will not be felt for several years.

However, Economics Nobel Laureate Paul Krugman further asserts that there are essentially no benefits for workers in 2018, despite the fact that a number of corporations have announced bonuses for workers while saying that the bonuses derive from the new tax law.

The simplest model of investment and worker productivity agrees that aggregate wage increases would not be discernible in the first year following a permanent and unanticipated capital income tax cut because of the time that it takes for investment to be planned, executed and translated in to greater worker productivity.

But Krugman, Obama economic adviser Larry Summers, and I, among others, agree that our economy and this tax cut have some meaningful differences from the simple model. One of those differences is that President Trump's signature last week was not an entire surprise.

The U.S. had been behind most of the world in cutting its corporate rate, and it was largely a matter of time until the U.S. did the same, especially in 2016 when Republicans won the White House and both houses of Congress.

Throughout 2017, businesses were making plans understanding the very real possibility that federal corporate tax rates would be lower, and the execution of those plans are already adding a bit to worker productivity.

The simple model also ignores that a lot of businesses are not organized or taxed as U.S.-based C-corporations, which are the types of corporations that have been subject to high statutory rates by worldwide standards.

This has resulted in too little business activity occurring with the legal and organizational advantages of the C-corporation, and productivity has suffered as a result of companies' keeping activities away from the high C-corp rates.

Reallocating activity to U.S.-based C-corporations can happen more quickly than the building of new structures or manufacturing new equipment does. This means that part of the productivity effect can occur quickly too.

The simple model also treats labor costs as variable, which is a reasonable treatment for multi-year time frames. But over a period of a few weeks or months, which is the time frame discussed by Professor Krugman, much of the labor costs are slow to adjust, due primarily to the fact that it takes time to attract and sign good employees.

With businesses anticipating productivity growth over the next several years, it makes sense for them to take some immediate steps to solidify their workforce. (It's odd that Krugman missed this effect: he frequently writes about the "JOLTS" labor data, the entire point of which is that labor costs adjust slowly from the perspective of weekly or monthly data).

I agree with Professor Krugman that actions speak louder than words in matters of economics. Although they sometimes agree, often businesses say one thing and do another. This is especially true when the federal government uses its regulatory might to encourage businesses to say the "right thing," as it did when it rolled out the Affordable Care Act a few years ago.

But it is inaccurate to claim that workers must wait before seeing any benefits of the corporate tax cut.

Monday, December 18, 2017

At 21% or 20%, new corporate tax rate will boost US economy


Since the 1990s, U.S. corporations have been subject to one of the highest statutory tax rates in the world. The high rate has caused them to rearrange their affairs to avoid investing, especially in lines of business subject to the full rate, and thereby reducing productivity and workers’ wages.

But now Republicans in Congress appear to have agreed on reducing the rate by 14 points, to 21 percent, plus the applicable state rate, bringing the total into line with the statutory rates elsewhere in the industrialized world.
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President Trump had originally insisted on a federal corporate rate of no more than 20 percent, but Congress appears to have chosen 21 in order enhance the bill’s revenue outlook. It is worth assessing how much revenue was gained, and worker wages lost, by this deviation from the president’s plan.

Although I expect that the federal government will be getting less corporate tax revenue than it would without any tax reform, it is possible that the change from 20 to 21 percent by itself has little or no effect on revenue.

That one extra point may prevent the U.S. from undercutting a number of countries such as Spain, the Netherlands, Austria and Chile and thereby reduce the amount of business activity that relocates here from those nations.

So, as compared to the president’s plan, the IRS will be collecting an extra point on corporate income, but there will be less corporate income than there would have been.

The tax reform’s expensing provisions — generous deductions for new investment projects — also encourage business investment apart from the rate cut, and it has been argued that expensing provisions by themselves create a lot of the economic growth generated by the reform.

Thus, even if adding a point does little to enhance revenue, it may also do little to limit the wage gains that come with reforming corporate taxes.

It is important to remember that much business is not corporate business, but rather organized as partnerships, S-corporations, etc. Ideally these organizational decisions would be made for real business, rather than tax reasons.

It remains to be seen how the new corporate rate meshes with the reform of taxation of non-corporate businesses, because it depends on how the IRS and tax accountants interpret the new rules.

But I expect that there are some non-corporate businesses whose rates would have been a couple of points higher than a 20-percent corporate rate (plus the relevant personal income and state corporate taxation), so that adding a point to the corporate rate mitigates some of the unintended consequences on that margin.

Finally, future Congresses may be willing to further change the rates, especially to the degree that the changes are small. Recall that the last big corporate rate cut in 1986 was followed by a one-point change during the Clinton administration.

For all of these reasons, the consequences of a one-point deviation from the president’s plan are small compared to the overall economic benefits from a long-overdue reform of the corporate tax.

Monday, November 20, 2017

The ACA's Employer Penalty is Distorting Business

Taxes and regulations are known to affect the size distribution of businesses, due to the fact that smaller businesses are less subject to enforcement.  Large informal sectors are an obvious result in developing countries, but measurement challenges have hindered quantifying the size distortions’ impact on developed-country employment and productivity.  This paper uses new and unique data that is readily linked to a specific regulation: the 2010 Affordable Care Act’s (ACA) employer mandate.  The mandate’s size provision took effect in 2015 and is especially interesting, not only due to its notoriety, but because of its bright-line threshold and enforcement by monetary penalty.  This paper quantifies the size incentive of that penalty, develops a framework for combining evidence on size with evidence on voluntary compliance, and uses a new survey of businesses to quantify the number of businesses that changed from large to small as a consequence of the law.
The key size threshold in the ACA is 50 full-time equivalent employees (FTEs), which establishes the legal definition of a “large” business that is subject to the employer mandate.  Momentarily ignoring the distinction between FTEs and total employment, I display in Figure 1 a time series of the share of employment by small businesses, by a 50-total-employees criterion, among private businesses sized 25-99.  The data is sourced from the tables prepared by the Agency for Healthcare Research and Quality from the insurance/employer component of the Medical Expenditure Panel Survey. Both the 2015 and 2016 shares are well outside the range observed in the recent history 2008-14, and in the direction to be expected given that large employers were subject to a new regulation.

Garicano, Lelarge, and Van Reenen (2016) show how the distortionary effects of size-dependent regulations appear muted when the observer uses a different measure of size than regulators do.  This is the case in Figure 1, which looks at total employment as opposed to the full-time equivalents specified by the ACA and has total employment binned rather broadly (25-49 and 50-99).  Both Garicano, Lelarge, and Van Reenen (2016) and Gurio and Roys (2014) therefore obtain size measures that are especially close to regulator measures and find large size distortions in the French economy.  They do not link the distortions to specific regulations, but instead focus on France where there are many size-dependent regulations thought to be binding.  One of their estimation methods is to compare the actual firm size distribution to a Pareto distribution and measure the nonmonotonicity of the actual distribution in the neighborhood of the threshold.
The Mercatus-Mulligan data used in this paper has five measurement advantages.  First, it separately measures full- and part-time employment and therefore can produce good proxies for FTEs.  Second, the size distortion can be linked to a specific and relatively new regulation, which permits a before-after analysis as shown in Figure 1.  Third, voluntary compliance – that is, offering employer-sponsored health insurance (ESI) even when exempt from the mandate – can be measured.  This allows the measurement of size distortions to focus on businesses for which the employer mandate is binding.  Fourth, the survey was not conducted at the corporate level and therefore did not require any corporation’s approval to publish results.  Rather, individuals were confidentially surveyed, and these individuals happened to be managers at businesses.  If the sample aggregate happens to reveal politically-incorrect business practices, such a finding cannot impugn any particular business.  Fifth, the managers of the sample businesses were asked whether and how the law changed their hiring practices, with answers that can be compared to size and compliance.
Before-after comparisons between the Census Bureau business survey and the Mercatus-Mulligan survey show little change in the size distribution of businesses between 2012 and 2016, except among businesses in the total-employment range 40-74.  Among the latter businesses, the employment percentage of those with less than fifty employees has increased from 37 to 45, and this does not count the fact that a number of 49ers reduce employment below 50 full-time-equivalent employees (FTEs) without reducing their total employment below 50.  Annual time series from the MEPS-IC show an extraordinary jump in the employment percentage of those with less than fifty employees, beginning in 2015, which is the same year when the large-employer designation began its 50-FTE threshold.
            The size distortion is closely linked with whether a business offers employer-sponsored health insurance (ESI) to its employees.  Even by comparison with businesses employing fewer than 30 full-time workers, the propensity to offer ESI is low among employers with 30-49 full-time employees.  The size of this dip in the ESI propensity indicates the prevalence of 49er businesses: they do not offer ESI and thereby keep employment low enough to avoid the ACA’s large-employer designation.  The cross-section finding is my second and strongest piece of evidence that the ACA’s employer mandate is pushing a significant number of businesses below the 50-FTE threshold.
My point estimate is that the United States has 38,327 49er businesses that collectively employ 1.7 million people.  This translates to roughly 250,000 positions that are absent from 49er businesses because of the ACA, but the Mercatus-Mulligan sample by itself is not well suited for accurately assessing the average number of positions that the 38,327 49er businesses eliminated.  The sample also indicates that businesses continue to adjust their employment over time.  For example, many of them reported that, because of the ACA, they hire fewer workers or at least fewer full-time workers, but tried not to adjust the situations of their existing employees.  If the ACA and its employer mandate remains in place, perhaps the prevalence of 49er businesses will increase over time.
            By definition, the 49er businesses have less than 50 FTEs and do not offer ESI.  But it appears that a majority of them had been offering it in the prior year.  Employers with 30-49 FTEs are also disproportionately likely to report that they hire less or have shorter work schedules because of the ACA.  This is my third finding pointing toward an economically significant effect of the ACA on the size distribution of businesses.  To my knowledge, this is the first paper to find a business-size distortion that is readily visible in aggregate U.S. data.  It is also remarkable that the distortion can be linked to a specific regulation with a precisely known penalty for violations.
            Individual-based surveys of businesses are rarely used in economics, but that is bound to change as the survey industry is becoming more efficient (i.e., cheaper for the researcher).  It is worth noting the contrast between the Mercatus-Mulligan survey design and in-depth studies of a particular business (e.g., (Einav, Knoepfle, Levin, & Sundaresan, 2014; Handel & Kolstad, 2015)).  The former design has the advantage of representing a wide range of industries and geographic areas.  Moreover, this study is not sponsored by any business and therefore does not require a corporation’s approval for its release.  Corporate approval is a concern for studies of a particular business, especially when the topic involves public-relations-sensitive issues such as distorting business practices to lessen the cost of well-intended federal regulations.  Another dividend from using a professional survey research firm is that every respondent completed the survey.
            This paper does not put its estimates into an equilibrium framework. Future research needs to estimate the number of eliminated positions at 49er businesses that resulted in jobs created at businesses that compete with 49ers in product or labor markets.  To the extent that the employer mandate shifts employment from 49ers to other businesses, future research needs to assess the aggregate productivity loss from the shifts, recognizing that the ACA’s large-employer definition is just a vivid example of a more general pre-existing enforcement phenomenon.  Even without the ACA, businesses are taxed and regulated, and understand that adding to their payroll tends to increase the enforcement of those rules, albeit not discretely at 50 FTEs (Bigio & Zilberman, 2011; Bachas & Jensen, 2017).  One ingredient in such productivity calculations would be the number of positions shifted, which I found to be roughly 250,000.
From the equilibrium perspective, another interpretation of my cross-section finding – the nonmonotonic relationship between ESI and employer size around the threshold – is that businesses below the threshold did not adjust their size but merely dropped their coverage, in which case, I have mislabeled them as 49ers.  Indeed, I find that such businesses are disproportionately likely to have dropped their coverage in the past year.  However, this alternative explanation does not by itself explain why (i) so many businesses were added to the 25-49 (total employment) size category, (ii) so few were added 50-99, or (iii) coverage rates are not particularly low for businesses with less than 30 FTEs.
The implementation of the employer penalty in January 2015 coincides with a sudden slowdown in the post-recession recovery in aggregate work hours per capita, with 2016 national employment about 800,000 below the trend prior to the implementation of the employer penalty (Mulligan, 2016).  This paper’s estimates permit us to gauge the aggregate importance of the 49er phenomenon, not counting the marginal employment impact on non-ESI businesses that continue to employ 50 or more FTEs.  If 250,000 positions were the aggregate employment effect of 49ers (see the equilibrium caveat above), that would be about one third of the recovery slowdown.  Perhaps more important would be the social value of those positions, given that employment and income are substantially taxed by payroll, income, and sales taxes even without the ACA thereby creating a wedge between the positions’ social and private values.  If that wedge were $20,000 annually, that would be $5 billion of lost annual social value, plus the usual Harberger triangle, which is 38,327 businesses in the quantity dimension and up to $68,987 annually in the price dimension (about $1 billion annually).

Monday, November 13, 2017

Low effective rate not an argument against corporate tax cut


President Trump says that U.S. corporations face the highest tax rates in the world, whereas opponents of his tax reform say that “actual” corporate tax rates are in line with other countries. What gives?

The president is referring to the rate that applies to taxable corporate income, known as the “statutory rate.” The federal statutory rate is 35 percent, and the combined federal-state corporate rate is typically about 39 percent. This rate is greater than anywhere in the industrialized world.

But the statutory rate does not apply to all of the income-generating activities of corporations, because some of those activities create deductions that can be subtracted from business income for corporate-tax purposes.

Debt-financed activities are a good example, because the income they generate goes corporate-tax free to the extent that it can be distributed to investors as interest income.
Intellectual property investments are another example, because they are not obviously attached to a physical location, thereby helping accountants assign their returns to Ireland and other low-tax jurisdictions.

As a result, corporations are paying less than 39 percent of their income to state and local treasuries. The Government Accountability Office estimates 17 percent, which it calls the “effective rate.”
It might seem that the 22-percentage-point difference results in a free lunch for corporations at the government’s expense. But the opponents of corporate tax reform are mistaken to ignore the fact that the corporate tax has corporations paying a lot more than the checks they write to government treasuries.

The Internal Revenue Service (under the Obama administration) estimated that corporations and partnerships pay over $100 billion annually in complying with business-tax laws, including their costs of recording, keeping and hiring paid tax professionals. Compliance costs are not checks written to the government, but are real costs nonetheless.

In fact, the high compliance costs are a symptom of the low effective rate because business-tax deductions are a complicated enterprise. Corporations are paying for some of their 22-point savings in terms of the extra compliance costs that come with complicated tax strategies.

More important, our economy is less productive because taxes have induced investors to pursue tax-favored activities beyond what value creation would dictate. The most vivid example is the housing sector, where returns have been depressed by a factor of two or three because those returns are essentially tax free.

In other words, by having so many deductions, the corporate tax involves a substantial hidden tax on businesses beyond what they pay the government, with the extra payment in terms of lost income.

The chart below illustrates by splitting the economy into two kinds of activities: those that pay full tax and those that are tax favored.

If nobody adjusted their investment plans, the tax-favored activities would be a great deal — they would earn the amount up to the dashed line and owe no tax. But there is no free lunch. The tax favors induce investors to engage more in those activities.

Their movement depresses the income accruing there — otherwise nobody would be willing to do the activities subject to full tax. The chart illustrates this by showing how the income ultimately earned has been depressed enough so that the net-of-tax earnings is the same for both types of activities.

The low effective corporate tax rate is therefore not an argument against President Trump’s call for tax reform. That low rate is further evidence of the economic damage done by the tax, as businesses pay to comply and pay by accepting comparatively low-return investments.

Because the effective rate only counts costs in the form of payments to government, a low effective rate is telling us that cutting the corporate tax will benefit economic performance far more than it will cost government treasuries.

Sunday, November 5, 2017

Does Communism have a universal constant? From the October Revolution to Bernie Sanders

To acknowledge the 100th anniversary of the Russian revolution, I have assembled data -- from Holmes (2009), Pipes (2001), Fontova (2013), and others -- on Communist regimes that lasted more than 5 years.
[Communists] openly declare that their ends can be attained only by the forcible overthrow of all existing social conditions. Let the ruling classes tremble at a Communistic revolution. The proletarians have nothing to lose but their chains. They have a world to win. Working men of all countries, unite!

(1) The chart below counts Communist state killings -- war deaths not included -- of its own people by purge, massacre, concentration camp, forced migration, famine, or escape attempt.

The counts are expressed as a percentage of population. 6% is a typical result.

You might say, "94% of people survive Communist regimes." But that's a lot less than the percentage of people who survived history's major tragedies. The U.S. Civil War was especially deadly, but "only" killed 2% of the population and, unlike the 6% above, this counts war deaths (civilian deaths were more like 0.2%). AIDS/HIV killed "only" 2% of Africa's population.

(2) Facts about Communist results are not part of the standard training in economics. Indeed, as recently as 1989, they were denied by some of our best and brightest. E.g., Samuelson and Nordhaus' best-selling textbook asserted "the Soviet economy is proof that, contrary to what many skeptics had earlier believed, a socialist command economy can function and even thrive."

(3) Another example: this year's New York Times commemorated the Russian revolution with fantastic claims such as "Women had better sex under socialism." That article shows a photo of a smiling woman on "a collective farm near Moscow" without mentioning how the Communist system left women and men so malnourished that their bodies no longer functioned normally. Take a look at the birth rate in Ukraine under Stalin:
Click here for a similar picture for China under Mao.

(4) The above are examples of the intellectual class indulging their fantasies about the effects of apparently well-intentioned public policies. But the more general phenomenon was that results were suppressed, both outside and inside the Communist countries, because they were unpleasing to those in power.

(5) Disastrous results can more easily become public when there is competition both in the media and in the public sector. Obviously the Communist regimes operate in a one-party system. But even in our political system, the competition is far from perfect, and both media and state officials sometimes work together to attract attention away from negative results.

It is not so easy to have a government that tightly controls economic resources, but is unable and unwilling to exercise control over ideas. 

Perhaps even Senator Bernie Sanders, who has admired more than one Communist regime and insists that government should freely provide everything from health care to college to housing, might now notice as much: his presidential campaign was one of the most recent victims of the Party Line and political collusion.