Further new results on the marginal rate of income taxation

I study optimal income taxation when human capital investment is imperfectly observable by employers. In my model, Bayesian employer inference about worker productivity drives a wedge between the private and social returns to human capital investment by compressing the wage distribution. The resulting positive externality from worker investment implies lower optimal marginal tax rates, all else being equal. To quantify the significance of this externality for optimal taxation, I calibrate the model to match empirical moments from the United States, including new evidence on how the speed of employer learning about new labor market entrants varies over the worker productivity distribution. Taking into account the spillover from human capital investment introduced by employer inference reduces optimal marginal tax rates by 13 percentage points at around 100,000 dollars of income, with little change in the tails of the income distribution. The welfare gain from this adjustment is equivalent to raising every worker’s consumption by one percent.

That is from the Harvard job market paper of Ashley C. Craig, via Steven Hamilton.

Comments

This is getting embarrassing Tyler.

Check your biases :-)

Thank you for your substantive argument.

Cut him some slack - he probably did not know that the appropriate term here is 'mood affiliation.' And he is far from the only one noticing this current passion of Prof. Cowen's, and commenting on it.

It is obvious that Tyler is opposed to a very high income tax rate and is pointing to some research that supports his stance. Since this is a personal blog, not a news source claiming impartiality, there is nothing wrong with that.

If he is referring to junk or ignoring flaws in the work because of his bias, that would be a problem--but to show that, one would have to make an actual argument about what is wrong with the study.

It is kind of an oscillation to go from theoretical limits on taxation (in a recent post) to a specific (dare we say cherry picked) behavioral anomaly.

As you may recall, in the theoretical thread I advised incremental movements in practice, because while I believe these BE factors are real, they are too muddy to predict.

We should be much room are open to politicians you say "well, that didn't work" and try something else.

If the Wright brothers had been politicians they would have been voted out of office after their first airplane didn't fly. Of course, if the Wright brothers were politicians they might have been forced to insist their first plane did fly and keep on hammering on with the same failure.

A structural problem.

"room are?" More.

No one should pay more than 50% of their income in taxes, all taxes. If their state taxes are 9% and their property taxes effectively are 2% of their income and their sales taxes are 2% of their income than the total additional taxes they should pay should not exceed 37%. Conversely no one should be exempt from taxes and all income e should be counted. At a minimum everyone should pay 10% taxes on any income they receive.

Did George Washington come to you in a dream?

Speaking of airplanes, how is that trade war flying?

I very much agree that should empirically evaluate whether policies work. However, I'm skeptical of the practicality of doing this for tax policy.

The problem is that you can't reason much from a single change implemented nationwide. There are too many other things going on to assess the effect of the tax cut, and the impact often lags the implementation. It's similar to debates about whether the economy performs better under Democrats or Republicans. The debate ends up being meaningless, driven by prior commitments, because the evidence isn't clear enough.

For many policies, I would advocate pilot programs, ideally with randomisation, to test their impact. However, I'm not sure this is workable with tax rates. Can you select 1000 people and make them pay much higher taxes for a few years as a test? I don't think so.

We might agree, because I'm not really proposing optimization to an endpoint, but rather continual approximation.

Consider for example a slope to a line for effective tax rates versus income. That slope could be tweaked up or down just a few percent every few years, rather than what, major tax bills every 5 or 10 years?

Basically now we have a bad optimization process, one which is almost guaranteed to overshoot the optimum first in one direction and then the other.

(Not to mention a dangerous disconnect between taxation and spending.)

" Can you select 1000 people and make them pay much higher taxes for a few years as a test? I don't think so."

No, but you could certainly draw a line through a largely similar area, charge significantly higher taxes on one side and spend the taxes within the area. And leave the other side alone. Then wait and record the results.

My suspicion is that people moving into the area who would be subject to the higher taxes will tend to locate on the non-taxed line. But it would be a good test if repeated enough times.

We have that experiment. It’s called California. It has amenities, climate, culture, etc that rich people want.

High paid tech workers move in, middle class moves to Arizona. It’s an interesting equilibrium: poor and rich. But makes sense: what’s the Democrat party constituency? Poor enough to receive benefits, rich enough to not care about paying.

That's not really true. The universal rule, covering California but also Texas, is that urban density correlates to liberalism. And if anybody is moving to rural Arizona they might be self-sorting to low density conservatism.

Of course if they are moving to the core of Phoenix they might just be moving in with other Clinton voters. See the blue splotch kind of in the middle:

http://rynerohla.com/wp-content/uploads/2016/11/2016-AZ-Inverted.png

(Even in very "red states" the densest population areas will be the most liberal in those states, relatively speaking.)

I've been harshly critical of some of TC's posts on this subject, mainly the ones that are just speculation on his part. But this actually an interesting study! I find the result highly credible! It doesn't give a definitive answer, in my opinion, but it does provide a pretty good argument that whatever you think the revenue maximizing rate would be, it is lower when you take this into account.

Tyler, why should we discuss any type of investment as part of the "optimal" income tax? Shouldn't you be specific about the time-framework of your analysis to assume that income may be temporarily different from consumption? Please don't tell me that in the long run, we are all dead, just tell me why you circulate theoretical work in which a person's life-cycle is ignored. I don't have time to go back a review Modigliani's work and its application to different issues, but you are teaching and you have to use some theory of consumption. Tell me, for example, what would be the "optimal" taxation of Lebron James' consumption over his life-cycle.

Lebron James? Maybe talk to people who try to attract players when they have the choice between high tax markets like Canada and lower tax like the US.

People who are able to make this kind of money have choices. We saw over the last two decades much of the industrial production move from the US to cheaper offshore because at the end it was more profitable. Extremely high tax rates for the most successful will simply move the economic activity they would produce somewhere where they welcome economic activity.

FYI, Tyler is linking to a paper on "optimal" taxation and if you understand what you are saying you should be arguing that "optimal" taxation by any nation-state must take into account the competition among nation-states to attract high-consumption people. Yes, your point should be an important consideration in determining the optimal taxation of Lebron James and any other American over their life-cycle. Thanks for your contribution.

What do we know about the political future?

The future is women.
The future is brown and black.
The future is a more equitable society.
The future is trans.
The future is homosexual.
The future is all religions living piecably.

If we want to get there we must raise taxes on those who stole.

'The future is all religions living "piecably."'

Indeed.

The great glory of American civilisation is the blueberry pie so "piecably" is the mot juste.

“The future is known. It’s the past that keeps changing.”

Sure hope nobody was being mean to billionaires in the course of this work.

Though it is interesting to see how the National Enquirer is being mean to a billionaire - can we look forward to a post on the subject of how billionaires are treated badly being using this example of how the media targets billionaires, apparently for political purposes? https://medium.com/@jeffreypbezos/no-thank-you-mr-pecker-146e3922310f (Though you have to wonder when lawyers will grasp that writing 'CONFIDENTIAL & NOT FOR DISTRIBIUTION' in an e-mail is stupid, and a great way to ensure something will not remain confidential, nor undistributed?)

Mr Bezos is getting an intro to how the game is played in washington. And in the media for that matter.

The weapon is embarrassing info, smears, manufactured outrage, and lies.

Like Thiel did with gawker, He has decided to call their bluff. Bully for him. He can afford to play ths game. And his marriage is over already, so that leverage is gone.

He will be fine, so long as he stays out of the part of the game that gets people dead

Speaking of optimal rates, does anybody know of a good studies on what the optimal work week is for extracting the most long-run production from normal workers during long crises? My father said the federal government did a study at (IIRC) Lockheed during WWII and came up with a 52 hour workweek as being the best balance of quantity and quality for winning the war. This would be, I presume at a company like Lockheed that needs to do high quality work or pilots die, and employs a good quality workforce, but not a super elite one like McKinsey or a top law firm.

But I've never seen a similar study since WWII.

Wonder how that varies with the type of work and if reading MR counts as work.

I understood a survey of literature would give you something like a 49 hour work week for blue collar labor and actually lower for knowledge. Most of the studies are from the 50s. I can believe this applies to your typical software - even one who is exceptionally talented but has a normal human's commitment and passion for their job (ie, almost all of them). I'm not sure I would believe this kind of study can capture what is optimal for your managerial work force. And the same for jobs like consulting, law or ibanking. Responsiveness to the client substantially drives the hours involved and I'm not sure how you separate productivity from what is going on there.

But that was for winning the war.

"Taking into account the spillover from human capital investment introduced by employer inference reduces optimal marginal tax rates by 13 percentage points at around 100,000 dollars of income, with little change in the tails of the income distribution." I can't read Mandarin, but my interpretation of this sentence is that we should lower tax rates on what are middle income workers (i.e., at around $100,000 in earnings), while leaving tax rates of high and low earners (the "tails") as they are. I have made a similar point many times: that middle income workers are actually paying a higher tax rate than the highest income earners because the middle income workers are also paying the roughly 15% flat payroll tax rate on all of their earnings whereas the highest income earners only pay payroll tax on a small fraction of their earnings. Of course, this occurred partly as the result of the compression of the tax rates. Before the adoption of the tax cuts in the 1980s, there were 24 tax brackets. Today, there are only 7. There's a good reason the middle class has such difficulty saving: they are being taxed at rates higher than the wealthiest Americans. Let's lower the tax rate on the middle class and add more tax brackets.

Here is a good podcast on taxing the rich. It is from the economist.

https://open.spotify.com/episode/4zqdG0GNzcjDoKIFYrQOIn

The economic intelligence of Rutger Bregman is, as expected, unimpressive. But what I found most alarming is how he is so casual about completely destroying our current economic system. This is the common theme of the progressive wing. All we have to do is be radical and the utopia will follow.

Yeah, I tend to agree. Even if the current system really bothers you, I think it is unacceptably arrogant to think a completely different untested system would work just as well or better with enough confidence to believe that we should just switch already.

But there is a huge amount of denial about how good even the poorest people in our current society have it compared to actual realized examples in almost all of human history.

"he is so casual about completely destroying our current economic system. This is the common theme of the progressive wing. "

Look no further than the "Green New Deal".

This is an excellent candidate for sitting back and letting the Dems sort out their internecine issues over far left causes.

AOC goes to Washington, lesson one:

"The green dream or whatever they call it, nobody knows what it is, but they’re for it right?"

"The green dream or whatever they call it, nobody knows what it is, but they’re for it right?" - Nancy Pelosi

To paraphrase Nancy Pelosi: " That's nice, we'll put it right here on the refrigerator. Now go outside and play with your friends, dear."

McGovern '72!

"You have to pass it to read it." Who said AOC wasn't paying attention to anything?

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Labor markets have a flaw, it is hard to buy and sell labor in small quantities as needed. A wedge is a transaction costs that requires a labor deal to be stretched out in time. Labor wedges are all over the place.

Why do most of the commenters here seem to think this article suggests the optimal marginal rate on the very top earners should be lowered? I don't think it has much to do with that issue at all. It seems to be focused on what the optimal rate curve should be on wage incomes between zero and $300K. Perhaps D, in the very first comment should check *his* biases! :-)

As far as transitions (or tangents) go, from wages, taxation, and Bayesian adjustments to employer outlooks .. I think I have one of the better ones:

"The workers say @realDonaldTrump paid them $8/hour to operate heavy equipment. No benefits.
A licensed, legal operator would have cost him $51/hour, including benefits."

Hmm. I don't even know where to start, but it looks like the billionaire employer knew how to cut the mathematics off at the knees.

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